American insurance salesman Gordon McCormick set up Equity Funding Corporation of America (EFCA) in 1960. The idea was that people would buy a mutual fund and then borrow against the fund to pay the premiums of the life-insurance policy. Provided the mutual fund's returns outperformed the interest payments on the loan, people would be protected in the event of death and have money left over. Six months after EFCA was set up McCormick was removed in a boardroom coup, leaving Stanley Goldblum (pictured) in charge. In 1964 EFCA was floated on the stock exchange.
What was the scam?
Initially, EFCA started exaggerating revenues to attract new investors. When it began acquiring insurance companies of its own, it also started to sell fictitious policies to reinsurers (companies that buy insurance policies from insurers). This gave EFCA a large revenue boost, but meant it had to pay the reinsurers hefty annual premiums. At first it covered the costs of this by selling on more fake policies (turning it into a de facto Ponzi scheme). Later it started pretending the subjects of the policies had died to save on future premiums and pocket the death benefits.
What happened next?
In March 1973 Ron Secrist, a former EFCA executive, contacted Ray Dirks, a well-known insurance stock analyst, as well as the New York insurance commissioner. Dirks interviewed EFCA's management and, unconvinced by their depiction of Secrist as a disgruntled ex-employee, went to the Securities and Exchange Commission (SEC), though not before advising his clients to dump their EFCA shares. After learning about the fraud, the SEC suspended trading in EFCA shares. The company was formally placed under court supervision in April 1973, and a $100m discrepancy between reported and actual assets was discovered.
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Lessons for investors
Goldblum was sentenced to eight years in prison for fraud (he served four) and EFCA's auditors were forced to pay $44m in compensation. Investors were wiped out (losing an estimated $300m) and the reinsurance companies were left holding $1.8bn in losses. The whole EFCA debacle demonstrates that investors should never solely rely on auditors they cannot be relied upon to uncover fraud.
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