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Accounting, Dishonor & a Dash of Bad Manners

Table of Contents

Accounting, Dishonor & a Dash of Bad Manners. 4

Robert A. Spira and Shirley Goldstein. 4

“Money For Which No Receipt Has Been Taken Is Not To Be Included In The Accounts.”  Hammurabi (ca. 2000 B.C.) 4

John Law Screws Up. 8

The World In Which We Now Live. 10

Edna, The Guy with The Green Eye Shade Is Dealing From The Bottom of The Deck. 11

The Big Guys Went Wrong. 17

Ernst & Young. 17

Arthur Andersen, 18

KPMG Peat Marwick. 20

Price Waterhouse, Coopers. 20

I Understand It Now, But Who Pays An Accountant To Be Independent?. 23

The Banks Gone Bad. 25

BCCI, Now Watch The Little Pea And Put Your Money On The Table. 25

Credit Lyonnais, Vive La France’ 32

The Savings And Loan Crisis, One of The Most Costly Series of Frauds In American History. 36

All I Want Is A Couple Of Bucks Under The Table And You Can Have Your Jumbo Mortgage! 36

What Hath Michael Milken Wrought?. 38

The Big Eight, Err Six, I Mean Five And The Savings And Loan Industry. 39

What Do You Think I Am?  A Squealer?. 39

The Carter Years. 40

The Reagan Years. 42

Beverly Hills Savings & Loan, A Trustworthy Institution. 45

Congress Takes A Look. 47

Call Me Mr. Keating, Sonny. 50

Silverado Banking Savings & Loan, Just Plain Lost Its Luster 57

Bank Management Is Weak and Unprepared For an Unregulated Environment. 59

The Day Boston Ran Out Of Money. 60

Barings, A Singapore Sling. 62

Manhattan Investment Fund Ltd. 65

Accounting Serves Its Function. 71

Maricopa Funds. 72

Cambridge Partners. 76

In The Beginning. 82

Bankers Trust, or DisTrust As The Case May Be. 83

Penn Square Crumbles. 86

Ponzi Schemes For Better Or Worse. 93

Trust Me, I Have This Plan And We Can Really Clean Up. 93

Bennett Funding, Ponzi Would Have Been Proud. 103

Regina Really Didn’t Clean Up At All 110

Anthony De Angelis and His Magic Water Tanks. 113

Billy Sol Estes We Are Proud of You, The Boy’s In Fertilizer You Know.. 115

Finance Companies Gone Bad. 117

Towers Financial, A House Of Mirrors. 118

Mercury Finance. 119

The Brokers Took No Prisoners Either 124

If You Listened When E. F. Hutton Talked You Were In Deep Trouble. 124

J. B. Hanauer Brokerage & Money Laundering. 130

Plain Vanilla Theft 133

Robert Maxwell, Everything Has To Be In Motion Or The Game Will Stop. 133

ESM Government Securities. 134

Bre-X,  King Midas Revisited. 141

This Phoenix Kept Coming  Back Just Like The Bird. 142

California Micro Devices Corporation The Home of Vanishing Sales. 154

Crazy Eddie & The Cooked Books and Vanished Electronics. 156

The Old Republic International Corp. Does It Their Own Way. 161

Equity Funding And Counterfeiting. 162

Fraud, or Worse. 169

Cendant, A Deal Gone Super Sour 169

Livent, One of The Best Shows On Wall Street, But It Closed Early. 174

Philip Services Corporation Is Really Proactive. 177

Making Phar-Mor, Phar-Less. 179

Investing In Azerbaijan. 186

Globalization and Its Effect on Accounting. 189

Really Bad Accounting Practices. 197

McKesson & Robbins, The Case Of The Missing Auditors. 197

Southmark. 201

Emcore, Racketeering By the Numbers. 209

What’s Happening Now.. 213

Tyco, The Home Of The Doubly Big Bath. 213

Koger Properties, Inc, A Strange Bequest 215

A Saving Grace, Not! 222

Waste Management, We Specialize In Collecting Sorted Garbage. 226

These Folks May Have Just Been In Over Their Heads. 228

BarChris “De”-Construction Corporation () 228

Kaypro Corp. 237

Kurzweil Didn’t Apply Intelligence. 245

National Student Marketing Becomes Unglued. 249

Chairman Arthur Levitt, Securities and Exchange Commission, “The Numbers Game”, Remarks At The NYU Center For Law and Business, NY, September 28, 1998. 260

The Role Of Financial Reporting In Our Economy. 261

The Pressure To  “Make Your Numbers”. 262

Accounting Hocus-Pocus. 262

“Big Bath” Charges. 263

Creative Acquisition Accounting. 263

Miscellaneous “Cookie Jar Reserves”. 264

“Materiality”. 264

Revenue Recognition. 264

Action Plan. 264

Improving the Accounting Framework. 266

Improved Outside Auditing in the Financial Reporting Process. 266

Strengthening the Audit Committee Process. 267

Need for a Cultural Change. 268

Conclusion. 268

A  Charity of a Different Color 269

New Era Philanthropy Tries An Old Con. 269

America’s Future, Maybe Yes, Maybe No. 273

Management That Just May Have Been Very Confused. 289

SensorDramatic, Can’t Stop The Con. 289

American Public Automotive Group Runs Out of Gas. 294

The Not-so-Merry Go Round. 295

Rite Aid, A Prescription For Disaster 297

Politically Oriented Criminal Behavior 302

Politics, The Good, The Bad and The Symington. 302

Wedtech Corporation, The Whole House Came Apart At The Seams. 305

Chainsaw Al Dunlap Defoliates Sunbeam.. 312

Mattel & Barbie and Their Legacy. 316

Yale Express, Life In The Fast Lane. 323

Medical Fraud And More. 327

Paracelsus Poorcare. 327

Drugs Made It Turn Bad. 333

The DeLorean, Cars, Cocaine and Closed. 333

Equity Fudging. 336

The Euro,  A Strange Idea,  Countries Cheat As Well 339

The Euro, Makes A Lot Of Sense When Looked At On Paper 339

Something Tells Me That Germany didn’t Give Up On The Thought Of World Domination In 1945  342

You’re Not Watching Closely Enough,  The Pea Is Under The Shell 343

Political Screw Ups. 346

First Executive Life, Much Ado About A Lot 346

The Officers. 353

The Rating Agencies. 353

Milken. 353

The Accountants. 353

United American Bank Busts. 355

So You Want To Be In Pictures. 364

Cannon Group, Inc. 364

De Laurentiis Entertainment 376

Now A Word From PricewaterhouseCoopers. 383

Accountants Do Not Always Check Out Their Facts. 384

View From The Top. 385



Accounting, Dishonor & a Dash of Bad Manners

Robert A. Spira and Shirley Goldstein

“Money For Which No Receipt Has Been Taken Is Not To Be Included In The Accounts.”  Hammurabi (ca. 2000 B.C.)


Accounting is the language in which one business can communicate with another.  When the message is transparent, communications are conducted fluidly with both sides having the satisfaction of knowing that they are perceiving the whole picture.  When accounting is opaque or managed, business goes into suspended animation until both sides fully understand the intent of the statements.  In international business, when the two accounting systems are based on different theories, interpreters have to be hired to explain what the statements mean.


The accounting profession has evolved into an industry where transparency has given way to translucence and the once hoped for universality of accounting has slipped dramatically into the dust.  For the most part, the auditing industry is cutthroat, with the competing firms desiring the business literally at almost any cost.  This “win at any cost” philosophy brought with it moral concessions to management that destroyed a portion of the Big Eight Firms during the Savings and Loan Crisis and caused consolidations in most of those remaining.  More recently, the Big Five have acquiesced to clients’ demands at the expense of transparency.  However, the stakes have grown geometrically in the last decade.  Both the accounting firms and their clients have globalized, and interdependency among professional firms and their clients and among businesses as a whole has grown.  As a result, major economic sectors are vulnerable to the fallout of fraudulent accounting.


We are told that rudimentary accounting began six or seven thousand years ago in the Nile Valley of Egypt, The Pharaohs ran the equivalent of a very large conglomerate utilizing massive amounts of manpower.  They had to keep track of progress and outlays.  How many massive bricks of what size and in what order would they need to finish the next pyramid?  What about the logistics of feeding, housing, and clothing the tens of thousands of workers that made up the construction crews.  How much water would they need and when would it have to arrive before the men started to collapse in the desert heat?  They developed a dual system of advanced logistics and a complex, highly organized system of accounting:


“The ancient dwellers in the Nile Valley first combined to organize the artificial irrigation their fields, a bailiff was appointed in every small village along the river to look after the irrigation canals.  Each farmer had to pay him a certain quantity of grain and flax after every harvest.  When the farmer had done so, a rude picture of a grain measure was drawn on the wall of his house, together with a number of lines indicating how many measures he had paid.  This was the primitive form of receipt.”  ([1])


Accounting could not really have its day of glory until several things came together; the first and most important was the invention of money, the ultimate accounting common denominator.  In early history, man probably started out to trade with his neighbors by exchanging one item of perceived value for another of equal perceived value, such as a metal digging instrument for food.  As time went on a change took place, because the person that desired a particular item may not have had something that the maker wanted in return.  In addition, there may have been a perishable commodity involved in the transaction.  Without Internet, which although many are unaware of it, did not exist in the years before Christ, two people that had items that they wanted to trade were more likely than not, unable to find a third party to close the transaction’s loop.


Thus, I have a digging utensil that you greatly desire; you only have food, which I have in abundance.  Although unknown to both of us, Caveman Albert, just over the mountain needs the digging utensil desperately and has numerous seeds to grow highly valuable golum ([2]), which is in amazing demand around these parts.  Sadly, our society of that era does not stretch over that particular mountain, while Albert and his family are able to gorge themselves on mountains of golum, much goes to waste as does the excess digging utensils and there is much hunger in the village on the other side of the mountain.  Because golum does not store well and Albert’s cave family is without a digging utensil, the following season brings disaster to the mountains inhabitants and those below as well.


Money came into existence by necessity, and it took many forms from beads to cattle, but ultimately it happened that the easiest way of doing trade was with a currency that had an inherent value of its own, a gold or silver coin for example was perfect and it had intrinsic value, a critical element in gaining market acceptance for money.  Precious metals were replaced by paper money backed up by these same metals with the exception that instead of residing in the buyer’s pocket they resided in a common place such as a government vault, a goldsmith’s shop or in someone’s vivid imagination. 


Money came into existence by necessity, and it took many forms from beads to cattle, but ultimately it happened that the easiest way of doing trade was with a currency that had an inherent value of its own, a gold or silver coin for example was perfect and it had intrinsic value, a critical element in gaining market acceptance for money.  Many say that in the sixth century BC, Croesus, who was the king of Lydian Empire was the first to refine precious metals into coinage.  The Lydian’s were warriors and many historians of the time such as Aeschylus wrote much about all the gold stored in Sardis, the capital of the Lydian Kingdom.  This was where the original saying about a truly rich man originated, “rich as Croesus” indicated fabled wealth even in those times.


The residents of Sardis were said to have panned for gold in the rivers that flowed near the city.  This gold was mixed with silver and cooper and thus had to be refined.  “…The Lydians placed the raw material in small bowl-shaped hearths in the ground and, fanning hot coals with bellows, heated it in combination with lead to remove the trace metals.  Then the remaining material, mixed with common salt, was subjected to prolonged heating in earthenware vessels until the gold was completely separated from the silver.


As time moved on, these valuable metals were mandated to exist by government decree and resided in the particular country's central bank.  ([3]) Moreover, it was usually stated within the currency that holders could exchange their paper for the more intrinsically valuable precious metals. 


Many times throughout history, governments have attempted to mandate value for their paper money without proper backing, and as you could well have expected, those attempts have generally failed.  On the other hand, they only failed because the people had no confidence in the continuity of the government and economically most important of all, that government’s ability to collect taxes.  As anarchy started to reign as it did in post World War I Germany, the people lost all their confidence in the country’s money and in spite of everything that the government could do to stop its decline, the post World War I German currency probably lost more as a percentage of its value in a shorter period of time than any other currency in history ([4]).


Until the emergence of money, by adding row upon row of dissimilar items together, one could figure out what gross assets an entity had, but no clue existed as to what it was worth.  There was no common denominator.  In other words, if I had as assets, two fish, one cow and one mud hut and the bank wanted to know what my assets were I would write out a slip saying that I owned: two fish, one cow and one mud hut, and sign it.  Until a translation into a common denominator occurred, accounting could only go so far.  Many different denominators were used in various civilizations, but once trade extended beyond the boundaries of the country, those symbols meant little or nothing.  Let us assume that the Indians had only wanted Wampum for the Island of Manhattan.  Since wampum had no cachet in the Western World, Manhattan would still belong to the Indians.  Luckily, for us, they liked jewelry, gold, and trinkets.


Goods were probably first translated to standard coinage sometime during the Greek ascendancy, although it was not until the late fourteenth century that anything approaching double entry bookkeeping came into being.


The first paper money was really a form of negotiable receipt.  It came into being during the Middle Ages, most probably because highwaymen were robbing so many travelers that they were giving travel a bad name.  Early monetary transfer systems were rather rudimentary in that the transaction really consisted of the traveler depositing his valuable coins with a goldsmith who in turn would issue a receipt.  Because the goldsmith’s reputation was impeccable, the receipt was readily transferable among all of the people that were familiar with the goldsmith’s reputation and this became the earliest form of paper money.  The early United States tried to create paper money by government decree with the Continental Congress issuing reams of it during the revolutionary war and giving it value by mandate.  The war for independence was not going well so there were not a lot of believers around in those times and the new money laid an egg.


As inflation took hold of the fledgling American economy, the currency started to lose value.  Many of the members of the Continental Congress thought that this could easily be taken care of by edict.  And in January of 1776, “Resolved, therefore, that any person who shall hereafter be so lost to all virtue and regard for his country as to refuse said bill in payment, or obstruct or discourage the currency or circulation thereof shall be deemed, published and treated as an enemy in this country and precluded from all trade or intercourse with inhabitants of these Colonies.”  I think it was a frustrated George Washington that once said during the Revolutionary War, “it takes a wagonload of Continental Currency to buy a wagonload of feed.”  When the smoke had cleared, the paper money that the government had issued at what they said was 100 cents on the dollar had plummeted to 2 cents.  The new American Government learned the hard way that there were certain critical basic elements missing in their idea, and the two most important were non-existent, confidence in the longevity of the government and its ability to collect taxes on an ongoing basis. 


The next time the United States looked at paper money was during the Civil War.  The story of its rebirth had an interesting beginning when Lincoln sent his advisors to meet with Salmon P. Chase, the then Secretary of the Treasury to convince him that the North should be issuing paper currency.  Chase told them to advise Lincoln that paper money was illegal and could not be issued by the government because it was also unconstitutional and he would have no part of the scheme.  Lincoln replied to Chase, “If you take care of the money in the Treasury, I will take care of the Constitution. 


With the North and South beating up on each other, people still were reticent about buying into the concept but they did accept the issuance of paper currency by their local banks with which they dealt and had confidence.  This in turn led to the start of a new business, the objective evaluation of banking soundness.  Thus, several companies started rating the banks that were issuing currency and their ratings were to be based on ability of the financial institution to exchange their worthless paper money for silver or gold.  Thus, certain money issued by weaker banks could only be exchanged at a discount and in some cases, money issued by large banks were worth a premium.    


A rhyme was created in 1801 to better acquaint students with the rules of the double entry systems.


            “By Journal Laws—What I receive

            Is Debtor made to what I give;

            Stock for my Debts must Debtor be,

            And Credit my Property;

            Profit and Loss Accounts are plain.

            I debit Loss, and credit Gain.”  ([5])


Therefore, when you did your books in the old days, life was much simpler.  There were no weasel words like “materiality,” whose only purpose seems to be to hide critical financial information from innocent creditors or shareholders.  Accounting has now become something similar to neurology, in that you have to figure out all of the possible pathways a company’s books can lead through, then bring in a forensic accountant and a number of consultants in order to even begin to understand what is going on with the financial reports.


John Law Screws Up


I am reminded about the story of John Law, who grew up in the early 17th century.  John was precocious as a youngster, showing early signs of being a mathematical genius by solving exceedingly complicated analytical problems that had been enigmas to even the most clever people of his day.  He also possessed two other distinct disadvantages, he was extremely handsome and an inveterate gambler.  However, as his successes substantially exceeded his failures in all of his many pursuits, his fame spread far and wide, and eventually he caught the eye of Louis XIV of France.  Louis, as opposed to Law, was having a bad time of it.  He really wanted all the better things in life, but not having enough money in his own treasury, thought to siphon some from his neighbor’s kingdom.  Alas, this was an colossal mistake, it seems that he had not chosen his adversaries propitiously and he barely escaped with his life, and do to his blunder, went much further into debt.  King Louis XIV did not earn the nickname molasses brains without good reason.


Louis was bummed out and when Law, always on top of his game, came up with a startling pronouncement, “We’ll start a Royal Bank, and I’ll run it.”  Louis retorted looked at Law as though the man had lost his wits, “What good will that do, nobody in the kingdom has a franc, I have glommed on to everything that the people didn’t tack down.  How can they possibly have anything left to deposit in your silly bank”? 


Law was not unprepared, “Lou, you know all those stories about the New World, all that gold and stuff like that”?  Louis indicated he was indeed familiar with those stories but further indicated that he had heard that opposed to precious metals, his intelligence had indicated that unfriendly savages and pestilence primarily inhabited the land.  “Look at all those strange diseases the Spanish soldiers brought home,” he countered.  Law was non-plused and continued, “We start a company and sell stock in it to the peasants.  You know yourself that if we hire a top-notch public relations firm and give the deal the right amount of hype, we can make the commoners believe anything.  We play down the bit about diseases and savages and tell them that the streets are made of gold in the New World and those chumps will fall for it and they will take what is left their money out of hiding.  We take all of the money that comes from them, put it in the treasury and pay off all of your debt, and Louis, there may be even a little left for some of those bizarre little trinkets you really like, you know, the really weird stuff.”  Louis thought for a moment and concluded, “John, I think that is a capital idea, we have nothing to lose and if it works, I will be indebted to you really big time.”


Well the idea worked.  The money came in from unexpected places by the gobs and the government’s debts were paid, and there was even enough left for Louis purchase a few of his bizarre little trinkets and to throw a party or two for his friends in the court.  But wait!


The peasants, having lost all of their money, now could not pay taxes.  They were thrown out of work, and the country went into a depression far worse than when John Law had originally been given his assignment.  Louis became disenchanted with his erstwhile friend, and the people harbored extremely grave ill feelings against the man.  John Law, a brilliant conceptualist who just hadn’t thought his plan through to its inevitable conclusion,; was run out of town and died a pauper.  The plan he devised became know as the “Mississippi Scheme”, which along with England’s “South Sea Bubble”, almost drove Europe back into the dark ages.  Economic planning and a good accounting background would have told both the King and Law that their proposal was a lose-lose situation, but they didn’t have Big Five Accounting firms to rely on and plot their course then, did they?  As we continue on you will see how the many new accounting innovations could have been taken advantage of and more importantly, if you ever have a kingdom of your own, you will be in an extremely advantageous position to take advantage of these tricks of the trade, so to speak.


The World In Which We Now Live


However, today, choices among the numerous potential accounting pathways are dictated by the nuances of international tax regulations, transfer pricing; derivative oriented profit and loss along with complex currency computations.  On the other hand, that and a subway token will only get you a ride in underground New York.  You still will have to understand the nuances of tax-oriented transactions, inventory restatements, auditor changes and a world of highly complex accounting trails that amazingly are not there for information purposes but to hide the real facts and thoroughly confuse investors.  And after you have diligently studied the financial statements, it is highly likely that you will have come up with the wrong answer because accountants today, take some much leeway with the facts and are so good at inventing new characteristics, which are totally opaque and they are no longer interested in making the books comprehensible in any form whatsoever.


Life was never intended by our ancestors to be so complex and the role of the outside accountant has shifted dramatically to that of a corporate advocate, not an honest third party entrusted with protecting the public interest.  The interests of businesses that are too big or too powerful to be governed by the regulators are driving the evolution and resultantly, the demise of accounting as a useful tool.  Despite endless tough talk by the regulators, little has been done to make derivatives more transparent.  Because of peculiar nuances with the accounting term “materiality,” massive potential ([6]) losses can be hidden over a period of years and shareholders can be totally deceived.


More businesses practice tax evasion today than at any time in American history and that undertaking has become so pervasive that the U. S. Government has used every weapon at their disposal to slow it down, with little or no result.  Today’s public company’s bottom would cause Hammurabi to turn over in his grave.  Adding to the problem is the fact that the number of students studying for a degree in accounting in American Universities has dropped almost a staggering fifty-percent in the last several years.  Although, we are aware that other industries offer a lot more excitement and possibly substantially more remuneration as well, we are just forced to speculate whether the younger generation with their environmentally uncontaminated attitude have not determined that the accounting profession presents a contaminated cesspool that is so totally polluted from conflicts of interest and gimmickry that almost anything may represent a better alternative.  


Hammurabi in his infinite wisdom had a fantastic solution for excessive creative accounting; if the books did not reflect accurately the person or company’s affairs, the instigator was summarily put to death.  This, theory has followed us through history; in recent history, the penalty for attempting to defraud by keeping incorrect books has been a substantial amount jail time, unless of course your inventive accounting was used to fool the King when tax time rolled around.  In that case, the King had several options available; accountants who fudged were either boiled in oil under a slow flame or stretched on a horrible contraption until they no longer fit into their clothes.  The later is somewhat of a misnomer in that at that point whether the accountant could wear his clothes or not was no longer relevant; he would not be needing them.  Thus, accounting quickly became cleansed of those with visions beyond the books that they were auditing and the profession developed a reputation for a degree of piousness.


Maybe we should go back to simpler times and look at the books in the same way the kings did.  Life probably would become much easier and it certainly tends to keep the game more honest.  As you read the following, I will leave it to your decision whether you think that accountants, who fudge the numbers, should be placed on a rack in the center of town where each citizen could take one turn at the wheel.  


Theodore Hook made up the following little rhyme when talking about paying the correct amount of taxes:


            ‘Here comes Mr. Winter, collector of taxes.

            I advise you to pay him whatever he axes:

            Excuses won’t do; he stands no sort of flummery.

            Though Winter his name is, his presence is summary.”



Edna, The Guy with The Green Eye Shade Is Dealing From The Bottom of The Deck


We know of no service industry that has had the kind of attrition that the accounting industry has recently succumbed too.  It does not seem to matter whether times of good or bad, these firms are equally able to fail under varying economic conditions.  You only have to look at the number of letters in the names of each of the Big Five to see where they have been and what they have gone through.  The amount of money that their litigation has cost the insurance industry is legendary.  And yet, knowing that the accountants will regularly get caught trying this maneuver or that tactic in order to separate the public from its hard earned dollars does not seem to matter.  While settlements for class actions, claims against the accounting industry have literally rocketed out of sight, so to have the premiums that the insurance companies charge to insure their longevity.  Obviously, the ultimate provider of the funds to pay for the insurance are the accounting clients and it almost seems that they are starting to charge on a risk reward basis and not by they hour.


Accounting firms engage in heated negotiations when major firms are in the market to replace auditors.  Often they will indulge in substantial “opinion shopping ([7])”, and discuss in advance with potential clients how aggressive these accounting firms will be when reporting earnings, hiding loses, carrying over profits and managing earnings, should they get the account.  The sad part of this bizarre mating process is that opinion shopping or in the alternative, the threat of it, more often than not causes the once sacrosanct “corporate books” to sink to their lowest procurable common denominator, sending the industry standards into moral freefall.  The following legal cases are not meant to be indicative of the total number of times that major auditing firms have either fudged earnings or looked the other way when management has become overly creative in their sales or earnings reports.  It restricts itself to only those situations in which plaintiffs felt that their interests were compromised and that the accountant’s work was so egregious to be worth noting in a court of law.


The accountants always had  their best faces on when it came to facing the news people relative to their countless screw-ups and historically have mouthed such homilies such as “we have our defenses to the charges and will be vindicated by a court of law,” or better yet: “we have not seen the charges so we are in no position to comment at this time,” “The firm stands by its work which we believe follows GAAP principals to the letter.”  Usually after this initial round of weasel talk is over and the case goes against the accounting firm, their management comes up with a new series of responses when found guilty of breaking the public trust: “our attorneys advise us that we have substantial defenses to the charges and that we should be vindicated on appeal” or when caught “red handed”, “this has been a case where one bad accountant has spoiled it for an entire firm whose reputation to this point has been impeccable” and when all else has failed, “the firm and its managing partners will suffer no substantial monetary damage due to the massive award against us as our insurance carrier is responsible for the entire amount, naturally less the deductible”. We can count the number of outright victories by the major accounting firms on the fingers of one hand, at least in the examples that we cite. 


In addition, if anything, the situation has gotten far worse as it appears that the U.S. Treasury is close to losing control entirely over both consistency and transparency in tax reporting.  Significant American corporations and their accountants now visualize tax avoidance as an integral part of doing business in today’s globalized economy.  Among other wondrous creations has become the formation of endless offshore insurance captives where money can be stashed for rainy days or can earn substantial additional dollars tax-free while providing insurance or reinsurance is ubiquitous.  The countries in which these captives are based usually have accounting regulations that were created with the maximum tax latitude as a criteria.  After all, the industry of tax avoidance may be that countries largest source of hard-dollars.


In a global economy, transfer pricing ([8]) is a critical strategy in insuring that taxes are paid to the most favorable domicile.  Although transfer pricing is more of a daisy chain then offshore insurance captives, they are both equally effective in keeping money off of the tax rolls.  Simply put, as the product moves through its various stages from gathering the raw materials to creating the end product, there are places where labor is cheap and places where taxes are low.  Sometimes you can even find places where labor is cheap and taxes are low in the same country.  These countries are usually called dictatorships and substantial rewards are usually bestowed on those in power in order to receive these munificent benefits.  If a company is looking to save money on its tax bill, it will create its greatest profit where taxes are the smallest or perhaps non-existent, for the right price.


Monolithic international mega-mergers have become as normal as brushing your teeth in the morning, yet the European Community (EU), also sets up critical barriers that must be addressed when analyzing corporate strategy.  How incredible it was to see the EU’s Monopoly Commission threaten to literally kill the proposed merger between two American Companies, Boeing, and McDonald Douglas.  At first glance, it was the consensus that Boeing would tell the EU to stick it, but when faced with their planes not being allowed to land at European airports, carry European travelers or be purchased by EU countries the mood suddenly changed.  Boeing blinked, and made serious concessions to the EU in order to get their blessing. 


This is not exactly the point thought, the EU, however, had their own agenda, a competing plane built by Airbus and instead of the free trade envisioned by the World Trade Organization, (WTO), it would almost appear that among those that argued the strongest for bringing down the barriers, protectionism has come back to haunt us with a vengeance.  All that has happened is the that large global villages have been created by organizations such the European Community, The Nafta Signatories, the ASEAN countries and the emerging Latin American Block.


Moreover, that is not to mention the fact that the “International Oil Cartel” which crosses all boundaries in their effort to act in restraint of trade and impoverish their benefactors.  Why doesn’t the all-powerful EU attempt to place a food embargo on these countries in those arid regions where oil seems to come from deserts in enormous quantities and is regularly withheld by what is literally a criminal cartel of thugs.  But, in their wisdom, the EU would rather chose to fight a far lessor battle then address the real needs of their constituents.  We have indeed entered a strange new world where the inhabitants are like characters out of Alice in Wonderland.  Morals have become a function of politics and economic battles are fought in the press, and not be governments.  The battlefield is chosen relative to the chance of success, not the worthiness of the cause.  


Another anomaly of our “New Age Accounting Based Economy” is the fact that in the last two years, a period in which the stock market climbed to unprecedented heights, unbelievably, corporate tax payments declined.  However, during this same period, these same corporations publicly reported that their earnings dramatically increased.  Talk about “Alice in Wonderland”.  One has only to look at the outlandish accounting statements emanating from companies such as AOL, Cendant, Livent, and Waste Management and their high priced magical making accountants to wonder whether the world really hasn’t turn upside down and the Mad Hatter isn’t running things.  Motorola, Compaq Computer, and WorldCom have all taken eye catching, one-time charges of astronomical proportions.  Hammurabi and the king would have stretched new suits for all of these folks.


Outright fraud, over-aggressive accounting, and misleading numbers have taken away the time honored practice of requiring that corporate statements reflect how well the company has performed during a particular accounting period, when comparing that period with another one.  No longer is this achievable because the accounting processes used to determine earnings and even sales may be totally inconsistent from period to period ([9]).  More exasperating is the effect of companies changing accountants midstream when the current auditor will rightfully not allow a deduction or balance sheet item that another equal prestigious accountant thinks is acceptable.  Obviously, when this occurs there is also a change in methodology and yet when looking at the footnotes, you cannot tell where one accounting firm has begun and another had ended.  This is truly amazing and obviously has the tendency of making the accounting profession one of not only selling its sole to the highest bidder but dropping off a precipice and falling until it has reached the lowest possible common denominator.  ([10])


Front-loading expenses and taking the “big bath” all at once are tricks that permit corporate earnings management; something that has concerned the Securities and Exchange Commission no end.  The SEC’s chief accountant, Lynn Turner, in a meeting with officials of Big Five Accounting firms among others, states; “If the basic accounting foundation ever loses credibility with investors, then the whole process would fall apart.”  Arthur Levitt Jr., in a speech delivered on September 28, 1998 sounded like he was talking a foreign language when he addressed these issues, which included, “Big Bath Charges,” “Creative Acquisition Accounting,” “Cookie Jar Reserves,” Materiality and “Revenue Recognition”.


It is critically apparent that the accounting profession discovered little or nothing from their near-criminal and criminal behavior in auditing the Savings and Loan industry.  Recently, Big Five Accounting Firms have routinely started recommended extremely aggressive tax shelter positions for their clients.  Creative new tax shelters are cropping up all over the place and have had such a huge impact on tax collections that the IRS has signaled its intention to scrutinize these ploys very closely.  Henceforth, the IRS states, it will not only refuse to allow any deductions without a reasonable business purpose, but, in a deadly one-two punch, it will also require disclosure of the names of all tax shelter clients of the accounting firm.  Not satisfied that these two solid ideas have done the job, the Administration has stated that they will put more IRS agents into the field to ferret out corporate cheating.  Between managed earnings and sheltered income; transparency, as defined by GAAP, the SEC, The World Bank, The U.S. Treasury, the IMF, the United Nations, and the Bank for International Settlements and a host of other do gooders, has become a mirage.  ([11]) Transparency can now be defined as a process that can only be foisted on underdeveloped countries and small public companies with limited resources.  It is readily apparent that we are arriving at the never-never land of tax anarchy for the big and powerful.  Thus, the meek and sickly will be forced to take on more of the burden in the years ahead if there isn’t a rude awakening. 


When the time comes, and it has, that earnings can go through the roof while tax collections decline, financial reporting has obviously reached a new level of sophistication.  Corporations have become mobile beyond comprehension.  Chief Executive Officers (CEOs) are now able to maintain control over their divisions from almost any point on the planet.  Of the 200 largest economies in the world, at least 100 are corporations.  Because of the universalism of the Internet and globalization of manufacturing, the catch phrases “Made in the USA” ([12]) or “An American Corporation” have literally lost all of their meaning.  Today you need a scorecard just to figure out where a company is really domiciled and even when you have pinpointed what you think may be correct, you will find that their portability is infinite.  Their offices are in the corporate jet in which the CEO travels.  Moreover, what does made in American mean anyway?  Manufacturers have been avoiding a foreign label by having the buttons put on shirts made in Hong Kong in the American possession of Guam since the end of World War II.  What you see has never been further from what you get in history.  When the American Government determined that the term “Made in America” had become a total myth, the unions banded together and forced the Federal Trade Commission to reconsider its proposed changes.  Once again, Alice and her friends prevailed over reality, and local interest groups have snatched truth out of regulation.  Thus, we continue to live a sham.  


Clients, especially dot.com companies, tell their accountants that aggressive tax accounting is critical to their global survival.  Yet, the rules with regard to transparency and fraud have tightened.  Moreover, the stock market has always been a wonderful equalizer, you can only blow smoke for so long but ultimately you will have to deliver.  If that delivery day does not arrive within a reasonable interval, the stock market and then the public will severely punish both you and your accounting firm.  Once again, the accounting industry is being set up for a fall but this fall will be even worse than the last.


Unprecedented numbers of reasonably capitalized companies will fail because of an number of factors: mis-guessing technological changes, not having the funds to keep up with competition, inexperienced management who were idea rich and delivery poor along with sudden unforeseen shifts in technology.  Companies such as Amazon and Priceline who have promised much and delivered little will eventually cause their accounting firms severe financial indigestion when disgusted investors look for scapegoat.  The simple consequence of being wrong in any of these areas has always been extremely severe.  Jail time, corporate bankruptcy and lawsuits against accounting firms are a few of the tools available to an angry public and the class-action attorneys that are always circling the playing field like a vulture looking for carrion.  The stock market is an economic “grim reaper” ultimately separating the wheat from the chaff; as high-tech anomalies that demanded unusual accounting treatment fall by the wayside, so will the accountants.  Instead of the Big Five, we may soon be looking at the Big Zero and the day of the honest outside accountant dedicated to protecting the “public interest” will go the way of the Dodo Bird and the Wholly Mammoth. 


Accountants are now looking for new ways to increase revenues:  they have sought changes in the anti-rebate regulations of the American Bar Association and have acquired law firms, investment bankers, consulting firms in almost every industry.  By dealing through their “independent” consulting arms, they have even learned to take stock in promising companies.  By having their consulting arms in separate corporations, the accounting firms feel they have avoided some degree of legal risk, but in our world of expo facto justice, this will hardly win the day.  The Mad Hatter and the Queen of Hearts set Alice straight, but who will send the accountants the message, “you will be the fall guys, one more time.”  Or perhaps there is method in this insanity, ensconced management is only in it to take the money and run, live the good life and not worry about their junior partners who will take the brunt of today’s excesses.


The “Big Five” accounting firms have not acquitted themselves with flying colors when it comes to protecting the public interest.  Both the public and private sector have prosecuted them all for incompetence, fraud, and theft.  To give you some idea of how well the major accounting firms have protected the public trust and avoided conflicts of interest, we have listed below, a short synopsis of a selected list of fairly recent litigation.  The list shows the names of the accounting firms, who they were auditing and what went wrong.  Moreover, most of these cases ended up in court or with people going to jail.  We have tried to synopsize these shortcomings in the auditor’s work.  We have concentrated for the most part on public companies and Big Five auditing firms.  The material that we have listed below comes from numerous other sources.


With their track record, the accounting firms should be more prescient.  In simpler times, when accounting was tamer than it is now, these scandals occurred:


The Big Guys Went Wrong



Laventhal and Horwath,

          Went out of business rather than fight over $2 billion in litigation regarding their work product.  Primarily caused by the Savings and Loan problem.


Ernst & Young.
  • Filed misleading audits of Republic Bank of Dallas, Texas.  SEC filed charges in a complaint.
  • Settled with litigants for $335 million, one of the largest cases in accounting history; Cendant Corporation and the fat lady hasn’t stopped singing yet.

         BCCI, Accountants were sued by investors and regulators for $1.6 billion for there actions in covering up the bank’s fraudulent activities.

  • Part of Lincoln Savings and Loan.  (Arthur Young).
  • In one of the great votes of confidence of all time, The General Accounting Office of the United States Government stated that Arthur Young’s audits of the Savings and Loan Industry, “did not meet professional standards.”
  • In November 1992, Ernst and Young agreed to pay $400 million in settlement of misleading regulators regarding the financial health of miscellaneous thrifts.
  • Resolution Trust Company as Conservator for Imperial Savings sued Ernst and Whinney for $26 million.
  • Ernst & Whinney was sued by the Federal Deposit Insurance Company concerning their audit of City and County Bank of Anderson Tennessee for $255 million.  CIV-3-87-364
  • Ernst & Whinney was sued by the Federal Deposit Insurance Company regarding their audit of City & County Bank of Knox County.  CIV-3-87-364 for $255 million.  (See above)
  • Ernst & Whinney was sued by the Federal Deposit Insurance Company for their audit of First Peoples Bank of Washington County Tennessee.CIV-3-87-364 fir $255 million.  (See above.)
  • Ernst & Whinney was sued by Federal Deposit Insurance Company for $255 million because of their audit of United American Bank of Knoxville, Tennessee.  CIV-3-87-364 (see above)
  • The Federal Deposit Insurance Company sued Ernst & Young for $560 million concerning their audit of Western Savings Association.
  • Merry-Go-Round, Ernst & Young provided consulting services for the company and was charged by the Trustee in Bankruptcy of incompetence, fraud, and misrepresentation.  Ernst & Young settled the matter for a stunning $185 million after being sued for an even more stunning $4 billion.  This case had more conflicts of interest imbedded in it that probably any other accounting matter in history.
  • The General Accounting Office of the United States Government stated that Ernst & Whinny’s audits in the Savings and Loan Industry, “did not meet professional standards.”
  • Stockholder derivative actions were filled against Ernest & Whinney for tens of millions of dollars for failure to use even a modicum of due diligence in the amazing case of ZZZZ Best.  This is an instance of a prepubescent child taking on one of the top accounting firms in the world and making  them like utter fools.


Arthur Andersen,
  • Settled with investors regarding their accounting in the demise of Lincoln Savings & Loan for $30 million.
  • Settled with Federal Government for their errant accounting in the case of Lincoln Savings & Loan, approximately $25 million.
  • In July 1993, Arthur Andersen agreed to pay $79 million in the case of Lincoln and five other thrift oriented lawsuits.
  • DeLorean Motors, Arthur Andersen paid big bucks to settle with Trustee for inept accounting in motor deal gone bad in which drugs paid a critical role.  Arthur Andersen was so awed by DeLorean that they couldn’t see either the conflicts of interest that he had created or the fact that their numbers we inaccurate.
  • Sunbeam, Company was guilty of fudging literally all of their numbers under the guidance of turnaround expert, Chainsaw Al Duggan.  Duggan got rich while thousands of loyal employees got fired.  Andersen did his bidding and when the smoke had cleared, they were totally taken in by Duggan homilies.
  • Waste Management, One of the biggest restatements of earnings in financial history because literally everything the company reported was fudged.  Once again, Andersen ultimately  paid a dear price.
  • HBOC, McKesson, Bought HBOC on strength of the their growth which was none existent.  Almost everything about this company was a fraud and the accountants missed it.  The shareholder’s derivative actions are immense and there is little way for Andersen to escape major claims
  • E. F. Hutton, Arthur Andersen made no bones about the fact that they were aware of a massive check kitting and money laundering operation going on at Hutton.  They even warned the firm, but did not qualify their statements, report the mater to the authorities or resign.  If ever there was a case of an accident just waiting to happen, this was it.


Deloitte & Touche,

  • Charged with fraud and negligence in audit of Executive Life Insurance Company.
  • Part of Lincoln Savings and Loan action.  (Touche Ross)
  • Federal Deposit Insurance Company (FDIC) sued Deloitte & Touch for $400 million regarding their audit of First South, FA.
  • Resolution Trust Company sued Deloitte Haskins & Sells for their conduct in auditing Royal Palm Federal Savings & Loan for an undetermined amount.
  • Sued by Federal Savings & Loan Insurance Corporation (FSLIC) for $300 million over their audit of Beverly Hill Savings and Loan.
  • Sued by Resolution Trust as Conservator for Aspen Saving Bank regarding the audit of Commonwealth Federal Saving and Loan for $50 million.
  • Deloitte Haskins & Sells was sued by Resolution Trust Company regarding their audit of Peoples Federal of Oklahoma for $467,000
  • General Accounting Office of the U.S. Government made an example of them when they stated that their audits of Savings and Loans “did not meet professional standards.”
  • Livent shareholders have united to file a class action lawsuit against the company's auditors, Deloitte & Touche in Canada, and co-founders Garth Drabinsky and Myron Gottlieb.  Suits have been filed against Deloitte for tens of millions of dollars.  The auditors in this one seemed to have missed the fact that there were truly two sets of books.
  • Philip Services, a situation in which the SEC has accused Deloitte of almost filing no audit at all.  To see how bad accounting can get, this deserves a look.
  • Deloitte & Touche settled along with Coopers for over $50 million to the administrator of Barings, for failure to weed out financial irregularities in the books of that company.
  • Cendant, This Company was one of the great accounting frauds of all time and the auditor’s, Deloitte Touche were ordered to repay over $300 million, a record to that point.  Almost from the day of inception, there was not a lot that was real about this company.
  • Koger Properties, A jury found that Deloitte Touche aided in cooking the books of this company.  They found against the company to the tune of $81 million.  This was appealed twice and Deloitte won the third round in a question of causation.  Plaintiffs are taking the matter to a higher court.  The SEC sanctioned Deloitte’s auditor on the account because he was a shareholder of Koger and thus not truly independent.  We have seen numerous instances of accountants holding stocks in companies that they are auditing and are totally mystified by the process.  In one case, the Chairman of the Board of the accounting firm was a stockholder.
KPMG Peat Marwick
  • Resolution Trust Corporation sued for $100 million regarding misleading audits of Hill Financial Savings Association.
  • Sued by Resolution Trust as Conservator for audit  of Duvall Federal Savings and Loan for $16.6 million.
  • BarChris Construction Company, a senior auditor, not a CPA, 30 years old and in charge of his first audit was asked to do the accounting of a company that built bowling alleys.  He failed miserably in uncovering a fraud and Peat Marwick was found with others to be guilty of negligence in the classical case of its kind.
  • Crazy Eddie, Probably the classic fraud of the 1980s where the accountants, Peat Marwick made every mistake that was possible.  Settlements with shareholders were substantial and Crazy Eddie is still in jail.  Inventory was going out the backdoor faster than the accountants could keep track of it.
  • Wedtech, This Company rounds out the list of classical companies that Peat Marwick represented.  They probably shot the new business partner after this one.  This case undoubtedly set the all time record for politicians associated with a company going to jail.  Once again, shareholders sued and collected substantial monies from the accountants for their auditing miscues.
  • Yale Express, While you can make a fairly good case that what Peat Marwick lacked in quantity it made up in quality.  The BarChris, Crazy Eddie, Wedtech, and Yale Express cases are absolute classics in how not to do accounting.  In Yale Express, Peat Marwick although warned several times would not force the company to make necessary adjustments in the financial statements to make them truly reflect the business conditions as existed.  Because Peat Marwick never followed up, it was sued for its non-actions and ultimately settled for an undisclosed sum of money. 


Price Waterhouse, Coopers
  • English lawsuit in the amount of $3.5 billion regarding their audit of BCCI.
  • Coopers and Lybrand charged by Phar-Mor for compensatory and punitive damages: Phar-Mor demanded that the accounting firm be held liable for civil actions filed against the chain.
  • Coopers and Lybrand was fined over $1 million and assessed costs of over twice that much for accounting errors in the Robert Maxwell fiasco, in which hundreds of millions of dollars were lost.  Worst of all, Maxwell was using the employee’s profit sharing and retirement funds as his private piggy bank. 
  • Coopers and Lybrand was accused of conspiring to overstate MiniScribe’s financial health to the bondholders.  (Settled with bond holders for $40 million)
  • Conspired to overstate MiniScribe’s financial health to the stockholders.  (Settled, amount unknown.)
  • ZZZZ Best, Took over the accounting of this sham company without kicking the tires causing massive stock market losses for investors.  Involved in class action.  A classic instance where one accounting firm has had enough and another blithely marches in without asking the right questions.
  • Silverado, Coopers agreed to pay the Federal Deposit Insurance Corp. $20 million over three years.  Things probably would have been a lot worse if wasn’t for the fact that one of George Bush’s sons was a director.  It may be that Coopers got off easy.
  • Guarantee Security Life Insurance Co., of Jacksonville, Florida, Coopers was charged with breach of fiduciary duty, negligence and breach of contract by Florida Regulators in a $300 million action.
  • Cal Micro, A situation so egregious that the SEC in an unprecedented announcement stated that they would try to ban Coopers from ever again signing off on a public audit.  Obviously this was worked out behind the scenes but we are unaware of any other instance when the Securities and Exchange Commission became so enraged over a public audit.
  • Kurzweil Applied Intelligence, Coopers & Lybrand did the audit during the period when the company was going public.  It was later announced that sales had been inflated by approximately 40%, which Coopers obviously had missed.  When they ultimately caught the fraud, investors had already invested in the company and lost everything when the stock collapsed.
  • Barings settled with administrator along with Deloitte Touch, the predecessor accountant for Barings, for over $50 million for failure to catch financial misdoings in 1992 by Leeson.
  • Towers Financial, $450 million lost by investors with the principal claiming that he was aided in his fraud by Price Waterhouse, Barbados.  While we don’t give any credence to the fact that Price Waterhouse aided in this blatant fraud, there is no question that a lot got by them in their audit responsibilities.
  • Emcore charged Price Waterhouse, Coopers and senior employees of Racketeering.  SEC censures PricewaterhouseCoopers for not complying with the standards of independence.  1998. Once again we have an instance of the accounting firm creating their own conflict of interest.
  • Fidelity, Securities and Exchange Commission censures Pricewaterhouse- Coopers with not complying with the regulations covering auditor-independence.  It seems that PricewaterhouseCoopers and Company had a lot of problems with keeping track of what companies their auditors owned stock in and thus, created a series of mistakes that could have easily been avoided.
  • TYCO, PricewaterhouseCoopers guilty of allowing some of the most innovative and aggressive accounting seen on this planet to that date.  Case has set standard for how not to do books unless of course you want to have big time IRS and shareholder problems. 
  • Robert Maxwell, Drained the pension fund right in front of the accountant’s noses.  Used money to support lifestyle and acquisitions.
  • America’s Future, Charity headed by General Colin Powell used PricewaterhouseCoopers data that was both unchecked and incorrect to push phony charity claims.  Pricewaterhouse acted in almost a disgraceful manner when they claimed that it wasn’t their fault because although they authored and issued the misleading report, they hadn’t conducted an audit.  Sounds to me as though their public relations department should have left well enough alone.
  • W. R. Grace, Pricewaterhouse aided Grace in managing their earnings illegally and hiding the rise in compensation of retiring CEO.
  • Symington, Coopers & Lybrand, climbed aboard Arizona political machine in representing the governor, phonied up his books in exchange for political business.  Also took care of incorrect fillings in his real estate company, which went under.  Ex-Governor is now in jail and will be for foreseeable future.
  • Old Republic, PricewaterhouseCoopers allowed Old Republic through their strange sense of morality to literally steal the money belonging to their clients from an escrow fund.  This was one of the most substantial breaches of the public trust that we have seen to date.
  • Coopers & Lybrand, were auditors for Phar-Mor, Giant Eagle, and Tamco.  All three were literally owned by the same person who appears to have been swindled along with investors and creditors in one of the largest private companies ever to go under in the history of the United States.  Estimates of the fraud vary from $500 million to $1 Billion.  Coopers settled with creditors for a substantial payment.  Coopers fell for one of the oldest inventory deceptions in the book on this one by not creating a large enough sampling and going back on their work.



“Phar-Mor, Leslie Fay, ZZZZ Best, Kendall Square Research, Crazy Eddie, Mini-Scribe, Kurzweil Applied Intelligence, New Era, the savings and loan crisis and  First Executive.  The list of notorious financial frauds and scandals in recent years goes on and on.  And in each instance, angry investors and an incredulous public were left wondering: Where were the auditors?  In most of the instances above, they were totally out to lunch.  Any of the above frauds could have been easily uncovered by a motivated accounting student with a degree of paranoia in his soul.  The deceptions were shallow to say the least and the fact that shareholders lost billions because of bumbling accountants is a crying shame.


However, for the auditors, that has proven to be a mighty expensive question.  In the wake of those and other scandals; lawsuits against the green-eye shaded types have soared to a point of unbelievability.  Burned investors - who along with government regulators in the Savings & Loan debacle - argued that accountants who did little to unearth questionable practices and thus, determined that they were just as liable as the corporate execs in actually misrepresenting the numbers.  Moreover, plaintiffs won in court much more often than not.  Accounting firms have spent upwards of $1 billion to settle civil lawsuits since the early 1990s.”  ([13])  In addition, it has been estimated that the Big Five have spent over $400 million per year since 1990 just on litigation costs.


I Understand It Now, But Who Pays An Accountant To Be Independent?


In theory, the outside accountant provides a set of checks and balances on a public company in their financial communications with the public.  Also relying on the independence of the outside auditor are regulators such as the Securities and Exchange Commission, which has a requirement that a public company has an independent outside accountant.  Other regulators are also dependent on their reports such as the Self Regulator Organizations (SROs).  Primarily, these are the stock exchanges and the National Association of Securities Dealers (NASD) who have regulatory status.  Listing requirements vary from exchange to exchange, but a substantial negative change in a company’s outlook can get their listing removed.  When they receive a warning (which they will) that such an action is in the works, it sends a strong message to shareholders to watch out.  On the other hand, if the independent auditor is not doing his job, the message does not get sent and the public and the exchange are none the wiser until the bottom drops out and pandemonium rules the day.


On the other hand, we know what everyone thinks of squealers.  These are not necessarily great people and usually they are willing to tell all about someone because something is in it for them.  With the independent accountant, things are very different.  If they tattled to the SEC every time that one of the companies that they audit does a no no, two things will become inevitable.  First and foremost, they will probably loss that client, and secondarily and even more import, they will probably never get another client as long as they are in business.  Yet the SEC has instilled them with them with the fact that they must be truly independent, which is impossible for the reasons above and the fact that they must follow the letter of the law when doing an audit.  Although this is wonderful in theory, in practice, each company has its own vagaries.  The risk of calling in the marshals on your own audit client can be just as bad in many instances as not doing it.


Thus, the accounting industry as practiced under existing regulations is about as logical as an old shoe.  There just ain’t any winning in it for anyone.  Moreover, it only has become a matter of how much you, the accountant, are going to lose and whether or not it can be made controllable through insurance and other insulating devices.  One thing is for sure, this isn’t a business for the faint of heart.  Imaging how long you would last if you were to be known to be in the business of ratting on your own clients, which is exactly what is expected by the regulators.  The auditors fight tooth and nail over potential clients; this courtship itself creates an aura of mutual dependency that, in spite regulation, flies in the face of becoming a stoolie.  But this isn’t a story that concerns itself with how hard it is for accounting firms to operate in this kind of regulated environment, the fact that it is tough is a given, however, this is a story of many accounting firms that went to far overboard under any set of circumstances in their efforts to keep a client alive.  We are talking about those that went beyond both logic and the law and that seems to cover the accounting spectrum, at least on the high end.


Moreover, an accounting firm that consistently turned in its own customers to regulators would find that new clients were, kind of shying away from them with good reason.  Historically, the rules require that an accountant take a neutral position toward his client, auditing the books as though he was working for an anonymous third party.  In the real world, this assumption makes about as much sense as catfish jumping into a hot frying pan.  However recently, the price of admission has been raised, requiring a more jaundice yardstick to be used when analyzing a client’s books.  In the meantime, the public and private sectors have both paid a horrendous price for accounting firms’ lack of true independence, as well as their stupidity, laziness and lax standards.


Despite the regulators’ tough talk, the reality is that accounting standards have been lowered substantially and laxity regulating the dot.coms have taken accounting creativity to a new level which has now overflowed into non Internet companies.  Either the SEC has grown unwilling to enforce the rules of the game or they have changed those rules dramatically to give some breathing room to Internet oriented technology companies to reach puberty.  Ultimately, the public will be rewarded for this mistake on the part of regulators by paying a price even in excess of that which was the tab when the Savings and Loans went down.  On  the other hand, once the accountants for the dot.coms invent a new method of  making their balance sheet unreadable, companies that are normally considered to be in the main stream, pick up the cudgel and join the party.  Hell, if those guys can do it, why can’t we?


It appears that the public rather than the regulators ultimately creates a level playing field by filing litigation when earnings become inflated due to enchanted accounting.  When investors lose money, everyone pays for the indiscretions.  Litigation will increase in geometric proportion to the fall in technology stock prices and margin calls.  We will soon be faced with the old boulder going down the hill scenario; the faster it goes, the more velocity it picks up, and eventually the only thing that can cause it to stop is its loss of dynamics.  It has lost its pent-up kinetic energy.  These lawsuits could well exacerbate market declines to the point where the process may spiral out of control.


In order to prove our point we will give numerous examples of how auditors closed their eyes to accounting misdeeds in order to maintain a client relationship.  The SEC regulations state that outside accounting firms should take the position that their client is neither honest nor dishonest and treat the books accordingly.  This is usually translated as:  if the accountant suspects something amiss, the trail must be followed until the doubt is put to rest.


Sadly for the public, this rule is not followed about as often as an Atheist goes to church.  Accounting firms have turned themselves into pretzels to accommodate the bizarre activities of some their clients.  Again and again, the major accounting firms have proved that they are not really independent when it comes to auditing their own clients’ books.  They have looked the other way consistently even in instances when they have been put on notice that something may well be amiss.  In addition, often when an accounting firms resigns because it has serious doubts about its client, little or no checking is done by the new firm as to the motivation behind such resignation.  Moreover, it is has been literally a game of musical chairs within the industry that when one accounting firms leaves, without letting the seat get cold, a new auditor “assumes the position”.  Think of this; can you ever remember a situation no matter how bad the company that they were unable to get an auditor to do their books.


In many cases, no checks are made to confirm that sales booked have even been made.  While costs can be fairly well established, when they are spread over fraudulent sales, earnings skyrocket because there is literally no charge against them.


The Banks Gone Bad

BCCI, Now Watch The Little Pea And Put Your Money On The Table.


“The Bank of Credit and Commerce International, S. A. (BCCI) story is important not just because a lot of people stole billions of dollars but because they got away with it right under the noses of the authorities and none of these watchdogs barked….This is a story of the breakdown of our institutions.”  Larry Gurwin, Senior Investigator, The Investigative Group, Inc.    


The bank was formed by Agha Hasan Abedi whose United Bank Ltd was nationalized in Pakistan by then President Zulfikar Ali Bhutto.  Abedi was a good friend of Sheik Zayed bin Sultan al-Nahayan, a highly pro-Arab billionaire from Abu Dhabi.  They were joined with Bank of American as the original investors in BCCI.  The total capital of the bank was $10 million with the American Bank being by far the smallest investor.  It didn’t take Bank of America long to see that the financial institution was not going in any direction that they would be contented with and they pulled out, stating that they did not trust various elements of the transaction.  The Bank of Credit and Commerce International was chartered in Luxembourg and opened their doors there in 1972.  Within a short time, they had opened five additional offices in The United Arab Emirates, Britain, and Lebanon.  The bank probably grew faster than any previous similar enterprise in world history.  Three years later, it had almost 150 branches in over 30 countries.


The bank was set up very shrewdly with the regulators in mind.  It was everywhere and then again, it did not seem to rest anywhere.  No major country with strict banking regulations seemed to want to call it their own, so no one did and the bank was allowed to move wherever and whenever it wanted to with no one checking its business or its capital.  Robert Morgenthau put the matter succinctly when he indicted the bank in 1991:


“The corporate structure of BCCI was set up to evade international and national banking laws so that its corrupt practices would be unsupervised and remain undiscovered, this indictment spells out the largest bank  fraud in world financial history”


The people that headed the bank were well versed in the game of bribery and were able to buy their way into Central Bank deposits from such countries as Barbados, Belize, Morocco, Panama and Jamaica as well as a host of others.


BCCI was even-handed in its operations.  It dealt at the senior levels only in crimes of the first magnitude:  drugs and illegal military shipments from Peru and Columbia, and money laundering in Panama.  It was at the forefront in the financing of terrorism throughout the world, including Hungary, East Germany, Czechoslovakia, Yugoslavia, North Korea, and Cuba, while gaining substantial expertise in counterfeiting numerous types of documents.  BCCI funded atomic weapons thefts and the purchase of unconventional weapons for radical Arab regimes.  They became skilled at the creation of false end certificates, the nuances of bribery and the art of covering-up kickbacks.  The bank became embroiled in countless murder investigations while serving as a front for political extremists throughout the Middle East.  Moreover, they still had time to involve themselves as a substantial investor in CenTrust, a victim of the Savings and Loan fiasco, which  cost American taxpayers over $2 billion.  BCCI was even an important cog in siphoning $4 billion in U. S. Agricultural funds into Iraq, which indirectly aided Saddam Hussein’s war buildup.  ([14])


Of all of the disturbing elements to arise from the ever-unfolding BCCI drama was the use of BCCI’s private airplane by the Secretary-General of the United Nations while on official business.  When any entity provides amenities to heads of supposedly independent representative organizations, it shows a total lack of regulation and discipline on the part of those organizations.  Ex-U.  S. President Jimmy Carter’s introduction of BCCI to most of Asia was reprehensible; however, he was not representing his country when it was done. 


Other Americans were also highly involved with BCCI, Bert Lance had $3.5 million in his debts paid off by the bank with a loan.  Andrew Young while in office was a paid consultant to BCCI and Jesse Jackson received numerous favors.  Among the rest of BCCI’s American help mates were former Secretary of Defense, Clark Clifford, former Senators and Congressmen, John Culver, Mike Barnes), former federal prosecutors, Larry Wechsler, Raymond Banoun and Larry Barcella, Former State Department Official, William Rogers, former White House aide, Ed Rogers and James Lake, former Federal Reserve Attorneys, Barldwin Tuttle, Jerry Hawke and Michael Bradfield.  With that kind of ammunition you can certainly get your share of mileage.


Many people consider BCCI the greatest business scandal in history.  Years later, lawsuits by the bank’s liquidators against the accounting firm of Price Waterhouse continue.  Price Waterhouse is being sued for $3.5 billion and Ernst and Young for $1.6 billion.  The complaints allege that they are partially responsible for losses by thousands of depositors.  Even the Bank of England, which was the regulator for BCCI British-based operations, has been hit with suits totaling $898 million.


We can do no more justice than print an excerpt from the report issued to the Committee on Foreign Relations of the United States Senate by Senators John Kerry and Senator Hank Brown, in December of 1992.  We are paraphrasing the report and to some degree changing its order:



BCCI's unique criminal structure -- an elaborate corporate spider-web with BCCI's founder, Agha Hasan Abedi and his assistant, Swaleh Naqvi, in the middle -- was an essential component of its spectacular growth, and a guarantee of its eventual collapse.  The structure was conceived by Abedi and managed by Naqvi for the specific purpose of evading regulation or control by governments.  It functioned to frustrate the full understanding of BCCI's operations by anyone.


Unlike any ordinary bank, BCCI was from its earliest days made up of multiplying layers of entities, related to one another through an impenetrable series of holding companies, affiliates, subsidiaries, banks-within-banks, insider dealings and nominee relationships.  By fracturing corporate structure, record keeping, regulatory review, and audits, the complex BCCI family of entities created by Abedi was able to evade ordinary legal restrictions on the movement of capital and goods as a matter of daily practice and routine.  In creating BCCI as a vehicle fundamentally free of government control, Abedi developed in BCCI an ideal mechanism for facilitating illicit activity by others, including such activity by officials of many of the governments whose laws BCCI was breaking.


BCCI's criminality included fraud by BCCI and BCCI customers involving billions of dollars; money laundering in Europe, Africa, Asia, and the Americas; BCCI's bribery of officials in most of those locations; support of terrorism, arms trafficking, and the sale of nuclear technologies; management of prostitution; the commission and facilitation of income tax evasion, smuggling, and illegal immigration; illicit purchases of banks and real estate; and a panoply of financial crimes limited only by the imagination of its officers and customers.


Among BCCI's principal mechanisms for committing crimes were its use of shell corporations and bank confidentiality and secrecy havens; layering of its corporate structure; its use of front-men and nominees, guarantees and buy-back arrangements; back-to-back financial documentation among BCCI controlled entities, kick-backs and bribes, the intimidation of witnesses, and the retention of well-placed insiders to discourage governmental action.



“BCCI systematically relied on relationships with, and as necessary, payments to, prominent political figures in most of the 73 countries in which BCCI operated.  BCCI records and testimony from former BCCI officials together document BCCI's systematic securing of Central Bank deposits of Third World countries; its provision of favors to political figures; and its reliance on those figures to provide BCCI itself with favors in times of need.


These relationships were systematically turned to BCCI's use to generate cash needed to prop up its books.  BCCI would obtain an important figure's agreement to give BCCI deposits from a country's Central Bank, exclusive handling of a country's use of U.S. commodity credits, preferential treatment on the processing of money coming in and out of the country where monetary controls were in place, the right to own a bank, secretly if necessary, in countries where foreign banks were not legal, or other questionable means of securing assets or profits.  In return, BCCI would pay bribes to the figure, or otherwise give him other things he wanted in a simple quid-pro-quo.


The result was that BCCI had relationships that ranged from the questionable, to the improper, to the fully corrupt with officials from countries all over the world, including Argentina, Bangladesh, Botswana, Brazil, Cameroon, China, Colombia, the Congo, Ghana, Guatemala, the Ivory Coast, India, Jamaica, Kuwait, Lebanon, Mauritius, Morocco, Nigeria, Pakistan, Panama, Peru, Saudi Arabia, Senegal, Sri Lanka, Sudan, Suriname, Tunisia, the United Arab Emirates, the United States, Zambia, and Zimbabwe.


In 1977, BCCI developed a plan to infiltrate the U.S. market through secretly purchasing U.S. banks while opening branch offices of BCCI throughout the U.S., and eventually merging the institutions.  BCCI had significant difficulties implementing this strategy due to regulatory barriers in the United States designed to insure accountability.  Despite these barriers, which delayed BCCI's entry, BCCI was ultimately successful in acquiring four banks, operating in seven states and the District of Colombia, with no jurisdiction successfully preventing BCCI from infiltrating it.


The techniques used by BCCI in the United States had been previously perfected by BCCI, and were used in BCCI's acquisitions of banks in a number of Third World countries and in Europe.  These included purchasing banks through nominees, and arranging to have its activities shielded by prestigious lawyers, accountants, and public relations firms on the one hand, and politically-well connected agents on the other.  These techniques were essential to BCCI's success in the United States, because without them, BCCI would have been stopped by regulators from gaining an interest in any U.S. bank.  As it was, regulatory suspicion towards BCCI required the bank to deceive regulators in collusion with nominees including the heads of state of several foreign emirates, key political and intelligence figures from the Middle East, and entities controlled by the most important bank and banker in the Middle East.


Equally important to BCCI's successful secret acquisitions of U.S. banks in the face of regulatory suspicion was its aggressive use of a series of prominent Americans, beginning with Bert Lance, and continuing with former Defense Secretary Clark Clifford, former U.S. Senator Stuart Symington, well-connected former federal bank regulators, and former and current local, state and federal legislators.  Wittingly or not, these individuals provided essential assistance to BCCI through lending their names and their reputations to BCCI at critical moments.  Thus, it was not merely BCCI's deceptions that permitted it to infiltrate the United States and its banking system.  Also essential were BCCI's use of political influence peddling and the revolving door in Washington.


Federal prosecutors in Tampa handling the 1988 drug money laundering indictment of BCCI failed to recognize the importance of information they received concerning BCCI's other crimes, including its apparent secret ownership of First American.  As a result, they failed adequately to investigate these allegations themselves, or to refer this portion of the case to the FBI and other agencies at the Justice Department who could have properly investigated the additional information.


The Justice Department, along with the U.S. Customs Service and Treasury Departments, failed to provide adequate support and assistance to investigators and prosecutors working on the case against BCCI in 1988 and 1989, contributing to conditions that ultimately caused the chief undercover agent who handled the sting against BCCI to quit Customs entirely.


The January 1990 plea agreement between BCCI and the U.S. Attorney in Tampa kept BCCI alive, and had the effect of discouraging BCCI's officials from telling the U.S. what they knew about BCCI's larger criminality, including its ownership of First American and other U.S. banks.


The Justice Department essentially stopped investigating BCCI following the plea agreement, until press accounts, Federal Reserve action, and the New York District Attorney's investigation in New York forced them into action in mid-1991.  Justice Department personnel in Washington lobbied state regulators to keep BCCI open after the January 1990 plea agreement, following lobbying of them by former Justice Department personnel now representing BCCI.


Relations between main Justice in Washington and the U.S. Attorney for Miami, Dexter Lehtinen, broke down on BCCI-related prosecutions, and key actions on BCCI-related cases in Miami were, as a result, delayed for months during 1991.  Justice Department personnel in Washington, Miami, and Tampa actively obstructed and impeded Congressional attempts to investigate BCCI in 1990, and this practice continued to some extent until William P. Barr became Attorney General in late October, 1991.


Justice Department personnel in Washington, Miami and Tampa obstructed and impeded attempts by New York District Attorney Robert Morgenthau to obtain critical information concerning BCCI in 1989, 1990, and 1991, and in one case, a federal prosecutor lied to Morgenthau's office concerning the existence of such material.  Important failures of cooperation continued to take place until William P. Barr became Attorney General in late October, 1991.  Cooperation by the Justice Department with the Federal Reserve was very limited until after BCCI's global closure on July 5, 1991.  Some public statements by the Justice Department concerning its handling of matters pertaining to BCCI were more cleverly crafted than true.


When Hill and Knowlton accepted BCCI's account in October, 1988, its partners knew of BCCI's reputation as a "sleazy" bank, but took the account anyway.  In 1988 and 1989, Hill and Knowlton assisted BCCI with an aggressive public relations campaign designed to demonstrate that BCCI was not a criminal enterprise, and to put the best face possible on the Tampa drug money laundering indictments.  In so doing, it disseminated materials unjustifiably and unfairly discrediting persons and publications that were telling the truth about BCCI's criminality.


Important information provided by Hill and Knowlton to Capitol Hill and provided by First American to regulators concerning the relationship between BCCI and First American in April, 1990 was false.  The misleading material represented the position of BCCI, First American, Clifford and Altman concerning the relationship, and was contrary to the truth known by BCCI, Clifford and Altman.


Hill and Knowlton's representation of BCCI was within the norms and standards of the public relations industry, but raises larger questions as to the relationship of those norms and standards to the public interest.


BCCI's decision to divide its operations between two auditors, neither of who had the right to audit all BCCI operations, was a significant mechanism by which BCCI was able to hide its frauds during its early years.  For more than a decade, neither of BCCI's auditors objected to this practice.


BCCI provided loans and financial benefits to some of its auditors, whose acceptance of these benefits creates an appearance of impropriety, based on the possibility that such benefits could in theory affect the independent judgment of the auditors involved.  These benefits included loans to two Price Waterhouse partnerships in the Caribbean.  In addition, there are serious questions concerning the acceptance of payments and possibly housing from BCCI or its affiliates by Price Waterhouse partners in the Grand Caymans, and possible acceptance of sexual favors provided by BCCI officials to certain persons affiliated with the firm.


Regardless of BCCI's attempts to hide its frauds from its outside auditors, there were numerous warning bells visible to the auditors from the early years of the bank's activities, and BCCI's auditors could have and should have done more to respond to them.


By the end of 1987, given Price Waterhouse (UK)'s knowledge about the inadequacies of BCCI's records, it had ample reason to recognize that there could be no adequate basis for certifying that it had examined BCCI's books and records and that its picture of those records were indeed a "true and fair view" of BCCI's financial state of affairs.


The certifications by BCCI's auditors that its picture of BCCI's books were "true and fair" from December 31, 1987 forward, had the consequence of assisting BCCI in misleading depositors, regulators, investigators, and other financial institutions as to BCCI's true financial condition.


Prior to 1990, Price Waterhouse (UK) knew of gross irregularities in BCCI's handling of loans to CCAH/First American and was told of violations of U.S. banking laws by BCCI and its borrowers in connection with CCAH/First American, and failed to advise the partners of its U.S. affiliate or any U.S. regulator.


There is no evidence that Price Waterhouse (UK) has to this day notified Price Waterhouse (US) of the extent of the problems it found at BCCI, or of BCCI's secret ownership of CCAH/First American.  Given the lack of information provided Price Waterhouse (US) by its United Kingdom affiliate, the U.S. firm performed its auditing of BCCI's U.S. branches in a manner that was professional and diligent, albeit unilluminating concerning BCCI's true activities in the United States.


Price Waterhouse's certification of BCCI's books and records in April, 1990 was explicitly conditioned by Price Waterhouse (UK) on the proposition that Abu Dhabi would bail BCCI out of its financial losses, and that the Bank of England, Abu Dhabi and BCCI would work with the auditors to restructure the bank and avoid its collapse.  Price Waterhouse would not have made the certification but for the assurances it received from the Bank of England that its continued certification of BCCI's books was appropriate, and indeed, necessary for the bank's survival.


The April 1990 agreement among Price Waterhouse (UK), Abu Dhabi, BCCI, and the Bank of England described above, resulted in Price Waterhouse (UK) certifying the financial picture presented in its audit of BCCI as "true and fair," with a single footnote material to the huge losses still to be dealt with, failed adequately to describe their serious nature.  As a consequence, the certification was materially misleading to anyone who relied on it ignorant of the facts then mutually known to BCCI, Abu Dhabi, Price Waterhouse and the Bank of England.


The decision by Abu Dhabi, Price Waterhouse (UK), BCCI and the Bank of England to reorganize BCCI over the duration of 1990 and 1991, rather than to advise the public of what they knew, caused substantial injury to innocent depositors and customers of BCCI who continued to do business with an institution which each of the above parties knew had engaged in fraud.


From at least April, 1990 through November, 1990, the Government of Abu Dhabi had knowledge of BCCI's criminality and frauds which it apparently withheld from BCCI's outside auditors, contributing to the delay in the ultimate closure of the bank, and causing further injury to the bank's innocent depositors and customers.


While to some degree we believe that we have somewhat pushed then envelope in quoting the Foreign Relations Report on BCCI, we wanted to make it crystal clear that this was no minor happening and without tremendous assistance from BCCI’s credible accounting firm, this scandal would have certainly be nipped before it became a global problem.  While it is certainly true that Price Waterhouse was not the only culprit in this cesspool, they knew what was happening and when it happened and did not lift a finger to stop it.


Moreover, it is our belief that had the BCCI scandal transpired ten years later; it would have brought down the world’s financial systems.  In the early 1980s, derivatives had not yet appeared on the scene and electronic transmission had not yet matured.  The subversive power of today’s financial mechanisms would have triggered a decades-long global depression.  Yet, the accounting firm’s that were auditing BCCI’s books to our knowledge, never brought any of those activities to the attention of regulators.  They continued to allow the Bank to function as a going business long after they should have been closed and sent to pasture.  They turned a blind eye when the bank to engaged in money laundering to such a large degree that they were cleansing funds for most major criminal organizations on the planet.


The same forces that would have turned a BCCI into the trigger for a world financial meltdown would make Credit Lyonnais’ debacle particularly dangerous.


Credit Lyonnais, Vive La France


Credit Lyonnais was and is a chattel of the French Government, the victim of the biggest measured internal bank fraud in history.  Today, over a decade after the French public decided that the bank’s mismanagement had gone on far too long, most of the pieces to the puzzle are still  missing and investigations are still continuing.


For decades, the officials of Credit Lyonnais were literally “the gang that couldn’t shoot straight.”  ([15]) Everything they ever did was wide of the mark, and it took the resources of the French Treasury to bail out the sinking ship.  Bad loans on the bank’s books totaled a staggering $35 billion ([16]) when originally reported, but recently discovered indicate that even this number is far too conservative.


An in-house newsletter, published by the Consortium de Realization (or “CDR”), said:  “investigations into Credit Lyonnais and its subsidiaries had shown how the bank’s senior management had allowed the fraud both in France and abroad.  The further CDR’s team goes…the clearer it becomes: There was organized financial fraud until 1993….  The fraud was concentrated in seven subsidiaries…, which acted as the unbridled horsemen of this financial apocalypse.  The real figures involved are substantially greater than those recently quoted, already huge.”


In March 1997, CDR’s Chairman, Michel Rouger, was quoted by a French legislator as telling a parliamentary commission that about five billion francs had been embezzled by bank executives and businessmen with links to the bank.”  ([17]).


Credit Lyonnais’ banking practices during that period, can be illustrated by describing the bank’s relationship with an Italian thug by the name of Giancarlo Paretti, whose rap sheet was almost unlimited.  The Bank, whose senior officers had been bribed by Paretti, knowing his criminal background, extended over $2 billion him, enabling him to acquire and run companies.  His primary acquisition was MGM. 


The crimes of which he was convicted included:


Fraud in connection with the bankruptcy of IL Dirario newspapers, sentenced to:  3 years in prison.  Under appeal.  March 1990.


Fraud in connection with the Siracusa soccer team.1975

            Fraud in connection with a Hotel company in Sicily.  1984

            Forgery in connection with savings bonds in Sicily.  1984

            Bankruptcy of a newspaper in Paris named Le Matin, 1986

            Judgment, Credit Lyonnais, June 1997.  $1,466 billion, MGM

            Convicted perjury and evidence tampering, Delaware, 1996

            Fugitive from justice, flight to avoid imprisonment, 1996


Parretti’ s partner in his dealings with the bank was Florio Fiorini, currently serving time at Champ Dollon prison in Geneva.  According to Fortune Magazine (7/8/1996), “[Fiorini] has figured in every major financial and political scandal in Italy in the past two decades—and that’s saying a lot.  He learned political bribery and global money laundering at the knees of the notorious Vatican-connected Italian bankers Michele Sindona and Roberto Calvi, whose violent deaths in the wake of banking scandals in the 1970s and 1980s remain unsolved.


His mentor was Bettino Craxi, the former Prime Minister of Italy and Socialist Party chairman; and Gianni DeMichelis, the former Italian Foreign Minister, who spent his nights in discotheques.  According to Fiorini, Craxi and DeMaichelis took bribes from Paretti and Fiorini to induce the French government and its bank (Credit Lyonnais) to back the Italians’ purchase of MGM.


Parretti’ s background was no secret:


“According to Jerry Brodsky (head of due diligence for Drexel Burnham Lambert) Giancarlo Paretti asked Drexel in the late 1980s to help raise the money he needed to buy MGM.  When Kroll’s (private detective agency) agents reported that Parretti had been convicted of fraud in Italy, Brodsky nixed the deal.  Instead Credit Lyonnais loaned Parretti the money—something it’s since regretted, since much of the money vanished, along with Parretti himself” ([18]) ([19])


In spite of Credit Lyonnais, being informed of Parretti’s background and associates on numerous occasions, the Bank continued extending him credit, which exceeded $2 billion when it had had enough.  The reason Paretti had been able to continue using the Bank’s money for his schemes was simply that he had bribed the senior Bank officers.


Georges Vigon - head of European lending for Credit Lyonnais until his ”departure.”

            Jacques Griffault - head Credit Lyonnais, Milan branch.

            Jean-Jacques Brutschi- head of Credit Lyonnais, Holland.


In Geneva, a judge eventually charged Credit Lyonnais Chief Executive Jean-Yves Haberer ([20]) and General Manager Francois Gill with fraudulent complicity.  Haberer credentials were superb.  He went to all the right schools, graduated at the top of his class, knew all of the right people, and did all of the right things.  There was only one thing wrong; he just could not legitimately run a bank or probably anything else for that matter:


“An arrogant man, Haberer held himself aloof from everyone at the bank except his immediate colleagues, an inclination symbolized by his installation of a “floating floor” of felt, rubber and cork under his lavishly appointed office to insulate it from the noise of the street, the Metro, and, his detractors said, the real world.  They started calling him “le megalo”—the megalomaniac.”  ([21])


Within five months of the time Paretti took over MGM, with the help of Credit Lyonnais’ loans, it was bleeding at the rate of $1 million per day and was a bankruptcy candidate within five months.  The Bank ultimately took over MGM and was forced to sell it at a staggering loss.


Now, too much of this kind of thing can give banking a bad name.  These were trusted employees splitting the loot.  If you can’t trust trusted employees, who can you trust?  Credit Lyonnais, during a substantial period of time, was not just out of ratio; it was bankrupt, but doing business.  Had the Government of France bet the country on a successful bailout, a true international debacle would have ensued.  The French People will be paying a staggering price for many years to come.  The only saving grace was that the Credit Lyonnais scandal occurred in the 80s rather than the late 90s.


And yet, in the midst of attempting to put a badly mangled house back in order, Credit Lyonnais again went on the offensive and found a way turn victory in defeat.  Few felt that the bank’s management had anything but a death wish when, in Asia, they started lending everybody and anybody that they could find, knowing that the situation was perilous.  Among a portfolio of bad investments, one item stands out, Garuda Airlines.  Credit Lyonnais was there with the fastest check in the west and now, payments have stopped and the bank is “sucking wind.”  “While the (Asian) loan problems are not expected to severely damage any of the banks, one bank could have serious problems: Credit Lyonnais, a long-troubled French financial institution.”  ([22]) This is an ill-stared institution and the French would probably be better off pulling  the plug and putting the bank out of its misery.


In the meantime, looking for a patsy, recently, Credit Lyonnais has filed an action against the Dutch subsidiary of KPMG looking for about $2 billion.  The suit indicates that when the bank (Credit Lyonnais Bank Nederland) lent money to MGM, KPMG had already discovered a large-scale fraud in 1989 but provisions for loans in 1989, ’90 and ’91 were not only adequate but no addition investigation was necessary.  In the action in question, the Dutch apparently feel so strongly that they got the shaft from KPMG that they are also holding 160 KPMG employees responsible for the action as well as the KPMG parent.  Major league!


Now the bank is facing serious problems in the United States.  A French whistleblower informed various parties that the transaction consummated in the early 1990s between the California Commissioner of Insurance acting as the liquidator of Executive Life and Credit Lyonnais was fraudulent.  Executive Life was the largest American Insurer to go out of business to that time.  It was taken down because of a combination of a proliferation of junk bonds in its portfolio and a bad market for debt instruments in general.  The California Department of Insurance put the company and the portfolio up for joint bid and the winning bid was ultimately made by a consortium consisting of a group put together by Credit Lyonnais and a handful of ex-Drexel Burnham executives.


This wasn’t even a fair battle, the insurance commission was advised that the transaction put forth by this group was inferior to others that the background of the people was questionable to say the least, but he made the transaction anyway much to his long-term regret.  Among the nuances of the transaction was the that neither the government nor bank; Credit Lyonnais could own an American Insurance Company under the existing Glass Steagall prohibitions.  Furthermore, under California law, a foreign government could not own an California domiciled American insurance company.  The California Department of Insurance and the Executive Life policy holders were still smarting over the mistakes of almost a decade ago committed by an Insurance Commissioner who was indirectly running for Governor of California the entire time he held that office.


He seemed more interested in making boisterous statements of how well he was doing than actually doing anything of consequence that would help anybody.  When the whistleblower blew his whistle in California it seemed like an opportunity for the State to undo that entire transaction because of its illegality and they have filed lawsuits against the bank and just about everyone else that had anything to do with the matter.  In the meantime, the Commissioner has called out just about everyone but the National Guard in an attempt to investigate the matter.  The Federal Bureau of Investigation, The Justice Department, and Department of the Treasury are all conducting investigations into what will soon turn into a very serious matter.  We believe that this is the second coming of Daiwa Bank who folded its tent in the United States after actions were filed against it for, in effect, lying to the Federal Reserve.


This case make may that one pale in comparison.  It appears that Credit Lyonnais lied about their position from the very beginning to take advantage of something that they knew was illegal.  Daiwa got themselves into a fix by accident and just did not know how to legally extract themselves from the problem.  Two very different matters.  The French Government is so concerned about the matter that they.  The overall inquiry of what has occurred at the French Bank has been called the largest investigation of its kind ever conducted in France.


“…Even a former governor of France’s central bank has been questioned.  Investigators have discussed with other top officials whether their actions or inactions might have fostered Credit Lyonnais’ frauds and losses.  Prominent financiers, well-known in global banking circles, face possible imprisonment, financial calamity and public disgrace.”  ([23])


Interestingly enough, Credit Lyonnais as already had been hit with a substantial fine in the MGM matter.  In that settlement, the bank agreed to refrain from committing any felonies in the United States.  If they violate that settlement, the penalties in that case skyrocket almost 400%.  It would seem that there is no question that this has already occurred. 


In today’s banking system, the presence of a BCCI along with a savings and loan scandal and/or a long-lead time disaster like that at Credit Lyonnais, could bankrupt the healthiest sectors of the world’s economies.  The same court in Paris is hearing the claim against KPMG that years earlier fined Paretti one million francs for fraud in the same deal.  When he didn’t show up to pay the fine, he was given an additional gift of four years in a French prison.  With this kind of history, KPMG probably better start taking its checkbook out of the drawer and checking with its insurance carrier.



 The Savings And Loan Crisis, One of The Most Costly Series of Frauds In American History.

All I Want Is A Couple Of Bucks Under The Table And You Can Have Your Jumbo Mortgage!


Sounds good in principal, but is it that good in practice?  At the same time that the Savings and Loan crisis occurred in the United States, the banking system became simultaneously, totally insolvent.  The two had roots in some of the same general problems.  Real Estate values collapsed on loans made by both banks as well as by Savings and Loans.  Believe it or not, values depreciated across the board and both industries had a pro rata share of disasters.  Luckily for the banks, they were more diversified, and thus were cushioned by other loans.  However, unluckily for the banks, their South American loans became worthless at the same time.  If one was doing cost accounting on the simultaneous disasters and concentrated on both the top ten U.S. Banks and the top ten thrifts, it is my belief that they were all equally bankrupt.  The thrifts from bad domestic loans and poor management, the banks from a combination of domestic and foreign loans.   


In just 10 years, from 1980 to 1990, of the 13,500 banks in the United States, 1,500 failed.  A survey conducted by Heidrick and Struggles Inc., an executive recruiter, and the American Banker, concluded that almost 50% of the bank officers currently employed were incapable of dealing with the problems that would exist in a deregulated environment.


New York had not had a bank failure since the 1930s, and when Greenwich Savings Bank collapsed in 1981, it caught everyone by surprise.  After all, hadn’t The Greenwich been in business for almost 150 years, with assets in excess of $2 billion?  Those that formed the line the day after also formed the nucleus of the first run on a bank in the United States in over 50 years.  Nobody went to jail, there weren’t any really horrendous loans and with the exception of the FDIC, almost everyone was made whole.  It was just a case of a bad economy and a Federal Government that either had not come to grips with the infrastructure problems that were being created or were stultified by their own inexperience.


“So what’s the big deal?  I mean, for the most part here we are talking about serious fraud.  We really aren’t interested in a bank that just went, there must be more to the story.”


Well, you’re right, but sometimes things just kinda happen, even when people really mean well, but just are kinda dumb when it comes to economics.  You see, Jimmy Carter, a well- meaning guy, never found out that Savings Banks loan money for up to 30 years, while they borrow from customers for less than 5 years.  If short-term rates ever became higher than long-term receipts for any protracted period of time, literally the entire industry would fail.  The rates did and the industry did.  It was only the magic of accounting and a government bailout of immense proportions that preserved anything at all.  The banks, which were restricted from lending long, were able to prevent collapse despite holding as many disastrous real estate loans as the S & L’s, and struggling with defaulting Latin American debt.  With the entire S & L industry stultified, banks were able to step into the breach with high interest loans and provide a perceived safe harbor for investor’s funds that had fled their competitors.  The saving grace may well have been that the run on the thrifts caused money to pour into the drought filled banking industry.


The prime rate hit 21 percent in 1981, causing investors to withdraw their money from the Savings and Loans, which could not pay over 5.5 percent.  The majority of the funds were deposited into money market funds and the banks, where six month CD’s were yielding 15 percent.  Because failures were occurring faster than they could be absorbed by the system, the FSLIC changed the adequacy rules, allowing some breathing room for the regulators, while staving off total panic among depositors.  The failure of the press to totally grasp the gravity of these events was the economy’s ultimate salvation.  Having bought time to grab a breath or two, a few S & L’s were shorn up, merged or liquidated, and calm returned, for a time, to the system.


The Fed feeling that inflation had been brought under control turned the spigot on again in earnest.  The regulations governing the S & L’s borrowing policies were loosened, and they borrowed to the hilt.  Historically, the savings and loans were more a local enterprise, as opposed to a money center banking institution; they became overzealous lenders in an attempt to make back their losses of the previous 5 years.  Loans were made everywhere and anywhere, in all areas allowed by the regulators, and frequently in areas that were not.  Money was thrown at developers and cities like Houston, Dallas, Denver and Phoenix became monuments to the god of vacancy.  The Savings and Loans had done it to themselves all over again.


 The debacle of the Thrifts cost the taxpayers almost $100 billion dollars.


We have listed a few and they’re cost to taxpayers and disposition of principals in 1993:

Lincoln                                   $2.6 billion                Charles Keating, serving 10 Year


Vernon                                   $1.0 billion                Don Dixon, 10-year sentence

CenTrust                               $1.6 billion                not determined, Up to 10 years

Columbia                              $2.0 billion                facing charges and $40 million in


Silverado                               $1.0 billion                Director Neil Bush agreed to pay                                                                                      $50 million to settle charges.


What Hath Michael Milken Wrought?


Within three years, the industry literally collapsed twice, for two very different reasons, one the drought of funding and the other the riches of funding.  Loopholes opened to provide survival escape routes in bad times were left open and created the excesses of the good times.  The Savings and Loans have easy access to people with bankrolls that could acquire the weaker businesses of the very early 80s.  The institutions were then allowed to merge and acquire beyond the scope of their charters.  Junk bond funding provided much of the fuel for the conflagration, which was ignited by inept management.  How soon we forget!



The Big Eight, Err Six, I Mean Five And The Savings And Loan Industry


What Do You Think I Am?  A Squealer?

There were many accounting firms that got into trouble over their audits of Savings and Loans.  Various explanations have been put forward for the fact that no member of the Big Six came away unscathed.  In a general sense, there were a great number of inquiries into what could have caused everyone to have gone wrong simultaneously.  Their report, in part, stated:


“The AICPA Audit and Accounting Guide for Savings and Loan Associations was last substantially revised in 1979.  It contains little discussion of the risks associated with the land and ADC loans; ([24]) the effect of increases in restructured loans on collectability; coordinating audit work with the results of regulatory examinations; the importance of disclosing regulatory actions and violations to depositors, shareholders, regulators and other users of audit reports.”  


Although the then Big Six now proclaim their innocence in the S & L crisis, (‘It wasn’t our job to find fraud,’ they insist), a General Accounting Office study of eleven bankrupt thrifts revealed that the audits for six of the S & L’s failed “to meet professional standards.’  The firms involved included Arthur Young, Deloitte Haskins & Sells and Ernst & Whinney.  ([25])


Moreover, the cause was more one of unhealthy relationships between the S & L’s and their auditors, greed by accounting firms in bringing in business at any cost and, more important was the fact that the accounting firms just weren’t up to recognizing the sophistication of the new financial instruments being purchased by the Savings Banks.  The latter problem bodes for firm requirements in accounting and for increased continuing education, within particular areas of audit.  Additionally, if teams of industry specialized (dedicated) auditors had to be certified in order to conduct the certification process, the excuses given for the total incompetence of the Big Six in their S & L audit would have fallen under  their own weight.


In many cases, management of troubled S & L’s contended that problem loans were collectible or, in cases of default, that collateral underlying the loans was sufficient to cover the outstanding loan balance.  Standards require auditors to obtain independent corroboration that key management assertions are true - often a time-consuming, but necessary audit function.  However, the CPA’s in our review did not always perform this function and, instead, often relied on management’s unsubstantiated oral assertions that problem loans were collectible. 


“In two cases in our review, CPA’s did not point out in their audit reports that their S & L clients had materially misstated their income.  In one of those cases, the S & L client had lost four times as much money as it had reported in its financial statements for that year.”


“In some cases, CPA’s did not report serious regulatory violations, such as excessive loans to single borrowers and formal cease-and-desist or similar orders by regulators.  Thus, report users were unaware of those operating risks and the corresponding potential regulatory actions, all of which may have impacted the S & L’s operation.”  ([26])


The Carter Years


During the Carter years, interest rates, as we all know, went through the roof.  Savings and Loans had numerous restrictions on lending and borrowing (raising money in one form or another) that did not encumber the banks.  Banks for example, would historically tie their loans to the "prime rate,” Libor or any number of other potential scenarios that could be thought up to work profitably on their behalf.  Thus, the bank always had a profit locked in.  The loan would carry an interest rate of, let us say prime plus two or whatever else.  Whenever the prime rate changed the customer’s interest rate either rose of fell.


The Savings & Loans were not allowed this escape valve and they were constantly in a position of lending long and borrowing short.  Thus, as rates rose, a number of very unpleasant things would happen to the Savings & Loan industry.  In addition, Savings Bank's main source of funds was what we call certificates of deposit or CDs.  These instruments were usually issued for a year at a time with a fixed rate of interest.  On the other hand, they could be issued for another year or two if both the issuer and the purchaser agreed.


Therefore, by picking a starting date where all of our numbers are constant, the Savings Bank would have a portfolio consisting of mortgages that they had issued to people purchasing homes or business property and certificates of deposit that their customers had purchased from the institution.  There is no question that there are other items, which make up the balance sheet  mix but in comparison to these two, they would be insignificant.  Undoubtedly, the S & L had equity; it probably had preferred and certainly had assets such as a home office, furniture and the like.  It would also have money on deposit with the FSLIC or State insurance fund.  These numbers when looking at the total health or sickness of an institution in this industry were just not consequential.


Having dispensed with that piece of housecleaning, let us make the assumption that the portfolio of our institution, Ajax Savings Bank is $100 million consisting of 2-year average maturity certificates of deposit paying their owners 5% interest per year.  On the asset side of the ledger, we would see that Ajax had $100 million of mortgages receivable bringing in approximately 7 1/2% interest and averaging 25 years remaining on their maturity.  By simple arithmetic we can easily see that under the circumstances outlined above, Ajax seems to be in good shape with income exceeding payments by $2.5 million per year before salaries, mortgage defaults, rent, professional fees and other sundry charges.  Most probably, if Ajax is well managed, it will return a tidy profit to shareholders and principals.


Now, lets kick interest rates up a notch as the Federal Reserve did under the Carter Administration.  With Burt Lance, a corrupt banker guiding him, America's ever faithful president from the state of George thought that more was better and allowed rates to climb into the stratosphere.  Banks were charging 22% and people were happy to pay it and you could get 17 1/2 percent interest on your CD's.  These rates eventually broke the real-estate market’s back.  New buyers couldn't afford to buy anything and sellers unless they had transferable mortgages, were unable to provide financing for their properties.  Building came to a screeching halt.


Hypothetically, the new Savings Bank picture looked as follows: The bank was still receiving 7 1/2 percent on the mortgages that had not run off.  Assuming that no new mortgages were written, which was just about the case, and the average loan had been for 25 years, 2/25 of the mortgages no longer existed or about 8 percent.  Eight percent subtracted from $100million gave the Savings and Loan about $92 million in mortgages and for the moment let us assume that everything else was equal, which it wasn't, $92 million in Certificates of Deposit.  The Certificates of Deposit would have been re-written by this time and let's make the assumption that the rate was now 12 1/2 percent.  (Which appears to be conservative under the circumstances)  Thus, the Savings Bank under this scenario was now losing about $5 million per year and this was before any expenses.  At this point in time were are talking about, $5 million in net capital for a Savings Bank was not a bad number and as you can see, the entire equity would have eroded within approximately eight months.


However, the story was far worse than that.  People weren't sure what was going to happen next.  They had completely lost confidence in the Carter Administration and if it made sense to squirrel their money under the bed that is what they would have done.  The Federal Savings and Loan Insurance Corporation (FSLIC) was totally out of money as 500 institutions had already collapsed with thousands more on the brink.  Banks on the other hand appeared much safer, the government seemed to be willing to throw money at them in order to restore confidence and keep them solvent, and the banks were not bogged down with the awful real-estate portfolios that were sinking the Savings Banks.


Actually, the banks were in much worse shape ([27]), in spite of having more diversified portfolios.  The banks saw an opportunity to make quick money in Latin American, invested almost everything there, and the countries tanked.  In order to prevent financial chaos, the Treasury came up with all manner of new rules, which made the worthless collateral that the banks were holding appear to have value, at least from a regulatory point of view.  The American Government stiff-armed both the International Monetary Fund and the World Bank to throw dollars at the problems in Latin American and ultimately the countries  were able to come back.  Lastly, the government mandated that the usurious interest charged by credit card companies owned by the banks was somehow totally legal.


This form of debt floated with the prime rate and if the banks decided to make more money all that they had to do was widen the differential between lending and borrowing.  The same option was available on Bank Savings Accounts, which normally paid interest based on either the prime rate, the discount rate or Libor, whatever worked the best for those institutions.  Thus, while both the Saving and Loans and the banks were in equally precarious positions, the U. S. Government having only enough credit U.S. Government to save one or the other, naturally chose to save the banks.


The Reagan Years


An ex-actor named Ronald Reagan blew Carter out of the White House.  Reagan concocted all kinds of new economic theories that sounded good but that nobody understood and that was the way it was meant to be.  They did know that anything was better than the peanut salesman from Georgia and his band of crackers.  Reagan espoused some unknown philosophy he referred to as deregulation.  It was intended to let everyone do whatever they wanted.  When we went to school, we called it anarchy and we were told that these kinds of people were murderers and even worse.  By calling it deregulation, none of the college professors were able to determine what he meant and many said that it must be good.


However, it was good for some and very bad for others.  Let us take a look at the differences between three very different industries; Banking, Stock Brokerage and Savings and Loans.  We are only going to analyze them from one point of view and that is what effect deregulation would have on each of them.  Let's take a look at the Savings Bank first.  The average head of a Savings Bank knew every piece of property within his lending area.  He had probably grown up in the neighborhood and inherited his position from his father.  He or other people at the S & L knew the borrowers and what kind of people they were and what kind of jobs they had.  They also knew what the replacement cost was on the property that they held as collateral and they knew what the percentage of equity they had.


All in all, they were very knowledgeable lenders and as long as anything didn't go too far askew, they would be in good shape.  On the other hand, they knew nothing about the outside world, their employees were minimum wage people that lacked any skills whatsoever.  They could be trained to perform reasonably in the one-dimensional job they had but, asked to split the atom or find their way downtown, they would be equally lost with either scenario.  


These were the guys on the firing line when things did go askew and they were still there when the actor came up with his new plan to save the world.  Deregulation was the Savings and Loan industry's poison pill.  Suddenly, they could get involved in other securities, buy buildings instead of only lending on them, purchase corporate bonds and even take over their competitors.  The only thing wrong with this is that they all tried at once to turn an industry that had not ever made a change in philosophy into one that didn't know which street to go barking up next.  There was also this guy in New York at that big fancy brokerage firm called Drexel Burnham.  You know, Members of the New York Stock Exchange, these guys had a fellow there that specialized in helping the Savings Banks get higher interest rates with things called junk bonds.  Although they didn't sound very nice, he assured everyone that these bonds would perform and by buying these instead of putting on mortgages you could substantially improve your overall yield.  These junk bonds came with things called kickers as well.  They also had warrants, rights, and convertible features.  They even came with things that were hard to understand called exploding equities.


Those young men from Wall Street would come to call in their pin striped suits  and they would sell the savings bank people things called repo's and then they wanted them to buy reverse-repo's which seemed to be the opposite of the repo's.  No one understood either so it didn't matter a lot but it appeared to be good and this became when of the best reasons for thrift failure the we are aware of.  Some of these fellows explained to the heads of the Savings Banks that by lending the brokerage firms their hard earned collateral, they would become rich.  They would give the brokers their collateral and get back something less.  Usually the broker used the difference to support and affluent life-style.  This allowed the broker to con even more savings & loan people because they saw the fancy cars and the planes and the beautiful women and homes and they wanted into the action as well.  If by giving the broker some of their collateral it would get them the better things in life, they wanted in.  What they got for their trouble, usually was a Chapter II filling, they weren't it was Chapter VII.  They didn't seem to want to  understand the highly difficult concept that there is really never any free lunch.

This was, when all was said and done, like taking candy from a baby.  Not one of these schemes was destined to work for the Saving & Loans although the brokers made a pretty penny in the process.  It was just a matter of highly educated people in pin stripped suits spouting a lot of big words doing to the S & L's what the traveling medicine men did to the same townspeople a hundred years before.  The only difference was that most of the townspeople survived the medicine and were out only a couple farthings.  The pinstripes left the S & Ls  and buried and their guy in charge not only lost everything but stood a good chance of going to jail for among other things, criminal stupidity.


Along with these "tools for idiots" many of the Savings Banks started issuing instruments called "Jumbo CDs.”  A Jumbo CD was a CD on steroids that carried a substantially higher rate that the regular issue variety.  On the other had, the purchaser had to go for a lot more money and keep the CD on the rolls of the S&L for an extended period of time.  These products only made the end come sooner to the institutions that were issuing them.  The higher rates on a greater number of instruments made them only that much harder to service.


I think you are beginning to see the point but let me talk for a minute about the banks and the brokerage firms just to make a point.  After the 1929 crash, the banks were very much made the fall guys for the fiasco.  In spite of the fact that history has proven that they didn't do a lot of the things that they were accused of, there had been a heist in town and someone was going to dang well swing for it.  The banks swung.  An law called the Glass Steagall Act was passed and in general it prevented the banks from going into business that they owned other than banking, sticking within their territory, lending money and charging interest.  Not a lot different than the regulations governing the thrifts.


While the United States Banks were hamstrung, the banks in the rest of the world resembled the Wild West.  Regulations if they existed at all were weak and not enforced.  After World War II had ended, the global banking systems were in taters and the only place on the globe where there was an appreciable amount of money was the United States.  The American banks were not restricted from investing in foreign subsidiaries that had to conform with local laws, which more often than not didn't exist.  American Banks somehow or another got into almost every business in the world through their overseas investments and whenever Congress determined that they were pushing the envelope, the banking lobby stepped up to the plate and brought the votes.


The Saving & Loans on the other hand were restricted from making these kinds of investments and was far from organized politically the way the banks were.  They had no agenda and were staffed with people who were unaware of what was going on in the next neighborhood; forget about Europe or the Far East.  Where money center bank employees came from the Ivy League, Savings and Loans senior executives went to the school of hard knocks and there was not a college graduate in the average institution throughout the 1960s and 70s.  Deregulation to this group of locals was like throwing oil on a fire.  It would consume them.


The stock brokerage business was similar to the banks.  They had more leeway relative to product development and with the help and guidance of the Securities and Exchange Commission they were able to come up with a string of new products to entice investors.  Pay on Wall Street in the employee of brokerage houses was even better than it was in the money center banks and the top of the “B” School class gravitated to the Street.  Brokerage houses invaded Japan before the banks ever thought of the idea and they were in London soon after World War II had ended.  Eventually their nets encompassed the free world and as in the case banks, overseas regulations were slim or non.  Brokerage firms were highly qualified to exist in Reagan's deregulated environment.  They had been doing it for 40 years.  Matching these guys up against the S & Ls was just a game in seeing how long it took to literally clean the community they were in bone dry.  Instead of deregulating, Reagan should have enlisted the help of the National Guard when the slaughter became uncontrollable. 


Beverly Hills Savings & Loan, A Trustworthy Institution


Beverly Hills Savings and Loan is an institution that made everyone one of the mistakes listed above and probably a number that we haven't even touched on.  Their first move was to change from a Federally Chartered S & L to a State Charted institution.  Thus, they were able to become even more aggressive with their actions as the California Charter allowed even more leniency than did the Federal Charter.  Jumbo Certificates of Deposit was the next important field of endeavor for Dennis Fitzpatrick, Beverly Hills Savings & Loan's (BHSL) chief executive officer.  He went to the brokerage community for help and they were more than happy to oblige for a substantial fee.


The program was a success and mid-sized BHSL had grown in the four years from 1980 to 1984 from $290 million in deposits to $2.3 billion.  The next order of importance was getting this money out-to-work profitably.  The thrift entered into joint venture agreements with contractors that gave them a piece of the equity on the upside by literally giving up the comfort of being a creditor.  Thus, they began betting big on the California real estate, which at the time was boiling.  It soon turned ice cold.


In the midst of this no-lose program, a California developer noticed how BHSL had grown and bought a large block of the stock and announced that he was starting a proxy fight.  Not wanting to share their potential profits with this interloper, BHSL brought in a white knight that was carrying around a lot of baggage.  The white knight offered to help up proposed that he would exchange many of his properties for stock in BHSL.  The stock would water the shares of the Savings Bank while putting more power in the hands of incumbent management.  This temporarily kept the wolf from the door but took a big bite out of what had been a reasonable healthy institution.  An independent study of one of the properties that had been assigned to BHSL by the White Knight should have sent a chilling message to the institution but they were forced to believe otherwise.


"With the exception of three buildings, the property has not been painted in some time, the gutters are falling down, the downspouts are off, porches have little or no screens, there is rotten wood, windows are broken, front doors are peeling, the landscaping is almost nonexistent, pavement is broken up, and large areas are not paved at all."


"Very large dogs roam the grounds, residents work on cars on Saturday and Sunday in the parking lots, motorcycles, bikes and neglected wood piles abound in breezeways, on patios, and on walks.  Basketball goal sag, the word "pot" was spray-painted in white on the end of a two-story brick building.  The laundry room, which was just completed six months ago, was filthy and looked about six years old.  The pool area is scraggly; a cover on the pool has two feet of water on it.  There is no pool furniture."


"An apartment was filled with sewage, under almost all of the building there is between three to fourteen inches of water, appliances are missing from almost all vacant units, all carpets need to be replaced, all appliances, if they are there, are in bad, if not inoperable condition, and should be replaced.  This includes stoves, dishwashers, refrigerators, disposals, and traps.”  ([28])


The White Knight had double dealt BHSL.  The property discussed above turned out to be one of the better properties in the package that had been exchanged.  BHSL in an effort to prop up their failing empire meet with Michael Millikan and his people.  They were told to purchase some particular junk bonds that would solve all of their problems.  Three hundred million was thrown at the junk bond market and it did not take long before the companies that they had invested in started to collapse like a house of cards.


In spite of new management assuming control, a close look at the books it now made it appear that things were going from bad to worse.  In the third quarter of 1984, BHSL reported a $10 million loss as opposed to a profit in the previous period a year ago, but that was only the beginning.  The 1984 audit of the company was delayed and a terse announcement made that the company could have suffered a loss of $100 million in the previous year.  That was not particularly good news for shareholders in that the total assets of BHSL had only been $35 million at the start of 1984.  Thus, anyone that had finished the second grade could swiftly figure out the fact that BHSL was under water by no less than $65 million.


There was no question that this represented a death knell for the company and everyone jumped in to find out what had gone wrong.  Part of the report issued by the FSLIC was not kind to the auditors, Touche Ross.  It said in part:


"…Touche rendered its written opinion that Beverly Hills Savings & Loan's consolidated financial statements "present fairly the consolidated financial position of Beverly Hills Savings and Loan Association and subsidiaries … in conformity with generally accepted accounting principles applied on a consistent basis.”  At the same time Touch rendered these written opinions, it knew or should have known that such opinions were materially false, inaccurate and misleading in that BHSL's consolidated financial statements as of December 31, 1982 and 1983 did not present fairly the consolidated financial position of BHSL and subsidiaries as of those dates…”  ([29])


Congress Takes A Look


This wasn't the only thing that Touche Ross did wrong.  They had used some magical accounting in BHSL's entry into the construction business.  When things didn't go as planned they switched to books around to reflect a deal, much different then the one that had originally had been made in order not to reflect the write-offs that would be necessary under the first arrangement.  This Alice & Wonderland booking did not make any friends for Touche Ross in Congress and Mark Stevens in his Book, The Big Six once again shows us an interesting exchange that took place between Nelson Gibbs, a Touche Ross partner and Representative Dingell's subcommittee that was investigating the bizarre happenings at the Savings & Loan.  Dingell ate Gibbs' lunch in an exchange.


            Dingell:          On what grounds could they be accounted for as loans?



Gibbs:             Based on the contractual relationship between the parties and the equity in the interest          


Dingell:          What was the equity at this particular time?


Gibbs:             The Amount of the equity?


Dingell:          Yes


Gibbs:             I don't know.


Dingell:          Was there any equity?


Gibbs:             I believe there was, yes.


Dingell:          You believe or you know?


Gibbs:             I believe there was.  I don't know the amount.


Dingell:          You don't know?  You don't know the amount?  You believe.  Now, when one believes, one believes without knowledge.  I believe in the Holy Trinity.  I do not understand them.  I have never seen them.  I do not know what they look like.  I do not know how they function together.  But I believe in them.  Bud I do now know.  I believe.


                        But I know that you are sitting there at the witness table.  That is knowledge.  You understand the difference?



Dingell was only getting warmed up to the task at hand.  Having philosophized with Gibbs relative to the meaning of life he got into the meaning of the agreements;


Dingell:          What was it that caused Touche Ross to agree that these loans could be properly accounted for as loans rather than equity transactions.


Gibbs:             The change in the relationship between the two entities, the legal form of the transaction, and the cross-collateralization agreement.


Dingell:          Were any of these properties making money?


Gibbs:             Most of the properties were servicing all prior debt, and in that context, there was positive cash flow.


Dingell:          Positive cash flow, but were any of them making money?


Gibbs:             Making money in a financial, accrual accounting sense, no.


Dingell:          Okay.  So in point of fact, money was moving through the books, but not enough to amortize the anticipated debt, is that right, to put it in layman's terms?


Gibbs:             Yes, that would be a fair statement.


Dingell:          So what they were doing, in point of fact, was really moving toward bankruptcy, is that right?  When you have money moving through the books but not enough to pay off the debts, you are just moving slowly toward bankruptcy, or maybe you're moving very fast.



Once again, we come to rely on some of Mark Stevens’s research that appeared in his extraordinary book about the "Big Six.”  He shows without question that the bank and everyone literally knew what was going on all the time.  He quotes and internal memo from BHSL's internal auditor, Ellen Goodman that leaves nothing unsaid:


"We have completed nearly two years of audit procedures on the major loan files.  The audit department's findings, McKenna's [McKenna, Conner & Cuneo, BHSL's outside legal counsel] findings and even the Leventhal [Kenneth Leventhal, a CPA firm specializing in real estate transactions] study all support the conclusion that remedial action is needed in major loan department operations.  What is disturbing is not as much the severity of the errors as the volume of exceptions noted time after time.  It would probably serve no useful purpose to correct most of the individual exceptions post mortem; however, the underlying fundamental issues do need to be addressed."


            I would categorize these recurring problems as


(1)          Violation of association policy and procedures

(2)          Violation of regulatory requirements

(3)          Inconsistencies and questionable practices…


Goodman went on to give chapter and verse:


"Staffing: It appears that everybody is conscientious and for the most part competent; however, the quality of the work is still lacking.  With the rapid expansion of the department, it could just be that they are in over their heads with respect to organization, administrative abilities and technical expertise."


Regulatory Requirements: I have noted with one or two exceptions, no one in the major loan department has a copy of the California Guides.  I recommend that several copies of these, and the regulations for other states in which the association conducts business, be maintained in the major loan department."


Goodman spoke plainly and there could be no question what was meant in the materials that she circulated in internal memos, which were given to the Touche Ross people.  Their attorney admitted that the firm: "did review the internal controls at Beverly Hills and utilized the results of that review in setting the audit scope.  Ms. Goodman's concerns as expressed at the time were taken into account in the course of the review."


We find it most pathetic that the internal auditor is telling everyone that wants to listen, literally that the institution is out of control, the accountants make absolutely no bones about the fact that they read the memo and yet the issued clean statements for the bank for the two years before it collapsed in a heap.  We are talking about auditing errors literally in the hundreds of millions of dollars.


Once again, Congress wanted to know why the accounting firm had not listened to what they were being told.  Touche while testifying and in particular discussing the records of former vice president Robert Newberry was told that all of his files were contained neatly in seven boxes and one box contained shredded paper work of the Newberry’s.  Touche indicated to Congressman Wyden who was pressing the issue that it seemed odd that they could be happy with records that contained a shredded box:


"How can your firm be so sure in its conclusion that there were no irregularities when one of the eight boxes which contained relevant information was "accidentally shredded"?…  Is the shredding machine at Beverly Hill big enough to shred an entire box of documents all at once, or do they have to feed the documents page by page?  How an independent auditor could stand by and watch or, even worse, simply go along with the construction of an elaborate financial house of cards that ultimately consisted of nothing more that blue smoke and mirrors.  When combined with an incredible series of poor investment decisions, mismanagement, and apparent self-dealing, the result was inevitable --total collapse."  


We rest!

Call Me Mr. Keating, Sonny

Charles Keating was a former swimming champion and worked as a lawyer for raider Carl Lindner.  It was from Lindner that he  started his ball rolling by buying American Continental Corporation, a house-building company in Ohio in 1978.  From there, he raised the money to acquire Lincoln Savings and Loan of California (Lincoln) through a junk bond offering floated by Drexel Burnham ([30]).  In his commitment to the regulatory officials that controlled the thrift's license, Keating promised faithfully to stay with the course with the same management that existed before the takeover for the reason that the regulators felt that they had done such a good job.  Moreover,  the California regulators also extracted the promise form Keating that he would not sell jumbo CD's to facilitate the thrift's growth nor would he go out of the Savings & Loan's principal business of issuing home mortgages.  Faster than you could say “liar, liar, your house is on fire”, Keating had fired the incumbent management, issued jumbo CDs and started working in concert with developers to get into massive proprietary real estate projects.


Once Charles became president of Lincoln and sold worthless bonds to 23,000 people, primarily California residents directly from the thrift’s branches, by causing them to somehow believe that the United States Government had guaranteed them.  ([31]) When Lincoln was forcibly closed in 1989, only slightly more than 2% of the over $5 billion dollars in assets that Lincoln reported were in residential mortgage loans, almost 70% in risky land deals and eventually cost the taxpayers of the United States over $2.5 billion.


Lincoln’s investment philosophy under Keating’s guidance included takeover stocks, hotels, junk bonds, financial futures, and high-risk loans, which ultimately accounted for over 60% of the S & L’s assets ([32]).  Keating took these investors for everything they invested, but that wasn’t all, the bailout paid for by American Citizens required another $2.5 billion before the loop was closed.  Lincoln became the largest S & L failure in U. S. History and its conspirators were charged with concealment of illegal cash payments, securities fraud, racketeering, conspiracy, transporting stolen property, forgery, and false and misleading statements made to the regulators.


An example of the activities that were taking place during Keating’s reign at Lincoln is the following story that describes it to perfection:


“One of the most scrutinized of Lincoln’s multimillion-dollar real estate deals was the large Hidden Valley transaction that took place in the spring of 1987.  On March 30, 1987, Lincoln loaned $19.6 million to E. C. Garcia & Company.  On that same day, Ernie Garcia, a close friend of Keating and the owner of the land development company bearing his name, extended at $3.5 million loan to Wescon, a mortgage real estate concern owned by Garcia’s friend, Fernando Acosta, The following day, Weson purchased 1,000 acres of unimproved desert land in central Arizona from Lincoln for $14 million, nearly twice the value established for the land by an independent appraiser one week earlier.  Acosta used the loan from Garcia as the down payment on the tract of and signed a non-recourse note for the balance.  Lincoln recorded a profit of $11.1 million on the transaction—profit that was never realized, since the savings and loan never received payment on the non-recourse note.


In fact, Lincoln never expected to be paid the balance of the non-recourse note, Lincoln executives arranged the loan simply to allow the savings and loan to book a large paper gain.  Garcia later testified that he agreed to become involved in the deceptive Hidden Valley transaction only because he wanted the $19.6 million loan from Lincoln.  Recognizing a profit on the Hidden Valley transaction would have openly violated financial accounting standards if Garcia had acquired the property directly from Lincoln and used funds loaned to him by the savings and loan for his down payment.  Acosta eventually admitted that his company, Wescon, which before the Hidden Valley transaction had total assets of $87,000 and a net worthy of $30,000, was only a “straw buyer” of Hidden Valley property.  In a Los Angeles Times article, Acosta reported that Wescon “was too small to buy the property and that he signed the documents without reading them to help his friend, Ernie Garcia”[33]


Keating couldn’t have stolen $250 million without substantial help.  Three accounting firms, Arthur Andersen & Company, Touch Ross & Company and Arthur Young and Company, along with three law firms, Kaye Scholer; Sidley and Austin and Jones Day, stock broker, Drexel Burnham Lambert and Michael Milken individually paid over $240 million in settlements regarding their actions in regard to Lincoln’s failure.  These firms were charged with allowing Lincoln Savings and Continental to hide the truth about the real state of affairs underlying their financial data ([34]).


Keating could personally spend Lincoln’s money as fast as it could come in the Lincoln’s door.  His lavish parities were the envy of the jet set and a literal cross section of Who’s Who would be present whenever it became known that Charlie was going to throw another bash.  American Taxpayers, directly paid for spending of this nature, because Keating wrote a voucher for literally every nickel he ever spent and would turn them in and get re-paid back from Lincoln as a company expense.  Luxury vacations, private jet planes and lavish lunches and dinners were only the start.  Keating lived the good life on money illegally drawn down from Lincoln.


Keating also had a team of U. S. Senators to whom he had transferred $1.3 million in campaign contributions who would plead his case at the drop of a hat.  Arizona’s DeConcini and former presidential candidate McCain, Cranston of California, Riegle of Michigan and former astronaut Glenn of Ohio became known as the “Keating Five” for their cozy relationship with him.  He was also able to secure a job on the Bank Board as Commissioner to man that was substantially in debt to his institution.  Talk about conflicts, it was the Bank Board that regulated Lincoln.  He was also able to hire, now Chairman of the Federal Reserve to lobby for him to increase Lincoln’s “direct investments.”  Eventually, Greenspan wrote a letter to a California bank regulator regarding Lincoln management stating: “seasoned and expert with a long and continuous track record of outstanding success in making sound and profitable direct investments.”


Keating remained arrogant until the end and once again we can sum up his attitude with a quote from the man himself:


“One question, among the many raised in recent weeks, has to do with whether my financial support in any way influenced several political figures to take up my cause.  I want to say in the most forceful way I can: I certainly hope so.”  ([35])


Keating collected other famous people in the same way he was able to draw in the senators, at his trial among the 120 letters were submitted by notables in his defense.  One, from Calcutta; sent by Mother Teresa pleaded his case by pointing out how generous to the Indian poor he had been.  Mother Teresa should have given some thought to the poverty his schemes had created in the United States.  The money that was spent by the American people to rectify the damage caused by Keating could have fed every man, woman and child in the City of Calcutta for over a decade. 


Their theory was that the Farm Home Loan Bank Board Chief, Edward Grey and other regulators were too tough on Lincoln.  The ammunition for the theory was provided by an Arthur Young analysis, which gave Lincoln high operational marks.  Incidentally, the author of the Arthur Young analysis, Jack Atchison, soon left for the employ of Mr. Keating at Lincoln at three times the salary ([36]).  Congress asked a lot of question regarding Atchison’s dual role and in particular, Congressman Lehman was grilling an Arthur Young senior official, William L. Gladstone:


Congressman Lehman:     Did anyone at Arthur Young have any contact with Mr. Atchison after he left and went to work for Lincoln?


            Mr. Gladstone:                      Yes Sir.


            Congressman Lehman:     In the course of the audit?


            Mr. Gladstone:                      Yes


Congressman Lehman:     So he went from one side of the table to the other for $700,000 more?


Mr. Gladstone:                      That is what happened,


Congressman Lehman:     And he—just tell me, what his role was in the audits…when he was on the other side of the table.


Mr. Gladstone:                      He was a senior vice-president for American Continental when he joined them in May 1988.


Congressman Lehman:     Did the job he had there have anything to do with interfacing with the auditors?


Mr. Gladstone:                      To some extent, yes.


Congressman Lehman:     What does “to some extent” mean?


Mr. Gladstone:                      On major accounting issues that were discussed in the Form 8-K, we did have conversations with Jack Atchison.


Congressman Lehman:     So he was the person Mr. Keating had to interface with you in major decisions?


Mr. Gladstone:                      Him, and other officers of American Continental



It was unquestionable a conflict for Young to be interfacing with one of their former employees in their role as Independent Auditor for Lincoln.  They had made some terrible mistakes and apparently didn’t know how to handle the resolution of them and were literally floundering.  Kenneth Leventhal was asked to act as an independent forensic evaluator of what had occurred.  They never mentioned anyone by name but there was no question to any one reading what they had to say as to who they felt the villains in matter really were.  


 “Seldom in our experience have we encountered a more egregious example of misapplication of generally accepted accounting principles?  This association (Lincoln) was made to function as an engine, designed to funnel insured deposits to its parent in tax allocation payments and dividends.  To do this, it had to generate reportable earnings.  It created profits by making loans.  Many of these loans were bad.  Lincoln was manufacturing profits by giving money away.”  ([37])


In their, take no prisoners report, Leventhal laid the blame where it should well have been placed.  Arthur Young countered with the fact that, by number Leventhal had only check 15% of the real estate transactions that Lincoln had made and that under the circumstances, without getting a greater cross section, Leventhal retorted that their check covered approximately 50% of the transactions the Lincoln was involved in and there for Young was literally trying to blow smoke.  In addition, they pointed out that of the transactions that they went over, something was literally wrong with every one.


Congressman Leach even found a problem with Young relative their approach with the investigating committee:


Congressman Leach:                 I am going to be very frank with you, that I am not impressed with the profession ethics of your firm vis--vis the United States Congress.  Several days ago, my office was contacted by your firm, and asked we would be interested in questions to ask of Leventhal.  We said.  “Surely”.  The question you provided were of an offensive nature.  They were to request of Leventhal how much they were paid, implying that perhaps based upon their payment from the U.S. Government that their decisions as CPA’s would be biased.  I consider that to be very offensive.


Now, in addition, one of the questions that was suggested I might ask of the Leventhal firm was: Could it be that their firm is biased because a partner in their firm did not make partner in your firm?


Mr. Gladstone:                          I do not know who contacted you and I certainly do not know how the questions were raised.


In effect, one of the senior partners of Young was indicating that he wasn’t sure that it was a Young employee or even whom it was that had provided the questions.  Naturally, it would have extremely odd for the defense team representing Young not to have gone of the matters relating to Gladstone’s potential questions and answers from Congress.  It was later determine of course, that it indeed was one of the people from Young that had provided the questions to the panel.  Leach had time to reread the report and countered with:


Congressman Leach:                 I read that report very carefully, and I found no angry vengeful sweeping statement.  But I did find a conclusion that Arthur Young had erred rather grievously.  In any regard, what we are looking at is an issue that is anything but an accounting kind of debate.  One of the techniques of Lincoln vis--vis the U. S. government was to attack the opposition.  You are employing the same tactics toward Leventhal….  I think that is unprofessional, unethical and, based upon a very careful reading of their statement, irresponsible.


Now, I would like to ask you if you would care to apologize to the Leventhal firm.


Mr. Gladstone:                          First, Mr. Leach, I stated in my opening remarks that I believed that their report was general and sweeping and unprofessional, because (what) I would call unprofessional about it is the statement that looking at 15 transactions that therefore they would conclude that nothing Lincoln did had the substance—


Congressman Leach:                 I have carefully read their report, and they note that they have just been allowed to look at 15 transactions.  They could not go into more detail, but they were saying that American Continental Corp. (Lincoln’s owner) batted 15 for 15, that all 15 transactions were unusual, perplexing, and in their judgment in each case breached ethical standards in terms of generally accepted accounting principles.


Your firm in effect saying, “We think that there may be some legal liabilities.  There, we are gong to stonewall, an we are going to defend each and every one of these transactions.”


I believe that you are one of the great firms in history of accounting.  But I also believe that big and great people and institutions can sometimes err.  And it is better to acknowledge error than to put one’s head in the sand.


I think before our committee you have righteously done that.                                                      



Of particular interest is the fact that both the accounting and law firms involved had impeccable reputations both before and after the Lincoln debacle.  If they had not cooperated, the repercussions of this felony would certainly have been less devastating.  Keating, found guilty of felonies, is in prison and has declared bankruptcy.  I am sure this has not assuaged his victims.


During the congressional hearing that had been enabled to review the thrift industry in general and Lincoln in particular so that it could be determined what went wrong.  During the hearing Congressman, Jim Leach named everyone as guilty parties:


I am stunned.  As I look at these transactions, I am stunned at the conclusion of an independent auditing firm.  I am stunned at the result.  And let me just tell you, I think that this whole circumstance of a potential $2.5 billion cost to the United States taxpayers is a scandal for the United States Congress.  It is a scandal for the Texas and California legislatures.  It is a scandal for the Reagan administration regulators.  And it is a scandal for the accounting profession.”  ([38])


The Securities and Exchange Commission started an investigation on the various securities problems that had been inherent in the entire Lincoln mess.  The biggest of the violations occurred when Lincoln set up offices in their facilities to push debt instruments which most people were led to believe were guaranteed by the government.  Richard Breeden was particularly vocal about the fact that Arthur Young was not helping the SEC in any way with their investigation:


Commissioner Breeden: We subpoenaed the accountants (Arthur Young) to provide all of their work papers and their back up.


Congressman Hubbard: Do you know if they were forthcoming and helpful in helping you resole some of these questions, or helping the SEC resolve some of these questions?


Commissioner Breeden: No.  I would characterize them as very unhelpful, very unforthcoming, and very resistant to cooperate in any way, shape or form.  ([39])


Remember Lance Ito, the California Judge that received so much publicity during the O. J. Simpson trial.  Ito also was the presiding judge in the Lincoln case.  Well, Ito was no Keating fan and sentenced him to 10-years in jail for securities violations.  In a concurrent case running in federal court, it must have been felt that Keating had gotten away with murder under Ito’s guidelines and they handed him an additional 12 years behind bars just for good measure.


But Keating was if anything, a gladiator, he appealed the Ito decision claiming that incorrect instructions were given to the jury.  He was found to be correct and Ito was overturned on appeal.  This same judge was simultaneously hearing an appeal of the federal case on the same grounds.  If he overturned one, how could he not overturn the other?  It seems that the Judges in both cases did not check to see if any of the jurors were aware of Keating’s conviction in the rival case and because some had been aware of what had gone on before, it was determined that Keating did not receive a fair trial.


By this time, Keating had already been jail waiting the outcome of his various appeals.  The government announced that rather than see Keating walk, they were going to retry the case.  When push came to shove, no one really wanted to do that whole thing all over again and just before the trial was to reconvene, both sides worked out a deal.  Keating would agree that he had indeed done something terribly wrong ([40]) and for their part, the government would agree that he had been in jail long enough and would let him go.


Out of a total of 22-years in sentences that Keating had been given, he only served approximately 25% of that time in jail.  In the meantime, everyone else involved with Keating suffered substantially in the derivative lawsuits that had been brought against one and all for helping to create the disaster.  Three accounting firms were involved with Keating and Lincoln in one way or the other and the costs to all of them were not insubstantial.  Young’s bizarre defense was a disaster waiting to happen and it did.  They really came out looking like the villains in the case because of the hardball manner in which they conducted their defense.  In the end, it did them little good and made the firm look like the villain, not an innocent party that had been set up by an ogre.



Silverado Banking Savings & Loan, Just Plain Lost Its Luster


The progeny of high-ranking officials benefit in strange ways from their father’s office.  So it was with Neil Bush and a bizarre financial Institution called Silverado Banking Saving & Loan.  The Kansas Federal Home Loan Bank was the ultimate regulator for Silverado.  Although regulators auditing the bank in 1986 found a massive fraud, their efforts to close it by serving a cease and desist order on March 10,1987 were reversed by Kermit Mawbray, president of Kansas Federal.  Because of Mawbray’s actions, it has been estimated that the fraud’s cost to American Taxpayers rose from about $400 million when the scam had been discovered to almost a billion when the institution was finally closed down due to Mawbray’s intransigence.


Eventually, the Federal Deposit Insurance Corporation sued the Board of Directors of Silverado for $200 million for their part in the fraud and more specifically for their negligence in allowing the thrift to make high-risk loans and investments while simultaneously concealing its virtual insolvency.  According to government officials, the high-risk loans produced substantial fees for Silverado, which in turn paid outrageous salaries to its top officials.  Many of the major developers who were recipients of the Savings Bank’s largesse were business associates of Neil Bush, the son of then President George Bush.  The reputations of those people were highly questionable and several in depth stories have been written about their backgrounds


In the meantime, one of the men, Bill L. Walters, had loaned a substantial amount of money to Neil Bush before he was affiliated with Silverado, once appointed to that board of Directors, Bush repaid Walters’ generosity in spades.  Bush was helpful in getting Walters a series of loans amounting to over $100 million, with the help of the rest of the Silverado board.  After the books on the thrift’s debacle had been closed, the Office of Thrift Supervision (OTS) estimated that those particular Walters loans had cost American Taxpayers $45 million.


The final score in the closing of the thrift was that the American people were out $1 billion.  Of the $200 million accessed the directors of Silverado by the Government, a Directors and Officers liability policy took care of $26.5 million and another $23 million had been held out by the savings bank early on for use on a rainy day.  Well it was pouring; $23 million was paid from that fund in a total negotiated settlement of the problem.  Bush got a cease-and-desist order from the OTS for his part in the matter, which is about as small a penalty as was conceivable.  A push was made with U.S. Attorney General Thornburgh to appoint an independent prosecutor to investigate both Bush and Silverado.  You know that that idea didn’t go anywhere.


Michael R. Wise, the former CEO of Silverado, was indicted in 1992 by a Federal Grand Jury regarding a loan to him by his own bank.  Ultimately, Wise beat the case and walked with only a simple cease and desist order.  It would have been hard for the government to have convicted Wise of anything when it probably would have also brought in other Silverado directors and officers into the case.  On the other hand, Wise was sentenced to 3 years in Leavenworth in 1999 after he plead guilty of stealing $9 million in an unallied matter from Aspen investors in a case fraught with wire fraud.  The strangest twist that this case took was the fact that Wise had 23 year-old filing clerk by the name of Anne Liv Slemmons.  She watched all of the stealing going on and grabbed $110,000 for herself.  She got 96 months of hard time to Wise’s 42 months in a white-collar facility.  You could kind of wonder how they figured that one out; then again, the wheels of politics sometimes grind in strange ways.


Many people were interested in what the government had actually uncovered in the Silverado affair but all attempts to view papers covering the matter that were forwarded to the OTS were denied.  Interestingly enough, Bush’s defense along with that of other defendants was the fact that everything that he done while on the Board at Silverado was approved or sanitized by the OTS itself.  They too had asked for the records so that they could prove that fact in court.  If you believe that one, I think that you will love this bridge I have for sale.  The fact is that Bush probably knew that the information was never going to be released and used it to his own advantage.  We call this on Wall Street a “red herring.”  Many say that it was only this ploy that enabled the government to make the very favorable settlement with the President’s son as well as others.


Coopers and Lybrand were the auditors for Silverado and consistently proclaimed that the thrift was in excellent shape.  At the time that Coopers was putting out audited statements showing the Savings Bank’s health to the tune of positive earnings in 1986 of $15 million, the real number turned out to be a loss of the same amount of money in that very same year.  When you aren’t paying attention it is not hard to change a minus sign to a plus sign.  As opposed to being the picture of health, Silverado was a disaster and hardly solvent.  Coopers was also hit with a cease and desist for its “abusive and self-serving actions.”  One week to the day after the cease and desist had been presented, they received a lucrative contract from Resolution Trust to manage almost $300 million in loans and real estate from other failed thrifts.


Hey, when you are on the right side, you are on the right side.


Bank Management Is Weak and Unprepared For an Unregulated Environment.


So, you don’t lose track of recent history, return with us now to those thrilling days of yesteryear, just a couple of years ago, when the banking and the wild west were synonymous.  Just so we don’t forget, the following represent a series of vignettes concerning recent problems in the banking industry.  Rumors had started to spread that the Bank of New England was in trouble.


“Worried depositors phoned their banks for reassurance.  And the three phone lines at Veribanc Inc., a Wakefield (Mass.) company that ranks banks’ safety, were jammed for days after the run on BNE.  “It’s sad,” says Warren Heller, Veribanc’s research director.  “There’s beginning to be a recognition that not all banks are safe.”


“Why are folks so worried?  It can’t help that the nation has plunged into recession.  Or that a war may be waged in the Mideast.  That’s enough to set people on edge.  But depositors have more direct reasons to fret.  One big concern is that the regulators might not be as generous in future bailouts.  Indeed, the FDIC paid big depositors at New York City’s Freedom National Bank, a black-run bank that counted Jackie Robinson among its founders, just 50 cents on every dollar on deposit above the $100,000 maximum when it failed last November.  Those that have lost money include not just wealthy individuals and businesses, but local churches and charities….


“Yet the banking industry these days is far from healthy. Commercial real estate loans continue to sour as office-vacancy rates rise and the real estate market deteriorates. “It’s not unique to New England,” observes Lawrence K. Fish, Bank of New England’s Chief Executive. “The economy, and particularly the real estate markets are continuing to slip.” Loan write-offs are 10 times higher than a decade ago. Making the industry’s fundamental troubles more worrisome is the plunging balance in the FDIC’s bank-insurance fund…


The Day Boston Ran Out Of Money

“So the FDIC moved in Sunday night. Almost from the start, regulators agreed to guarantee all BNE deposits. Their big fear: public confidence had been so damaged that other big, troubled New England banks—Bank of Boston and Shawmut among them—would find themselves besieged by depositors clamoring for their money. “Given the condition of the financial system in New England, it would be unwise to send a signal that large depositors weren’t going to be protected,” Seidman said. Moreover, the Fed was concerned about wider damage to the banking system and possible international repercussions. BNE, like other large banks, held over-the limit deposits from other banks, which would have been hurt by getting less than full repayment…


“Nonetheless, the bailout is only a band-aid on one of the industry’s many grave wounds.  Economists fear the credit crunch could worsen in New England, condemning the region’s economy to a lengthy recession. With much of the staff at BNE unsure about their future, many fear that lending officers will spend more time getting their resumes together than looking for new business. ([41])


Global banking as a rule has not been as safe as many in the industry would have us believe.  We tend to forget yesterday’s failures and concentrate on today’s successes. But then again, that is human nature. The Economist in their April 12, 1997 issue put it well:


“…Since 1980, more than 100 developing countries have suffered some kind of serious banking-sector crises. In some of them, reckless lending has left banks with unrecoverable loans that far outstrip their shareholders’ capital. In others, banks have been sculptured by a sudden loss of confidence that led to runs by depositors.


“Many bank-watchers worry that, on the evidence of the past few years, things are getting worse. In Africa, banking systems have been going down the tubes at the rate of two a year. According to the World Bank, between 1988 and 1996, systemic banking crises struck in 20 African countries, five of which had to spend more than a tenth of their GDP to mend the damage.


“In Eastern Europe, banks in almost every country have run into trouble as they swapped communism for capitalism. Hungary’s government has thrice had to bailout state banks that had been sliced off from its communist-era Central Bank, taking with them huge portfolios of bad loans to smokestack industries. Over the past five years, the financial systems of all three Baltic States have been rocked by explosions among the new breed of private banks. The Czech Republic, one of the region’s star economic performers, blotted its copybook with a series of banking scandals and bust-ups that last year threatened a systemic collapse. In Bulgaria, a failure to reform state industry and banking supervision has left banks with a collective negative net worth of over $1 billion.


“Banks in Latin America have been just as accident-prone. Chile suffered a devastating banking crisis in the early 1980s. The currency turmoil in Mexico at the end of 1994 came on top of banks’ over-expansion and careless lending binges that had stored up trouble. Mexico’s problems also tripped up Argentina’s already-wobbly banks as panicky customers drew out 40% of their deposits in early 1995. Venezuela’s banks were brought to their knees by a combination of incompetence and fraud. Several billion dollars-worth of bail-outs later, they are only just learning to stand again.”


“Banking crises are not confined to emerging countries. Over the past decade or so, the rich world too, has had to deal with various financial traumas, including a property-lending fiasco in Scandinavia, America’s $150 billion savings-and-loan disaster and Japan’s current bad-debt mountain. But, except in Japan, these problems have long since been fixed.  In the past five years, the most serious problems in rich countries have cropped up at individual banks, such as Britain’s Barings, which collapsed under the weight of ill-advised derivatives deals, and France’s Credit Lyonnais, which ran up $4 billion ([42]) of loan losses. In emerging markets, by contrast, banking troubles have more of a habit of spilling over into the economy at large.”


“Moreover, such crises have growing international implications. The “tequila effect” produced by the Mexican debacle, not only spread south to Argentina, but briefly reverberated in financial markets, as far away as Thailand. The risk of contagion, economists now say, may be growing as emerging markets forge stronger links with each other - for example, through increased cross-border trade, investment and lending - an become part of global markets. The financial ties between rich and poor countries are also strengthening all the time. Private capital flows, from all sources, to emerging markets have risen steadily, despite the peso crisis. Last year, they reached $239 billion, more than four times higher than flows of international aid.”


This has caused fears that banks, which provide much of the plumbing to carry these flows, will become ever more vulnerable, without a concerted international effort to avert such crises. Multilateral officials have become preoccupied with this fragility. James Wolfensohn, the President of the World Bank, says that banks are the “Achilles heel” of emerging economies, and that one in five of these economies faces a banking crisis. His counterpart at the IMF, Michel Camdessus, has said that the next mishap of the Mexican kind is likely to start with a banking crisis, and has promised that the IMF will concentrate harder on bank supervision. America’s Treasury and central bankers’ committee of the Group of Ten (G10) have joined the chorus of concern.”  ([43])


Neither governments of highly evolved first-world countries nor those of emerging nations, are able to control the international impact of their internal policies; some global oversight is necessary.  Threats to our worldwide financial system can come from over-zealous multinationals, wayward employees, itinerant bankers and nave governments.


Barings, A Singapore Sling


Barings was special.  We have only to quote the Duc de Richelieu reply in 1817 when he was asked about the six great powers in Europe; “England, France, Prussia, Austria, Russia and Baring Brothers”, he replied.  Barings was broker to the Queen of England while being the oldest merchant bank in the country. It was always customary for the Baring people to arrive late for meetings with customers so that their clients would realize how honored they were to be in that kind of company.


Johann Baring was the founder of the lineage we know of as Barings and after starting out as a wool merchant, married well and died as one of the richest people in his community.  His third son, Francis had a penchant for banking and started the ball rolling by successfully acting as a guarantor in commodity contracts.  On the other hand, Francis was also a natural speculator and oversaw a series of disasters such as the time when he attempted to corner the markets in both soda ash and cochineal and got his head handed to him in each.


As the years rolled by, calmer heads took over at Barings Brothers and the company concentrated on financing the British Government’s various wars.  Among which were the American Revolution and the war with France.  Barings also helped the United States finance the Louisiana Purchase in spite of the fact that this indirectly aided England’s enemy, France who was scurrying hither, and yon trying to finance their coming battle against Great Britain.  When Alexander Baring succeeded his father upon his death as head of the banking empire, it was already the largest merchant bank in Europe with the possible exception of the Rothschild’s.


Alexander was brilliant and the bank prospered.  Ultimately the line of succession grew stale, and an American Joshua Bates was brought in to run the show.  Other than the fact that Joshua shared Francis’s penchant for attempting to corner markets and got creamed in an attempted to control tallow in 1830, things were uneventful.  As the years wore on, the Baring’s men acquired beautiful women as wives, expensive paintings as hobbies and peerages in their natural right of succession.  By the middle of the century, the bank was the prime financer to the United States and Canada.  Barings was headed by a succession of over-reaching people who in 1890 made a classical blunder.


The bank had been so successful in everything else that it had taken on that it believed that the name Barings, had enough cache’ to sell anybody anything.  That was at the time when the Buenos Aires Water Supply and Drainage Company came calling.  Baring’s people were not all that familiar with the nuances of Argentina and found that the bank was in the unenviable position of owning literally all of a dismal deal.  Great Britain had their own, “too big to fail” criteria even then and determined that should the bank go under, it could well cause a financial crisis in the country.  They were bailed out at the last minute.


On the other hand, the individual partners were first responsible for the debt that had been run up and it took the sale of everything that had been accumulated over the last 100 years by the partners to make the bailout work.  The family named this period “Deca-Dance” for some unknown reason, but they had learned an extreme lesson during this time.  Speculation had now become a no-no for the Baring Brothers but arrogance was still in.


The only thing that Baring Brothers seemed to accomplish through most of the early twentieth century was their decision not to finance Germany’s recovery from World War I, which avoided another disaster when that country inflated dramatically.  Scandals were about the only excitement that the family generated and the ones that leaked out were legendary.  In 1985, the “Big Bang” came to England with its regulations that allowed for banks to own brokerage firms and the like.  Finally, Barings expanded and jumped into the fray, one small toe at a time. Their sole move in the direction of moderninity was the acquisition of Henderson Crosthwaite a small firm specializing in Pacific Rim securities.  The deal had little to make note of other than the fact that the Baring Family were said not overjoyed by the banks acquisition of a firm run by Catholics.  The man in charge of Henderson Crosthwaite was Christopher Heath who became the highest paid person in London in 1986 with a salary and bonus from Baring Brothers of well in excess of $4 million.  This made the Baring family both happy and sad.  He was making money for them but at the same time, some said that they did not like paying anyone of  his religion that kind of money.


Markets in the Pacific Rim continued to be good for both Barings and Heath.  Japan, especially was a place where Heath could make his presence felt.  Barings Bank became the focal point of English Language research coming out of that area and Barings was the place to go if you needed information about anything that was going on in the region.  Barings seeing the light of day opened offices in Singapore, Geneva, Los Angeles, Taipei, Bangkok, Osaka, Manila, Kuala Lumpur Karachi, Seoul, Melbourne, Sydney, Jakarta, and Paris.  Heath who started with 15 employees now had almost a thousand and his division was accounting for no less that half the bank’s total profits.


Nick Leeson was born Nicholas William Leeson on February 25, 1967.  His father was a plasterer and mother a nurse at a hospital for the insane near London.  Leeson was a slightly above average student in school and had shown some promise in sports.  On the other hand, Leeson couldn’t get into college because of his grades and took a job at Coutts & Co., a subsidiary of the National Westminster Bank.  It was there that Leeson began to receive his early financial education.  After several years, he left Coutts for Morgan Stanley.  Morgan Stanley taught Nick how the back office worked and how integral it was in the total operation.  Leeson became particularly adept at settling futures-and-futures option trades in Japan.  When Baring Securities needed someone to run their Japanese back office, Nick Leeson was chosen from numerous applicants.


Leeson was still hanging out with his old cronies from his former neighborhood on the weekends, whom at best could be called a bunch of hooligans. While at work he had adopted the air and demeanor that fit the bill of an up and coming banker.  When a problem developed in Indonesia, it was Leeson that got the call to straighten it out. Leeson impressed everyone with his work ethic including people at the Hong Kong and Shanghai Bank who asked for Leeson’s assistance in their own operations.  In the meantime, Leeson had arrived for his assignment in Indonesia with a slightly wet-behind the ears attractive female associate from Barings in London.  They worked very closely together in Indonesia and as a result, they became engaged soon after the job had been completed. 


No sooner, had Leeson arrived back at headquarters than he was able to clear up an account that was illegally trading through Barings that ultimately would have resulted in a substantial problem had it not been caught.  Once again, Leeson received accolades and his long-term success at the Bank had been assured.


Leeson, as a result of a job well done and the respect that he had established among his cohorts, got the nod when an office was opened by Barings in Singapore in 1992.  “Besides running the back office, the person who ran the office would also execute clients’ orders on the floor of the exchange.”  ([44]) Leeson had no knowledge of trading whatsoever but believed in himself and took the assignment.  This indeed became the beginning of the end for Barings, as we knew it at that time.


Manhattan Investment Fund Ltd.


When an employee is put in the job of doing the trading and simultaneously has the responsibility for the back office, it is straightforward to envision the ability that this person has to create havoc with the books and records of his employer. People’s motivations run the gauntlet from just wanting to be loved by showing better performance as we observed in the Leeson debacle, to out right robbery of the petty cash, to fraudulently jacking-up earning to increase a bonus pool, as was the situation with Joseph Jet when he single-handedly destroyed Kidder Peabody. But it has been rare when the boss himself gets his hands dirty with unequivocally cooking the books.


In most larger businesses it is necessary to have the inside accountant involved with the boss when he is cooking the books because he needs his assistance in making the illicit entries. Thus, while employees independently can operate their own brand of independent in-house crime syndicate,      the bosses must act in concert with others, most of the time. Manhattan Investment Fund was a horse of another color. Funds of the Manhattan type (Offshore hedge funds which generally preclude American investors) ([45]) essentially depend on two factors for their income stream, funds under management and the profitability of the fund itself ([46]). It stands to reason that the less profitable a fund is, the fewer people will be interested in owning it and thus, the less management will bring to their bottom line. Enormous funds such as Tiger and Soros guessed the market wrong in recent years and the result is Tiger is just about out of business and Soros is no longer the powerhouse that they once were. On the other hand, the rewards for success are tremendous, a piece of the money under management and a nice slice of the profits, in this case 20%.


On occasion a fund that guessed the market wrong, just does not want to deal with their defeat and once in a while they come up with various fraudulent methods of making their performance look substantial better than what it really was. This is what Michael W. Berger, now 29 years old, an Austrian citizen and a New York resident, as well as the manager of Manhattan Investment Fund tried to get away with.


Manhattan Investment Fund Limited was incorporated as an open-ended investment company under the laws of the British Virgin Islands and came with a Tortola address. Berger who at that time was only 24 years of age founded it in 1995. In spite of the fact that he had dropped out of college under strained circumstances ([47]), Berger desperately wanted to be a big time fund manager and he went to work for Salzburger Sparkasse ([48]) Bank as a financial analyst. He soon felt that he had outgrown the job and began publishing a newsletter called “SmartMoney, later called Wall Street Notes, about the U.S. stock market” ([49]) and moved to the United States where he intended to become rich and famous. Before much time had passed, Financial Asset Management Company of Columbus Ohio hired Berger as a technical consultant on the stock market used his market letter in mailings to their clients and he managed some money for them as well. After a short period of time spent in learning the territory, he opened a Park Avenue office and simultaneously retained a Paris based marketing firm to land him investors for his new concept, a money management vehicle, Manhattan Investment Fund.


He also utilized a high-powered public relations campaign in Europe to bring in investors by telling them that the Dow was going to tank and that Internet stocks would drop by as much as 80%. On the other hand, he was a one-horse shop; there were no professionals that worked for Manhattan in any capacity, a fact that should have drawn some investor interest ([50]). On the other hand, his message was not entirely illogical; he thought that the market in various areas was over-priced and that the fund would coin money by shorting these stocks. People bought his concept and the money flowed in, over $500 million of it, primarily from investors in Europe. Not having an existing track record was not a burden to young Berger, as an aid to bring in business, Berger created a record for his performance going back to 1992, three years before the fund was even in existence. He was able to make such a good case relative to his performance in those non-existent years that it helped him originally get the deal off of dead center. As we know, Berger made what seemed to be a logical bet but in spite of the fact that he had guessed miserably wrong, he liked his job, its power and the accoutrements and did not want to give up his position.


He found a simple solution. The firm that was executing his trades was clearing through Bear Stearns & Company, a large New York Stock Exchange Brokerage firm. They sent customers statements to Manhattan Investment Fund where Berger intercepted them and fashioned a similar to the format on the monthly brokerage house statements to which his investors had grown accustomed but changed the name from Bear Stearns to Financial Asset Management, an impressive sounding but hardly sizable, Columbus, Ohio brokerage firm that executed most of Berger’s trades. ([51]) ([52]) While Bear Stearns reports continued to reflect Berger’s dismal performance, Manhattan, considering the investments that they were making, seemingly performed in outstanding fashion, on paper that is ([53]). Instead of consistently losing vast amounts of money, Berger showed gains of 15% in 1996, 30% in 1997, 12% in 1998 and 14% in 1999. In reality, only about 10% the investor’s funds or less remained when the doors were forcibly shut.


In the new fangled electronic world that we live in, rumors of Berger’s appalling performance soon started circulating on the net as well as by world of mouth. Berger logically attempted to stem the tide and put these rumors to bed. He filled a lawsuit against five companies that were not named in the court documents that he swore were saying that his fund was down 30% when in effect, according to Berger, his fund had improved over 7% during the year. While this action was obviously never pursued, the rumors did go away for a time and Berger got a small reprieve that did more harm than good. He started playing even more heavily in those same investments that had already almost totally destroyed his fund and didn’t guess the market any better than he had before.


The outside accountants did not determine to compare the Bear Stearns statements with those furnished by Financial Asset Management and when the dust had cleared, approximately $400 million had been dissipated. ([54]) It was only after Deloittte & Touche, Manhattan’s accounting firm demanded to see additional documentation that they were fired. Naturally, this brought in the Securities & Exchange Commission as well as the class-action lawyers. 


Another strange accounting relationship with Manhattan is the fund’s administrator; Fund Administration Services of Bermuda was an Ernst & Young subsidiary. They also resigned when the facts surfaced ([55]). People close to the situation indicated that both Fund Administration and Deloitte were getting the stock pricing information directly from Manhattan and not from the clearing broker, Bear Stearns, a critical and highly unusual mistake. Apparently though, it was Bear Stearns that ultimately blew the whistle when they received a call from one of the fund’s investors trying to confirm its performance figures. It was apparently at this point that Bear Stearns thought that something was amiss and called the SEC.


Worse yet, when Deloitte & Touche sent letters to Bear Stearns and Financial Asset Management (FAM) requesting pertinent financial information, Berger requested that FAM forward the auditors’ request directly to him, which for some strange reason, they did. Berger in turn sent on the fictitious financial information to Deloitte & Touche, but first he reprogrammed his fax machine to make it appear as though the information was coming directly from FAM. The SEC stated: ”Although Deloitte & Touche also received information from Bear Stearns in response to its inquiries, Berger instructed Deloitte & Touche, through the Administrator, to ignore that information, claiming that it was not reflective of the Hedge Fund’s entire portfolio. Deloitte & Touche followed those instructions. Deloitte &Touche issued unqualified audit opinions on the Hedge Fund’s financial statements for the years ending December 31, 1996, 1997 and 1998. However, because of Berger’s intentional overvaluations of the Hedge Fund’s performance and assets, those financial statements were grossly inaccurate.” 


Cromer Finance, Ltd, a British Virgin Islands based company filed a lawsuit in the United States District Court, Southern District of New York and contained therein is an interesting quote relative to the culpability of Deloitte, “Experienced accounting experts described the failure to reconcile the Bear Stearns custodial reports with the information provided by Berger as “mind-numbing.” Howard Schilit, head of the Center for Financial Research & Analysis, Inc, in Rockville, Maryland, stated: “It is very unusual for an auditor not to have carefully studied records from Bear and used that as authentic information. Any reports that didn’t tie into it would raise significant red flags to auditors that something is wrong.” 


Particularly hard hit in the disaster were the customers of the Credit Suisse Private Banking Group who made up a substantial percentage of the fund’s investors. Also feeling heavy pain over the situation was Bank Austria AG, Cromer Finance, Ltd. and Scotia Nominees, a wholly owned subsidiary of Bank of Nova Scotia Channel Islands Trust, which has already commenced legal action against Manhattan Investment.


Simultaneously, federal district Judge, Denise Cote froze the company’s assets.  Some of the suits that have been filed name the normal list of suspects, Manhattan Investment Fund, Ltd, Michael Berger, Deloitte & Touche, Fund Administration Services, Bear Stearns and the usually number of John Does. One of the charges is rather interesting; it is against Bear Stearns and it accuses them of extending “margin credit in excess of Bear Stearns’ own internal, New York Stock Exchange and generally accepted margin limitations.” ([56]) But it doesn’t stop there, it also charges that Bear Stearns knew that these guys were skating on the edge the whole time and never once blew the whistle. The fact that they may have known that the funds performance was stinking up the neighborhood is one thing, but blowing the whistle on one of their clients for performing miserably may be a different subject entirely. Possibly, if Bear Stearns knew that the information being provided to the investors was being altered from what the statements that Bear Stearns was issuing, that’s one thing, but in a court of law, I think that they will find that people that bet big to win big can also lose big and that is just part of the game. When you go into one of these deals you sign an agreement that you are a big boy and you know that the game can go either way.


Many were flabbergasted that this new kid on the block could pull-the-wool over the eyes of so many sophisticated people and all at the same time. While the only explanation for his getting away with is total negligence on the part of many of those concerned, Barron ran a story by Jaye Scholl that at least made an attempt at explaining how it could have happened. “Some industry observers have suggested that the administrator and auditors agreed to Berger’s request ([57]) because they may have been low-paid and unsophisticated employees. Chris Sugrue, CEO of PlusFunds.com, a new service that provides real-time online valuations of hedge funds, describes the administrative and accounting firms as offering a buffet of services where the depth of inquiry can be a function of cost. “Some funds buy services at the lowest end of the spectrum,” comments Sugrue. An audit may look like an audit, he says, but in reality, it may be only “an informed opinion.”


This certainly can be classified under my category of, you learn something new everyday department. These are smart folks and their theory certainly goes a long way in explaining what occurred here but I always was of the opinion that an audit was an audit. In other words, GAAP states pretty clearly what has to be done to conduct an inspection of the books and how this inspection should take place. It tells the auditors how to investigate the items that make up the balance sheet and the profit and loss statements and I am not aware of the fact that they allow for degrees of certification or latitude within the process. I would have thought that if this was the case, they would have published the fact that this was a class IX audit which for example, only included looking at the books and records that the client furnished and not checking any deeper than that. Well that’s OK if that is what they told us, but I just don’t believe that things happen that way in the real world. Doing an audit from a menu, hmmpf. Even Deloitte Touche’s Rick Hansen announced that he had never heard of different levels of services within an audit and proclaimed that theirs had been accomplished within the framework of accounting principals. 


Meanwhile, not to be outdone, the Securities and Exchange Commission filed a complaint against Michael Berger, Manhattan Investment Fund Ltd. and Manhattan Capital Management, Inc. stating in part “Defendants created account statements that materially overstated the performance and value of the Hedge Fund and have caused the Hedge Fund’s administrator to send false and misleading account statements to investors. In addition, defendants have paid certain shareholders who have redeemed their shares more than the value of those shares, to the detriment of remaining shareholders.”


Manhattan Capital Management ultimately filed for protection under the Chapter II provisions of the Bankruptcy Act. The receiver that was installed to correct the mess seems to have his hands full, it was reported that the fund’s assets were about $36 million and its liabilities were $100 million. It does not appear that there is going to be a lot left over to pay back any of the poor investors. This caused a new eventuality to pop into the picture. In 1999, it was estimated that there $75 million in fund redemptions. Had Berger redeemed these shares at their net asset value, the story would have come out immediately about the huge losses. In order to keep the troops quiet, many people believe that the fund paid out those that redeemed shares, at the inflated prices that they were fraudulently reporting to shareholders. If that is the case and it makes perfect sense that it is, the shareholders that stuck with the fund into it its demise will unquestionable be going after those that cashed out earlier. In effect what was going on was the fact that the people that opted out early (the smart ones) were really taking along with them some of the money of those that stayed with the fund.


There doesn’t seem to be any question that from a legal point of view, in spite of the fact that they may well have been innocent of any knowledge of the distortions, the early out-opters are going to have to give some of the money that they received back. This is going to be one wild and wholly mess. Of the 280 known fund clients, less than ten of them had addresses in the United States. Thus, a lot of people are also going to have to be doing a lot of traveling if they want to see that justice ultimately gets done in this matter.


We think that this story contains a number of elements that are not part of any other chronicle contained within these pages. In just about every situation, the bad guys had earned the trust of at least some of their associates in order to get into a position of power where they could begin their life of crime. In other words, it is not really possible to steal a lot of  “white collar” money unless you are either placed in a position of trust or people believe in you for some other reason. The plainly is that you can’t be a “white color” criminal without some charisma. This lad had never succeeded at anything, formed the fund and hired a public relations firm to weave a story of the boy’s prowess at investing other people’s money when in reality he had literally little or no experience in anything of the kind. Money flowed in like rivers during a monsoon and this inexperienced child had soon accumulated $500 million that he would soon find a way to squander. I wonder whether someone isn’t going to sue the marketing company that literally created Berger, for misrepresentation. If they didn’t make up a total fantasy, these are the kind of guys I would like working for me when I want get rid of all of my left shoes.


While Berger denies that he stole any money, the fact that he took fees based on erroneous amounts of money under management, fraudulent performance and phony accounting hardly would classify him as Mr. Nice Guy.  Berger summed up his feelings with the following, “I don’t expect anyone to like me, I feel bad about the entire situation. The intention of what I did wasn’t bad. I’m cooperating with the U. S. Government to clarify the situation.” ([58]) A bit of the cooperation that Berger was involved in was the turning over his passport so he can’t leave the country while the proceedings against him are going on. Youngsters in the financial business have a way of growing up a little too fast.


Accounting Serves Its Function


As we can see from the above story, the accountants gave credence to a totally fake story and probably caused substantially more people to lose money than if there were no accounting at all. Savvy investors, the world over, want someone watching the store when they invest even though the story might sound great. Reporting companies, those that are listed on the various American Exchanges and traded on NASDAQ are required to provide an outside auditor who is supposed to represent a neutral party in going through the books. Because so much faith is placed in the fact that they have issued an unqualified opinion, more is lost when they blow it because that comfort always investors to pay a somewhat higher price than they would have otherwise.


There is no particular rule governing accounting when non-American’s purchase interests in what are called offshore investments. It would seem to me that the same rules would apply there; if you don’t have a certifiable track record and are not subject to a major accounting firms audit, there are too many alternative investments available globally to cause anyone to buy what I would call a “pig-in-a-poke. But there are investments that American’s can make that are not subject to the same scrutiny that is provided by individual listed companies. Those are investments made by what are called qualified investors, people who have had $200,000 or more in income the last two years and have a net worth of in excess of $1 million. And as we know, there are more of those than you can shake a stick at these days.


The American alternative for the offshore fund is called a hedge fund. It has no definable meaning and is allowed to do whatever its charter calls for. They can invest in stock market new issues, commodities or the Alice in Wonderland Stock Exchange if that is what they want to do. They American regulators are not going to get involved as long as what they said they were going to do in their original offering is what they wind up doing. Because we are in a universe that is moving a little faster than we are used to, often, what you see is not what you get and the market’s volatility and upward climb have lent credence to a naivety among sophisticated investors that has not been seen in this country since Ponzi.


While it is a bit off the subject, we are going to talk about a couple of hedge funds that did not have auditors or any particular reporting procedure, but in spite of the totally opaque investment climate, rich people shelled out substantial money into these schemes and all it got them was the ability to say that they had paid for the promoter’s brand new sports car and his mansion. They always used to say on Wall Street, “Where are the customers yachts?” That saying was never truer than it is now.


And why don’t they want to give you the information to that you check out the facts for yourself. Oh, they’ll think up stuff faster than you can believe. How about this one? “Our strategy is highly technological and our outstanding performance is based on that proprietary intellectual property. Should someone have to audit our books we would have to disclose how we are making so much money to a third party and could no longer guarantee that if that party went into competition with us, we would still be able to perform as well as we had been.”  This is a pretty standard story and only a tad more believable than the hopeless soul that would have us believe that he is a Nigerian jail cell and if we would just give him the name of our bank and our account number therein, we will be able to share untold riches.


You get the idea and if you hear either one of these stories, run, do not walk in the other direction as fast as you can. There are plenty of ways of protecting proprietary information and still get a damn good accounting job performed with risking anything, and of course, nobody sends money anymore to people in Nigerian jail cells, or do they. The amount scammed from people who fell for that one undoubtedly exceeds all the money lost in Long Term Credit, the biggest disaster in financial history.


Maricopa Funds


David Mobley graduated from vocational high school and then began his working career starting on a Jeep assembly line in Toledo. His father, a truck driver, had been careful with his savings and upon his death, he left the family some miscellaneous inner city property which had some value. David, ever the opportunist, attempted through expansion along with some misguided ideas to his inheritance into a fortune. This was not to be and David at the age of 25 years old had substantial overextended his empire and declared bankruptcy.


He was a man who had no college education but told all that would listen that he had been trading stocks in a highly successfully fashion since he was 13 years old. For some unknown reason, people seemed to believe him and soon almost 200 mostly retired millionaires in and around Naples, Florida had given Mobley money to trade for them. He continued to prosper and ultimately announced that he was managing over $400 million, a tidy number wherever you happen to live. However, many ultimately questioned that and any number of other things that Mobley had said, but then again that was only after an article had appeared in Barron’s showing that the real Mobley was not the same guy that they thought they were giving their money to.


People started to become concerned and they asked Maricopa either for an audit or their money back. “Mobley said on Thursday that he’s interviewing firms to conduct an audit and hopes to make an announcement to investors about audit plans by February 22, 2000. “We have had some investors request an audit. After the Barron’s article we saw that it was needed,” Mobley said.”


Mobley had previously declined to provide investors with audited statements of the hedge funds results conducted by an independent outside party. He indicated that in doing so, it could jeopardize his secret computer trading strategies and allow other investors to take positions against the funds, Mobley said Thursday.” ([59]) “Our systems are so simple and powerful that I simply must protect them to keep them for my family.” ([60]) Historically, Mobley has prepared performance figures for his investors personally with the help of his now estranged wife Gwen. Until 1996, his work was prepared by Brigid Soldavini, but they were just a compilation, which means that what you saw  wasn’t necessarily what you got and Brigid wasn’t going to risk her good name by certifying a word of anything that she didn’t look at in depth and she was out the door before any substantial funds had been put in the company anyway.


Talking about protecting his family, Mobley seems to be the ultimate nepotist. His brother William, an ex salesman for Waste Management’s garbage collection systems is the president of Maricopa, David Jr. his 20ish son who was a runner for a time on the Chicago Board of Trade is his head trader and the lovely Gwen in spite of the fact that they are not longer living together is the company’s CFO. Gwen’s cousin Lori, at 25 years old holds down the fort as Maricopa’s treasurer and David Radosti, Mobley’s son-in-law, who had never had exceeded the job title of restaurant manager doesn’t seem impaired by his lack of background in holding down the job as the firm’s systems-development manager. 


Well, as Barron’s indicated in their King Of Naples story of 2/14/2000 by Jonathan R. Laing, “…Today, at age 43, he lives in the affluent enclave of Naples, on Florida’s Gulf Coast. Mobley is having a multimillion-dollar home built in Quail West, an exclusive gated golf community near a fancy house that he owns but which is now occupied by his estranged second wife, Gwen, and their three daughters. He regularly flies by private jet to the Bahamas and to his sumptuous digs near Vail, Colorado, where he indulges his passion for snowboarding. As the founder and major underwriter of a Naples-area scholarship fund called the Quest Educational foundation, Mobley has been photographed hobnobbing with the likes of former President George Bush, retired General Norman Schwarzkopf, New York Times columnist, Will Safire and other luminaries who have spoken at Quest’s luncheons.” In addition, Mobley drives around Naples in a Porsche that is estimated to have cost him close to $100,000 while wintering in a $2 million home in Vail Colorado.


Well, the denizens certainly felt that anyone that lived that kind of life style must have both money and brains. This was their first mistake. And that wasn’t all of the credibility that Mobley had going for him, Van K. Tharp who gives lectures on securities trading all over the country gave Mobley the highest compliment that anyone can give a hedge fund operator. Tharp told Barron’s that Mobley was a “fantastic trader and businessman and a wonderful human being.” And he added that he had given Mobley the majority of his own money to manage, a hell of a compliment. We will see how much Tharp gave him and what it is now worth as the Maricopa disaster scenario evolves a bit further. 


Mobley was also, at least according to him, one hell of a businessman. He owned a lot of different things in and around Naples including a sports bar, a cigar lounge, a stock brokerage firm and a mortgage lending company, an Internet game distributor, a golf course and a stadium. Mobley was hit by a terrible run of what he called “bad luck”, others said, “Mobley just didn’t really know what he was doing.” The brokerage firm went under as did the mortgage company followed by the restaurant . The Stadium was a disaster resulting in a multimillion dollar debacle and an ensuing scandal[61] which nobody has heard the last of as investigations have sprouted up all over the place like weeds in an empty lot. The golf course never made a nickel while he owned it and only after he left and sold his interest did it turn around. The Cigar Bar, is still hanging on with greatly reduced hours. Regulars are not seen at the bar nearly as often as had been the case in the past and this to could easily become a mortality as well which would square the circle around Mobley’s outside business acumen.


On the other hand, Mobley kind of snickered when talking about returning people’s money almost as if to say, “Of course I’ll give back anyone’s money dumb enough to take it.” After all Mobley’s Funds  had been returning in excess of 50% a year since inception back in 1992 and $100,000 put into one of his funds at that point was now worth in excess of $2 million. And this mind you is after his enormous take from an  exorbitant management fee. Moreover, he has stated that he had only five negative months in the over seven year history of the hedge-fund.  And that isn’t all, the fund started with only $100,000 and now has, would you believe, $400 million. And if you could believe that anyone convicted of passing bad checks twice in 1983, who was sued in 1991 for screwing his partners in a real estate transaction out of their end of the profits and then indicted for grand theft in 1992 you can certainly believe Mobley. More recently he has been involved in bribery and conflict of interest charges. In addition, both Mobley and Maricopa were involved in a New York Federal lawsuit regarding false representations that had been to an investor in Maricopa.


In February of this year, the Securities and Exchange Commission had seen enough and accused Mobley of massive fraud. No one lost $400 million because it was never there to begin with, but between his bad investments and the payouts to hedge fund investors, there was only $20 million left. The SEC said that Mobley swindled folks out of $59 million but as in the case of Manhattan Investment Fund Limited that we discussed earlier, many of the earlier investors were probably substantially overpaid to keep a lid on the fraud, so this will be no less of a mess and there are going to be a lot of angry folks that thought they had missed the bullet. The difference between the two scams in terms of the investors is the fact that in the Berger matter, the patrons were wealthy off shore operators brought in primarily by their own banks, in Maricopa, they were primarily retired people without substantial outside income.


The scene as described by the Naples Daily News when agents of the Federal Bureau of Investigation and the Internal Revenue Service held a joint raid on the Maricopa Funds complex. Picture the parking lot filed with luxury cars with aging retirees watching the sorted event almost as you would a movie not knowing what was going to happen next. Records were being removed from the premises, the area was cordoned off and with it probably went the life savings of many of the observers. The agents would not discuss what was going on with the onlookers making their fears even more intense. Sources close to Mobley indicate that he flew to Washington and made a full confession over a two day period of time in between tears of anguish probably caused by his getting caught. That he confessed to numerous serious crimes and will probably not be visiting his relatives in Naples for some time to come.


The retirees may have some other problems facing them. The tax strategy employed by Mobley consisted of a series of offshore intertwined corporations that were set up, according to him, as a tax avoidance measures. Many of the people that cashed out will not only have to give a substantial portion of the money they received back, in the form of an even handed settlement but may also be hit with massive IRS claims. Not the kind of thing you want to get involved in when you are retired and do not have an outside income.  These are indeed the things that dreams are made of.


Cambridge Partners


It seems that you have to profess a strong commitment to your community and to God as well in order to become a really first-rate confidence man. People like to know that you believe in the community that you live in and worship in the same church that they do. If you can make them have faith in the fact that you are really serious about those things, you have passed your test in “Scams and other criminal activity, 101”.  Sad to say, these are the elements of that make for fraud. You are just not going to give anything to someone that you do not believe in.


John C. Natale, who had used his experience as a Chicago Board of Options trader to gain knowledge of securities became the managing partner of Cambridge Partners in Red Bank New Jersey and had been administrating the hedge fund since its inception 1992. He was a family man, no criminal record, a coach in three different sports for the neighborhood kids, a regular church goer and was recently voted the Man of the Year by the local Republican Club with the statement by its past president, Patrick J. Alwell to the effect that “He’s touched the lives of literally thousands of young people in our town.” Little did Patrick suspect at the time exactly how the 44 year-old resident of Holmdel ([62]), a small New Jersey community had been touched by this man.


As it turned out, 180 people had signed on as investors in Natale’s Cambridge Partners and they when the smoke had cleared it turned out that they were swindled out of no less than $59 million by the affable sports coach. No one had a clue that anything untoward was going on and as opposed to Maricopa where danger signals were coming out of the woodwork, there wasn’t a sign of any impropriety involved with Cambridge whatsoever. Natale had been explaining his enormous success to his investors as being primarily a result of his intimate knowledge of a little known trading method called the “Japanese Candlesticks Strategy”. This technique used a comparison pricing method that takes account of the opening, closing, high and low price of the stocks that are being traded by the fund on a regular basis. By somehow accentuating the positive and eliminating the negative, something magic is supposed to occur. While the system makes literally no sense to me at all, at least Natale had a system. All of the other folks that we have written about seem to flying mostly by the seat of their pants.


Although the investors were getting monthly statements that showed that the fund was performing in admirable fashion, in reality the $59 million that investors had originally sunk into the partnership had shrunk to only $3 million and another liquidation by a needy investor or two would leave the fund totally exposed. This, by the way was starting to occur on a regular basis due to the fact that the bad press coming from other fraudulent  hedge funds and offshore funds were getting on the partners nerves. They weren’t really concerned that it could happen here with such a prestigious citizen being involved, but this part of New Jersey is on the conservative side and many felt that it was better to be safe than sorry.


However, their beliefs aside, one morning Natale woke up and hiked himself down to the local Attorney General’s Office. He gave them chapter and verse of  what he had done and asked for a leniency because he had been such an upright human being. I kind of wonder whether his neighbors that he had wiped out will agree that the State should go along with that program just because Natale was good enough to turn himself in and save the State the money to indict, convict and house him in  a convenient jail for the next decade or so.


Townspeople were beyond mystified by this turn of events. No one had been more highly thought of in the neighborhood than Natale and his investors had just gotten word that their fund’s assets had increased substantial in recent months. The original investment of $59 million was now worth more than $70 million they said incredulously. In reality, Natale just as Mobley before him, had believed that the market was overbought and sold almost everything short. He was dead wrong and his friends are the poorer for it.


And once again, even those that got squeamish and had the sense to ask for their money back have the same surprise coming in this situation that they got with Mobley and Berger before him. Natale got caught in the same predicament that the others had to face. If he did not pay out the old investors the purported value of the fund, not the real value, they would immediately know that something was amiss and he would be instantaneously out of business. Sadly, these folks are going to learn that being smart enough to get out a tad early in a hedge fund or an offshore fund doesn’t quite guarantee you the price of a loaf of bread. You have to be smart in the first place and not invest in a fund that does not certify their books through a large and highly regarded accounting firm. You also need a third party acting as custodian for the investors. The brokerage firm most be sending the statements directly to the accounting firm and the escrow agent simultaneously and even then it isn’t anywhere near a sure bet. At least under those circumstances you have developed a deep pocket to turn to if there had been a fraud committed.


Kind of a double set of checks and balances, if the accounting firm doesn’t do the job they say they are going to do, you go to court and sue their pants off and more often than not, you will collect. If they do a legitimate job of auditing the fund, you only have to worry about the manager’s performance, not a fraud. At least you will have eliminated a part of the problem that has become so pervasive in recent years and is only going to get worse.


Natale was an early bloomer. He started sending out phony accounting statements almost the day he opened his doors for business. He bet on the wrong stock and got creamed right off the bat and had to cover it up. The next seven years were more of the same and he never could exactly get the investing process quite right. When people wanted to see a certified audit, Natale was fully prepared to give them one. He created an accounting firm out of thin air and ultimately had one of the numerous imaginary partners certify the Partnership audit.  After several years of that type of activity, it was painless to convince another accounting firm that the one he had been using was going out of business, and Natale would they take on the task. Natale kept right on going with his fabled ruse. He was also able to attract addition funds to his partnership by paying off or lying to web sites that recommended money managers on Internet.


And Natale wasn’t a really a good guy at all, he set up a brokerage firm by the name of CAJ Trading and when trades went bad, naturally his partners were given the short straw and when things worked out, CAJ, which he owned personally made a neat profit. Or how would you like to have been one of a number of Natale’s investors that regularly received 1099s showing illusionary income which they had to pay tax on. These folks have to be a tad unhappy right now.


His firm is now in receivership, Natale is awaiting sentencing and he is out on $500,000 bond, he has been ordered to make restitution and he is looking forward to about 10 years in the slammer. This may be preferable to living in the community that he ransacked. The New Jersey World in which he lived still finds it hard to believe what has happened to them and most of them are still shaking their heads trying to make sense out of what has occurred.


We believe that there are a number of disasters out their in the global trading world that have already occurred but had not yet been unearthed and because of all the jerks that are cooking the books, misleading the accountants or just plain to stupid to know what they are doing when they take on the responsibility of handling other people’s money; they have caused losses that will not go away no matter what the investors do about it. It is like a stick of dynamite that is going to explode, the fuse has already been lit but nobody knows how long it is.  Starting a stampede by demanding your money back will only hasten the day the fund’s managing partners are put away, but it doesn’t save the poor investors one penny. There ought to be a law.


Omega Trust and Savings


Talk about blue collar, you haven’t seen “Blue Collar” until you have seen Mattoon, Illinois. We are talking about a main street that looks like the illuminated playing field of a pinball machine until about 9:15 P.M. when they close the who thing down. The diners and bars outnumber the retail shops and most of the folks in the neighborhood work on an assembly line or for some manufacturing company in the neighborhood.  When I was very young and lived in the Chicago area, the folks that lived where I did, on the South Side of town were serviced by the Illinois Central Commuter Railroad. A friend of mine and myself were bored out of our minds one hot summer day and none of our associates were in the area so we went over to the Illinois Central ticket counter and ordered two roundtrip tickets to the end of their line. The lady at the ticket desk looked at us quizzically through he glasses and said, “that’s Mattoon young man, surely you aren’t going to Mattoon.” That only peaked our interest and my friend and I insisted that this was exactly where we were going, now certain that something really breathtaking lie at the end of the line, maybe, all of the ends of all lines, for that matter.  No one we knew had ever been to the end of any line and we weren’t even sure that we wouldn’t fall off the face of the earth, but when you are young these are the gambles you take and we certainly were not dissuaded by the ticket sellers reservations. 


Well, the end of the line was certainly Mattoon, and it was more a train yard than a town. What we hadn’t fully understood was the fact that when trains weren’t running, they had to be stored somewhere and the most logical place was always at the beginning or end of the line, whichever was which. Having already spent all of our money, we determined to make the best of it and see what Mattoon was really like. Interestingly enough, during the half hour between our train’s arrival and the next train departure, we saw literally nothing but weeds and hibernating trains. Literally no buildings, no people, no cars, no nothing, just weeds and railroad cars.  However, that was almost sixty years ago and perhaps  it has changed a tad since. I understand that it is a progressive town today with folks actually living there. Their mayor, a real person, sixtyish, Wanda Ferguson, was plucked right out of the local donut shop where she worked and was asked by local politicians  to run for the mayor’s office when the job was going begging.


You can imagine my surprise when I heard that one of the rankest frauds that we have seen in years originated right out of this sleepy little village. You knew something was up when you saw all the businesses and homes being  duded-up, new cars and trucks all over main street and some of the folks actually starting to throw some money around.  One of the people that had lived in Mattoon said that he began to wonder about what was going on when one of his friends traveled all the way to Chicago, about 30 miles up the track, just to buy a new suit from one of those fancy tailors in the Loop ([63]). We can certainly see that this must have been an intense indication that something big was up.


What was up was the fact that eleven of the most stalwart inhabitants in town  led by Clyde D. Hood, a 66 year-old retired electrician were involved in a massive fraud that had managed to separate over 10,000 people, from all over the world, from their hard earned money, millions and millions of it. Hood started up what he called Omega Trust and Trading and promised folks a return of no less than 50 times on their money in a short period of time. He represented himself as having worked in high level jobs for various Fortune 500 companies; as a person that was extraordinarily familiar with international banking and a member of a unique international banking clich that controlled vast portions of the world’s money supply. It was for this reason, Clyde explained that he was uniquely capable of returning geometric returns on people’s money. He used to say that “there were people on the inside and people on the outside, the people on the outside worked for the people on the inside, but no one knew who they were and where their power base came from. Clyde openly admitted that he was one of the proportionate few on the inside and that he was literally the first to admit his role as such. Ominously, he reported that by going public with his position, he was taking a great risk of retribution from both the United States Government and the International Bankers.


Luckily for Clyde, he didn’t put the touch on anyone in Mattoon for an investment in Omega or they would have laughed themselves sick, especially the part where Clyde promised investors that for every $100 invested they would get back $5,100 in 275 days and if they “rolled the money over” they would receive another $250,000 in the same amount of time. No one bothered to figure out that at that rate, every investor would be worth more money than existed on earth within one generation. But the people that were being solicited were not particularly sophisticated and Clyde didn’t bother to have an accountant check his numbers.  Holy Socks!


Clyde was not essentially a bad electrician most people said, but what he knew about money could have fit inside an ant’s brain with plenty of room to spare. Clyde used a more sophisticated tactic to separate the suckers and their money. He did it in the name of God with phrases such as “keep the Lord’s warehouse full, or  “a dollar invested in Omega is more than twice blessed.” How could you turn someone down that had a relationship with the Lord as Clyde did? It was readily apparent that you were not only going to make a killing, but God was going to appreciate what you were doing for him as well. And as for having all the money on earth, if you were doing the Lord’s bidding, that wasn’t necessarily all that bad.


Naturally, Clyde made it understood that when investors sent in their funds, they had to do it in cash or money orders wrapped in silver foil. No one seemed to understand what that meant or why they were asked to do it but one long term investor said that he had interpreted it to mean that the foil helped The Lord locate the investor and that this was an extremely important part of the investing process. Well if Clyde says so, then maybe this was helpful.


Well, as with all good things, Clyde was arrested and charged with almost one-hundred counts of fraud. His defense was astonishing which consisted of stating along with several of his compatriots in crime that the United States Government does not exist. Moreover, this may help us understand why he wanted the money wrapped in foil, or maybe it doesn’t. Clyde wasn’t finished yet, he added that “any judicial proceeding, determination, ruling, order, decree, entry, penalty, fine or arrest warrants which issues from these “courts” is null and void.” This little communiqu was sent to the local police department in town, the sheriff office and the United States Supreme Court. 


And the amazing part of this deal is that it was not a Ponzi Scheme. Ponzi couldn’t afford to have paid the interest that Clyde and his friend’s were offering for more than a week without going down the tube and these guys had kept the fraud alive for over six years. They added a touch that hasn’t been seen too often in schemes that are used to bilk the public. When you called to complain about not getting the promised return on your investment more often than not you were automatically connected to a message that ranted and raved for some period of time about the fact that the United States Government was holding up the distribution. On alternate weeks, the fact that there was a cabal of bankers that were apprehensive about Clyde’s going public with his work and that they had placed roadblocks in his way relative to forwarding their profits to them. Strangely enough, people went along with all of the weird rantings and ravings of this gang that couldn’t shot straight and the game went on for what much longer than it should have if anyone had even used a modicum of intelligence.


On the other hand, with the deputy sheriff being part of the conspiracy along with a former local police officer, it helped to keep the law enforcement community at arms length for a time. Their A-team also included a minister and a lawyer, a rather strong lineup when you consider that we are really taking about middle-America. 


Extraordinarily enough, no one is particularly up-in arms over what happened.   The amounts that were invested usually hadn’t been enough to wipe anyone out and most of the people who invested felt that Clyde was a really a good Christian down deep and would not have been going to jail at all if it wasn’t for those greedy bankers and the United States Government not wanting the common people to benefit from a good thing. On the other hand, in a real sense, the townsfolk of Mattoon did see unheard of prosperity come to Mattoon and are highly grateful for what Clyde and his friends accomplished. The fact that the money was stolen for others that created the temporary prosperity does not seem to register.


There are no accountants to blame in this  story and it is included mealy to illustrate simply how nave people can be when they are promised outlandish returns in the name of both God and conspiracies, a never miss combination.  While everyone in Mattoon had some idea of what was going on, the folks in the outside world believed on that this was a good Christian investment in which they could make lots of money.  My daddy always taught me that when it looks to good to be true, it usually is. Thanks dad.



In The Beginning


Many of the financial debacles of the recent past are a direct result of the tendency of financial institutions to place too much authority in the hands of literally unsupervised traders.  Nick Leeson, a 28-year-old purported whiz kid, engineered the demise of Barings PLC, the oldest merchant bank in Great Britain (founded in 1762), devising a flawed electronic trading system and covering it up through forgery and lies. ([64]) Initially, Lesson’s primary interest was speculatively arbitraging the 10-year Japanese Government Bond against the highly volatile Nikkei-225 stock index futures and options. As time went on, he graduated to unhedged bets on the Tokyo Stock Exchange. Leeson lost almost immediately and had accumulated a loss of almost $4 million within several months.


In addition to supervising the trading department of Barings’ Singapore operations, Leeson was also responsible for overseeing settlements. Thus, in his dual role, he could manufacture fictitious reports.  By the end of 1994, Leeson had made quick work of his benefactor as his losses already exceeded Barings’ yearly profit. For the most part, Leeson was brought down by the Kobe Earthquake, which decimated the Japanese Stock Market. In his final trading hours; at one point, he was able to control over 88 percent of the open interest in the June Contract for Japanese Government bond futures.  Leeson gave the market adequate warning by being the central figure in other contracts as well.


Even massive margin calls did not create concern on the part of Barings’ management. ([65]) It was only when irregularities appeared on the Barings’ Singapore Settlement’s books that the home office became concerned.  When these discrepancies could not be resolved, and Leeson was asked to explain, then and only then, did the roof collapse. Examinations were commenced and when the smoke had cleared, Barings’ Leeson oriented loss had become a staggering $1.4 billion.  The markets became erratic, prices fell, margins were raised and the aftershock produced dislocations all over the globe. ([66])


Coopers and Lybrand, who also shared notoriety as the auditors for Robert Maxwell, were also the auditors for Barings Bank. London’s Joint Disciplinary Scheme lost little time in preparing a claim against Coopers.  Apparently this same committee also had filed charges against them in the Maxwell matter.  London also has it in for Coopers relative to a company called Resort Hotels and their boss, Robert Feld who was jailed for eight years on a fraud indictment.


Coopers was directly on the firing line in the Barings matter, as it was that firm that was in charge of both the audit of the parent company in London and also Barings Futures in Singapore. Coopers and Deloitte & Touch, the predecessor auditor, eventually settled with Barings’ administrators for about $50 million.   It is interesting that it was the Administrators, Ernst and Young that brought the action against the accounting firms for failure to find irregularities in their 1992 audits.


Bankers Trust, or DisTrust As The Case May Be


I guess that we can understand a breach of the public trust by an insurance company but a large, money center bank just couldn’t take the risk for a couple of measly bucks.  I mean a federally chartered bank would just not do anything untoward, at least not the kind of things that Old Republic did, (p. 142) they  just don’t happen that way in the real world.


We do admit thought that Bankers Trust has had some moral issues relative to management decisions that seem to crop up on a fairly regular basis but when taken together the rest of the Banks highly honorable relationships we would not want to get into a discussion about  these small items. On the other hand, why don’t I let you decide whether or not this is a high-class institution.


Bankers’ needed some additional earnings in the mid-1990s.  They put out an all alerts into the securities processing division telling them to turn on the profits and the folks there stepped up to the plate to meet the challenge. They had to be very resourceful due to the fact that as a rule that division, was one which was not ordinarily considered to be a profit center.  However, these folks were “team players” and in spite of enormous obstacles, rose mightily to meet the challenge. This division had lots of dividend and interest credits that regularly went through the bank’s hands on the way to their customer’s accounts.  When the customers couldn’t be located over a period of time and after a reasonable attempt had been made to locate the client, the funds would then theoretically escheat to the state.


Bankers Trust did not do a very good job of looking for the benefactors of dividends and interest and pocketed the money whenever they couldn’t find the person to whom the funds rightfully belonged.  This reduced divisional costs dramatically and the resultant theft was about $60 million from both the state and from the rightful recipients.  The evidence clearly showed that the transaction was illegal and Bankers Trust pled guilty and paid a fine of $63 million.


B. J. Kingdon was the ultimate head of the division, which siphoned customer’s funds out of their accounts and into those of Bankers Trust.  He and three former Bankers Trust managers received target letters from the authorities for their efforts on Bankers behalf.  Kingdon’ s lawyer says that his client is “astonished and outraged”: over the affair and doesn’t know that anything that was being done was unlawful.  The fact that a guy running a major division of one of the biggest banks in the world that doesn’t know that taking money from customers accounts without their permission is wrong indicates that more likely than not, he was probably the wrong man for the job.  After all, if every bank had someone like Mr. Kingdon who seemed to became easily confused as to which money belonged to the bank and which money didn’t, we just couldn’t trust the bank now could we?


Well, Kingdon who had shown that he was over his head had his lawyer really get right to the crux of the matter.  His counsel indicated in effect that whatever happened was not done in the darkness of night. That a substantial amount of money came into the bank’s coffers through the division. The bank was monitoring that activity and knew from whence the funds had come.  I think we can see where he is headed on this.


What the lawyer seems to be saying in simple terms is the fact that, over $60 million was received by the bank from the division.  Officials at the bank knew exactly where the funds had come from and what their purpose was.  It would seem that Mr. Kingdon’s lawyer was sending a message to bank officials that his client would not be the only one to fry over this affair. While we can understand Kingdon’s attorney’s interest in his client’s well being, his approach is a bit harsh.


Bankers Trust is the same bank if you recall, that screwed a bunch of their own clients by literally stealing their money in a series of complex derivative transactions.  They took Proctor and Gamble, Gibson Greeting Cards, Air Products and Chemicals, and Sandoz along with others and when they got caught, legal actions were taken against them ([67]).  Unfortunately for Bankers, many of the embarrassing moments were on tape and we especially like the one where one of their top salespeople discusses how he is able to regularly screw the bank's clients but even in terms that are far more vivid.  This and other solid evidence seemed to be enough to have Bankers Trust run for cover and they hastily settled all of the derivative oriented litigation.


“According to P&G: ``Fraud was so pervasive and institutionalized that Bankers Trust employees used the acronym `ROF'--short for rip-off factor, to describe one method of fleecing clients.'' An internal document about a proposed derivative for Federal Paper Board allegedly says that Bankers would make $1.6 million on the deal, including a ``7 [basis point] rip-off factor.'' In a different instance, two Bankers employees are discussing a client's loss on a trade. One then tells the other: ``Pad the number a little bit.'' P&G quotes another Bankers Trust employee saying to a colleague: ``Funny business, you know? Lure people into that calm and then just totally f--- 'em.'' Procter & Gamble, through discovery, obtained 6,500 tape recordings, as well as 300,000 pages of documents from Bankers Trust. The material concerned nine Bankers Trust clients who lost money dealing with the bank. From this evidence, P&G is alleging that Bankers Trust:


(1)-- Engaged in a pervasive pattern of fraud spanning a number of years and involving numerous victims  (2)-- Induced customers to purchase complex derivative deals that produced high profits for the bank and often big losses for many of its clients  (3)-- Misrepresented to clients the pricing, current value and risks of the products it sold  (4)-- Refused to share its secret pricing models and other proprietary devices  (5)-- Caused customers who had suffered losses to engage in ever more complex transactions that were supposed to recoup losses but that often brought on even more problems ([68])


When the smoke had cleared, the traders that had been involved on Banker’s side were either barred, fined or suspended in an agreed settlement with the Securities and Exchange Commission. Bankers Trust also agreed to pay a fine of $100 million to the Commodities Futures Trading Commission (another regulator that is similar to the SEC but is only involved in commodities), Gibson got back $14 million, Procter $35 million and Air Products and Chemicals headed the class with a recovery of $67 million.


Well, you ask what was the end result of all of this? Obviously this gang of thieves had to get jail time for what they were trying to do. They couldn’t possibly have profited by ripping off their trusting clients now could they.  Well yes they could, Deutsche Bank merged with Bankers despite all of the handwriting on the wall.  The acquiring German bank became saddled with over $1.7 billion in write-offs and still paid almost $200 million to top management for inking the deal.  I guess that crime pays when you are a senior officer of Bankers, when you are a junior officer, you go to jail.  The moral is, be the guy at the top that thinks this stuff up and you eventually get a big bonus. But run a division and you can be sure as the snow in the winter that you will have your head handed to you.


“What about the accountants?” you ask. Well, there can’t be much question that they knew about what was going on just like Kingdon’s lawyer said top management did.  Banks are particularly exact in their audits because so many levels of regulatory people are looking over their shoulders.  To give you list of the national and international regulators that are interested in the affairs of a bank the size of this one would take next five pages but let me give you a sample. The Bank for International Settlements which determines who can play in the global marketplace based on their capital adequacy would be looking long and hard at Bankers.  The Federal Reserve, The State of New York, The Federal Deposit Insurance Corporation, The New York Stock Exchange as Bankers was a public company and the Securities and Exchange Commission to name a very few.  With this crew watching the store, it would almost impossible for this to happen in a vacuum.  There almost had to be collusion somewhere.


“Well if that’s the case and it makes sense that it is, why didn’t the authorities step and fine the accountants as well?  Interesting question and the answer kind of goes with the territory.  First of all, no class action suits needed to bring in other defendants because the bank was in itself, a deep pocket and everyone knew that when push came to shove, the bank would pay up, especially when caught with their hands in the cookie jar.  Next, some of the high-ranking people at Bankers Trust were big time political folks and had a lot of friends, as long as someone was going to get indicted, and they did, the regulators saw no reason to send an additional message.  Was this right? Absolutely not but considering the fact that after this incident, all of the top level management at Bankers left in disgrace, probably at least some price was paid and a message was sent to others.  On the other hand:


“Washington, (Dec. 7, 1998) Business Wire--The following notice is issued by the law firm of Cohen, Milstein, Hausfeld & Toll, P.L.L.C. on behalf of its client, who, on December 7, 1998, filed a lawsuit in the United States District Court for the Southern District of New York, on behalf of persons who sold or otherwise disposed of Bankers Trust (NYSE:BT) common stock or call options or purchased Bankers Trust  put options during the period between October 26, 1998 and November 20, 1998, inclusive.”


“The Complaint charges that Banker Trust, Deutsche Bank A.G. and certain officers and directors of those Companies during the relevant time period violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. Specifically, the Complaint alleges that defendants falsely denied that Deutsche Bank and Bankers Trust were engaged in takeover discussions and negotiations during the Class Period in order to artificially depress the price of Bankers Trust stock so that Deutsche Bank could purchase Bankers Trust at an artificially low price. The Complaint alleges that members of the Class who sold or otherwise disposed of their Bankers Trust common stock did so at artificially depressed prices.


We can tell you this though, just because a building has a sign saying that it is a bank doesn’t mean that you shouldn’t read you statement. Just because the president has white hair and is in the Rotary is no reason to trust him.  Banks are business people like everyone else and larceny is not the sole domain of second story men or axe murderers, it is sometimes done in the lap of luxury between large mahogany doors. 


Penn Square Crumbles


The Penn Square Bank of Oklahoma City got its start in 1960 as a small financial institution and was located in a small shopping center for 22-years.  In 1972, William “Beep” Jennings took over control of the bank and simultaneously OPEC started moving the price of oil higher.  Nobody’s fool, Jennings knew a good thing when he saw one, and created a new department to make loans to the oil-and-gas-industry in Oklahoma. These were also times when people did not care much what their return was going to be as long as they were able to take a bite sized write-off from their tax returns.


Thus, although Jennings was at the right place at the right time, he did not realize that not everyone who claimed to be looking for oil really was.  Those who were not, were looking for deductions and the more that they could leverage their write-offs, the less they would have to pay Uncle Sam.  Penn Square was also a dinky bank as far as banks go, and had a lending limit that could not have accommodated the drilling of one deep well.  Thus, the bank had to either find a way to accommodate the real players or concentrate on the mixed bag of not quite serious folks whom they were attracting.


It did not take the aggressive new management of Penn Square long before they found the right way to position themselves.  Being in the heart of oil country, they could act as an introducing agent to other banks and sell them their overage loans.  Thus, they could get into a market where there were real players.  This seemingly did a couple of really good things for banks like Chicago’s Continental and New York’s, Chase.  Both banks fancied themselves as oil experts.  All banks in the country were saddled by branch banking restrictions.  Thus, by buying loans instead of making them, they would effectively acquire a branch in Oklahoma without evading the Banking Regulations.  In addition, who would know the oil field in Oklahoma better then a bank that is right there?  Little did they realize that his was at best wishful thinking. 


In the meantime, Jennings did the same thing that Lincoln Savings and Loan along with others had attempted. He set up a department to market jumbo CDs that paid substantially higher interest rates than the garden variety. Considering the hot oil market and the fact that Penn Square’s clientele was really the larger money-center banks, it didn’t take a long time before a massive amount of this highly questionable paper was regularly walking out the door. 


Penn Square soon stopped taking any part of the loans they were putting on, and concentrated on turning them around to the city slickers for the one-percent they got for making the loan and some additional vigorish that they received for servicing the debt.  However, Penn Square was not being at all careful about who they were loaning to and why. Money was available from the “big city boys” for all comers and rarely if ever was an oil loan refused.  Thus, Penn Square had a severe conflict of interest with their loan buying bank customers.  However, Penn Square saw this deal is the second coming and foolishly, the money center banking people totally relied upon Penn Square for their due diligence.  Little did they know at the time that the people at Penn Square Bank had never even learned how to spell the word.


To Penn Square, servicing a loan meant keeping the pot boiling and getting the loans out the door.  Loans were sold where literally none of the documentation had been checked, there were contracts where documents were missing, there were agreements that were never signed, there were contracts where no UCC filings had been made., Jennings would make oral commitments without any paperwork, fund the loans and thus thereafter the  borrower had little interest in coming back to the bank to complete the paperwork.  He felt that he probably wasn’t even liable because he never signed anything and maybe he was right.  Moreover, the unfinished loans could not be resold in the secondary market because of among other problems, their lack of uniformity.


If things looked bad at this point, they soon got a lot worse.  When the loans started backing up, Penn Square didn’t want to ruin their reputation by having their bank customers get stuck with defaulting collateral so that a determination was made by the bank that rather than have anyone ever know that a Penn Square loan had gone bad, the bank would make the payments for the client and the funding institution would never be the wiser.  Continental and Chase never received to their knowledge, a bad Penn Square credit, which made them even more contented with the situation and they clamored for more and more paper.  Penn Square on the other hand didn’t have all of the ready funds to take on what was becoming an avalanche of defaults, so they kicked the plot up a notch by making a new loan to each defaulter, and selling that paper to the money center banks as well.  Thus, they had created their own cache of money to repay whatever went bad by sticking the banks that didn’t know that there already had been a default with more paper from the same bad credit.  “This was surely a wondrous idea,” said Jennings in a moment of self-glorification.


It was becoming readily apparent that some of Jennings’ loan officers just couldn’t get the paper out the door fast enough and they were replaced with people that would not need to carefully document their work. The top dog in Jennings oil and gas department became Bill Patterson ([69]) who although he was still in his twenty’s was entrusted with the entire oil and gas department accounting for over 80% of Penn Square’s business. This was a man that had been called “Monkeybrains,” by his friends.  However, Patterson married into a lot of money and the family was in Texas style banking.  He was able to get a job working for one of his father-in-law’s institutions but was not allowed to make a decision, loan out money or talk to clients of the bank.  Jennings must have seen something in Patterson and brought him aboard at Penn Square with great fanfare.  Patterson played his role for Jennings to the hilt, Patterson soon became renowned by one and all for his idiosyncrasies, such as “wearing a Mickey Mouse hat while doing business with prospective clients and drinking beer from his cowboy boots at swank Oklahoma City watering holes.” ([70]) His father-in-law, we are told, started celebrating the moment Patterson left his bank, and considering what happened, for all we know may still be celebrating the event today.  


Paterson did what Jennings wanted; he ran a truly loose ship.  One of Paterson’s traits was to never check on whether the money that the bank loaned went for what was agreed to in the loan documents.  When the bank closed, in the cases of many loans that had been made, you couldn’t even find the drilling rig, the pipe, or the location of a well.  Paterson always said that he was loaning with his heart and no one could argue with that statement. If that hadn’t given the bank enough headaches, the oil blip did not last forever because of excellent conservation measures put in place by the administration and over-production by OPEC, oil prices tanked. Even the occasional, well-documented, legitimate loans soon became an anathema to Penn Square and their bank partners. The world had gone from energy short to dramatically over produced in just a few short years. Many projects, especially those that entailed deep drilling, soon became economic dinosaurs.


The bank examiners and regulators were aware of what was happening in the oil patch and forced Penn Square to tighten its controls over loans. They also demanded that the bank hire a full-time professional president, increase its reserves, bring in addition executives with substantial banking experience, and tighten up lending requirements. However, the game was already a little “long in the tooth” and the regulators demands were too little and too late. Seeing the handwriting on the wall, Penn Square attempted to lend themselves out of trouble and only made things a hundred times worse. The quality of borrowers continued to decrease and loan defaults went through the roof. 


The borrowers were also hip to the fact that when you owe a bank a small amount, they are your creditor.  When the loan becomes larger, they become your partner.  Many savvy Oklahomans kept edging their loans right into the stratosphere and Paterson was always quick to oblige.


Penn Square’s money also went to political contributions.  One the large borrowers from Penn Square was J. D. Allen, the co-chairman of the Finance Committee of the Republican National Committee.  Allen went bust after Penn Square collapsed and his debts in bankruptcy exceeded $300 million.  Continental or Chase must have eventually discovered that their money  was literally given away in political contributions.  Robert Hefner III, listed as one of the richest men in America, was another major customer of the bank.  When the banks started to look for collateral to grab, all they found was a man whose debts exceeded his liabilities.


Continental Bank of Chicago, who was on the receiving end of the Penn Square fiasco to the tune of $1 billion, went belly up in large part because of that and  because the bank was determined to be “too big to fail” it became the recipient of a $5 billion government bailout.  The bank was never the same after that and even today, its character is drastically altered.  Seattle First National had to be merged with Bank of America in order to save it.  Chase had other problems that made those at Penn Square seem almost incidental but managed to get by because of a much larger capital base. Penn Square and it commando loan officers certainly left their mark on banking in the United States.


By the spring of 1982, regulators came back to Penn Square for another look at what was going on. What they discovered was literally unbelievable. The bank had now gotten into so much trouble that the Federal Reserve arranged an emergency loan for the bank. This gave examiners a chance to get some breathing room while they took a more critical look. It was determined that there was literally no helping the bank and when Penn Square’s doors were closed by the FDIC bank examiners on July 5, 1982, the bank’s total assets had risen from $29 million in 1974 to over $500 million at the time of its closing and it became the seventh largest shuttering of a bank by that institution.  More startling yet was the fact that a bank with only $500 million in assets could lose more that $2 billion, the biggest single bank loss in the history of the United States to that time.


Arthur Young had been the auditors in the bank’s earlier days and for the years of 1976 through 1979 they gave the bank a clean bill of health. In 1980, the auditors did not like what they were seeing and qualified its audit relative to whether or not loan reserves were sufficient to cover potential problems. Young found that the paper work backing up the bank’s loans was literally a mess. Jennings was not at all pleased with Young’s decision to qualify their opinion and summarily dumped the accounting firm and replaced it with Peat Marwick and Mitchell.


We know that it represents good business practice for the incoming accounting firm to check with the outgoing firm to find out what the relationship was between the client and the accounting firm and why they were leaving. At this point we get two totally separate stories. Peat Marwick stated that they had made such an inquiry and were told in no uncertain terms that Young had told them that the company was “free of significant problems.” Young’s position, which can’t really be refuted, is the fact that they had qualified the audit and whether they brought it to Peat Marwick’s attention or not is really not an issue. Young really couldn’t do more to wave a red flag than to qualify their opinion.


In spite of the knowledge that they may be stepping on a powder keg, Peat Marwick moved into the breach. They joined the team just in time to be hit by lightning and as such, they came in for some really rough treatment when congress tried to figure out what had occurred.  Peat Marwick enraged the House of Representatives by making the statement that their audit (which had been clean) was intended only for the bank’s directors.  Yet various members of the house including a usually calm Fernand St. Germain, Chairman of the investigation reacted violently.  He made the following comment:


“You are not aware of the fact that the people at Penn Square dealing with brokers gave your reports … to people, credit unions, S&Ls around this nation who put enormous sums of money into this institution based on your audit reports, since that was all that was available… Did it come as a complete and total surprise to you, like the fact that when you get to be 10 years old you find out that there is no Santa Claus?”


Naturally, the Peat Marwick and Mitchell partner that had given the stunningly imbecilic response to the House Committee had a really bad hair day. Peat Marwick’s situation is doubly troublesome because Arthur Young & Company who had been doing the audit pre-1980 had determined in 1980 that they would be issuing a qualified opinion.  In 1981, Jennings fired Arthur Young and hired Peat Marwick. Peat Marwick was intimately aware that the reason that Young wanted to qualify the audit was their opinion that loan loss reserves were substantially low. This in turn meant that expected loan failures, especially from Young’s point of view, were heading skyward.


Peat Marwick did not find doing Penn Square’s books clear sailing. As a matter of fact they were bothered enough by the condition of the bank’s books and records to tell the Board of Directors at Penn Square that they had better get their act together. However, in spite of that, Peat Marwick neither qualified their opinion, footnoted the financials nor informed the shareholders. A discussion on that subject was conducted during a meeting of the congressional subcommittee examining the events leading to the Penn Square debacle. This particular skirmish was  between Congressman George Wortley and Peat Marwick’s Jim Blanton and it was indeed enlightening:


Congressman Wortley:       Were Penn Square’s internal controls adequate?


Mr. Blanton:                          No, sir. We don’t believe they were adequate.


Congressman Wortley:       Well, did you criticize them in the public statement?


Mr. Blanton:                          No, Sir.


Congressman Wortley:       You only criticized them in the management letter?


Mr. Blanton:                          That is correct.


Congressman Wortley:       Do you think that is fair to the public? And is that a custom of the profession?


Mr. Blanton:                          I am not sure that I can determine what is fair or unfair to the public. I can say that it is a normal procedure to issue a management letter, and that we do not address in the financial statements or in footnotes all of the problems of a client.


Congressman Wortley:       Well, do you not feel that you have a responsibility to someone other than your client, in this case Penn Square? Is the whole purpose of an audit not to make certain that things are verified and the public is adequately informed of it, and shareholders and investors and depositor?      


The Office of the Comptroller of the Currency (OCC) was also introduced into the Congressional testimony and it certainly was not helpful to Peat Marwick’s position in view of the fact that both the OCC audit and that of the accounting firm were undertaken simultaneously:


“The unqualified opinion was rendered despite the identification of excess collateral exceptions, discovery of incidences where the bank was making payments of principal and interest to the correspondent banks on certain participations without first receiving payment from the borrowers, and acceptance of a reserve for possible loan losses which was deemed inadequate by the examiners during their review of the loan portfolio.”


Not only did Peat Marwick take the account, but they gave Penn Square an unqualified report card. Moreover, they did it at a time when Peat Marwick’ s Oklahoma City partners had two million in loans outstanding to Penn Square and a line of credit of a million dollars. Clearly, this represented an unacceptable conflict of interest, but that didn’t seem to bother the Peat Marwick people in the least. Penn Square did make an effort to get rid of the loans and sold them off, but four days before the bank closed, they were back on the books. I must say that we are speechless, but as usual, the accountants that do the kind of work Peat Marwick did in this case seem to always pay a price.


In the meantime, the shareholders got even, they filed lawsuits totaling over $1 billion against the Peat Marwick firm and charged them with just about every crime in the book. The U.S. Department of Justice filed actions against a dozen of the accountants current and former employees and to wrap up the dirty details, the FDIC sued Peat Marwick for $90 million. All of the incidents above were settled and the exact details are not public information. On the other hand, there isn’t much question that Peat Marwick paid dearly for its short-term romance with the people at Penn Square Bank. 


Patterson was found guilty of twenty-six counts bank fraud. A similar case took place in federal court in Chicago, which ended in a mistrial. When the day was over and a plea bargain had taken place, Patterson pled  guilty of misapplication of banks funds a was sent to federal prison for two years. An associate of Patterson also was sent to jail for similar bank related problems.



Ponzi Schemes For Better Or Worse

Trust Me, I Have This Plan And We Can Really Clean Up


Barry J. Minkow’s mother was a telephone solicitor for a cleaning company and that was how, at twelve years old he started learning about the restoration business. While not yet in his twenties, he sensed an opportunity to become wealthy from that business and became what is known as a rug sucker, someone that goes into, usually a home, makes a lowball estimate on a cleaning job, takes the rug upon striking a deal and when the price is jacked up later the customer either has to pay or is out one rug. The lad was already involved in all the niceties of life, check kiting, forgery and theft from insurance companies by making phony claims. This was a dangerous means for a kid to be making a living and Barry believed that there had to be a better way.


Barry gravitated to a derivative of that business. ([71]) By specializing in rug cleaning and insurance restoration (after fire or flooding had substantially damaged substantial portions of a building), he would be satisfying a lucrative niche. He needed credibility, someone of standing that would vouch for his business acumen and success. He found the sucker at his Los Angeles health club; his name was Tom Padgett, an insurance claims adjuster who Minkow agreed to put on his payroll at $100 per week if he would confirm that ZZZZ Best was legit. While still in high school, his vision flourished. Minkow already had hundreds of employees within a company with over $5 million in gross revenues. Minkow had named the company ZZZZ Best and he was the youngest chief executive officer of a major company in the United States, and soon had a luxurious home in a Los Angeles Suburb and naturally, a shinny new red Ferrari.


Already on a roll and with the motto, “The sky is the limit,” Minkow became a much in demand regular on the nation’s talk show circuit where he chided people to try and accomplish more. Little did they know how he had achieved his success.  Minkow’s next move was to take the company public but he had to establish credibility in stages. Although he did not think of it at the time, this move was making Minkow subject to the security laws of the United States and things soon became a little tricky. He needed an independent auditor to do his books and hired an accountant by the name of George Greenspan; when Greenspan naively called Padget to confirm that ZZZZ Best indeed had restoration contracts the circle had closed when Padget gave accolades. Now he had a set of books that would stand up to a degree of scrutiny, but he needed somebody more prestigious than Greenspan if he was really going to make a major score. With that in mind hired the prestigious New York Law Firm of Hughes, Hubbard and Reed and dumped Greenspan for the Big Eight accounting firm of Ernst and Whiney to give his young company the additional cache that he believed that white shoe, top drawer professionals on your payroll has a tendency to do.


ZZZZ Best’s offering memorandum indicated that in 1986, Minkow already had almost $25 million in "insurance restoration" business on the books scheduled for early completion, from thirteen projections ranging from hundreds of thousands of dollars to over $7 million. Minkow offered the public $13 million worth of stock, which was sold as a unit containing three shares of common stock and a warrant to buy an additional share. The offering went public at $12 bucks, which valued each of the shares at a tad less than four dollars, if you assume the warrant had some nominal value.


By 1987, the company’s earnings from these projects were estimated by internal ZZZZ Best auditors at $40 million, and Minkow was being favorably compared to Watson (IBM) and Land (Polaroid) in terms of business acumen.  His company became known as the General Motors of the cleaning business. As his success seemed to continue unabated, Wall Street embraced Minkow. The price of ZZZZ Best stock soared, increasing Minkow’s net worth at one point to over $100 million.


The problem with this story is that there was nothing much real about Minkow except his gift of gab and a startling imagination. His company in turn was almost a total fabrication.  The preliminary prospectus that he issued made the claim that: "The company began its significant insurance restoration business in April 1985 and since then has performed restoration service for buildings ranging in size from 100,000 to 750,000 square feet. Restoration contracts, all of which are performed on a fixed price basis, have ranged from approximately $150,000 to $7,000,000. The Company has restored buildings located throughout California and in Arizona, with the majority being in Southern California. As of September 30, 1986, there were 13 insurance restoration projects in progress, under contracts aggregating $24,362,000 (including seven aggregating $15,068,000 through joint ventures), all of which are scheduled for completion within six months." 


This totally illusionary restoration business played great on Wall Street and investors loved the concept.  There was not one iota of truth or a scintilla of evidence that anything the Minkow had said was true, but people wanted to believe. He had been able to convince both his lawyers and his accountants that a thriving business existed when in reality, it was totally a figment of Minkow’s fertile imagination. Statements of Wall Street brokerage houses like that of Ladenburg, Thalmann & Company were repeated everywhere; "ZZZZ Best meets the criteria of a company that has the same potentially explosive sales and earning characteristics and market opportunities that permitted McDonald's and 7-11 to reach the success each has achieved--sales of over $1 billion in a relatively short time from inception." He was even given the highest honor by the prestigious association of Collegiate Entrepreneurs calling him one of the leading young business founders in the United States.


His fraud cost the public over $70 million and Minkow was sentenced to 25 years in jail and fined $26 million. When accountants (at the time a big eight firm) Ernst & Whinney required on-site investigations of the restorations in progress, Minkow arranged for Ernst and Whinney to inspect buildings that had nothing to with ZZZZ Best. He would bribe workers on the premises to go along with his fabrications or in the alternative, he would rent empty buildings and create literally a “Hollywood set” of restoration work in process.


On one occasion, he was told by the attorney's and accountants that they would be examining a work in process at a restoration site in Sacramento.  Not having any restoration sites available because they didn't exist, it was no big deal for him to rent an old building for the day and bring in a number of people to act as though they were doing some work.  He dressed them up in cute little ZZZZ Best uniforms and the scam went so well that a totally nave Larry Gray, a senior auditor with Ernst & Whinney  gave the following report:


"We were informed that the damage occurred from the water storage on the roof of the building. The storage was for the sprinkler systems, but the water somehow was released in total, causing construction damage to floors 18 and 17, primarily in bathrooms which were directly under the water holding tower; then the water spread out and flooded floors 16 down through about 5 or 6, where it started to spread out even further and be held in pools."


"We toured floor 17 briefly (is currently occupied by a law firm), then visited floor 12 (which had a considerable amount of unoccupied space) and floor 7. Morze pointed out to us the carpet, painting and clean up work, which had been ZZZZ Best's responsibility. We noted some work not done in some other areas (an in unoccupied tenant space). But per Mark, this was not ZZZZ Best's responsibility; rather it was work being undertaken by tenants for their own purposes"


"ZZZZ Best's work is substantially complete and has passed final inspection."


Compare the pathetic report by Gray who had examined a building that had literally nothing to do with ZZZZ Best.  Then looked at work that ZZZZ Best had fabricated and wrote a glowing report on a building that was hired by the day; with the report given in Congress by Mike Brambles a detective with the organized-crime intelligence division of Los Angeles Police Department on the same building.  He is being interrogated by Representative Ron Wyden who is a member of a subcommittee investigating the affair:


Wyden:           Did the building ever have any damage, or could they found that out?


Brambles:       The building did not sustain any fire or waste damage. We ascertained that by checking with the building department of Sacramento in determining that in the previous two to three years there had been a very minor amount of construction work, that being only cosmetic in appearance and not involving fire and water restoration work.


Wyden:           How long did it take your people to find out about the condition of the building?


Brambels:       Approximately ten minutes at the building department and then roughly one or two hours at the restoration site.



In some instances, Minkow and his associates even gave the addresses of empty lots to Ernst and Whinney, believing that based on recent history they would not show up.  Luckily for Minkow they didn’t.


Outsiders were soon tipping Ernst & Whinney and local newspapers that ZZZZ Best was a fraud.  However, with the first commandment of accounting being "hear no evil, see no evil, speak no evil," they did nothing about it.  Even worse, one Norman Rothberg told Ernst and Whinney in no uncertain terms that the ZZZZ Best Sacramento restoration site was a total fraud.  Shortly thereafter, Rothberg had been properly paid off by Minkow to the tune of $25,000, he recanted his story.  This incident did not cause Ernst & Whinney to blink an eye.


Ultimately, the evidence could no longer be denied and even the accountants finally saw a massive fraud looming.  Ernst realized that it had been taken and resigned. Congress put Ernst and Whinney's Gray on the grill and Representative Lent had an interesting experience in interviewing him.


Lent:   It came to your attention that Rothberg was talking about a certain company, namely ZZZZ Best.


            Gray    Yes, sir. Yes, sir.


Lent:   He was talking about fraud at ZZZZ Best and he mentioned that the Sacramento job was a phony job?


            Gray:   That is correct. We heard that on May 19.


            Lent:   You had been out there and you had walked that job, had you not?


            Gray:   That is correct, sir.


Lent:   So you must have wondered whether you had been taken for a ride, whether you had been deceived, and it is logical to assume that you might have gone back there and looked at it over again, or made some further inquiry of the building department, the property owner, the contract, or other contractors, et cetera? You did none of those things?


            Gray:   No, sir.


In easily the most bizarre event in the annals of accounting, when Ernst & Whinney resigned, Minkow replaced them with prestigious Price Waterhouse, which, contrary to every accounting tenet, made no concerted effort to determine the reasons for their predecessor’s resignation.  ZZZZ Best indicated that the auditors found no fault with the company's securities filings.  Ernst and Whinney added insult to injury by failing to disclose their reasons for resigning.


Worse still, once they were hired,  Ernst &  Whinney signed non-disclosure agreements that would have prevented any successor accounting firm or anybody else, for that matter, from finding out the location of ZZZZ Best projects that they had visited.  Moreover, they gave written promises not to "… make any follow-up visits to the Project…."


"We will not disclose the location of, or any other information with respect to, the Project or the Warehouse, to any third parties or to any other members or employees of our firm; We will not make any follow-up telephone calls to any contractors insurance companies, the owner of the Project or of the Warehouse, or other individuals involved in the restoration projection;


We will not make any follow-up visits to the Project or the Warehouse, unless specifically authorized by the Company and Interstate Appraisal Services ("Interstate") [company set up to appraise ZZZZ Best renovation projects]."


The confidentiality letter raised more questions that it answered. One would wonder how you could check out whether something is real or not if you could only visit the site with the permission of your client.  An independent accountant cannot do his job and keep the public faith at the same time, if no follow up calls can be made to contractors, insurance companies, the owner of the Project or the Warehouse unless authorized by ZZZZ Best. If this is the way the practice of accounting works then the work product has to be laughable.


Another dialog between Congressman Wyden and Mr. Gray of Ernst and Whinney, which should have so embarrassed the accounting firm that they should have closed their doors on the spot:


Wyden:          "We go back to these confidentiality letters. They were signed by you personally, Mr. Gray, and they were signed also on behalf of Ernst and Whinney regarding the visits to phony insurance restoration jobs, one in Sacramento and San Diego. You mention personally in these letters on behalf of the firm that you won't disclose the location of the job sites to any third parties including other members and employees of the firm. You go on to proposals that you won't make any follow-up phone calls to any contractors, insurance companies, building owners, or other individuals involved in restoration projects. "


"I guess what raised my curiosity about these confidentiality letters is that I wonder how, after you signed them, you could then go out and independently verify material information given to you by ZZZZ Best management".


Gray:               "The signing of the letters does nothing to restrict what I wanted to perform. We--in fact it was done at the client's request. We get requests from our clients many times to confirm our confidentiality relationship. As I stated earlier, we have the overriding responsibility to keep our clients' information confidential. So them asking me to do this, my purpose was to go on the site and see the work done. It did not restrict me being able to perform that and I did go on site to see the work done, and Congressman, if I would have had any questions that came up in the course of that review, I would have pursued those questions and gotten answers to satisfy myself, or I would have quit".


It is most interesting to listen to this total bilge coming out of Gray's mouth. We are not talking about trade secrets or a list of confidential customers, we are talking about imaginary insurance restoration projects that in their magical state have been for the most part completed.  What were the odds of another restoration job occurring on the exact spot as the previous one?  What’s so confidential? In addition, in the one out a million chance that the place flooded again, do you think for one minute that ZZZZ Best would stand a chance of getting the work after screwing things up the first time?  At that point, the odds would stand directly at zero.  Gray must have held a very low opinion of the intelligence of the Congressional investigators.


Wyden brought in Brambles once again to refute Gray's fabrications.


Wyden: "I just want to pin down that in San Diego, as at Sacramento, we had a situation where the building really didn't have any damage, and it wouldn't have been hard, as you said your own people could do, to determine that, is that correct?"


Brambles:         "Yes sir, what we did was, we went again to the building department of San Diego and checked their construction permits on file. What our investigation determined was basically that the application for cosmetic construction had been applied for and granted by the city of San Diego. Their permit was paid for, but it was never inspected by the building inspectors, it was never finalized."


"That took us approximately ten minutes to do that. We also checked to determine whether or not the building had received damage in the area of fire and water, and that turned up negative results as well."


Wyden: "…what you have told us is that essentially in just a few minutes your  own people could determine the job was a fake. But somehow the auditors didn't discover it, and it seems amazing…" ([72])


In Dallas, ZZZZ Best did an even better job of confusing the auditors. They told the accountants they were getting a lot of business in Texas and needed a warehouse in Dallas.  When ZZZZ Best advised them that the warehouse was open, the auditors expressed an earnest desire to check it out.  In typical fashion, the company rented an empty building for the day and then shipped a bunch of recently designed ZZZZ Best uniforms and other items with which to stock the warehouse.  A telephone switchboard was installed, and when the people from the accounting firm were brought in to visit, everyone tried to look busy. Vehicles were in motion, products were being moved, trucks arrived and departed and the switchboard lit up like a Christmas Tree; not surprisingly with inquires from companies in the area wanting to use the services of ZZZZ Best for their insurance restoration work.  The scene had all of the earmarks of Class B Hollywood movie. Embarrassingly, Larry Gray was once again the fall guy for this cheap stunt and as usual, he fell for it hook, line and sinker. He even reported back to Ernst and Whinney that the warehouse would have to be expanded due to the increased business.


Although it was hardly possible, Gray had pulled the wool over his own eyes even further when ZZZZ Best gave him the unconscionable story that he could have the address where work was currently being conducted on a restoration, but they indicated that he couldn't visit it because it was a hardhat area.  You would think that these guys were working with atomic bombs, not with paint, brushes and brooms, In reality, the address was that of an empty lot that ZZZZ Best had once again rented for the day.  Gray, who had screwed up every other portion of his due diligence campaign, once again fell for the ZZZZ Best "Red Herring.”


Gray was so incompetent in his investigation of ZZZZ Best  that he should have been arrested for criminal stupidity. Not only did he set the all time record for negligence, but, in addition, everything that occurred was theoretically a red flag that should have caused him to realize that additional checking of the client should be in order.


I mean, a hardhat area in the rug cleaning business.  We believe that Gray deserves the "Millennium Incompetence Award.” This, too, is a great honor, as it is only given once every hundred years. There have been centuries where there has not been anything done that was stupid enough to qualify for the prize and the committee chose not to nominate anyone. Gray's incompetence was not even open to question and we are proud of the that he was the first candidate since Pontius Pilot to win a unanimous election.


This puts Gray in the same league as previous winners. You are all aware of their names; they are legion, but for posterity's sake we will remind you of some of the recent winners. The most recent was the U.S. Senator who, in the later part of the 19th century, wanted to close the patent office because in his opinion  it had become a white elephant due to the fact that everything that had ever or would  ever be invented had already been patented.  He simply felt that there was nothing left to invent.  Marie Antoinette won the award in the previous century for her famous slogan, "let them eat cake.” This was done when a starving population was begging for food because they had not had a square meal in months.  This award had been given because it shows how close Marie was to her subjects and what a caring person she really was.  The previous award was a one-time situation and uniquely, we gave a global award for those that wanted to burn Copernicus at the stake for his concentric theory of the universe.  Although Gray has never achieved the notoriety that his predecessors received, we feel certain that time will reward Gray with fame as word of his complete accounting incompetence spreads.


ZZZZ Best did not go quietly. Many Congressional investigations were launched into  the question of how this fairytale could have been constructed by an a literally prepubescent, inexperienced teenager. Moreover, the even more burning issue was how this same teenager, as we have seen above, could foil the due diligence process of the regulators, the accountants, the lawyers and the stock brokerage community?  The verdict seemed to be that without the incomprehensible ineptness of the accounting firm (Ernst and Whinney), the fraud couldn’t have gotten off the ground and that Ernst & Whinney had failed in their role of independent outside accountant and their successor, Price Waterhouse compounded the worst job of accounting since the dawn of time. 


John Dingell, who headed a House committee charged with looking into this type of fraud, literally couldn't believe his ears when the people from Ernst and Whinney started to testify. He already knew that someone had blown the whistle on ZZZZ Best by informing the accountants that the company was riddled with fraud. The newspapers had taken up the cudgel and the company was springing leaks all over the place. Dingell was trying to get a handle on whether the outside auditor, Ernst & Whinney, was representing the interests of the company or those of the public. He was interviewing Larry Gray who we have seen in action previously and Leroy Gardner, another principal of Ernst & Whinney, and seemed to get a lot more than he bargained for.  You can see how the scenario unfolds;


Dingell:          What happened to the stock during this period between June 2 and the date of bankruptcy on July 11? Did it go up or down? 


Gardner:        I didn't follow the stock.


Gray:               It declined with the adverse publicity that was coming out.


Dingell:          As a matter of act, it lost about fifty percent of its value?


Gray:               That may be the figure. I cannot recite the figures.


Dingell:          The price per share on June 2, when you resigned, was around six or seven dollars. When the bankruptcy took place, which our colleague indicates was July 11, the stock fell to less than one dollar, something on the order of fifty to seventy-five cents; is that right? 


Gray:               I assume.


Dingell:          I am wondering, it there some responsibility on the part of Ernst & Whinney to shareholders and other investors in this firm, or do you just have a peculiar special relationship with the firm?


Gardner:        No, no. Our responsibility is to the public, to the investors.


Dingell:          To the public and to the investors. How did you exercise that here? You initiated no contact with the SEC until July 16.


Gardner:        No, no.


Dingell:          Your contacts with the SEC on the seventeenth and nineteenth were initiated by the SEC. You did not initiate that contact…


Gardner:        I am sorry.


Dingell:          The SEC initiated the contact with you on the seventeenth to the nineteenth. You were sitting tranquilly by, informing your former client, during that period of time?


Gardner:        That is not correct, sir.


Dingell:          Your first communication to the SEC was on July 18?


Gardner:        After we talked with the SEC in early July, there was no point ---


Dingell:          They initiated that discussion; you did not?


Gardiner:       That is correct. We knew at that point what they knew.


Dingell:          Happily they called you up. But your first communication to the SEC was on the sixteenth. If the SEC hadn't called you on the seventeenth or nineteenth, would you have called the SEC?


Gardner:        Well, the fact is they did call us and they already knew the allegation.


Dingell:          I know they called you. We are in agreement on that. That point is not in controversy. If they, however, had not called you on the seventeenth or nineteenth, would you have called them?


Gardner:        I can 't speculate about that.



As we can see from the above, one way that independent auditors can screw up is by not specifically identifying all of the assets that are referred to in the company’s financial data, thus is if the asset supplying the income does not exist, the income cannot exist either. Failing to consider all of the diverse sources of revenue and adapting accounting procedures to pasteurize the data so that it remains in balance becomes a product of consistent practice. But unreasonably changing the form of the data also distorts the ultimate product by putting it into a appearance that is not realistically consistent with the general business of the account being audited. This lack of consistent product tends to distort the facts.


What was particularly grating in this case was the total indifference of the accounting firm to the public interest.


Once again, Congressman Dingell gets the last word with the accountants and our kudos as well:


"…we keep seeing this tremendous number of cases where supposedly men of goodwill are diligently watching and doing their job, but the public is being skinned, corporations are going under, rascals are prospering, honest men are suffering and the situation seems to be not improved…We have this wonderful relationship that seems to exist between the accountants and the corporations."


At the end articles started appearing in local papers questioning the company’s veracity. In particular, the Los Angeles Times started running a series of stories inspired by a woman that had been ripped off by Minkow at an early stage in his career. She had been the victim of a markup on her credit card by Barry and from that date on she kept track of everyone that she could find that had suffered a similar fate at his hands.


Her actions created a collapse in the house of cards. Within a short time, ZZZZ Best was hit with shareholders derivative actions, which named, the accountants, the lawyers, the brokers and the company. Everyone coughed up a chunk of money to make a non-public settlement, which totaled approximately $35 million.


The company was a sham and an interesting observation showed that while the company had a market capitalization of $220 million in July of 1987, an auction of its assets brought only $62,000. ([73]) As for Minkow, he was convicted on 57 counts of securities fraud and received a twenty-five year prison sentence for his trouble. While in prison, Minkow through a correspondence course received a bachelor’s and master’s degree in religion from the university founded by Jerry Farwell. He was released for good behavior and soon married a young lady that he met through an associate of Charles Keating who was simultaneously doing time for his part in the  Lincoln Savings debacle.


Ultimately Minkow became the senior pastor in a non-denominational, San Diego  church.  Barry once again has climbed aboard the lecture circuit and is now telling FBI agents and CPAs how to ferret out financial fraud. In his lectures he makes an interesting point. “The average restoration job is $1,000 with a profit margin of 8 or 9 percent. “We were reporting an average job of $3 million with margins of 30 to 40 percent…and we got three clean opinions.” ([74])



Bennett Funding, Ponzi Would Have Been Proud


New Era’s (P. 246)  Bennett, was a swindler with the same last name was around about the same time as  Patrick Bennett that brought us Bennett Funding. We will be seeing more about him down the road and for whatever damage he was ultimately able to do, was literally small potatoes compared with Patrick Bennett, Bennett Funding Group of Syracuse, New York who is unrelated to the Bennett of New Era.  When the smoke had cleared in what the government has called the biggest pyramid scheme in American history, $1 billion was owed to 200 banks and the 12,000 investors that had put money into the venture, which dealt in office equipment leases.  The trustee has reported that he is unable to find any trace of over $600 million of the stolen money.


Yet, Bennett Funding was voted the business of the year in Syracuse.  With that in its background, how could the company be all bad?  This Bennett was engaged in a classic Ponzi scheme, as was his predecessor.  The only difference between the two was the fact that when the smoke had cleared, at New Era, there was something left, at Bennett Funding, most of the money had gone into bizarre investments and high living by the principals. Bennett’s dad had started the finance company and for many years, it had been thought of as a legitimate leasing institution.  The son, Patrick, was able to play upon his dad’s reputation as an astute and honest businessman, and in doing so led the sheep out for a massive shearing.


According to the SEC, Mr. Bennett was selling investors either fake leases or leases in which as many as seven people, each unwittingly held simultaneous interests unknown to each other. The leases were basically on small items such as photocopiers and fax machines.  Because of the fact that the people leasing the equipment were primarily government agencies, it was not hard to discount this highly rated paper.  If this wasn’t enough, Bennett first borrowed as much money as he could from banks with the leases as collateral, thus giving the banks first lien on any recovery.  There were no less than 245 community banks that got taken in the fraud and among them were the Hibernia Savings Bank of Quincy, Mass., LSB Financial Corporation of Lafayette, Indiana, and Mid Am Inc. of Bowling Green, Ohio.  For the most part, these institutions accepted the paper at face value and never looked beyond the agreements they were holding. After the banks had already taken down the paper, Bennett thought it good business to resell the same paper all over again to individuals.



“Richard Breeden, the former chairman of the Securities & Exchange was appointed the bankruptcy trustee to overseeing the mess.”  ([75]) One lease, maybe more was sold seven times.”  ([76]) Some leases were totally fictional and were created “Equity Funding” (P. 144) style at the Bennett offices.  So far, over $205 million has been recovered but because of prior liens, all of it goes to the banks not the individual purchasers.  The Trustee, Richard C. Breeden, stated that although the company was taking in $13 million a month in lease payments, it was paying investors $30 million in principal and interest.


Breeden went on to say:


“The money all went into a giant “honey pot,” which Patrick Bennett, the son of the founders and the chief financial officer, could use as he wished.  Some of the money went to pay off early investors; the Bennett family also used the money “to plunge very heavily into gambling properties, and lost their shirt in every last one.”


What made this bizarre case a little worse than the others is the fact that instead of pleading guilty and blaming everyone else for the theft of so much money from so many, Bennett used the embezzled funds to purchase Vernon Downs race track. ([77]) As his wife continues to battle for control of the track, the horses keep on running as a grim reminder to investors of where some of their hard-earned dollars went.  In the meantime Bennett remains free to pursue whatever interests he desires, while, Kenneth Kazarian, a Bennett lieutenant who lied to regulators while helping to cover up the scheme, pled guilty ([78]) and is awaiting a sentence that can put him away for as long as 30 years.   


Additionally, eight others have been charged with criminal actions in the matter and five have already pleaded guilty.  Among them are Michael A. Bennett, Patrick’s Brother, Charles Genovese, a partner in the accounting firm engaged in auditing Bennett’s books and Gary Pfeiffer, an attorney.


Patrick R. Bennett, the man that made Ponzi look like a piker, did not play well to the regulators.  While his lawyers tried to convince the jury that instead of being a criminal, Patrick was really a clod who was so inept at business that he couldn’t get anything right.  While this was undoubtedly true, it didn’t change the jury’s mind that he was also a crook.  After he had finally been convicted during two trials on charges of bank fraud, money laundering, securities fraud, and perjury, he and his wife went through substantial machinations in attempts to hide their ill-gotten funds from the people from whom.


It is readily apparent that presiding Judge John Martin doesn’t particularly like Mr. Bennett and there seems no question that he has absolutely had enough of his continuing maneuvering.  He offered Bennett’s wife, Gwen a strange offer that she can turn down or not as she sees fit.  If, Gwen Bennett gives up the residence that she and her husband have been trying to shield from creditors, Judge Martin who apparently has some sentencing leeway, will give Patrick a solid 20-years in jail.  If she does not give up the residence, Bennett will be sent to prison for 30-years.  Keep tuned here to see what Gwen decides.  With this bunch, you can never be quite sure.  Judge Martin added the comment, “For me, one of the most devastating impacts for the investors is to see themselves living at poverty levels while Mrs. Bennett lives on a horse farm.”


We think that the judge’s temperament was determined early in the trial by Gwen when she indicated that she had never discussed the purchase of the “horse farm-residence with her husband.  If the judge couldn’t believe his ears on that whopper you can believe that he went ballistic when she said the money for the purchase came out of joint funds in 1992 two years after the fraud started she went on to say that her husband had absolutely no knowledge of what she had done.  Judge Martin had a little something to say about this in rebuttal: “The statements are absolutely incredible as well as false and perjurious.”  He went on to deride several other statements that Gwen had ventured as “hogwash.”  Well we can certainly feel good that the judge did not lose his judicial decorum over Gwen’s inability to distinguish the truth from fiction.  Many in the court said that her inability to discern fact came from living with Patrick Bennett for so long. 


Therefore, the question before the court is whether Patrick gets 20 years of hard time or 30 years of hard time.  In either case, the sentence will probably set a record for white-collar crime.  At the moment, the decision is solely in the hands of his loving wife, who, we are positive, will do the right thing by husband and all of the poor people that lost money in this fiasco.  Let me tell you a little about Gwen to help you predict how she will vote.  Patrick took her to Vernon Downs Race Track on their first date, his horse won and they both screamed.  Her father was an equestrian, and her local restaurant catered to the horsy set. Vernon Downs was built in 1953, and is located in a magnificent area between Syracuse,  and Utica, New York.  It is a harness racing track and is three quarters of a mile around, an excellent size. The track opened to a rush, and during the glory years of the 60s and 70s, as many as 10,000 would show up for a night of innocent gambling.


Gwen Bennett was the guiding force when Vernon Downs’ incumbent management started botching up things.  They were aided by alternative forms of gambling, such as the State lottery and off-track-betting parlors.  On the other hand, the track had minimal overhead, no debt, and a solid portfolio of investments.  It didn’t need a lot to survive.  Patrick Bennett became the controlling shareholder in 1992 when he bought out his father and two other men.  He relished the announcement that the Oneida Tribe was going to be opening up gambling a few miles away, and determined to erect a hotel that would accommodate people at the track and at the Indian Site.  On the other hand, should he be convicted and sent to jail, the New York Racing Commission would more than likely yank his license.  In late 1995, he transferred his ownership to a company controlled by the lovely Gwen.  Strangely, he made her sign a promissory note for $1.9 million, a true bargain, but once in possession of the note he immediately resold it to a friend.  Could that have ticked Gwen off?


In the meantime, she was now the owner of 54% of the stock in the track and Patrick Bennett started to talk to the other directors of Vernon Downs about letting Gwen get more involved. He told them that she had always loved horses, and that someone with so much love of the animals in the sport could never be a truly bad person. Logically, the track management retorted unmistakably that it didn’t want a lot to do with either of the Bennett’s at this juncture.  Gwen, on the other hand may not have felt that her husband had espoused her caused quite strongly enough.  Did she hold a grudge against Patrick for his inept handling of a board of directors of a company in which she herself owned 54% of the stock?


By this time, Mrs. Bennett was back working at a horsy restaurant in one of their hotels.  She had plenty of time to brood about what had occurred, and things were not getting any better.  When she was asked about how she was going to pay the note on her stock back from her restaurant salary and she indicated that it was going to be miraculously accomplished  by dividends on her stock in the track.  When she was informed  that the track hadn’t paid a dividend in a number of years, she was not dissuaded.  She indicated that she would find a way.  Lawyers for the note holder pointed out that her business judgment was severely lacking considering the overall state of affairs that the track was in.  Coopers and Lybrand the auditors for the track abruptly walked out as both the affairs of the Bennett’s and the handle at the track continued to slide rapidly downhill.


Gwen nominated her own board of directors to the track’s inner sanctum when she heard that the corporation that controlled Vernon Downs was going to borrow money without being able to pay it back.  Her slate was literally a disaster.  She nominated Robert McSweeney, the day manager at Comfort Suites Hotel, and Jeremiah Law, who was the owner of the Squat and Gobble restaurant where she had been a waitress.  To say that track officials were appalled would be on of the great understatements of all time.  Strangely, Neil Wager, the Long Island businessman who had acquired Gwen Bennett’s note on the track from Patrick also put up a slate and when the smoke had cleared, two of Mrs. Bennett’s candidates and one of Mr. Wager’s had been elected.  The incumbent officers of the company, in a sly move tacked on three new seats to the board and returned their defeated candidates to office.   


Gwen became frustrated, she had just removed them from of their positions with the track and indicated, “I did this because I cared about my community.”  Strangely, this event didn’t occur when they got married nor did it take place in 1990 before the fraud started, this event occurred in 1997 after the regulators had already determined that Gwen’s husband had just outdone Ponzi in the fraud department.  The lovely Gwen somehow was able to write a $4 million check to get a stake in the track through a small public company.  Richard Breeden has stated that the $4 million represents money missing from Bennett Funding, but never mind.


Breeden had some additional, very logical concerns relative to the track; should control get into the Bennett’s hands, with all the to-do over Ponzi schemes, theft, embezzlement, and fraud, it may make it difficult to raise additional money to keep the track operating he rightly thought.  Thus, the innocent, shareholders of the track would be caused even more substantial damage should this occur. As you can imagine, the scene became totally bizarre:


“Afterward, the lawsuits started flying.  Mrs. Bennett, who has four more candidates she wants on the board, has sued in State Supreme Court in Albany to force the Vernon Downs directors to schedule another election.  Mr. Breeden, the bankruptcy trustee, has sued in Bankruptcy Court in Utica to get control of the shares he says were really paid for by the Bennett investors.  And last month, Mr. Wager sued Mrs. Bennett in Supreme Court in Minneola, N.W. on Long Island, saying that because she has defaulted on her note, the Vernon Downs shares really belong to him.”


“The race track remains in a financial bind. The Oneida County government has offered to lend the track money to preserve jobs, but not until the ownership issues are resolved.  Track officials contend that no one will lend the track money as long as the Bennett’s are involved, and Mrs. Bennett says she can bring in local investors, but not until the current management is out.  ([79])


Mrs. Bennett was not a happy person and she badly wanted her track.  “I wish for the days when we were entertaining our friends, going to Vernon Downs and watching the beautiful horses race.”  Apparently she thought long and hard and if it was going to be a choice of letting her husband spend an extra ten years in a jail cell or giving up her life style, she thought it best that he serve the extra jail time.  She determine that the time would go by quickly for him there and in the meantime, even if she lost the track, she would have her horse farm and those lovely creatures to keep her company.  On April 29th, 2000, Patrick R. Bennett was sentenced to thirty-years in jail by Judge John S. Martin of United States District Court in Manhattan, one of the longest sentences in history for a white-collar crime.  Good Going Gwen!!


Michael Bennett wore the mantle of deputy chief executive of Bennett Funding.  His outside background was even more interesting in that he was a substantial backer in George E. Pataki’s run for New York’s governorship, was engaged in local real estate restorations and was a large donator to local charities.  Michael Bennett was also looking for a quick way out of troubles and admitted that he had lied to the Securities & Exchange Commission when talking about the fact that the company had not used any accounting tricks or maneuvers to make the company’s health appear more robust than it was.  When push came to shove, Michael A. Bennett pled guilty to perjury, obstruction of justice and conspiracy leaving himself open to 15 years in jail and almost a million dollars in fines.  


Kenneth P Kasarjian was an even more interesting case in point.  He was a Senior Vice President of Bennett and in that job, he was able to organize a network of brokerage firms to re-market their leases to customers who really didn’t know what they were buying.  He was the man that was singularly responsible for raising a ton of money from individual investors so that the collateral could be sold at least twice.  He was also the person that invented many of the shams and internal transactions that were geared at throwing the auditors off the track.


Criminality doesn’t come cheaply and Kasarjian was well paid for his efforts and among his other trophies was a home in Mahwah, N. J. that was featured in Architectural Digest.  Kasarjian had borrowed the money from Bennett Funding to buy the house and when he saw that his mortgage would soon be uncovered if he didn’t do something, he came up with the only possibility, he totally destroyed it.  After lying to everyone about the facts in the case, Mr. Kasarjian’s efforts were about to bring him up to 30 years in jail.  When the enormity of the sentence dawned on him, he saw a vision and determined to set things straight.  This included squealing like a stuck pig on his good friend Patrick Bennett. 


Edmund and Kathleen Bennett were the founders of Bennett Funding Group and the parents of Patrick R. Bennett and Michael Bennett.  They were not involved in the government’s case against their children but wanted to make sure that enough blame was placed everyone to totally muddy up the waters.  They charged that Breeden was at fault because he had frivolously quarterbacked the case against the boys.  They continued that Breeden had manipulated the group’s books so that the company would become insolvent.  These bizarre statements were probably brought about by Mr. Breeden’s audacity in suing the elder Bennett’s, asking for the money back that they had illegally received. 


What Patrick Bennett was thinking about when he embarked on his life of crime is beyond on comprehension.   Sometimes when things go bad, there becomes  a race to pocket as much money as possible before the law closes in.  Investment schemes prey on the herd instinct; if your neighbor is doing well, you want to do well also.  As we enter the global neighborhood, we all become each other’s neighbors and ostensibly successful ventures become popular at the speed of light.  While Ponzi’s scheme affected primarily Boston, Bennett’s was basically confined to Upstate New York.  Although Hoffenberg proclaimed his success internationally, it only effected investors within the lower forty-eight states.  The days when criminal acts could be confined within national borders are over.  With no competent watchdog on the net, people can be fleeced even before breakfast is served.  The toll is already being taken; we just don’t know which schemes have succeeded and how much money has already been lost.


When the Securities & Exchange Commission got involved, the fur began to fly. Their complaint reads:


“The Commission’s Complaint alleges that Patrick Bennett, Bennett Funding Group (BFG), and Bennett Management and Development Corporation (BMDC) also engaged in numerous sham transactions that enabled BFG to issue audited financial statements for 1992 and 1993 showing it to be a profitable company, when in fact it was losing money.  In 1992 BFG reported pre-tax income in excess of $2 million, when it should have shown a net loss of at lest $1.5 million.  Similarly, in 1993, BFG reported pretax income in excess of $2.6 million, when it should have shown a net loss of at least $2.5 million.  The complaint alleges that these transactions were facilitated by false invoices and other documents that Patrick Bennett caused to be created, and that Patrick Bennett and BFG lied to the company’s auditors to conceal the fraud.  The Complaint alleges that the fraudulent financials were included in the offering documents provided to investors in connection with the sale of an estimated $150 million in notes. 


In addition, the SEC alleged that a total of $900 million was transferred to BMDC from BFG’s general operating account - an account funded, in part, with the proceeds of the sale of BFG Lease Assignments and Notes.  The Complaint alleges that since 1992, BMDC has paid Patrick Bennett over $10 million, and BMDC has also paid over $30 million to various people and entities connected to Patrick Bennett and members of his family. 


Moreover, you rarely see a major fraud in which an accountant does not feature prominently.  In this instance, the guilty party was Charles Genovese, a name partner in the firm of Genovese, Levin, Bartlett & Co., who was named in a classic indictment containing forty-three counts of securities fraud for his roll in the Bennett Funding fraud.  The final indictment pointed out that 12,000 investors and  over 200 banks were fleeced while $700 million was being blithely stolen. “Genovese, allegedly conspired with Bennett Funding Group (BFG) on sham financial transactions designed to inflate BFG’s financial picture, and then tried to conceal those transactions from the Securities & Exchange Commission.  If convicted, he faces up to five years in prison. “ ([80])


Toward the end of March, 1998, two additional accounting firms were brought into the witches’ brew of Bennett Funding.  Arthur Andersen and Mahoney Cohen & Company were sued for substantial damages for their role in the mess.  Anderson had earlier been an accountant for the company and had resigned. 

Regina Really Didn’t Clean Up At All


Regina was clearly what you would call an old-line company having started out in 1892 in the business of manufacturing music boxes.  When technology turned the corner, Regina hopped on the electric broom business band-wagon and literally ended up owning that industry.  Although they were not setting any sales records, the company was indeed prospering.  Regina was owned by General Signal Corporation, a conglomerate who was not all that excited over their under performing subsidiary who they felt had only limited growth prospects.


As a thirty-eight year old business school graduate Donald D. Sheelen knew in his heart that he was ready for the big time. He took over Regina, and by adding products, beefing up marketing and most importantly, substantially cooking the books, he was off and running.  Donald’s ride up the ladder was fast, but his ride down was even faster.  When he was forcibly removed from the company to start his prison work-release program there was nothing left but ashes.  His legacy was one of lawsuits and corporate bankruptcy.


Donald never took his blinders off, he set his goals and plowed dead ahead when he made up his mind. If he did not achieve his benchmarks legitimately  he would still make sure that the outside world believed that he had succeeded.  Whenever there was a shortfall in projections, the financials were adjusted by underlings to meet Sheelen’s earlier projections, even if they never came close. His rise was meteoric.  His family was middle-class but he seemed to excel at whatever he did.  He was a splendid athlete in school, playing football and basketball, he was the President of his class at Dayton University and  graduated with a degree in marketing.  He ultimately received an MBA from Syracuse.  Donald became a stockbroker at a large Wall Street firm and from there went to work in accounting at Johnson & Johnson.  He arrived at Regina in 1980, and was soon made the person in charge of marketing.  It was the long hours and his unrelenting drive for success that got him noticed by management, and he proceeded to perform, vowing to succeed at any cost.


Donald became president of Regina in 1984 after displaying an uncanny ability to improve margins by adding a series of high end products. General Signal indicated to Donald that they would consider a leveraged buyout by employees.  Sheelen somehow got a hold of $750,000 and purchased the majority of that stock.  With control in his hands he proceeded to take the company private.  Never one to get caught standing still, the following year, Regina once again went public and Sheelen and along with certain other company executives were able to cash in their stock to the tune of $10 million.  Sheelen continued to offer hot products, and between knowing what the public wanted and a substantial advertising budget, he was seemingly able to make the company’s numbers purr.


Wall Street fell in love with him and what he was doing, and the stock soared.  He was a no frills guy and soon announced that he was going to take on the industry leader, Hoover.  The stock was now up over 500% from its price when he first took it public.  His personal earnings were on a par with those of heads of major public companies in the United and he and his wife, originally a Franciscan nun, started really living the good life with nothing spared.  Cars, home, servants, and all the niceties were his for the asking.


The problem was that the whole thing was only hype and no substance ([81]); the equipment that Regina was turning out was under engineered, inadequately  manufactured and over glorified.  The company soon began to be inundated with product returns.  Sheelen’s chief financial officer was Vincent P. Golden, a team player from the word go.  Sheelen directed Golden that if they didn’t record the returns, which were now running an astounding 16% ([82]), no one would be any the wiser. It would give the company time to correct the problem and, just as in all the fairy tales, everything would turn out alright.  Apparently because Golden had believed in fairy tales as a child, he went along with a scheme that not only had to fail, but one in which everyone would suffer grave consequences.


Golden and Sheelen were off and running with all those things that make corporate life worth living. They merrily created phony sales through the construction of false invoices, had expenses evaporate into thin air and returns had amazingly vanished. Sheelen indicated that he inform Golden what the earnings and sales were going to be and Golden had darned better hit the target.  But Sheelen was not finished trying to sucker the public.  He wanted to show that he could ultimately tame Hoover and had non-production model of his competing vacuum cleaner, hand tooled with a secreted. super-powerful suction engine hidden in the motor housing.  His machine sucked up all of the cereal that he dropped on the floor and his magical results put Hoover to shame. His audience went bonkers.  The fact is that this machine could not have been produced for a number of logical reasons ([83]) had nothing to do with the demonstration he put on for the Security Analysts on Wall Street.  The analysts came away very impressed, not knowing that they had been taken down the “garden path”.


Eventually the police came calling and with fanfare he  confessed to his wife, his family and his priest followed by the United States Attorney in Newark.  He then canceled the company’s annual meeting and resigned.  Sheelen ultimately cooperated with the government and received a year in jail and a small fine for committing mail fraud in connection with falsifying financial records.  He served his sentence at the Goodwill Industries Community Correction Center in Florida.  This was obviously not exactly hard time; the place had no bars and no locks on the doors.  As a matter of fact a number of the people that had stayed there called it Santa’s Village probably because of the colors that decorated the facility.  Sheelen’s partner in crime, Golden, was treated reasonably well considering the pain and suffering that he caused.  He was obligated to spend six months in the same type of correctional facility.


The company was left a shambles and ultimately filed for bankruptcy reorganization under Chapter II of the federal code.  The filling showed that the company’s earning had been a mirage and that the debts exceeded assets by over $10 million.  Regina filed lawsuits against both Golden and Sheelen.  The secured lenders came up with enough money to keep Regina going until it was acquired by TRC Acquisition Corporation, a unit of Electrolux.  The National Association of Securities Dealers also got into the act when they discovered massive short selling in Regina’s stock several weeks before the earnings were restated.  Would you believe that the volume in the stock shot up to twenty times the average of what it had been previously?


As a postscript to this story, it was the company that withdrew its financials and it was the company that asked the auditors to re-examine Regina’s previous filings.  Peat Marwick, which had prepared the audits for the company, was summarily replaced by Coopers and Lybrand.  According to company announcements, the switch was made because a restatement would have to be made, disclosures would have to be given, and a thorough analysis of events would have to be performed and published.  In a more formal vein, they said that they replaced Peat Marwick “for failing to give an audit opinion for the 15 months ended September 30.” ([84]) Were they saying that they thought the auditors were responsible and therefore no longer credible?  Regina stated specifically “Peat Marwick took their position in order to remain as the company’s auditors and have access to the company’s records in connection with its own defense.”  In an allied article, the Wall Street Journal pointed out that “Peat Marwick, with some $900 million in annual audit revenues, has the largest U.S. audit practice and appears to be the biggest target for disgruntled investors.“ ([85]) That Journal story went on to say that:


“…The Regina case, however, may prove the most nettlesome. The U. S. Attorney’s office in Newark, N.J. is investigating possible criminal charges against former Regina executives.  And the SEC has begun studying Regina’s financial statements.  “Where there’s been a big change in numbers, the SEC normally looks at the accountants,” one SEC attorney says”  ([86]) Regina hasn’t been helpful to Peat Marwick’s cause when the indicated that the accounting firm had a degree of complicity, “Returns of faulty products weren’t deducted from sales, some sales invoices were fakes and revenue was inflated.”  Shareholders claimed that everyone could have recognized the warning signs, when Regina started lying in the commercials about how they were outperforming Hoover.  There was no secret that Hoover sued, and that Regina pulled the false commercial. ([87]) This should have given the accountants notice that something was slightly rotten.


“But some Peat Marwick officials privately worry that the SEC may again make the firm an “object lesson” to the entire auditing profession.  In 1975, the SEC strongly censured Peat Marwick for failing to perform proper audits for five companies that collapsed soon after getting clean opinions.  Peat Marwick was suspended from taking new public audit clients from May through October 1975, and was forced to undergo a peer review of its audit procedures by outside accountants that year.  Additional but limited reviews were conducted in 1976 and 1977.”  ([88])




Anthony De Angelis and His Magic Water Tanks


This story is a little different than the ones that have preceded it. Previously we have discussed companies that have not been exactly what they appeared to be on the surface. Either by duping their accounting firms or having them act in complicity with them, the public had gotten bilked.  On the other hand, they always made some semblance of being in business.  DeAngelis, made literally none but because he had totally conned the company that owned the storage tanks, it didn’t matter, they gave him credible warehouse receipts that were as good as cash. He was able to discount this paper with local banks. De Angelis had also had several run-ins with the U.S. Government for his proclivity to attempt to move large amounts of phony letters of credit involving pork.


Anthony De Angelis had been around for a while.  He was an elderly guy who is credited with stealing a $1 billion dollars from folks when that was real money, back in the early sixties.  De Angelis knew a little about salad oil because he cut his teeth as a commodity trader and one of the bits of obscure information that he was aware of was the fact that when you mix together  water and  salad oil, the later will float to the top.  De Angelis, never much of an angel, thought to exploit this anomaly and rented some of American Express’s storage tanks in New Jersey.  In them, he placed a mixture of about 1% salad oil and about 99% water.  As we have previously elucidated, the salad oil, like a charm, popped to the top and unless someone put on a scuba diving suit there really wasn’t any way of not believing that the tank was full wasn’t filled to the brim with salad oil. 


American Express was acting as both the lessor of the tanks and the guarantor of tanks contents as well.  Once American Express was satisfied that the salad oil was in place, it would issue a warehouse receipt guaranteeing the products existence. \this instrument in turn was purchased by a third party with its existence was guaranteed by an irrevocable bond.  In this case there was no one to blame beyond whoever was responsible for due-diligence at the American Express. There was no accounting firm to blame. American Express had only one job to do and they jeopardized their entire company by bungling it.


One of the most interesting sidelights of the affair, was the fact that the loses run up on the disappearing salad oil were actually more than the net worth of American Express itself.  The stock tanked and people were not sure whether the company would be able to stay in business or not. Then, even worse news hit.  It turned out that American Express when it was formed began existence as a bank. Its charter was a bank charter and strangely even though banking was only a small part of its business, the charter remained the same. Banking laws had been changed after many banks had disappeared during the crash and one of those changes made shareholders in banks liable for two-times the stock’s par value.  As we recall, American Express had a par value of $100 per share, which was substantially more than the stock was selling at. Shareholders panicked when they learned that they could be liable for substantially more than, not only what they paid for the stock but up to four-times what it was then priced at.  Another classic American company, Kemper Insurance was also involved in the matter but less directly. Once again, their highly paid attorneys are probably the only reason that Kemper is still around.


Luckily, American Express survived by tanking the subsidiary and hiring a team of very creative lawyers, but until the matter was negotiated out, it was touch and go for one of Americas premier, blue chip companies.  On the other hand, at least two major brokerage firms bit the dust, one of them, J.R. Willliston Beane who had as its name partner, the Beane that originally adorned the masthead at Merrill Lynch.  Thinking he could do better with his own firm than he could at Merrill, literally his first move was his last and he forever rued the day that he ever heard the name, Tino DiAngelis, as he was known. The swindle was called by the Wall Street Journal, one of the “all-time financial crimes.”


The swindle was not created in vacuum. De Angelis was using the American Express warehouse receipts to purchase soybean-futures. Soybeans were an integral part of salad oil and by running up the price on the beans
Tino thought that he could make a large enough profit on the futures to cover any deliveries that he may chose to make on the salad oil. When the fraud was discovered, De Angelis’s position in soybeans was liquidated also causing the old-line commodity firm of Ira Haupt to collapse into an irrecoverable heap.

 Billy Sol Estes We Are Proud of You, The Boy’s In Fertilizer You Know


They brought this elderly 70-year old into the court and some thought that they had heard the name. “What’s he being tried for?” asked a local wag. “Oh, I’m not sure, I think something about tax evasion.” Replied another onlooker. “A guy that old, still hustling on his taxes, I can’t believe that.” Replied the first. Another bystander rejoined, “Guys, that’s Billy Sol Estes, the biggest crook ever produced in West Texas and that guy don’t know how to do anything but steal.”


This case was not a major event in Estes’ life, if what the family said is true, he may not even know that it happened. His lawyer pleaded insanity as a defense against the eight-count indictment on tax fraud that Estes was facing in the District Court in Brownwood, Texas. Relative to some of Billy Sol’s other exploits, this one was pretty tame. Billy and some of his cohorts started a charity, an alcoholism halfway house, and then treating it as a for-profit company, at least as far as the partners being able to siphon funds out of the company and pocketing the money. Many had pointed to Billy’s more charitable ways but they didn’t know the truth. In reality, this was minor league stuff and Estes was a major leaguer.


Billy Sol, who lived in Pecos Texas  had done bigger things in his life and stealing from a halfway house charity is hardly fitting for a criminal with such excellent credentials. Years ago, Estes was an influential cotton grower who made a fortune by using his neighbors’ acreage to grow cotton during the years when the U.S. Government was paying a fancy premium for those sorts of things.  He was always politically plugged in, which certainly helped a lot when it came to getting government subsidies. However, the agriculture department determined that there must be something wrong with getting government money to raise cotton on some else’s land on a fully subsidized basis. When the inquiries started coming in droves, Estes decided that he was getting bored with producing cotton and determined to get into a new line in which he could make money without even having to have a product. After substantial research he determined that this non-product would be an imaginary liquid fertilizer tank farm.


Estes and DeAngelis came upon the same sort of scam thousands of miles from each other, almost simultaneously.  Estes as opposed to DeAngelis had always been successful and had accumulated a substantial poke, most of which came from dealings with many of his political friends in Texas who he supported with a flourish when they were running for office.  Tino DeAngelis was a nickel and dime crook that was always getting into trouble with the law if for no other reason than the fact that he just didn’t have Estes’s influence with the right people. Both used tank farms to create assets that were non-existent.  Both convinced sophisticated institutional suckers to throw money at their schemes, both made a fortune in their illegal activities,. both caused a substantial number of people to suffer extreme financial hardships. Both were approximately the same age. The only difference between the two was DeAngelis made every effort to fill every one of his tanks no matter what they contained, Estes never put anything in the tanks.  He couldn’t have because the tanks themselves didn’t exist.


Why I came from, people wouldn’t just buy a pig in a poke but Estes didn’t buy that.  His theory was that big institutions did lousy due diligence and that making the scheme work would not represent any problem. Estes went to the finance companies and told them that he had acres of tanks filled with fertilizer . If they would lend him money, he would segregate the tanks’ contents with a seal and a cast-iron imbedded nameplate, permanently bearing the name of any institution that would finance him on the basis of the tanks’ purported contents.  He offered his lenders the right to send inspectors of their choice to scrutinize the tanks without advance notice to verify Estes’ assignment of rights to them.


Many institutions considered this great collateral; Estes was able to borrow real money on the liquid fertilizer that he claimed filled his tanks. The trouble was that while a few tanks contained the liquid fertilizer, the ratio between these tanks and the empty tanks was colossal.  The institutions regularly did verify their collateral’s existence. However, what Billy Sol knew and what they didn’t was that in West Texas, where the tanks were, there was only one airport that could logically be used to get to his tank farm to do an inspection.  That airport had a handful of rental car facilities, whose employees all worked on Billy Sol’s payroll as a sideline.  When an Eastern auditor showed up with a corporate credit card, they called Billy or one of his people. As soon as they could be sure that the traveler was a creditor of Billy’s, they trotted out the shiny new nameplate bearing that creditor’s name, removed the old creditor’s plate, and soldered the new one onto the tank. When the due diligence auditor came calling, naturally he found his company’s name embossed on the tank just as Mr. Estes had promised.  Moreover, he found that it contained exactly what it was supposed to include.


Every inspector  in turn became a salesman for Billy Sol. They all went back and told their constituents that everything was as advertised and for the most part, this herd industrial sheep were more than happy to have Mr. Estes load another non-existent tank with imaginary liquid fertilizer and give him a little more money.


Ultimately,  Estes’ secret was revealed, and banks and finance companies all over the country went into a period of mourning. Estes had stolen them blue. The problem in this instance had been the fact that the tanks purportedly belonged to Estes and thus, there was no independent warehouse receipt. In the DeAngelis case, victims would have recourse against the issuer of the warehouse receipt, American Express.  In this case there was no third party receipt, no insurance, and the money had vanished. Estes went to federal prison for his trouble and once again he went to  the big house in 1979 for income-tax evasion. It appears that unless his insanity plea falls upon friendly ears he will have the government as his host for the third time at an age where a rest home would have been much more fitting, the tender age of seventy-two.  


As a sidebar, Estes never quite knew when to let well enough alone. He gave an interview with VSD, a big French Weekly in April of 1999 in which he claimed that Lyndon Johnson ordered the assassination of Kennedy. In addition, he raises in that article a point that he did not raise in the United States when he plead insanity.  That point is that he indicated that the reason for this astounding statement was the fact that he is dying of prostate cancer and wants to “set the record straight before he dies.” 


He went on to say that one Cliff Carter, a crony of Johnson and Malcolm “Mack” E. Wallace were also involved with Johnson in all kinds of nefarious stuff.  The story in the French magazine gets crazier and crazier so we won’t honor it with anything further except to say that Estes indicated that “He also has recording of all of his conversations with Wallace, Carter and Johnson. 


After Estes got out of prison the second time, he had a message waiting from God or somewhere else, in which he was told to clear the air.  Estes told the world about his relationship with LBJ and a slush fund that he had personally set up for him. He went on to recount chapter and verse of murders, pillaging and other strange and bizarre experiences, which the former President was involved in. On the other hand, everyone that he was talking about had died and even the fact that he had told this story to a Texas Grand Jury had little effect on the world at large.


The U.S. Justice department hearing about this testimony asked Mr. Estes to visit them. Estes said that he would tell them about seven murders that Johnson was directly or indirectly involved including President Kennedy if they would give him immunity. No deal was ever reached and so we are unaware of what could or would have happened had they worked something out. It appears to us that Mr. Estes should have used the defense of insanity a little earlier in his career. This guy is certainly one strange dude.


Finance Companies Gone Bad


Towers Financial, A House Of Mirrors


Steven Hoffenberg owned a company by the name of Towers Financial, which was ultimately closed by regulators and left investors holding the bag for $460 million. The New York Times called Tower one of the largest Ponzi schemes on record; Hoffenberg took 3,000 investors from literally every state in the Union by selling them worthless promissory notes. And yes, Towers reported to the SEC, which claimed that it too, had been defrauded, not by Towers, but by Hoffenberg’s accountants and lawyers, who were issuing phony financial statements and making false claims.


Apparently the SEC had it right. Dan Girard, an attorney representing the Tower investors said, "Because Hoffenberg’ s company is now bankrupt, the people who purchased Towers’ promissory notes, and lost an average of $80,000 each, will never recover even a fraction of the amounts they lost unless they are able to hold Hoffenberg’s accountants, lawyers and investment ratings advisors responsible.”


Ultimately, Steven Hoffenberg pled guilty on March 7, 1997 to criminal conspiracy and for his efforts received a 20 year prison sentence along with a $1 million fine and the order to pay restitution of $462 million for his roll in defrauding thousands of investors. Hoffenberg agreed that he had deliberately falsified Towers’ financial statements to show none existent assets or to inflate those that existed. The same was true of revenues and net income. In typical Ponzi fashion he used money from the later investors to pay off earlier maturing notes. Pension funds and individual retirement accounts were the major losers in the transactions. Tower ultimately implicated Price Waterhouse in Barbados. In his guilty plea, Hoffenberg stated that Price Waterhouse issued phony financial statements for Towers, which allowed him to sell the fraudulent instruments that he was peddling. 


But the SEC wasn’t done with the accountants yet; The Commission instituted public administrative proceedings pursuant to Rule 102(e) of the Commission's Rules of Practice against Leslie Danish, a CPA practicing in New York with the firm Richard A. Eisner, LLP. The Commission found that Danish engaged in improper professional conduct in connection with his audits of the financial statements for five subsidiaries of Towers Financial Corporation. The five Towers subsidiaries filed for protection under Chapter 11 of the Bankruptcy Code in March 1993, along with their parent. The Towers Chapter 11 Trustee determined that the financial statements for the Towers subsidiaries materially misrepresented the value of their assets, which were purportedly receivables purchased from healthcare providers with a value of $155 million.


The Chapter 11 Trustee concluded the net realizable value of these assets was only $28.5 million. The Commission also found that the Towers subsidiaries had made under-collateralized loans to two of the most significant healthcare providers, instead of purchasing receivables from them, and that the Towers subsidiaries had not reported these loans at their net realizable value, with an appropriate allowance for doubtful accounts. The Commission found that Danish departed from professional auditing standards by failing to exercise due care and to maintain an attitude of professional skepticism in the performance of the audits. With respect to the under-collateralized loans, the Commission found that Danish relied excessively on management representations, and concluded that there was no need for an allowance for doubtful accounts without seeking and obtaining sufficient competent evidential matter. (Rel. 34-39931; AAE Rel. 1030; File No. 3-9594)


Mercury Finance


Mercury Finance seemed to have everything going for it.  They were a sub-prime lender in the iffy business of making auto loans to people with poor credit.  They were able to charge in excess of 25% per year, rates that made it easy to gloss over an occasional default.  Earnings grew accordingly, and they averaged growth of around 23% for the last five years, certainly an enviable record.  They did so in spite of the bad credit ratings of their clients.  Somehow Mercury was beating the odds and bringing home the bacon by skillfully maximizing recovery.


They became the largest second-hand automobile finance company in the United States. Wall Street pundits said they had the Midas Touch, and their list of shareholders read like an edition of Who’s Who Among American Institutional Investors.  They had 231 offices in 31 states and the white shoe accounting firm of KPMG Peat Marwick was signing off on the financials.  Most of Wall Street analysts rated the company as a screaming “buy.”  Management was said to be top-drawer.  How could they be anything else after putting together forty-nine consecutive record breaking quarters?  Their Chief Executive Officer brimmed with confidence and with the kind of record that he had put together, who could blame him:


“Since inception, results at Mercury have been extraordinary.  Our consistent earnings improvement has been supported by controlled expansion.  We have and will continue to target quality growth, not just growth for growth's sake. Since becoming a public company in 1989, Mercury has recognized the importance of its commitment to its shareholders.  The Company strives to provide the highest possible return on investment while enhancing shareholder value through dividend increases and stock splits.”


This was the kind of stuff that dreams were made of and everyone had a warm and fuzzy feeling when it came to Mercury and their management.  Little did they know what was in store for them.


Ultimately disaster struck, Mercury announced that it had overstated its earnings for 1996, as well as the three previous years, by in excess of 100%.  James A. Doyle, Mercury’s Controller, didn’t ameliorate matters when he totally vanished.  Those in the know said that he was in a “safe house” cooperating with the Government in one of the most far-reaching investigations in the history of the finance business.  It didn’t surprise anyone when Doyle was fired after not showing up for work for a while, but rumor had it that he had been telling Federal Authorities that the Company was nothing more than a “charade.” In exchange for a sweetheart deal for himself.


The Mercury news continued to go from bad to worse, as First National Bank of Boston announced that the previously approved merger of their auto lending division with Mercury was permanently off.  Moreover, the poor investors, who had had no clue that anything so unsavory was afoot, totally lost confidence in company management and started selling Mercury Finance shares at whatever the market would bear.  The New York Stock Exchange, where Mercury was traded, was   besieged by sell orders, and ordered a halt in trading.  When the smoke cleared, the stock had tanked by a full 85% of its value, from fourteen dollars a share to just a tad over $2 per share, on a volume of 42 million shares.


Additionally, almost $100 million in corporate debt was up for renewal.  Lenders were not in the mode to pony-up any more funds for what was beginning to look like an out-of-control finance company.  Moreover, to make a bad hair day even worse, rumors ran rampant on the Street that the Securities and Exchange Commission had launched a massive investigation of the company.  It wasn’t more than a day or two later that no less than four stockholder derivative suits were instigating charging everyone in sight with every malfeasance known to man.  Some said that this was overreaching, but then again, no one had ever marked up annual earnings by 100% before.  The Company had made financial history.  Such prestigious names as the Minnesota State Board of Investment, T. Rowe Price, the Ohio Public Employees’ Retirement System, the Florida State Board of Administration, and the administrator for the company employees’ 401K plan, all jumped on the class action bandwagon. 


The charges were mostly the same: Mercury had disseminated false and misleading information, and had violated just about every part of the 1934 Securities Act.  Suits also contained charges that the company had engaged in deceit, negligent misrepresentation, and consumer fraud.  In addition, litigants charged that the accountants had not prepared the company’s books under generally accepted auditing standards.


Moreover, the bonuses of Mercury’s senior management were tied into the company’s earnings.  In this respect, Mercury was far ahead of most frauds; as examples of such arrangements did not become rife until later in the ‘80’s.  This practice had particularly unpleasant results at Kidder Peabody when James Jett inflated his profits dramatically and everyone’s salary was raised.  No one wanted to blow the whistle on Jett because they were all coining money, and as long as they weren’t directly in the line of fire, so what.  While in the Kidder case, everyone just watched, mystified and pleased, as Jett continued to rack up unsupportable profits, at Mercury the entire upper management was clued into the bonus pool and everybody was sharing in doing their part of the dirty work. 


Officials with the State of Minnesota indicated that suits seeking damages of over $1 billion had already been filed.  In the time the auditors were also brought into the fray and were equally named on most of the lawsuits that were been filled. There is an unusual twist to this story.  The auditors, KPMG Peat Marwick, found the fraud, told management, and hung tough.  Ultimately they were fired, but they had made their point and the Company’s earnings were restated to conform to the auditors’ requests.  Naturally things were not copasetic between management and the accounting firm, and Arthur Andersen was brought in to finish to books.  The Company prepared a public statement concerning its substitution of auditors, and tried to put the best possible face on it.  William A. Brandt, Jr. the company’s CEO and President, made the announcement:


"Under the circumstances, Mercury Finance will be best served by a new public accounting firm, which can bring a fresh independent point of view to the situation.  We have asked Arthur Andersen to proceed as expeditiously as possible."


While making the best of a bad situation is what management is supposed to do, Peat Marwick did not think that the company statement went far enough and they elucidated:


“Mercury Finance Company's announcement today loses sight of the fact that KPMG discovered the irregularities while conducting its audit of Mercury's 1996 financial  statements -- and immediately brought it to the board's attention.’


“KPMG is disappointed in Mercury's decision to change auditors.  We had been working closely with the company as part of the solution to help get Mercury back on its feet. In fact, KPMG was in the best position to assist Mercury in promptly getting accurate financial information to the public.  We had expected to complete Mercury's 1996 audit by late March.”


“It should be noted that on January 23, 1997, Mercury Finance Company issued a news release concerning its 1996 earnings -- before completion of the audit of 1996 financial statements and over the objection of KPMG.” 



While it sure looks like Peat Marwick did the right thing in forcing the issue and we certainly believe that have the better of the two public relations releases but that will not get you a one cent discount in court.  The fact is that this company was able to mis-state it’s earning by a humongous amount and the accounting people were out to lunch.  Among the many easy catches that Peat Marwick missed was the capitalizing of lawyers fees, for the most part, in acquisition deals.  These amounted to a substantial amount of money and were just put in the wrong place on the balance sheet giving earnings an additional jolt.  A junior accountant right out of college would have noted that one in a flash, so we are at somewhat of a loss to understand what really happened here.  One of the actions filed against Peat Marwick read as follows:


“19. (a) Defendant KPMG caused and allowed its opinions to be included in the Forms 10-K that Mercury filed with the SEC on or about March 31, 1994.  Further, KPMG caused and allowed its opinions to be included in Mercury's 1993, 1994, and 1995 Annual Reports filed with the SEC on or about March 21, 1994, March 21, 1995, and March 19, 1996, respectively.  As a result, KPMG rendered materially false and misleading reports on the financial statements of Mercury for the fiscal years ended December 31, 1993, December 31, 1994 and December 31, 1995, respectively.”


“(b) In the course of rendering services to Mercury, KPMG became aware (or recklessly disregarded) that Mercury was improperly reporting revenues and improperly recording earnings as part of a plan and scheme to inflate reported net income during fiscal 1993, 1994, 1995 and 1996.  KPMG knew (or recklessly disregarded) that the financial statements of Mercury suffered from serious reporting deficiencies that made the Company's reporting improper under Generally Accepted Accounting Principles ("GAAP").  KPMG's issuance of an unqualified "clean" opinion with respect to Mercury's fiscal 1993, 1994 and fiscal 1995 financial statements did not comport with GAAP or Generally Accepted Auditing Standards ("GAAS").”


Peat Marwick wasn’t able to raise a lot of defenses.  They were the ones that had caught the fraud.  The fact that the accountants had given the company a clean bill of health was their downfall.  And, in the “for whatever it’s worth” department we give what has come to be standard accounting language for an unqualified report.  This was one of many similar reports issued by the accounting firm assuaging investors, that above all else, they were watching the store, what a warm and cuddly feeling shareholders get when they read these:


“We have audited the accompanying consolidated balance sheets of Mercury Finance Company and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1993. We conducted our audits in accordance with generally accepted auditing standards.  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by the management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Mercury Finance Company and subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1993, in conformity with generally accepted accounting principles.”


The officers were not only paid well in bonuses but almost to a man, they had loads of stock, much of which they received as stock options, which they weren’t at all afraid to dump as soon as the shares were registered.  They foisted millions of dollars of stock on unsuspecting investors who were unaware of the financial fraud was being committed on an ongoing basis. 


Wall Street had been caught totally unaware and stock market losses became substantial.  However, anyone reading between the lines would have concluded that Mercury had telegraphed their punch.  In their second quarter 1986 financials, they admitted that they had double-booked their reserves in Mercury’s life insurance subsidiary.  Thus, if they had double the reserves on paper, but only had one-half of that amount backing up insurance claims in reality, these folks were soon going to be in very deep dodo.  It was plainly there for all to see.


The finance company was also required by the SEC to file an amended 10-Q with the Commission.  The 10-Q is primarily a financial statement that discusses earnings in the last reporting period.  This is filed with the SEC and then through their good offices becomes readily available to the public.  Double booking is bad enough, this is like absolutely losing track of where your money is, but when it is an amount in excess of 10% of total net income, we are talking really serious stuff.


On another front, Mercury’s success was also a partial cause of their demise.  They attempted to prove that people with poor credit would pay their car loans under the right circumstances and if not, proper safeguards could be put in place to minimize loan loses.  On the public relations front, we believe that Mercury did an excellent job.  They had made their point so well that any number of competitors looking at Mercury’s bottom line determined foolishly  that it may well be true that the higher fees and interest that could be obtained in this business would more that offset the risks involved.  As more competition jumped into the arena, Mercury’s loan quality started to decline precipitously.  Any number of security analysts seeing that trend developing talked about jumping off the “high risk auto lending” bandwagon.


The most interesting comment on the company was made by Westergaard Research.  “You are dealing in a business where the company is indicating that there is an enormous amount of write-able business available.  Your after-tax returns are running thirty percent.  You are paying out forty percent of your profits in dividends.  Would it not have been a better idea to pay out less in dividends to maximize the net return even further and more importantly, with the stock selling at a price-earning ratio, wouldn’t it have been more logical to have gone back into the equity markets for more money.”  The stock was once of Wall Street’s darlings and raising substantial funds at a reasonable cost was certainly in the cards.  Westergaard postulated that under the circumstances, the only logical explanation was the fact that the Company did not want to have anyone doing excessive due-diligence on the books because they couldn’t stand the heat. Westergaard was right on the money, but their logic would indicate that they also didn’t have a lot of confidence KPMG Peat Marwick’s ability to get to the bottom of things.


Before you could blink an eye, Mercury hired Salomon Brothers to figure out how they could tap the financial markets in consideration of their horrid state of affairs.  As an additional  “red herring,” Mercury hired two prestigious law firms to investigate its accounting practices.  The only good thing about the affair was the fact that the company had indicated that they were about to branch out; being so dependent on sub-prime auto loans.  They were going to start lending people with bad credit money for plastic surgery, one of the really dumbest concepts in financial history.  You know what happened next. The company filed for reorganization under Chapter II. The world had been spared their next idea.


The Brokers Took No Prisoners Either

If You Listened When E. F. Hutton Talked You Were In Deep Trouble


Edward F. Hutton the investment banker that founded the brokerage firm that bore the same name was born in New York City in 1877. His family was poor and his father died when he was just ten.  He was forced to drop out of school to help support his family and started his working career as a mail boy. Eventually, Hutton became a stockbroker, married well, and founded a small brokerage house with his father-in-law’s help.  His big break came when he opened up an office in San Francisco at the time of the 1906 quake.  Interestingly enough, Hutton had just about the only direct telegraph line to New York when no one else did and when the quake hit, he was able to rack up big profits before anyone else even knew what had happened.


Hutton ran an open shop at the brokerage house and encouraged each and every employee to let him know directly if they had any ideas for bettering the firm.  Paradoxically, Hutton’s shop was almost anarchistic; if you were not mature enough to make your own decisions, you really were not made of the stuff that Hutton was looking for. Whatever the logic, E. F. Hutton the brokerage company grew until it was the second largest firm of its kind in the United States next to Merrill Lynch.


Hutton had worked himself up through the ranks, ultimately becoming the Chairman of General Foods as well as the head the brokerage company.  E.F. Hutton, the brokerage house was merged into Shearson Lehman Brothers in 1987, and that firm is now called Salomon Smith Barney (part of Citigroup). The brokerage house became widely known for the slogan: “When E. F. Hutton speaks, people listen.”


Hutton’s management remained aggressive even after their leader’s death in 1962.  This aggression manifested itself in an awesome rejection rate of Hutton checks from Bank of America’s data processing equipment.  Bank of America noticed that easily 50% of the checks that Hutton wrote could not be processed by computer, fully 50 times the national average, and all of the checks that bounced out of the electronic system had to be individually re-entered.  The bottom line was that this scam allowed Hutton to profit from a much longer than average float on their checks. Hutton was thusly able to take advantage of the much longer float on their checks.  This little trick was accomplished in a number of ways.  When a greasy substance was rubbed into the check, it would bounce more often than not.  When a staple was placed in the bar coding, it would not clear the system  a high percentage of the time, and when an edge of the check was folded, the check could not make it through the data processing equipment.


Hutton’s shenanigans were causing a severe backup at Bank of America, and after a careful evaluation of what was going on, the bank voiced its suspicions that Hutton’s checks were being deliberately doctored.  Bank of America gave Hutton two choices: either they would stop playing with the checks, or the Bank would close their account and report them to the Treasury.  Hutton complied.


However, Hutton had already found a new way to beat the system.  It devised a “use of funds” system that predicted almost exactly how much money E. F. Hutton would need in a particular branch on any given day.  Whatever was in excess would be bundled up and wired out by 1:00 P:M so that it hit Hutton’s money center account the same day and started to pay interest immediately.  Hutton felt that in order for the system to work properly, they needed the total co-operation of their branch managers; 10% of the interest received was paid to the office managers as a bonus for helping defraud local banking institutions.


This was not a bad idea as far as managing money was concerned, but it created a lot of problems as soon as the managers realized that the systems could easily be rigged in their favor.  By drawing down excessive amounts of money, the manager created excess in the interest account against uncollected funds in his local account.  Small town banks did not have the oversight systems in place to figure out what was happening; indirectly they were being robbed blind by greedy Hutton managers who were selling their souls to the Devil for 10% of the action.


Historically, in 1978, Hutton’s management was not thrilled by its bottom line.  The firm had become a money-eating machine.  One possibility discussed among Hutton’s senior officials was that the firm go into an “overdraft mode” and subsist on the float. Even if they were caught, the banking regulators had no oversight over a brokerage firm, and Hutton would get off Scott-free. However, Hutton’s legal analysis was fatally flawed.  When regulators finally got wind of the scheme, they concluded that it actually constituted a radically illegal mail fraud.


By 1980, the checks heretofore written for a thousand dollars or more were  being replaced with multi-million dollar overdrafts, an act of theft against the banks that were clearing the transactions. From Hutton’s point of view the plan was a startling success, and in that year, Hutton was able to cut its bank borrowings on a daily basis from almost $400 million to a more manageable $200 million per day. Assuming that Hutton was paying 10% interest on the money, a figure that would probably have been conservative for that time of high rates, they would have saved almost $20 million in 1980 alone, a very pretty penny.


Branch managers were pushed to do even more by senior executives. Those that didn’t perform up to expectations were given a written memorandum showing in detail the difference between  the monthly commission that they actually received and the one that they could have gotten for being more productively involved in the plot.  They received the difference in monopoly money.


New York State Corporation owned the Genessee County Bank, a small upstate bank at which E. F. Hutton had just opened an account. The management at the bank soon noticed that Hutton was writing checks for millions of dollars that it was far from being able to cover.  Hutton was depositing uncollected funds from the United Penn Bank in Wilkes-Barre, Pennsylvania. New York State Corporation officials called the United Penn Bank asking whether or not there were good funds behind the checks. The response went, something like, “Hutton never has good funds.”  United Penn Bank told the caller that the check that they had issued to Genessee was indirectly backed by a third bank-check probably issued by Manufacturers Hanover, Hutton’s primary bank.


New York State Corporation officials told the Genessee Bank to bounce the Hutton check. ([89])   They then called upon the manager responsible for issuing the check at Hutton. He indicated that his orders were coming from higher up and he was only a small cog in the chain. He gave them his superior’s phone number and up the daisy chain they went. The buck stopped at a very senior level,  and the seriousness of what had just transpired was firmly impressed upon the executive with whom they spoke. Hutton offered to deposit $30 million to its Genessee Bank account to cover any inconvenience that Hutton may have put them through. Genessee officials accepted the funds an hour later, and promptly froze the account. Thus, $30 million of Hutton funds was tied up in the small bank for over 90 days.


In late December of 1991 Genessee officials wrote to “the state and federal banking regulators, the FBI, and the Secret Service describing everything Hutton had done. A few days earlier, United Penn had notified the Federal Deposit Insurance Corporation, a federal banking regulator about their problems with Hutton. As the complaints flowed in, the banking regulators realized they had a potentially significant problem on their hands. They had to investigate.” ([90])


As though Hutton didn’t already have enough problems, a new account started depositing astronomical amounts of money in the firm on a daily basis. An examination was commenced by the U. S. Government, supposedly with Hutton’s offer to be cooperative. Just as the Government was about to close in for the kill, they found out that the accounts in question had been closed and the money had be removed based on a tip to the account from Hutton management. Government investigators, which included FBI chief Louis Freeh, were incensed with Hutton’s backstabbing. Hutton had unquestionably made a very bad enemy.   


In 1983, Hutton overdrafts totaled one-half billion dollars and its bottom line effect on the brokerage firm was that this form of interest income accounted for 75 percent of the retail brokerage division’s profits.  The Justice Department of the U. S. Government soon discovered this intricate system and began an investigation.   Their conclusion was released in 1985 when Hutton “pled guilty to 2,000 counts of mail and wire fraud, charges stemming from the use of the nation’s postal service and telecommunications networks by Hutton to defraud its banks via the draw down system.  The firm teetered on the brink of insolvency until 1988, when it was bought by Shearson Lehman Brothers, one of its major competitors.  ([91])


Congressional investigators were particularly galled in the way Hutton’s auditors mischaracterized the overdrafts on in Hutton’s financial statements.  There was no “overdraft” item on Hutton’s balance sheet; Hutton accountants used the term “Drafts & checks payable” instead.  The two terms mean entirely different things, and Congress correctly concluded that this was merely a smokescreen.  They were also not to happy with the fact that while Andersen had sent a memorandum for the files to Hutton regarding their management procedures, nothing was completed and Arthur Andersen never followed it up. Congressman Hughes had a little discussion with the accountant’s audit partner regarding this matter:


Congressman Hughes:              Mr. Miller, what did you do after the meeting that took place on March 7, to check the accuracy of what was related to you?


Mr. Miller                                   Well, after the meeting, sir, I reflected on the entire meeting; the fact that I had a hundred bank confirmation with no exceptions noted…the fact that I found no evidence of checks bouncing, I found no unusual fees being charged by the bans to Hutton..


Congressman Hughes:              That’s not my question. My question is: what did you do after the meeting? Because, frankly, to your credit, you did see that there were some problems…Did you ever get to the bank’s point of view on the system?


            Mr. Miller:                                  No, Sir.


Congressman Hughes:              Well, here’s what you say, “Joel Miller then stated that he would discuss the matter with other partners at Arthur Andersen and Company whose clients include major money-center banks, to ascertain what the banks’ point of view is regarding these transactions.”


Mr. Miller:                                  Sir, I had a hundred confirmations from the banks. When I got back to my office and reflected on the entire meeting, I concluded that none of the banks had notified me of any problems—


            Congressman Hughes:              So you didn’t follow through.


Mr. Miller:                                  Well, I followed through in that I reflected on the entire problem and I concluded I would stick by the opinion that I believe Mr. Rae gave me.


Congressman Hughes was not all assuaged by Miller’s testimony or lack thereof. He called Brilloff to discuss the fact that in spite of the that the Justice Department had been examining Hutton with a fine tooth comb for over two years, there was not a peep about that matter from the usually ebullient Andersen other than an obscure footnote:


“The company and its subsidiaries are defendants in legal actions relating to its securities, commodities, investment banking, insurance and leasing businesses. Certainly these actions purport to be brought on behalf of various classes of claimants and seek damages of material [sic} for indeterminate amounts. In the opinion of management, these actions will not result in any material, adverse effect on the consolidated financial position of the company”;


Congressman Hughes:              In your opinion, was this disclosure adequate, given that it was a little more that a month before Hutton pleaded guilty to 2,000 counts of mail and wire fraud, that obviously, at this time, Andersen was on notice of the ongoing grand jury investigation, and, in fact, had been subpoenaed?


Professor Brilloff:                     This disclosure was very much like a bikini bathing suit, what it revealed was interesting, what it concealed was vital.


Whatever Andersen tried to do to have the matter corrected was largely wasted effort. While they did the right thing by going to the audit committee and pointing out various problems that they had uncovered. They might not have been aware that the audit committee was little more than a rubber stamp and that none of the committee members had the slightest idea of what was going as they were apparently picked solely based on their lack of expertise on any subject. One of the more auspicious members was a movie actress that was a granddaughter of Edward F. Hutton who had not concept of accounting principals.     


The Government was never able to affix the blame for this fiasco on any particular person or group of people.  The branch managers blamed the executives, the executives blamed the internal auditing staff, and they in turn blamed the outside auditors, who blamed the branch managers.  There was no particular paper trial for the government to follow.  Out of frustration, the Justice Department literally determined to indict the whole firm. In spite of that fact, there was a hearing before a congressional subcommittee to look into the matter. The committee asked the famous accountant, Abraham Brilloff to look into the matter and give the committee some insight into what he discerned:


“Where has Arthur Andersen failed?…At the outset and most importantly, they failed to follow through on what they absolutely saw and understood, as early as 1980, as to what was going on. They questioned counsel and counsel said, “Go away, we’re too busy to respond.” It is my view that had Arthur Andersen really fulfilled its responsibilities under the circumstances, the money-management excesses would have been stopped dead no later than 1980 or 1981.”   


Edwin Meese was the attorney general of the United States in 1985 and found the Hutton case was so egregious that he personally took charge of the announcement of its disposition, which read:


“The Department of Justice today filed a criminal information charging E.F. Hutton & Company, one of the nation’s largest securities dealers, with two thousand counts of mail and wire fraud. The essence of the charges was that Hutton obtained the interest-free use of millions of dollars by intentionally writing checks in excess of the funds it had on deposit.”


Congressman Mazzoli put Andersen’s roll in the Hutton scheme into perspective:


“Maybe some of the newer practitioners of accountancy have lost sight of the traditions and lofty history of the profession because they walk into firms now that are groveling for money just like the most mercantile of companies. Maybe they are incapable of having this high fiduciary standard that we, at least in my generation, grew up with in law, and accountancy and in medicine.”


With 2,000 different counts against it and substantial fines to pay, the firm merged itself out of business.  Arthur Andersen had done the accounting for Hutton and knew all about what was going on. They had indicated that the overdraft scheme was highly questionable. They did not resign, nor did they go  to the authorities or qualify their opinion. Seems like just another average day in the life of the accounting firm.  Edward F. Hutton probably turned over one more time in his grave. 



J. B. Hanauer Brokerage & Money Laundering

One of the most regulated businesses in the United States is that of the Securities Industry.  After having been in the securities business for most of my life as an officer of a brokerage firm, it began to seem that hardly a day ever went by that some regulator or other didn’t have some question to ask.  Because brokerage firms deal with the public and that they are insured by SIPC, it seems that every regulator has an opportunity  to look at the books.


Whether a brokerage firm is public or not, they are obligated to have an outside accountant review their books on a regular basis.  This is primarily done to insure that the firm is in capital compliance with the various securities regulations.  It is very painful when a securities dealer fails and if the regulators are able to have some notice that there may be such a danger, at least they can merge the firm out before the trouble gets even more critical.


More often than not, securities firms get into trouble buying their own stocks to support them.  Often no other market makers are willing to buy someone else’s deal, so the only buyer is the original broker that carried out the company’s initial underwriting.  After the firm’s salesmen  have gone through all of their customers, there is no one else left to call. If they don’t support the issue the brokerage house  could fail.  Their accounts are loaded with the stock and just the loss that potentially exists relative to margin calls may be enough to totally sink the firm.


One of the most import aspects of the outside auditor’s job is doing the books and then checking with the customer (confirming) whether everything that appears on his statement belongs to him and that the statement is essentially correct.  This prevents brokers from pilfering funds out of client’s accounts, making sure that stocks are not in the account that don’t belong to the client and that the brokers client is fully aware of what is happening.  The stock certificate is categorized the same way as finished merchandise would be in a manufacturing company.  In manufacturing, the process is more selective than it is in securities as everyone gets a confirmation letter from the outside accountants.  The reason that the securities industry has to be so carefully regulated is that you never see the final product.  The industry has gone totally paperless and the only way that you can be sure that you really own something is to look at your brokerage statement. At the same time you have to be sure that the statement is issued directly by the broker, not be a salesman with a fertile imagination and a printing press.


There are a number of different types of brokerage firms.  Some are what we call “full service” meaning that they specialize in all facets of the business, others pick smaller niches where they can be a big fish in a smaller pond.  Some firms specialize in over-the-counter trading, others concentrate on clearing transactions for other brokerage firms and you also have broker-dealers that do not directly take in money and only deal in mutual funds.


There are also brokerage firms that only deal in municipal bonds. It is one of these firms that we want to discuss here.  Remember, the confirmation process is critically important and having a strong outside auditor can protect both the brokerage firm and the public simultaneously.  Municipal bonds are issued by non-federal governments, that can mean, city, county, state, school districts or just about any non-federal taxing authority that  your mind can imagine. The only criteria is that the issuer is a taxing authority able to pay the interest on the bonds. The quality of taxing authorities is ranked by the rating services as to their ability to pay the interest on their obligations.  The better the rating, the safer the bond, the lower the interest rate.  There are also municipal bonds that are called industrial revenue bonds.  The only thing warranting any return at all on these instruments is the success of the particular, for profit company that they are aligned with.  These types of bonds are not as significant as they once were because of any number of fraudulent transactions that occurred, a cut-back on the number that can be issued by local & federal regulators and the proliferation of the industrial junk bond market. 


Municipal bonds are, for the most part, granted an exemption from federal taxation.  Most states also give an exemption from state taxes to residents that live within the state that issues the particular debt instrument.  Thus, many municipals are triple tax exempt, which means that you never really have to worry about paying anything to anybody if you own one of them.


Many people try to use money that has been laundered in some fashion to purchase triple tax-free bonds.  The benefit is that when the purchaser takes possession of the bond, no one really knows where it went and by clipping the coupons a nice income came be built up without anyone being any the wiser.  Regulators have recently attempted to have customers keep these bonds in “street name” (at the brokers office in his name) so that by culling the broker’s statements they can see who might be cheating on their taxes or laundering money.  For that reason, more often than not, a bond that is physical possession of the owner can command a premium in price to one in street name.


Municipal Bonds are also, what we would call a blind item.  Unless you are interested in the extremely large cap issues, there is no reliable place for the public to go to get quotes on their portfolio.  For the most part, this is an industry in which bonds move up or down with long-term interest rates and they are further affected by the Federal Government’s current income tax rate.  The most import factor in municipals, may be “the what the traffic will bear” department.  Shaving a few points here or there can result in making a municipal brokerage firm very rich in not too extensive period of a time.  The client generally is buying the bonds for the long term and therefore not particularly concerned about the day-to-day fluctuations that would effect the stock market so he is usually none the wiser when a firm takes advantage of him.  Basically, what we have described above are the various elements that are contained in a transaction of municipal securities.  If you add to what we have already learned, the fact that any transaction in which a cash deposit is made at the brokerage firm by the customer for more than $10,000, it must be reported to the government. The circle is now squared and your education is complete. 


Thus, if you had a brokerage firm whose management had convinced the outside accountants not to send confirmations to various selected customers and  then that firm arranged for customers to make deposits in denominations of just under $10,000 by taking in smaller amounts on successive days you can see that we are not dealing with a totally up and up situation.  And, if that same firm was unduly marking up the cost of the bonds because of the nefarious service that they were providing, you would have the Municipal Firm of J. B. Hanauer & Company, a New Jersey Municipal Bond dealer. This event happened some time ago and the company has new management and personnel but it happened and it is a story worth repeating.  Also involved on the periphery were the accounting firms of Touche Ross & Company and its predecessor, J. K. Lasser & Company and Eisner and Company.  (This was because J. B. Hanauer had a very friendly outside accountant doing their books by the name of Stanley Goldberg, wherever Goldberg went, that was where Hanauer wanted to go). 


On February 12, 1982, The Securities & Exchange Commission charged J. B. Hanauer with running a cash-laundering operation.  “Employees of the firm, often sold municipal bonds to customers for large sums of cash, and sometimes delivered the bonds at such unusual locations as restaurants, bars, and on one occasion, an airport parking lot.  The bonds were often purchased using fictitious names to conceal the customers’ identity, ([92]) and the customers often were overcharged.  The firm encouraged its salesmen to solicit business of person who, for income-tax avoidance or other reasons, such as anonymity in their bond transactions.”


In September of 1983, Stanley Goldberg was sanctioned by the Securities and Exchange Commission for his illegally narrowing the scope of the audit that he was obligated to perform regarding the J. B. Hanauer..  In 1984, the firm pleaded guilty of criminal charges resulting in their failure to comply with the requirements of the Currency and Foreign Transactions Reporting Act. 


Well, none of the customers filed a class action suit against the accountants, because they actually had become a party to the fraud in spite of being ripped off. The brokerage firm ultimately survived after going through some harrowing moments.  The only party that really got screwed in this case was the regulators and after what they thought was ample punishment, (eighteen employees of Hanauer were sanctioned and two of the firm’s executive officers were barred indefinitely from working in the securities industry. The accountant should have been barred for life for one of the most egregious vilification of American Law on record.   


Plain Vanilla Theft

Robert Maxwell, Everything Has To Be In Motion Or The Game Will Stop


Robert Maxwell was an Englishman of ordinary background who went to the top of his profession in meteoric fashion by acquiring over 400 companies in rapid succession. Among his possessions was the Mirror Group of Newspapers, which formed his base of operations.  Through his substantial largesse, Maxwell could always count on numerous politicians and bankers for advice and help in all of his endeavors.  He went first class in his hiring of accountants as well, and was ably represented by Coopers and Lybrand, who handled almost all of his acquired companies as well as the highly endowed, Mirror Employees Pension Fund. 


Although not known to all of Maxwell’s associates, a good portion of the money that he was employing was coming from his extremely aggressive exploitation of the Mirror Employees Pension Fund. Interestingly enough, beneficiaries of the pension fund saw what was happening and reported the matter countless times to the authorities, to no avail.  Finally after the pension funds had not given an account their status for some period of time, Maxwell committed suicide, probably due to the fact that an investigative reporter seemed to be totally on to him and his methodology.


Moreover, it turned out that Maxwell was indulging in just about every kind of manipulation known to man. He borrowed against his assets from the banks in order to purchase his stocks to prop them up and he insisted that the external pension fund managers who were supposed to be independent also join the group of those rigging the markets in his securities. In the final analysis, some 16,000 people whose retirement dollars were at stake had lost almost $750 million. Eventually the public went ballistic and an investigation was initiated at the urging of The Institute of Chartered Accountants in England & Wales. The result of that inquiry is quoted below;


“The verdict on the Maxwell auditors, Coopers & Lybrand (now part of PricewaterhouseCoopers) was delivered in February 1999, some seven years after Maxwell’s suicide.  A three man panel found that a lack of objectivity in dealing with Mr. Maxwell and his companies lay at the heart of many of the 35 complaints laid against the firm and four of its partners. The Joint Disciplinary Scheme (JDS) concluded that “The complaints reveal shortcomings in both vigilance and diligence and a failure to achieve an appropriate degree of objectivity and skepticism, which might have led to an earlier recognition and exposure of the reality of what was occurring.” The report concludes that the “firm lost the plot” and  “got too close to see what was going on”. The firm admitted 59 errors of judgment. “


“Most of the blame is allocated to the main audit partner Peter Walsh, who died in 1996. According to the JDS report, four Coopers & Lybrand partners failed to meet the required professional standards in auditing various parts of the Maxwell empire. The next senior partner John Cowling, against whom twenty complaints were listed, is censured and ordered to pay costs of 75,000 and fined a total of 35,000. The report says that Cowling had never encountered fraud before and criticized him for too easily accepting management explanations (see note 7) . He failed to qualify the accounts of London & Bishopsgate Investment; a business controlled by Maxwell, even though it had failed to maintain proper records or adequate control systems and did not reconcile clients’ money. Of the other three partners involved, two paid costs of 10,000 each and were admonished. Another partner paid costs of 5,000.”  ([93])


Maxwell was able to get away with his illegal activities only because of the fact that so many people who knew what was going turned their heads in the other direction rather than blow the whistle.  Although the accounting firm was severely reprimanded for their actions in this matter, it will not get the pensioners who worked their lives for various Maxwell enterprises, one dollar back.


ESM Government Securities


Not every business is obligated to have an outside accountant.  Those that are public companies are usually required to do so (if they are reporting companies) and those institutions that are regulated and those who deal with the public also have that requirement.  Brokerage firms fall under the later category and even if they are dealing in what were once called exempt securities (i.e. government bonds), the public trust is involved and are regularly analyzed for capital sufficiency among other things by their outside auditor.


ESM Government Securities Inc was founded in late 1975 and capitalized at less than $100,000. When it opened for business, the partners were Ronnie Ewton, George Mead and Bobby Seneca. Ewton who had a rather checkered history assumed the top job. ([94]) They in turn employed Alan Novick to manage the firm’s proprietary trading account. ESM was one of a group of brokerage firms that sprung up during the late seventies that for the most part indicated that they were in the business of attempting to improve their client’s overall portfolio yield.  This supposedly could be accomplished by a complex system of lending and re-borrowing of securities for fee. This process is called a “repo” (a repurchase agreement) or its more complex cousin, the “reverse repo.” (reverse repurchase agreement)  Interest rates were high during this time and savings banks had many restrictions relative to the dividend rates that they could pay on CDs which was virtually the only way that they could attract substantive money.  Thus, they were in a position of always lending long and borrowing short and in situations where rates were going against them the institution could potentially fail.


One of the problems with the industry was the fact that it was basically unregulated. Because of America’s growing internal debt, Uncle Sam wanted to make it as easy as possible to sell their own securities. They came up with the theory that you literally can’t lie when selling a Federal Government instrument. No matter what you would articulate about its safety would probably be an understatement, and on a relative basis, this indeed may have been very true. The second methodology that the federal government used to move their paper was allowing government dealers and their clients the opportunity of literally unlimited leverage. While margins on stocks have been set by the Federal Reserve at 50% and have remained at that level for decades, you are able to leverage government instruments at whatever the traffic will bear. This became the undoing of many small brokerage firms specializing in this business because they over-leveraged in a volatile environment. 


Many devices were used primarily by saving & Loans in an attempt to survive these interest rate orchestrated problems. The purchase of “junk bonds” and the purported magical Repo’s being served-up up by brokerage firms such as ESM could theoretically improve your yield while not substantially increasing your risk.  During their period of significance, many of these brokerage firms failed for varying reasons and when they did, they often took their clients, whose securities they were holding, down the drain with them.  Oddly enough, most of the individuals managing the firms were characteristically heartless, inveterate gamblers and self-centered individuals that were more interested in providing themselves with a substantial livelihood than helping their clients.  Names like Beville Bresler & Schulman and Lombard Wall all flourished and collapsed during this period to time bringing down many clients with them.  Strangely, these Government Securities dealers that were offering their clients a form of “Black Magic” almost universally had their beginnings in Memphis, a city that seemed to cultivate the right climate for securities fraud.


Being an outside auditor for these types of companies was not an easy task as the firms were able to construct inconceivably complex products at the drop of a hat, that only the makers seemed to totally understand.  (Probably best described as a forerunner of the derivative)  This made accounting for the portfolio’s current value a job and a half.  In derivatives, auditing firms and the product’s innovators seem to have found a way around accounting for these products by hiding behind the accounting term, materiality; which literally means that if the investments do not account for more than five percent of a firms assets, they don’t have to individually accounted and can be bundled.


Materiality was not something that could be hidden behind in those years, it literally become a day to day struggle between the accountants and the firm’s managements as to whether the books could ever be totally sorted out.  These so-called government brokers were dealing in the leasing, purchasing, "repo-ing,” and trading in government securities.  The ultimate question that could arise was that of, who was smarter, the accounting firm or the principals of the government dealer.


Into this bizarre environment stepped Jose Gomez, the son of Cuban emigrants who started his life in what then was called “Little Havana” in Miami.  His first job was as a bag packer in a supermarket which he stuck with for quite awhile. He stayed in the same industry when he tried to get enough money for college and became a buyer for another grocery store. Simultaneously he went to school at the University of Miami where he obtained a degree in accounting. He was bright and glib and was soon hired by the sixty-year old, Alexander Grant & Company (Now Grant Thornton) to handle the audit for ESM a government bond dealer.  He was assigned to them in 1977 and not only carried out his assignment but became close friends with the firms principal’s.  Gomez soon became a super-patsy for ESM when the firm’s principals found that they could hide offensive accounting items from him almost at will.  Alan Novick, an ESM principal and bond trader became particularly adept at moving the loses into crannies that Gomez would not conceive of looking in.


In spite of Gomez acting as Alan Novick’ s unpaid Huckleberry, in 1979 he became a partner at 31 years of age, at Grant and as such was certainly one of the youngest to achieve that position.  Gomez was an extraordinary go-getter and was on the boards of many fabled charities in the Miami area.  His theory was that in order to succeed in accounting, you had to go where the money was; a most noble idea.  However, not everything was so simple in Gomez’s life.  Gomez confided in his newfound friend, Alan Novick that his credit card debts were strangling him alive.  This of course was all Novick had to hear.  Gomez gratefully took $20,000 from Novick at the end December in 1979 and got rid of some of his more pressing problems.  On the other hand, Gomez had just bought the farm.


Credit card debt was not the only thing strangling the young accountant, he seemingly owed everyone for just about everything and set up numerous meetings with his benefactor, Alan Novick, in order to convince him to have ESM, take care of the rest of what he owed. In exchange ESM newly indentured servant,  Gomez was extremely helpful to  ESM in arranging to cover up close to a fifty million dollar hole in their balance sheet to close out the year 1979.Gomez later confessed the reasons for his foolishness:


“I was a young man in a hurry. I needed more money than I was making. I wanted nice clothes for my wife. I had to have a nice home, be seen at the right places. Take a trip to the Super Bowl. Do whatever was necessary to further my career. Use the plastic, the credit cards. When the plastic limit was reached, borrow and pay off the balances. Then use the plastic again.” ([95])


In the meantime, one of the most bizarre events in financial history occurred and as quickly as it had happened it once again vanished from sight. One of the senior partners at ESM was named Bobby Seneca.  He had recently unloaded his wife in a divorce matter but she decided that her settlement was not nearly adequate enough.  After all, “The loans, piled on top of the generous salaries, were feeding a lifestyle that was increasingly ostentatious.  There were luxury home, the lavish parties, Mercedes and Jaguars, lots of jewelry for the wives.  She saw how the other ESM wives were living, and she remembered the $70,000 Vatican wedding, the countless grams of cocaine, the mink capes, and the $8,000 Rolex watches” ([96])  


In the court trial, Bobby Seneca was represented by Gene Strearns of Arky, Freed who strangely “confessed” in court that ESM and its principals were actually broke.  Furthermore, Stearns argued in court, “if news of the facts that he was enumerating in court ever got out, countless people would be wiped out, and the firm would collapse in a heap.”  Seneca won the issue relative to support and ESM was the beneficiary of a true miracle when the judge bought Strearns' argument about secrecy, hook, line and sinker.  Thus, the conspirators had been saved to pilfer more of their client’s money, essentially under the good graces of the American Court System.


Besides all of the good things that the partners were buying for themselves, the firm was investing a substantial amount of customer money in energy oriented transactions.  They believed that the investments that they were making were so solid the even if everything else continued to go wrong with ESM, the investments would certainly bail them out eventually.  Gomez by this time was


now a more than willing “worker bee” in showing “the boys” how to falsify their records in ways that Alexander Grant would never imagine investigating.


Novick determined to get even and he bet over a “billion dollars” that interest rates would decline.  Either Novick was the worst trader that ever lived or just plain unlucky is not an issue for the moment, but naturally, as with everything else he was doing, he should have stayed in bed.  Novick was killed by his bet and in reality wound up the year of 1980 with a $13 million loss, which when added to his previous total, bought ESM a $144 million hole.  Interest alone was running ESM $20 million per year. However, the now debt-free Gomez was rock solid during this; period when he was desperately needed and imaginatively produced a $12 million profit for ESM totally out of illusionary profits for the year of 1980.


On the other hand, Pete Summers, a senior officer and shareholder of ESM decided that the game was getting a little to rough for him and wanted out. He would sell his stock back to the company for the inflated book value and keep his mouth shut.  In order to make his point, Summers’ lawyer composed a scenario for the folks at ESM to read and it went this way in part:


“Example: Customer owns $50 million worth of collateral.  ESM tells them they will give him $25 million for the collateral.  ESM in turn puts the collateral out and receives $40 million.  ESM nets out $15 million which they use to cover the loss ESM Government Securities took. They do this example three times to raise money to cover losses taken in the market. “


You may ask why any legitimate Savings Bank would give up $50 million in collateral in exchange for $25 million.  In reality, there is no real problem, as long as the management’s of the Savings Banks were receiving enough money under the table from ESM, nobody seemed to be overly concerned. In any event, Summers was on the mark with his example and was quickly paid out by ESM management in exchange for a non-disclosure agreement and the promise to let them alone and to go bother someone else. 


The rest of the news for ESM was both good and bad.  They had dodged the bullet in a problem with the Federal Home Loan Bank Board and another with the Securities & Exchange Commission through the magic that Gomez ([97]) was able to construct with his magical use of the pitiful ESM numbers.  However, these were nervous times for Novick who was seemingly now putting out one fire after another.  However, when he left the office, there was a lot to go home to.  A loving wife and three children that he adored.  Race horses; show dogs and an imperial, castle like dwelling in Fort Lauderdale.  The horses were an expensive hobby and for the most part could see all of the others when they raced from their usual position in the rear.  On the other hand, his dogs were world-beaters and one; Ch. Braeburn’s Close Encounter won the best of the show award at Madison Square Garden, marking the dog as the world’s best that year.


Sadly for his family and partners, Novick died at the age of 44 from a heart attack just three months before ESM was officially closed. ([98])  Close encounter’s victory at the dog show occurred fully six months after Novick had died.  It was probably Novick’s death more than anything that caused the ultimate unraveling of ESM, because he was the glue that was holding things together and when the glue was no longer available the unraveling occurred rather quickly.


Eventually, everything started going down the tube at once and because of Gomez’s fancy accounting work on behalf of Alexander Grant, the accounting company became the vehicle of choice by creditors to repay everyone’s losses.  There were four-hundred-seventy partners of Alexander Grant at the time and each one of which was jointly & severely liable to both each other and the creditors.  On the other hand, Grant had the foresight to have purchased a $500,000 deductible policy to the sum of $190 million.  Caught with their hands in the till, there was never much question about how much Grant would pay, and ultimately by a series of shrewd negotiating maneuvers, the partners were let off the hook for their $1000 per man, deductible amount with the insurance company picking up the remainder.


What had occurred was theft and greed of the highest order. The results of these efforts by ESM management to pillage their company and others is listed below:


“The ESM merry-go-round screeched to a halt and devastation followed when the firm declared bankruptcy in March 1985.  Its collapse caused pain and hardship to clients throughout the U.S., from Washington and Nevada to Texas and Pennsylvania.  Ohio was hit hardest; ESM lasses bankrupted the state’s second largest S & L, Home State Savings of Cincinnati.  A frightening panic followed, and a week later Governor Celeste was forced to shut down 68 other S & Ls. Half a million depositors endured agonizing weeks worrying if they’d ever see $4 billion of their money again. True tragedy struck when two of the ESM players committed suicide.  Another died at his desk.  Marvin Warner, Home State’s owner who was once worth $100 million and who had served as Ambassador to Switzerland, was forced in bankruptcy.  He and an associate recently had criminal convictions overturned on technical legal issues, but further appeals and retrial loom for the in the months and years ahead. In the end, a large measure of justice was brought to the victims.  The system creaked and groaned, it moved in fits and starts; but the thieves are in jail and the victims with the help of a very able lawyer of Ohio’s elected officials, have recovered almost all their money.”  ([99])


George Mead and Nick Wallace, two principals of ESM had seen enough and hired legal counsel for protection.  It was soon evident what had occurred at ESM and that $300 million was missing. The ESM principals were advised to cooperate with the regulators and close down the firm because when the nature of what had occurred became known, there well could have been a major panic in the financial markets in this country. The biggest creditor was a New York Stock Exchange listed company (a savings and loan) and there were still billions of dollars in open positions that had to be prudently unraveled.


ESM had set a number of standards when they were closed up for good.  It was probably the largest financial crime that had ever been committed up to that date.  The accountants were so involved in the deception that the audits done by them had to be restated for 1978 - 1984 inclusive. This was probably the landmark in restatements as well.  In several instances, the entire fraud had come perilously close to coming unglued yet no one had ever thought of blowing the whistle.  The most interesting aspect of this affair was the fact that all reports to the IRS were essentially correct and through the use of subsidiaries, the numbers were clearly available as to what was going on should there have been a desire to look.  Obviously, Most bizarre was the fact that Grant was doing both the IRS returns as well as the company’s financial statements and they showed dramatically varying sets of numbers.  In spite of the fact that the information was available in Alexander Grants’ records, no senior person thought to compare the two.  Lastly, the entire sordid affair was given, chapter and verse to a divorce court when the issue of increased support had been raised; the court sealed the verdict and the information because it had determined that it would have been adverse to ESM.  I guess we should ask the Judge, what about the creditors and the depositors?


Congress opened an entire subcommittee hearing on the matter and the words of congressman Ron Wyden probably expressed the feelings of the committee as a whole after they had gotten a dose of what occurred:


The auditors tell us that they had no choice but to rely on second-party confirmations—in this case, the word of Mr. Gomez—that the collateral for these large loans did exist and did adequately secure their clients’ interest. What disturbs me is that the system literally breeds this kind of buck-passing. If the auditors went as far as the system and the rules of their profession require in confirming the collateral, any reasonable person would conclude that once again, the auditing system has failed…it is my view that the only watchdogs throughout this sorry spectacle were either asleep, forgot how to bark, or were taking handouts from the burglars.” ([100])


Ewton got a 24-year sentence for his efforts, Novick died of a heart attack, Arky and one of the accountants who was convicted and sentenced to jail both committed suicide. Grant was sanctioned by the Florida Board of Accountancy, received a 60-day suspension from accepting new clients and was absorbed by Grant Thornton never to be seen again.


Bre-X,  King Midas Revisited


Indonesia is a country that has been doubly blessed with natural resources and its oil industry is the envy of its neighbors.  The local mining industry is also world class and there are not too many days that go by when an another “elephant find” is discovered in one of the many thousands of islands, which comprise the country.  Indonesia is the largest producer of the robusta coffee beans, which make instant coffee, it is the second leading producer of cocoa and palm oil and one of the world’s largest producers of rubber.  It is one of the largest exporters of oil and has vast amounts of copper and aluminia.  It therefore was not a major bombshell then, when a small Canadian mining company announced that they had discovered gold in Borneo, one of the islands that make up the archipelago of Indonesia.


As the weeks went on, the find’s size increased regularly until it eventually became by far the richest mother-lode since creation.   Bre-X, of Calgary, Alberta, a junior company that only had a secondary listing on the Toronto Stock Exchange, announced that the find exceeded 200 million ounces of gold, ($120 billion) the stock soared on the Canadian Stock Markets, starting at pennies and raising to stratospheric heights.


In reality, the stock started life at 12 cents per share and before the magic carpet ride was over the price had risen to over $281.  Fidelity Investments, one of the largest financial money managers in the world sunk substantial money into the company, as did a number of Canada’s largest pension funds.  It’s geologist, John Felderhoff, won prospector of the year award because of his purported discovery and with an associate he shared the distinction of being mining men of the year.  The market capitalization at the peak on Bre-x was $6 billion and class action suits have been filed against everyone within serving distance to the tune of $3 billion once it was discovered that they story was totally fabricated. 


A team of highly trained geologists had evaluated the gold samples and pronounced that they were legitimate which had sent the stock even higher, and the frenzy assumed unstoppable proportions.  More importantly, Freeport McMoran, a highly regarded expert in the field announced that they were creating a joint venture with Bre-X were also advancing substantial funding for the mining venture. l. 


At this point the strangest of things occurred, the world-renowned chief geologist for Bre-X, Mike De Guzman, seemingly became disoriented aboard his helicopter and stepped off the plane into the ocean, thousands of feet below.  Although this caused some consternation, pundits disregarded the aerial circus by remarking that “Mike always was tripping over himself.”  While this homily satisfied many, an investigation was begun and Forensic Investigative Associates was hired to look into the claims that had been made.  They found that the gold had been salted and that De Guzman had committed suicide.  They named one Cesar Pupos as De Guzman’s accomplice.


Others have far more esoteric theories on Guzman’s demise and a have placed a broader conspiracy spin on the overall Bre-x hoax.  There are some that are convinced that sometime before Guzman’s outrageous stories of gold all over the landscape first emerged, he was kidnapped by an Indonesian group and informed that he had to find lots of gold on the property or they would resort to serious dismemberment of his torso.  These conspiracy buffs were led by a respected author in the Philippines, who just happens to have a book coming out in which she accuses Indonesian factions of helping to plot the scheme which resulted in the largest mining scandal in history. 


In the early West, when someone wanted to sell his mining claim and then move along to greener pastures, he would often take gold and fill his shotgun shell casings with it, load the shells into his shotgun.  From there it was a simple task of taking aim at his mine site and pulling the trigger.  Gold particles became imbedded deeply into the rock and when a sample was taken it appeared as though the claim was awash with the precious metal.  Mr. Guzman used modern technology to salt his claim and the saga of what has become known as the “bungle in the jungle,” a fiasco in which a global record six billion dollars was stolen from investors in the greatest scam in dollar terms in history.  On November 5, 1997, the Court of Queen’s Bench, Alberta put Bre-X Minerals Ltd. into bankruptcy.



This Phoenix Kept Coming  Back Just Like The Bird


We have seen many companies over the years that I would call “tortured.” What I meant by that was the fact that management just didn’t know when to let well enough alone. Effectively, there was a death-wish surrounding these companies and in many cases if they had only been managed a little less, they could have succeeded. That was not the case with our next case study. Of all of those, the most tortured that l ever ran across was a small company located in the San Francisco area by the name of Phoenix Laser. The company was headed by the despotic Steven Schiffer, a Wall Street alumnus who was literally too bright for his own good. Schiffer knew all of the tricks and used them all. 


Phoenix Laser was a rather earlier entrant in the field of computerize-laser eye corrective surgery. The field was in its infancy when Phoenix entered and no company in the industry had done enough work to get a blanket FDA approval for their product. However, there was a company by the name of Summit Technology that had paved the way and had a big lead. The numbers that people were able to throw around were mind-boggling. As an interesting example, there could well have been 300 million near sighted people in China alone. Assume that you could cure all of them, wouldn’t that indeed be a wonderful thing and think of all the money you can project by multiplying 300 million times the cost of the surgical procedure.


Because the industry was in its infancy, the company was able to make claims about anything and everything, and were not bashful at all about doing it.  Phoenix Laser’s public relations firm’s hired other public relations firms to help them tout the stock. Anything and everything was done to keep the company in the public view. Certain officers of the company literally spent all of their waking moments visiting with brokerage firms and giving brokers a pep talk, and more, on why this was a wonderful stock to own. If they had spent one tenth as much time developing a workable product, they could have changed the world.


Schiffer was an interesting study, his reading material was literally unworldly and his library contained the works of many of the world leaders in the games of mind control. He was able to create an allegiance from the public relations people by offering them stock that they may or may not get several years down the road if they performed some unknown task solely based on Schiffer’s unilateral approval of their work product. Nobody ever knew what performance really meant and whether it would have mattered or not, not very many qualified for Schiffer’s largesse as he kept most of the leavings for himself. 


On the other hand, Schiffer knew every registration trick in the book and was able to raise money by selling stock under various securities regulation exemptions that were more than somewhat of a stretch. Foreign buyers were exempt from the same regulations that American Citizens were bound by and if they owned stock, it could be legally sold and they could use the proceeds to put money back into Schiffer’s Company. Kind of a perpetual motion daisy chain.


The stock seemed to go up and down like a yoyo and whatever direction it was going in, seemed not to satisfy Schiffer. It seems that he had an unusual clause in one of his offering memorandums relative to one of the classes of preferred stock that allowed him to convert into more shares of stock s its price declined. This has to be the most unusual clause in the history of public securities, when a chief executive officer of a company is allowed to profit more substantially from his own stock’s decline than from its advance. I guess you would call it a bonus for failure. The company would free up shares for the faithful under various securities exemptions and the more that got freed up, the lower the stock would go. At that rate It wouldn’t have taken a lot longer before Schiffer himself owned every single share.


We are talking about a company that was desperately in need of money to finish the development of their highly complex laser eye-surgery device.  Even when the machine was completed, it would take a small fortune to get FDA approval. Thus, management should be hoarding every penny that it could in order to get over the hurdles it was facing. Not exactly! On August 8, 1990, Phoenix Laser made one of its first and most startling announcements. It announced that the board had authorized a stock buyback of up to 5 percent of the outstanding preferred and common stock in the open market over a period of time. They made the concept sound good by also stating that the trials being held at the prestigious Barraquer Institute in Bogot, Columbia had been concluded. They didn’t indicate on what note that the studies had been concluded, only that they had been concluded. It would probably not have been a push to figure out that things had gone well if the company was going to buy back its own stock. While this announcement portends violations of disclosure regulations and just about everything else under the sun, the happy shareholders only wanted to think the best but they soon got another message.


The shareholders started to get the message where things were headed in January 20, 1992 when the company not only declared a 1-for-10 reverse stock split but also increased the number of authorized common shares from 25 million to 75 million. The reverse split was effective immediately and as though that weren’t enough, management was able to railroad through a resolution limiting the rights of shareholders to either call present proposals a corporate meeting. But the company had even more tricks up its sleeve. Through their control of the proxies they were able to get approval of a strange new class of preferred, designated preferred A, and there would be 50 million of those along with 25 million shares of another bizarre instrument called class B stock which could be converted into common. This single incident probably represented the greatest inside job every pulled on a public American Company since the Robber Barron’s had their own stock printing presses.


By January of 1993 the fat was in the fire. Schiffer, never anyone to give a gift without a rubber band around it that would bounce back into his pocket should the need arise, had created a trust earlier where the control of the company was held. He had appointed the seemingly independent and irreplaceable Sun Sun Chan as successor voting trustee of those shares. Whenever anybody thought that Schiffer was over-reaching he would point to the fact that the controlling shares were held by Mr. Chan, not himself and if I remember correctly he would finish the thought by stating that Mr. Chan was a highly responsible individual and the head of the SEC in Hong Kong. Well that certainly sounded good enough.


On the other hand,  it turned out that if you were to read the very small print, it also went on to say that Schiffer could replace Chan whenever he wanted to and did so at that time. Apparently Schiffer was still concerned that he had not explained away getting rid of Chan after all of those niceties about him that had been explained in intricate detail earlier. He had to make more of a statement and that he did. Schiffer noted that “in recent weeks there has been substantial volume in its common stock on the American Stock Exchange and that he had reason to believe, without total certainty, that a substantial number of common shares previously subject to the voting trust agreements have been sold. Since the persons who executed the voting trust agreements retained the right to sell their shares subject to such agreement with knowledge or approval of the trustee. I kind of wonder what kind of a voting trust you are talking about when anyone involved in it can sell shares whenever they feel the urge. If that indeed are the terms, then we can only wonder what mortal sin Chan committed. 


On April 5, 1993 it was announced by Phoenix that a dissident group including Sun-Sun Chan may seek to rescind the creation by the company of Advanced Medical Laser Company (AML) into which they had poured a substantial part of Phoenix Laser’s assets. Furthermore, the company had announced that they were going to do a substantial private placement of the stock in AML and Mr. Chan and his group were proposing to have the whole deal nullified.


Moreover, certain other investors were becoming cognizant of what was really going on and on April 21, 1993, Bernard Szeto filed a suit against the company stating the Phoenix Laser had transferred substantially all of its assets to two new companies, which would not be controlled by Phoenix. Szeto further announced that he was going to launch a proxy fight to gain control of the company. Apparently, Phoenix had gotten wind of the fact that Szeto had about enough of the shenanigans that were going on and in a preemptive action filed just short of two-weeks earlier, charged Szeto with misappropriation of funds. We don’t see how Szeto could have done that because he does not appear to have been a corporate officer or director. Maybe this is what made the accountants start to get nervous and they did become very nervous.


After the smoke had cleared things became a little clearer. Szeto had applied to the State of Delaware for an “inspection” of various books and records of the company in order to commence a proxy fight. A lawsuit was instigated against  Szeto by Phoenix more likely than not to prevent him from seeing any of the company’s books and records. Without the litigation, he probably would have had clear sailing in getting everything he needed to make a sound case against management. It seems that the company realizing this, blew smoke into Delaware and Szeto was only granted a few of the things he had requested. On June 6, 1993, the court also ruled that Szeto was acting in concert with another major Phoenix shareholder named Chan and thus the restrictions. We don’t know what Delaware found that made two people unable to get what one could have gotten without any trouble. Phoenix Laser’s press release went something like this:


“Phoenix Laser said the court determined Szeto was acting in concert with another investor, Sun-Sun Chan, and that the two had ''caused their counsel to write threatening letters to two potential acquisition candidates'' and others. The company said the court said it found it ''troubling'' that Szeto ''has not undertaken any of the steps that obviously will be necessary if he is to mount a proxy battle with any hope of success.''


''We are very pleased with the court's decision, which we believe recognizes Phoenix's legitimate interests in protecting itself from the harmful activities of Mr. Szeto and Mr. Chan.'' ([101])


On October 8, 1993, the company announced that undisclosed foreign investors would purchase two million shares of stock if all the incumbent board members were re-elected. Considering what was going on at the time with Phoenix, this statement must have seemed like something out of Alice in Wonderland. Why on earth would anybody want to keep these folks in office one day longer than necessary. As if on schedule, Phoenix management announced that the deal was not going to happen for some reason or other. On the other hand they had never indicated whom these people were that were going to buy the private placement anyway, so nothing was perceived to be lost other than the fact that management’s statements were becoming more and more transparent to the accountants, the regulators, the shareholders and the law.


On October 18, 1993, in spite of all the twisting and turning, the management slate was voted out of the company and as you would expect they found fault with the vote and management announced predictably that they would challenge it. I think that it would be interesting to note at this point that incumbent management has a tremendous advantage in proxy fights. They have the names and addresses of the shareholders, most people blindly vote for management anyway and they also have the company’s purse strings. Most important, the election is usually run by management under their terms, at their place and at their convenience. It is a difficult job to get rid of entrenched management no matter what they do. Obviously in this case management had done a lot and then some. 


In November of 1993, when Phoenix Laser’s Board with the sole exception of John K. Vyden resigned as part of a settlement with the litigants it became crystal clear who were to good guys and who wore the black hats. Apparently instead of dipping into the till as Phoenix management had accused the belligerents of, it would appear that the dispossessed directors had the goods on management and a bad settlement was preferred over the bloodshed that would have gone on in court. Apparently wanting to clean the company up, new management agreed to put money into the company as well as amending various reports filed with the SEC that were substantially in error. All lawsuits that had been filed were dismissed without prejudice and why not, the bad guys had been routed and new management was now in place


On September 9, 1993, Schiffer strangely became ill, resigned all of his offices with Phoenix Laser and hurriedly left the company. This may have had something to do with the fact that foreign investors had agreed to put up $10 million into the company pulling Schiffer’s bacon out of the fire.  On the other hand, the whole deal was contingent on Phoenix Laser’s filing a 10K ([102]) This of course was easier said than done because of the pending resignation of the accountants. 


Apparently simultaneously with Schiffer’s resignation, two of the founders of another public company somehow became involved in Phoenix Laser. Barry Witz, a California lawyer with a history of being involved with public companies talked his associate Chadha, the head of Osicom, into getting mixed up with Phoenix in spite of its checkered history of nothing but lawsuits and its astounding lack of a product. Chadha became Chairman of the company and indicated that he was going to do a financing based on SEC Regulation S. The deal was supposedly with Hibernian International financial Services Company. In the strangest twist of all, Chadha in an interview with Barron’s indicated “he was really trying to sabotage a deal put in place by his predecessor.” I would assume that he is talking about Stephen Schiffer. The deal tanked and two months later, in November of 1993 Chadha resigned as Chairman of the company. One stranger chapter in the life of the most bizarre public company on earth.


I have always had the concept that taking the role of director in a company is an issue of the public trust. In this amazing story, Chadha would have us believe that two uncanny things happened in tandem. First, his associate, Witz had asked for his help with Phoenix and he came to his aid by killing a financing started by former management. We do not know what was so inconceivable bad (if that was the case) about the financing, but if it was not a good deal, Chadha was Chairman and could have killed it by relaying the facts, not dealing in sabotage. The other strange occurrence was the fact that he served on the board for only two months and then resigned. Why on earth would anyone take upon the kind of liability that is concurrent with a renegade company like Phoenix Laser for only two months?


On February 3, 1994, it was announced by Phoenix Laser that “three former employees and Microdyne Inc. filed involuntary Chapter 7 bankruptcy proceeding against the company.” Naturally, the new Phoenix management found something wrong with all of the claims. Employee contracts had been rescinded and claims by Microdyne had no merit. The said that the claims are “spurious and malicious” attempts by former management to hurt the company. So apparently the folks that had resigned under pressure had come back to haunt the company once again. Well no one ever said that life was fair.


This was apparently the straw that broke the camel’s back for BDO Seidman who  formerly resigned in the same month without completing the year-end audit or the 10K. In one of the strangest declarations of all times, Phoenix Laser put out a press release in early April of 1994 that they had not been able to find anyone to replace Seidman because of the liability involved in doing so. This company had gotten so bad that even the jaded accountants didn’t even want to step in to problems.


And it was not just Schiffer that ran out, Directors Jon Solow, Doug Hege and John Zee also departed for greener pastures probably figuring that the game was already over. Three new board members that probably didn’t have a clue as to what they were getting themselves into replaced them.


Among other things that came out, was the fact that the company would report a loss of $17 million for the year-end 1993 which followed a loss of almost $38 million the previous year. This mind you is for a company that has almost no employees, no products and no sales. They topped that off by saying that there was insufficient cash to last out the year and that it’s “pie -in-the-sky” product, the Ophthalmic Surgical Workstation and accompanying hand-held laser could not be completed under the circumstances. In reporting the brighter side of the matter, Phoenix Laser indicated that they lost a lot less because they weren’t hit by $7 million in stock offering costs that they had to pay in 1992.They also were able to avoid the massive write downs that they were suffering in their DGRI unit which was sold in June of 1993.


On the other hand, who was to know what the true facts of the matter were: Phoenix Laser explained away its estimated filling because of a number of reasons,


'…'due to the unsuccessful efforts to date in engaging an independent accounting firm and assessing the legal and financial complexities related to the poorly drafted and ambiguous contract for the sale of the company's subsidiary, DGRI and the lack of proper documentation underlying the financial records related to this sale.''


As if this saga would never end, on March 17, 1994 the bankruptcy court in California dismissed the Chapter 7 petition as frivolous. The court left standing only the claims that the company may have against those that had filed the petition in the first place.


''This was clearly an harassment suit, frivolous in content and designed to tie Phoenix up in a humongous web of suits and legal costs,'' said Richard Bliss, chief executive officer. ''But we will not be deferred from our focus on completing successfully our technology for refractive laser surgery.''


Phoenix Laser was finally able to get an accounting firm to represent them on March 20, 1994 and the unlucky company was Dohan & Co out of Florida. This also has to be the record for trying to find an accounting firm that will take your money but with Phoenix going in and out of bankruptcy like a rubber ball, directors resigning and lawsuits flying all over the place you can not blame anyone for being a tad cautious.


They didn’t have to wait too long to get indoctrinated. On May 26, 1994 the FDA issued a recall on what they called, Phoenix Laser’s Model 1000, Ophthalmic Laser Workstation. They indicated that things weren’t going that well on the research front either. The FDA report said in part: The device was found to lack an emission indicator for the aiming beam, the warning logotype label carried inaccurate HeNe output information, and the operator's manual lacked calibration procedures. New management didn’t really need to hear that.


Every time we think we have seen last of these folks they seem to come out of the woodwork once again. On January 30, 1995, a demand was received by the company from holders of almost seven million shares of B-1 preferred stock. The demand stated in essence that the company would be in default if they didn’t redeem these shares for 87.5 cents each immediately. The shareholders “maintain that they have the right to cause the company to repurchase their shares because of the company’s failure to register the common stock issuable upon conversion of the shares and list such common stock for trading on a national securities exchange.” The company stated that it had neither the obligation nor the money to do what was requested. If it were ultimately determined that the series B-1 stockholders had the right to sell their shares to the company, and the company failed to purchase such shares, the series B-! Stockholders would have the right to foreclose upon certain of the company’s patents, including the patents for its principal product, the Laser Knife. The company’s prospects would be highly uncertain should this occur” 


I used to go to the movies on Saturday afternoon when I was a kid and the best thing about the show was a continuing segment called “The Perils of Pauline.” Every week, Pauline would get herself into some unbelievable spot and you could see her tied to the train tracks with the express bearing down on her or her going off a cliff without any hope of survival. This saga reminds me of those Saturdays I spent as a kid watching Pauline clutch victory from the jaws of defeat as we would see the real end of the previous weeks segment the following Saturday. But by the end of the reel, Pauline would be back in deep dodo again. It would seem that Phoenix Laser’s management contingency program was unlimited in its scope and just about every time the good guys attempted to get the ship righted again, a new scheme is polished off and brought to bear.


This is the company that the word bizarre was created for. They may have had a higher percentage of “stock offering costs” per dollar raised than any company since the beginning of time. Part of the costs were public relations oriented, I remember when I went to visit their facility in San Francisco, the scene was literally out of the Keystone Cops.  All of the employees worked out of an elegant  house in one of the better sections of San Francisco. As the clock hit high noon, people started assembling in the garden where a caterer had set up tables and was preparing a magnificent selection of cuisine. New faces suddenly appeared as if from nowhere for what was described as an everyday event at Phoenix. It almost looked liked someone had called a theatrical casting company and hired appealing people to make pleasant conversation. It was somewhat odd that these people never identified themselves or indicated what department they worked for at Phoenix but yet, every once in a while they would throw in some incongruous statement about how wonderful the company and its senior management was. The entire house could only hold, maybe ten or twelve people and we easily must have had fifty or more for lunch. It seemed that we were once again revisiting Alice and Wonderland.


The next surprise was the following day when Steven Schiffer took us out to the research facility personally. He talked about how “state of the art” the place was and indeed, that was what it looked like when we stepped inside. Machinery, wires, gadgets that we couldn’t discern, strange lights going off and on, but most significant was the presence of the requisite Israeli female Scientist. This was right out of James Bond, she was about six feet tall, dark and beautiful with so many degrees from so many great universities that we totally lost track. She was to be our guide within the plant. As best as I can gather, more people were in the plant seemingly working on wondrous things than were listed in the company’s report to the SEC as being employed in the entire company. Once again, it seemed that Hollywood Casting had come to the aid of Phoenix Laser and the show we were witnessing was an absolutely first class performance.


But the piece de resistance was yet to come. We were to be taken to see the doctor that was experimenting with the finished eye-laser devise and we were going to absolutely see it in operation. We were taken to a hospital in the San Francisco area and from there into a lab, which once again would have made Buck Rogers proud to be associated with it.  The only problem was that we were the only ones on the floor. The doctor that ran the 25th century device apparently had gotten his signals crossed and did not show. We felt that this was rather odd in that we had traveled all of the way to San Francisco from New York, not to have lunch at the pretty house on the hill, not to see the research facility with all of the wires and machines, but to see the corporation’s pride and joy, they eye-laser that was going to cure the entire Asia Continent of near sightedness.  I became depressed.


We never saw the machine in action as the company filed for bankruptcy in December of 1995 for the second time. Once again it was not of its own volition. The petition in bankruptcy was approved and an attorney for the company indicated that “the company has no officers and only three directors and has not been operating for some time.”  Shortly thereafter, VISX acquired the rights to Phoenix’s patent portfolio. The package represented 11 issued U.S. Patents and two that were pending. This was the last of the assets that had once been the property of the company.


The Securities and Exchange Commission by this time was all over the company and on August 7, 1997 they released the following report:


Today, the Securities and Exchange Commission ("Commission") filed a Complaint in the United States District Court for the Southern District of New York, alleging market manipulation, insider trading, the making of false and misleading statements in Commission filings, and the sale of unregistered securities, all in violation of the federal securities laws.  All of these activities related to Phoenix Laser Systems, Inc. ("Phoenix"), a now-defunct company that was in the business of developing a laser workstation to perform eye surgery.  The defendants are:  Steven H. Schiffer (former chairman and chief executive officer of Phoenix), Joann R. Schulz (Phoenix's former president and chief operating officer), Gary S. Kramer (former investment relations representative of Phoenix), Jonathan Solow (formerly Phoenix's vice president, secretary, and director), Frank J. Cannata (a stockbroker and consultant to Phoenix), and Peter G. Mintz (a stockbroker and analyst, who covered Phoenix for his firm).


According to the Complaint, between May 1992 and August 1992, Schiffer, Kramer, Solow, Cannata, and Mintz, manipulated Phoenix's common stock to increase and/or stabilize its price in order to maximize the price of future stock sales.  Based on this activity, the Complaint alleges that these defendants violated the antifraud and anti-manipulation provisions of the Exchange Act, Sections 9(a)(2) and 10(b) and Rule 10b-5 thereunder. The Complaint also alleges that from May 1990 to April 1992, Schiffer and Schulz caused Phoenix to make materially false and misleading statements in Commission filings concerning the status of its Food and Drug Administration ("FDA") applications, the number of orders for Phoenix's product, and anticipated revenue from the sale of its product.  Based on  this activity, the Complaint alleges that Schiffer and Schulz violated the antifraud and reporting provisions of the federal securities laws:  Section 17(a) of the Securities Act, Sections 10(b) and 13(a) of the Exchange Act, and Exchange Act Rules 10b-5 and 13a-1.


The Complaint further alleges that from January 1991 through July 1993, while in possession of material, nonpublic information concerning the true status of the company's FDA applications, the number of orders that it had received, and realistic anticipated revenues, the same matters they caused the company to misrepresent in its filings, Schiffer sold approximately 1.5 million shares of Phoenix stock directly for approximately $4.2 million, and he sold approximately 2 million shares through the purported Regulation S transactions described below, for approximately $11 million, thereby avoiding losses of $15.2 million.  Similarly, between December 1991 and September 1993, while in possession of such material, nonpublic information, Schulz sold a total of 251,050 shares of Phoenix stock for approximately $626,000, thereby avoiding losses of $626,000.  Based on this activity, the Complaint alleges that Schiffer and Schulz violated the antifraud provisions, Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder. Finally, the Complaint alleges that, between September 1992 and July 1993, Schiffer and Kramer violated the Securities Act of 1933 ("Securities Act") by selling approximately 2 million shares of unregistered Phoenix stock for approximately $11 million.  They disguised these sales as transactions that appeared to, but did not, comply with Regulation S, an exemption from the registration requirements of the Securities Act.  Based on this activity, the Complaint alleges that Schiffer and Kramer   violated the registration provisions, Sections 5(a) and 5(c) of the Securities Act.


In its Complaint, the Commission is seeking injunctive relief against each of the defendants.  The Complaint also requests that the Court order Schiffer, Schulz, Kramer, and Cannata to disgorge all profits that they made and/or losses that they avoided as the result of their violations of the federal securities laws, and that they pay prejudgment interest on those profits and losses avoided.  The Complaint further requests that all of the defendants pay civil monetary penalties.  Finally, the Complaint requests that the Court issue an order barring Schiffer from serving as an officer or director of a public company.


The Commission acknowledges the assistance of the American Stock Exchange in this matter.



On February 11, 2000, the Securities and Exchange Commission made a deal with the broker involved in the case, Frank J. Cannata, who agreed to leave the securities industry for five-years for his role in the Phoenix matter. Looking at the consent decree will give you a pretty good idea of what the manipulation was all about:


“The Commission's complaint in the District Court action includes the following allegations: Between May 1992 and August 1992, Cannata and four other defendants manipulated the price of the common stock of Phoenix Laser Systems, Inc., a now-defunct company that was in the business of developing a laser workstation to perform eye surgery. During this period, Cannata was associated with registered broker-
dealers headquartered in New York, New York; and, beginning in July 1992, he was simultaneously employed by Phoenix as a consultant pursuant to a written agreement which provided that he would receive thousands of dollars of monthly compensation from Phoenix. As part of the scheme to manipulate the price of Phoenix common stock, which
traded on the American Stock Exchange, Cannata caused a number of purchases of Phoenix common stock to be executed for the accounts of his clients. These purchases were executed during the day and often at or near the end of the trading day, in a manner that increased the price of the stock. The end-of-day purchases frequently caused
Phoenix's daily closing price to be higher than it would have been in the absence of those purchases. Although Cannata solicited and caused a number of these purchases to be executed while Phoenix and a registered broker-dealer simultaneously employed him, he did not disclose to the broker-dealer or to his customers that he
had entered into an employment agreement with Phoenix. (Rel. 34-42416; File No. 3-10146)”


The Securities & Exchange Commission was on a roll. On June 2, 2000 they grabbed another broker for manipulating Phoenix Laser stock at the company’s behest. We will paraphrase their report:


The Commission's complaint in the District Court action includes the following allegations: Between May 1992 and August 1992, Mintz and other defendants manipulated the price of the common stock of Phoenix Laser Systems, Inc., a now-defunct company that was in the business of developing a laser workstation to perform eye surgery. During this period, Mintz was associated with a registered broker-dealer headquartered in New York, New York. As part of the scheme to manipulate the price of Phoenix common stock, which traded on the American Stock Exchange, Mintz, at the direction of Phoenix's CEO and vice president, caused a number of purchases of Phoenix common stock to be executed in nominee accounts. These purchases were executed during the day and often at or near the end of the trading day, in a manner that increased the price of the stock. The end-of-day purchases frequently caused Phoenix's daily closing price to be higher than it would have been in the absence of those purchases. For further information see LR-15435 (Aug. 7, 1997); Rel. 34- 42416 (February 11, 2000). (Rel. 34-42880; File No. 3-10216)


Another method of manipulating the stock that was used by the conspirators was to get a credible analyst to recommend the stock of Phoenix Laser in a newsletter. In Jerome Allen, Phoenix Laser had found their man. In September of 1997, Allen acknowledged in a court action that he had produced phony reports on a number of securities in exchange for cash payments. Along with recommending Phoenix Laser, under the prestigious sounding name Cambridge Research, the play for pay, Jerome Allen put out a buy  recommendation on the stock of  “Main Street.” He then recommended Ferrofluidics and pled guilty to felony charges for his role in that stock where he tried to cover up payments he received of over $1 million. Jerome Allen produced other bogus reports. He was also paid under the table to recommend Seiler Pollution Control Systems and York Research Corporation. Mr. Allen did some of his best work in writing a company orchestrated research report on Phoenix Laser. That report  seemed to highlight the company’s phony press releases and progress reports giving the company substantial credibility on the “Street.” Mr. Allen for his part in this an other matters was facing sentencing on criminal income tax evasion charges but could get some kind of pass because he was turning state’s evidence in some other above cases. 


From the looks of things, the SEC has only recently gotten down to housecleaning in this matter and we would expect much more to be coming out soon. Not to pick on anyone in particular, let’s just look at what one person accomplished with Phoenix in a very short time and what an accounting firm missed. Steven Schiffer, manipulated Phoenix Lasers common stock, he issued false and misleading statements to the SEC concerning, the status of its equipment as it related to the FDA, he issued false statement relative to projected revenue form the product and the number of products that had been sold. During the short time he ran the company he was able sell 3.5 million shares of stock for $15.2 million..


That’s a pretty good job of taking candy from a baby. Schiffer was running the company and knew exactly what was going on. He was telling his good buddies on Wall Street what a super company it was going to be and whenever they would buy based on his recommendation, he would always be selling. I would think that having stuck his associates with tens of millions of dollars in losses, whether Schiffer goes to jail for his actions is incidental. I would think he will be looking around every corner that he passes for the rest of his life.


The accountants were there during the whole messy period and BDO Seidman conducted themselves in extremely poor fashion. There was nothing correct about the financials, the company’s product, its sales or the Wall Street research reports that had been issued. Violations had been made in regulatory reporting, earnings and registration of shares, all using data accumulated by the accounting firm. They never blew the whistle and yet it would have seemed that they had to know that very strange things were occurring right under their noses. They resigned at the last possible moment and only when things had gotten so bad that another accounting firm could not be hired to replace them for months. (we have never seen this in any company). The fact that the accounting firm has not been named in the SEC action is somewhat astounding.


I have been around the securities industry for a long time and during that period I have literally thousands of SEC releases. I do not remember anything worded like this one during that entire time. These guys as officers and directors were seemingly rigging the stock literally every day of the week. They were equally adept at going in both directions and were thus able to benefit from the stock’s movement no matter whether it rose of fell. Some pumpkins!


California Micro Devices Corporation The Home of Vanishing Sales  


California Micro Devices Corporation (Cal Micro) was a fast growing supplier of high-tech products primarily to the computer industry.  Early on, Price Waterhouse LLP, their auditor, had seen the handwriting on the wall, questioned the company’s financial controls, and raised numerous other red flags including some regarding the quality of people responsible for financial reporting.  Ultimately, Price could not come to terms with Cal Micro management and resigned the account. Coopers & Lybrand were offered the assignment and accepted without any substantive discussion with either the company or Price Waterhouse about their concerns.  ([103])


It must have seemed to the Cal Micro folks that they had found a patsy in Coopers because it didn’t take too long before the company’s senior management began to generate sales out of thin air in order to make their projections.  The transgressions were so onerous that two senior officials of Micro pleaded guilty of insider trading and were sent to prison.  Six more were investigated with two of the former group ultimately convicted by the SEC on charges of both insider trading and financial reporting fraud.


Coopers & Lybrand was in the middle of doing the company’s books when it announced that it was writing off a large percentage of its receivables.  The stock tanked and lawsuits were filed by irate shareholders that believed that they had been defrauded.  In spite of these actions, within a short period of time, astoundingly, the accounting firm gave Cal Micro a clean bill of health. Two auditors from Coopers & Lybrand, Michael Marrie, and Brian Berry were charged by the Securities and Exchange Commission (SEC) with improper professional conduct relative to the audit that they conducted of Micro in 1994.  The basis for the SEC charges against Marrie and Berry were the fact they missed numerous accounting irregularities in spite of the fact that Cal Micro had been singled out for special attention.  “Even though the management at Cal Micro still committed fraud, Coopers should have done its job properly and it didn’t.  They basically audited with blinders on and ignored red flags.” ([104])


“The auditors did increase the number of so-called confirmation letters sent to customers with outstanding bills; the letters covered 91% of the accounts receivable.  But, according to the SEC, the auditors ignored warning signs flickering from some of the responses.  Of the 37 replies to the auditors' 54 letters, the SEC says, one-third raised serious issues with Cal Micro's bookkeeping.”  ([105])


Numerous employees testified in court that they gave the auditors chapter and verse on what was taking place and they had chosen to ignore the warnings.  Ronald Romito, who was Cal Micro's chief accountant, testified in federal court in San Francisco that he asked the auditors if the company could book revenue on products sold but shipped after the close of the fourth quarter in June 1990 -- a practice almost universally considered improper.  "And they said yes,"  What makes things more opaque is the fact that Cal Micro had no revenue-recognition policy -- that is, no guideline dictating at which point in a transaction it could be treated as a sale.  We are also unaware of any guidance by Coopers in initiating one, certainly a very strange situation where the company’s CEO is also sitting on the audit committee, a very unusual state of affairs considering the fact that in almost all cases, this committee is reserved for outside directors.


“Cal Micro managers faced aggressive revenue goals, and by late 1993 were relying on ever-easier definitions of a "sale.”  Besides the outright faking of product shipments, trial testimony showed that managers began booking revenue for products shipped before customers even wanted them; they often didn't reverse sales when customers returned goods; and they paid distributors "handling fees" to accept products that sometimes had unlimited rights of return, then booked the products as sales. “To keep track of it all, clerks compiled memos titled "delayed shipment," which became a euphemism for fake sales.  Soon, even low-level workers were "joking about" the fraud, a former Cal Micro administrator, Karen Pujol, testified at the criminal trial.”  ([106])


Substantial evidence was presented by the Securities and Exchange Commission that in spite of red flags flying all over the place, the accounting firm brought in junior personnel that in many cases were even unfamiliar with even the most basic accounting terminology. More specifically the SEC has charged the Coopers auditors with granting Cal Micro a clean bill of financial health while recklessly failing to conduct their audit in compliance with professional standards.  Among other things, that the Securities and Exchange Commission looked at with particularity was the fact that Cal Micro wrote off over one-third of its account receivables.  Such an obvious red flag would normally send a strong message to other auditors.  In this case, it did not even create a ripple.  The SEC therefore sought among other things to bar the offending accountants from ever doing a public audit again.


Ernst & Young were hired to re-audit the books and in 1995, Cal Micro restated its fiscal 1994 results.  The Ernst & Young numbers showed that the company had lost $1.88 instead of the 62-cent profit that it had earlier reported.  What is particularly disturbing about this situation is the fact that Coopers could have simply checked the company’s cash flow against its sales.  Obviously, the numbers would not match.  You can book all of the phony sales that you want but in the end, the whole thing explodes when the cash is not in the bank.  This is the most simplistic form of accounting and it seems not to have been practiced by either Cal Micro or their accountants.


Crazy Eddie & The Cooked Books and Vanished Electronics


Eddie Antar never finished high school but that didn’t make him any less the entrepreneur. Eddie was a strange sight around the neighborhood; he was a body builder whose muscles had muscles. That along with his ritual outfit gym sweats that it seemed he never took off and the massive guard dog that was his pet, it didn’t take everyone in the area to know who Eddie was.  Upon leaving his Brooklyn high school he started selling television sets door to door in his neighborhood. He ultimately opened up a unpretentious 150 square foot facility in Coney Island to sell consumer electronics in partnership with his cousin.


If you lived on the East Coast at the time, you can probably remember a fast talking pitch master who would recite the names of products so fast that you couldn’t even discern what he was saying.  He would wind up this garbled spiel by telling you that you should shop at Crazy Eddie’s because his prices were insane!!!  And effectively Antar’s pricing was first rate. If you walked into one of his early stores and if he was there ([107]), if you tried walking out the door without making a purchase, he would block your way, quote you lower and lower prices on the goods that you had been looking at, until he had made the sale. This was when Antar received the nickname Crazy Eddie. Antar continued to expand Crazy Eddie until he had established over forty stores selling almost $400 million in merchandise a year. Antar created other innovations such as the “double dip” warrantee. Effectively, Antar would have store customers purchase an additional warrantee when in reality they were already covered by the manufacturer. When a customer made a claim on defective merchandise, Eddie would reclaim the cost from the manufacture and was able to make a tidy profit. If Crazy Eddie was able to sell all their client warrantees, he discovered that he could sell his inventory at cost and still make a sizeable profit.


Eddie had so much power with the manufacturers because he was buying in such large quantities that he could resell to smaller dealers at prices that even the manufacturers themselves wouldn’t match. While no one other then Eddie Antar and his smaller clients were happy with this practice, numerous attempts to pull the plug on this part of Crazy Eddie’s business were unsuccessful.


It did not take the Crazy one long to start cashing in on his hard work. The company by this time had gone public and it would seem that Antar was a natural seller of his own stock. He kept on selling until he had dumped over $70 million worth of shares in his own company ([108]). Then again, Antar knew something that the public didn’t. His prices may well have been insane, but Eddie Antar sure knew how to cook the books when it came time to report earnings. When Crazy Eddie’s was taken over by another group in a proxy fight, they found that his inventory had been dramatically overstated and the profits that he had been consistently reporting were a total illusion. Antar ultimately pled guilty to a racketeering conspiracy charge relative to his scheme to defraud investors of over $74 million.


Antar had impressed Wall Street with his no-nonsense approach to the retail business. He was, would you believe, a grammar-school dropout who wore a sweatshirt to the office and carried on conversations in which every other word was literally unprintable.  Street analysts advised him on what numbers he had to achieve in order to have his stock perform well and in Antar’s mind, if he didn’t hit those numbers, he could fabricate them.  In the meantime, he was consistently peddled his stock, as did his dad, who pocketed almost $20 million by also misleading shareholders. 


In the meantime, without knowledge of the “Street,” Crazy Eddie was running into the same kinds of problems that every business has to go through. The cycles in the consumer electronic business were dramatic and Crazy Eddie was now caught in a vicious downturn. Being public had placed an additional strain on management with all of the reporting that was required along with the necessary Wall Street interviews.  Employing executives that were hired solely for their loyalty (relatives) instead of their competence soon began to exact a price and that problem escalated when Eddie and his wife split up. The divorce was horrendous and the relatives took sides in the disputes. In the meantime, Eddie’s brother was the CFO and doing the books, a job where he was clearly over his head. 


The store chain closed when the vendors’ cut off all credit, and Crazy Eddie’s net worth dropped from healthy (albeit phony) positive numbers to almost $26 million in the red.  The new board, which had committed to try and keep things going, threw in the towel when they learned that both the company’s credit and its net worth were literally zero or less. The Securities and Exchange Commission in an investigation that they conducted found that the books had been cooked by Crazy Eddie’s almost from the minute that they had gone public. He would constantly overstate inventory while understating his accounts payable. Another trick that Eddie used was most unusual, he would take the sales that he had been making to other stores and assign them internally to his own shops. This made the financials appear that sales were ever increasing on a same store basis; a critical part of the Wall Street security analysis process. For a guy that was forcibly retired from school at 16, Antar certainly knew how to cover his bases.


The case reads like a detective novel, and in 1990 Antar did not appear in court to answer charges by the Securities and Exchange Commission. He thought that he was better off taking up residence in Israel than facing the music.  His flight cost Antar dearly, the option of appealing the case which was instead, decided in his absence.  The fact is that when Antar saw that the regulators were moving in, he not only fled to Israel but changed his name five times in his attempt to avoid arrest. He was not heard from again until investigators cornered him and forced Antar back to the states to face charges. 


It took two years to bring Antar back because, although he had civil judgments, at that time, had not been criminally indicted.  Eventually a Grand Jury supplied the needed criminal documentation and the U.S. Marshals who had been keeping track of his whereabouts simply plucked him off the street.  When arrested, he was carrying a Brazilian Passport in a phony name.  Antar had become an Israeli citizen but was unfortunat