The policyholders did not exist. Not some of them. Tens of thousands of them.
Equity Funding Corporation of America ran a computer department whose job, on certain nights, was to manufacture life insurance policies for people who had never been born, and then sell those policies to other insurance companies for cash.
By the time it collapsed in 1973, the count of bogus policies ran into the tens of thousands. Published accounts put it between 56,000 and more than 60,000, worth approximately two billion dollars in face value. Fortune, reporting in August 1973 while the trustee was still counting, put roughly two billion of the roughly three billion dollars of insurance the company claimed in force as fictitious. BRG’s account calls the whole thing a two billion dollar fraud, the largest single-company fraud in the United States up to that time.
The pitch that was legal
Equity Funding began with a real idea, and the idea is why nobody looked closely for a decade.
The company sold a package. A customer bought mutual fund shares, then borrowed against those shares to pay the premiums on a ten-year term life policy. The theory was that the fund would grow faster than the loan interest, so the insurance would eventually pay for itself.
It was aggressive, and it was sellable. Equity Funding grew into a Wall Street favorite, reporting rising earnings every year through the 1960s and into the 1970s. By 1972 the company was claiming around five hundred million dollars in assets.
Rising earnings, every single year, is what eventually needed help.
How a fake policy turns into real money
The mechanism ran on reinsurance, which is insurance that insurers buy from other insurers.
A life insurer can sell a block of its policies to a reinsurer. The reinsurer takes on the risk of paying out on those lives, and in exchange the original insurer gets cash up front, often a large share of the first year premium.
That cash arrives immediately. The obligations arrive later.
So a company that could produce policy files could convert paper into money on demand. Equity Funding produced policy files. Programmers were brought in to write software that concocted fictional policies to feed to the reinsurance market, and the company sold the resulting blocks for cash it booked as earnings.
The trap is in the second year. On a real block, the reinsurer expects renewal premiums to keep coming from real customers. Phantom customers pay nothing, so the company had to fund the renewals itself out of new cash, which meant inventing a larger batch of policies the following year.
The fraud could not be held level. It had to grow or be seen.
To keep the block looking real, the company simulated policyholder deaths at a rate comparable to actual mortality, according to Earmark CPE’s account of the scheme. A group of employees the same account calls the Maple Drive Gang created physical policy files to fool auditors.
The auditors
An operation this size does not survive without financial statements that carry an accountant’s signature.
Equity Funding’s statements were certified year after year.
Investigators later concluded that as many as one hundred employees had taken part in the deception from 1964 onward, deceiving investors, auditors, reinsurers and regulators.
The phone call
On 6 March 1973, a securities analyst named Ray Dirks took a call from Ronald Secrist, a former officer of Equity Funding.
Secrist told him the company’s assets were vastly overstated and its life insurance business was substantially fictitious.
Dirks did what an analyst does. He went to the company’s Los Angeles headquarters and interviewed officers and employees. Senior management denied it. Certain employees corroborated it. Then he told the people who owned the stock, and some of them sold, including five investment advisers who liquidated holdings of more than sixteen million dollars.
The share price had been above $28 on 9 March. By 13 March insiders were selling. The Supreme Court’s later account has the price falling from $26 to below $15 during Dirks’s two weeks of digging, and the New York Stock Exchange halted trading on 27 March 1973.
The company filed for bankruptcy on 5 April 1973.
What happened to everyone
The file separates from the usual corporate scandal because two verdicts came out of it and they point in opposite directions.
In November 1973 a federal grand jury indicted twenty-two people. Every one of them either pleaded guilty or was convicted.
Stanley Goldblum, the chairman and chief executive, received an eight-year sentence and a twenty thousand dollar fine, and served roughly four years. Fred Levin, an executive vice president, received seven years. More than fifty civil suits followed.
That is the outcome most retellings stop at.
The whistleblower was punished too
Ray Dirks, the analyst who exposed it, was charged by the Securities and Exchange Commission.
The SEC’s theory was that by repeating the fraud allegations to investors before the information became public, Dirks had aided and abetted a securities violation. He was censured.
He fought it for a decade. On 1 July 1983 the Supreme Court of the United States decided Dirks v. SEC and ruled in his favor. The test, the court wrote, “is whether the insider personally will benefit, directly or indirectly, from his disclosure. Absent some personal gain, there has been no breach of duty to stockholders.”
The insiders who talked to Dirks were trying to expose a fraud, not to profit. So there was no breach for Dirks to inherit.
BRG’s account calls that standard the Dirks Test, “which the SEC uses to evaluate when someone has engaged in insider trading,” and it exists because the man who uncovered the Equity Funding fraud spent ten years defending himself for uncovering it.
Why this case still gets taught
Equity Funding is usually filed under accounting scandal. It belongs in the insurance file.
The vulnerability it exposed was specific to how the industry moves risk. Reinsurance runs on documents describing people the buyer never meets. A block of policies is a stack of records, and the buyer’s checks were built to test whether the records were consistent, not whether the humans were real.
Consistency is exactly what a computer produces best.
Auditors in 1973 were not expecting to audit a company’s software as well as its books. When they pulled records, a second custom program filtered the data to hide the fake policies from them. The files they saw were internally perfect, so the check proved the wrong thing.
Tens of thousands of people who were never born taught an industry to ask whether its customers exist.
The Supreme Court’s opinion in Dirks v. SEC, 463 U.S. 646, carries the case’s timeline in its statement of facts and is published in full.