The Golden Girls Rush | The Case of Four Seasons Nursing Centers of America

Before Medicare, nursing homes were often just old motels or converted bowling alleys. But after the landmark program became the law of the land, money flooded the industry and along with it, wildcatters looking to strike it rich. One early player, Four Seasons Nursing Centers of America, boomed and busted in spectacular fashion and at the center of it: fraud.

[00:00:00] Earn free CPE by listening to this episode

Blake: If you'd like to earn CPE credit for listening to this episode, visit Download the app, take a short quiz, and get your CPE certificate. Continuing education has never been so easy. And now onto the episode.

[00:00:24] Intro and info on healthcare industry size

Caleb: This is Oh My Fraud, a true-crime podcast where criminals slice and dice numbers instead of humans. I'm Caleb Newquist.

Greg: And I'm Greg Kyte.

Caleb: Greg, do you have any idea how much we spend on healthcare in this country?

Greg: It is 3.8 metric shit tons.

Caleb: That is correct.

Greg: Google it

Caleb: Yeah. If you're not fluent in the shit ton conversion, according to the National Health Expenditure Accounts, and that's the official government estimates of health spending in the US, US healthcare spending grew 9.7% in 2020, reaching 4.1 trillion, trillion with a T or 12,530 per person, and that as a share of our GDP is 19.7%.

Greg: Yeah. That checks out. I have to pay the health insurance premiums at my company, and $12,530 per person sounds about right.

Caleb: Yeah. So, as we have established, I think we've established this on the podcast, but we're not bringing any news here, but wherever there are mountains of money, there is bound to be fraud. And the healthcare industry is right with money and air go fraud. And I think that's especially true today. But in the not-so-recent history, Greg Kyte, it has also been a target.

Greg: Yeah. Well, and one of the things... I mean, when we talk about healthcare and fraud, one of the things that comes to mind for me is the HealthSouth fraud that was right around the same time the Enron happened in the early 2000s, and HealthSouth was like a $2.8 billion financial statement fraud. But I believe the fraud you're talking about is even not so recent than the early 2000s.

Caleb: That's right. That's right. That's right, Greg. But this episode, I would say this is the deepest cut we've ever done, Greg. I'm excited about it. Yeah.

Greg: Yeah. Nice. I'm looking forward to a deep cut.

Caleb: Yeah. It centers on an Oklahoma-based company that built, leased, and operated nursing homes at a time when nursing homes were one of the hottest, high-flying businesses of the day. It's kind of like how the dotcom bust of the late '90s, early 2000s. The nursing home industry was basically that in the late 1960s and-

Greg: Right. Because dotcoms were super sexy. And when people think of nursing homes, they think, "Super sexy."

Caleb: Super Sexy. And so, none of them boomed bigger or busted harder than Four Seasons Nursing Centers of America.

Greg: Wait, Four Seasons? You mean the company that Rudy Giuliani had his press conference in front of? That Four Seasons?

Caleb: That's close enough.

Greg: Right on. I can't wait. Tell me everything.

[00:03:31] Medicare and the boom of nursing homes

Greg: All right, Caleb. So, Four Seasons Nursing Home Centers of America. This action started significantly before you and I were both born, correct?

Caleb: Oh, yeah. Yeah. It was late '60s. And if you know your healthcare history, and I know you do, Greg Kyte.

Greg: I know it like the back of my damn hand.

Caleb: Oh, good. Good. Anyway, so then you know then the back of your hand tells you that the Medicare system was established in 1965 when President Lyndon Johnson signed the Social Security Act Amendments into law. And interestingly enough, it was July 30th, 1965. I was born on July 30th but not in 1965.

Greg: Right on. But-

Caleb: But in any case, it was an auspicious day. So, as you can imagine, when Medicare... It must've been a hell of a time when Medicare was brand new. You know when Obamacare was brand new, people were mostly just complaining. That's what I read.

Greg: Yeah. So pissy.

Caleb: They were super pissed off. And now, almost... Wait, it's been over a decade now, and people love Obamacare. And so, I think to try to... I mean, we weren't around. But to think when Medicaid was brand new, if I understand it right, people were also pissy. But some very savvy, very morally compromised people saw opportunity.

And so, the idea being that the government, if you knew how to work the system, that there were government dollars to be had. But prior to Medicare, it was interesting, in the research I did for this podcast, I found this quote from a case study that said the typical nursing home of the mid-1960s was a converted motel or bowling alley that was operated by individuals with little or no medical training. And that's kind of crazy to think about, that just a regular person that probably doesn't even know CPR was just watching, was just keeping track of old people in a converted bowling alley.

Greg: Or a motel. I guess that didn't stick in that it was a motel. So, to get from one room to the other, the nurse's assistant has to go out into the parking lot and walk past the ice machine to get to the next room where grandma's just holding on.

Caleb: Right. Needs a fresh oxygen tank.

Greg: Right. But also, kind of... I mean, because I hear what you're saying, when we think of nursing homes today, that's not really what we're thinking. But you got to think-

Caleb: No.

Greg: ... when nursing home was a brand-new thing, people were probably going, "Oh gosh, just any old schmuck takes care of their elderly parents. So, anybody's got the required skills to be able to do what we need at this nursing home. So let them do it. Let's put a couple of beds on lane seven and eight and make this happen."

Caleb: Yeah. So, to give you an idea of kind of the boom around nursing homes that was happening, I found this particular stat I believe that was on yes But anyway, the guy writing there said in 1966 there are only a few publicly traded nursing home chains. By 1969 there were 58. And by 1970 there were 90. And the best known of these nursing home companies were called the Fevered Fifty, which I didn't believe, and I dug into it, and it's like, "No, it turns out people were calling this everywhere."

And these nursing home companies were promising returns. They were promising investor returns of 20% to 25%, which kind of sounds like a Ponzi scheme but now they're legitimate businesses. And in many cases, it said that a lot of these companies were going public before they had completed construction on the nursing homes with prices at a huge premium in the rest of market. So pretty speculative in nature. But in a way, Greg, it's really not that speculative because you know what's guaranteed?

Greg: What's that? Government money.

Caleb: Well, yes. But also-

Greg: That people get old and die.

Caleb: People get old and die.

Greg: There we go. Boom, I got it, second guess.

Caleb: So, the customers will just keep coming. And I have to imagine, it must've felt like a geriatric... well, not a gold rush, but a geriatric rush, something. Yeah.

Greg: Right. A Golden Girls rush.

Caleb: There you go. That's it?

Greg: I think that's what it was. But like you said, I mean, the first thing that you said, if it's 20% to 25% returns every year, that does seem astronomical. That seems too good to be true. But at the same time, I also could see where the people trying to sell, people on that investment could say, "We just got Medicare passed. Everybody gets old. Everybody needs this. This is the new thing. Get in now. You're going to see a huge return on your money." So, I could see that be-

Caleb: Right.

Greg: If I were pitched at that time, it would seem believable just based on the current events that were happening around it.

[00:09:09] Four Seasons formation

Caleb: Right. Right. So, the company we're going to talking about is Four Seasons Nursing Home Centers of America. It was incorporated in 1967, and the two founders were Jack Clark, a former milkman, homebuilder, and salesmen of golf carts and gypsum products and-

Greg: Right. And didn't he have a big New Year’s Eve party too in New York?

Caleb: Yes, that's him.

Greg: Wasn't that the same guy?

Caleb: Well, I think it was his distant cousin, Dick Clark, but close.

Greg: So close.

Caleb: Yes. Yes. But his half-brother-

Greg: His half-brother, Dick Clark?

Caleb: No, distant cousin. He's a distant cousin.

Greg: Okay.

Caleb: It was half-brothers Tom Gray. And he was a small hotel operator. So, he must have heard about these people sticking old people in old hotels, and he thought, "Huh, we could probably build something nicer and convince a lot of people to give us money." I don't know.

Greg: Right. Yeah. Yeah. It is funny that... I mean, just based on what we said about how the first nursing homes were put together, it does seem like a small hotel operator would kind of have the skillset you're looking for to slap together a nursing home in the late 1960s.

Caleb: Yeah. Or someone who delivers milk.

Greg: Or someone who delivers milk. Because a bottle of oxygen, a bottle of 2%, it's the-

Caleb: They spoil at the exact same time.

Greg: Exactly. Look at the expiration date. Pour that oxygen down the drain if you're concerned that it went bad.

Caleb: So, Clark and Gray, they were builders. Like I said, Jack Clark, he was a former home builder. And they wanted to build them and then sell them to investors. So again, they sounded like speculators. I mean, it's Oklahoma. There's a wildcatter tradition and old Oklahoma. And so, people were... It sounded like risk-takers. They saw opportunity, and they wanted to go for it. And so, Clark initially pitched doctors about these nursing homes. But they just weren't expanding as fast as they wanted to.

So, in 1968, the company's executives and their investment bankers kind of came up with a strategy to significantly expand Four Seasons operations. And this strategy involved establishing an independent company that would buy the nursing home from Four Seasons and then operate them or sell them to other parties. And this private company, which is going to become important later when we talk about the fraud, was called Four Seasons Equity. And it was organized in 1968, and they capitalized it with about 20 million bucks.

Greg: Gotcha. So, you had the first company, which is the Four Seasons Nursing Homes, which is the main company we're talking about. They set up another company called Four Seasons Equity. So basically, they build them. They'd sell them to Four Seasons Equity. Four Seasons Equity would either, A, operate these nursing homes themselves, or B, I guess franchise them out, sell them off to other parties.

Caleb: Yes. So anyway, Four Seasons, they IPO'd in May 1968 at $10 a share. Okay.

Greg: That seems like a lot.

[00:12:21] The 18-month boom and bust of Four Seasons

Caleb: Yeah. It's all relative.

Greg: I feel like there's companies today that IPO at $10 a share.

Caleb: Yeah. But IPO prices are relative. Because it depends on how much stock you're issuing. It depends on a few other factors. So, the price isn't really... You wouldn't adjust that to inflation because it's just all relative. No.

Greg: Okay. Gotcha.

Caleb: Like you say, a company going public today would maybe IPO at $10 if that's what they [crosstalk]-

Greg: But they probably would just have more shares out to get the capital they need. [crosstalk]-

Caleb: Yeah. Probably. Yeah. Depending on how much money they wanted to raise.

Greg: Those are the knobs you can twist. Okay, I get it.

Caleb: You got it. So, the share price hit $100 in the fall of 1969. So just over a year later, the stock had already increased tenfold. And the stock increase was due to the strength of the company's or supposed robust financial performance that it reported in its, there we are, audited financial statements-

Greg: There it is.

Caleb: ...filed with the SEC. But also contributing to the kind of the surge in the price was the projections made by Jack Clark that he made in speeches and news releases. And in 1969, he declared that Four Seasons was well on its way to becoming one of the largest... Wait, excuse me. It was on its way to becoming the largest corporation in the world.

Greg: Right. Which is hysterical because it started like a year and a half ago. So, it's like, "Listen, we've increased 10 times since we opened our doors in 18 months. And if we continue that trend of increasing 10 times every 18 months, then hey, within four years, we're going to have more money than exists on the face of planet earth. Get on the train, unless you're a dumb ass. Screw NFTs. NFTs are for losers. This stuff is where the money is right here."

Caleb: I think I want an NFT of Four Seasons Nursing Home Centers of America is what I want. Anyway, the stock hit a high of $181, and that includes a stock split. So-

Greg: Right. Wait a sec. Because I read some of the stuff. I want to make sure people understand that that factors in the stock split. So-

Caleb: It does. It factors in the split. Yes. Yeah.

Greg: Okay. Because initially, when I read that that includes a stock split, I went, "Oh my God, that means that it was really worth $362." But not true. They had a stock split. So, if you factor in, if you had an original stock and you got through the stock split, you would have had $181 at the end. Right. Okay. Cool.

Caleb: You got it. And then finally, finally, it all came crashing down in June of 1970. And it was suspended from the trading on the American Stock Exchange in September of 1970. Investors lost $200 million. And this is where adjustment for inflation comes into play. In today's dollars, that would be about $1.3 billion.

Greg: Ridiculous. And-

Caleb: And let's forget. It IPO'd in May of 1968, collapsed in June of 1970.

Greg: That's 25 months. This thing went from-

Caleb: Correct.

Greg: ... nothing to everything to everybody getting off screwed-

Caleb: [crosstalk]-

Greg: ... in 25 months

Caleb: I mean, it's impressive That's an impressive-

Greg: $200 million in 1970. That's crazy. That's crazy.

Caleb: Yeah. A lot of money.

Greg: Yeah.

Caleb: So that is the boom and bust of Four Seasons. So, should we get into some fraud?

Greg: Yeah.

Caleb: Let's get into some fraud talk. Let's do the fraud talk. Okay. So-

Greg: Let's unpack how these bad guys did this bad thing.

[00:16:09] Inflated revenue

Caleb: Let's unpack it. So first we'll start with some inflated revenue. Okay. It's a very common occurrence.

Greg: So basic.

Caleb: So basic, but yet so true.

Greg: It's like the fundamentals of basketball. If you can't dribble and do a layup, what are you even doing here?

Caleb: Yeah. If you're not going to inflate your revenue, then what are you even doing? All right.

Greg: Yeah. Start here. Get creative from here.

Caleb: Yeah. And we're going to need your accounting chops here eventually, Greg. Y'all listen, and you'll see why in a minute. But the primary means the Four Seasons management used to inflate its profits was to misapply the percentage of completion method in accounting for nursing homes under construction. So initially, they were using the physical percentage of completion method to determine the amount of profit to recognize on nursing homes under construction at the end of the fiscal year. Now, I've been out of the game for a while. I kind of know what that means. But Greg can you give us a two-sentence explainer on percentage of completion method?

Greg: It'll probably be a little bit more than two sentences, But yes, I can do that.

Caleb: Fine. Okay.

Greg: So basically, what happens is usually on most contracts that you have, the timeline for getting the contract and fulfilling it to the point where you should be able to recognize the revenue under normal circumstances, that happens within one accounting period. So, you can then-
Caleb: Right. Like a quarter or a... Usually a quarter or a year.

Greg: A year. Yeah. Usually, we're talking a year. If something can be done... Most transactions can be completed within a year. But when you get into construction, a lot of these big construction projects take longer than a year to complete. As a matter of fact, so if I haven't said this on every single podcast, my day job, I'm a in-house CPA for a group of medical office buildings. Intermountain Healthcare, one of my buildings is on campus with one of their big hospitals, and they just did a remodel of their campus that took five years. So that's a great example of a construction project in the healthcare industry that's a multi-year project.

And so, if you were doing a very, very anal-retentive matching principle kind of thing, then as you created this building, all of your costs would just go into a work in progress or a cost of goods sold kind of account, and you wouldn't recognize any of those costs until you completed the project. And at that point, you could recognize the revenue for the entire project, and you could recognize the expenses for the entire project. But when you're looking at a multi-year project, that's going to take-

Caleb: It doesn't make any sense to do it that way. Right. Yeah, yeah, yeah.

Greg: Right. And it would make things really weird because then you'd have these years where you had no revenue at all.

Caleb: No revenue.

Greg: And then you'd have a ridiculous amount of revenue in this one year. And that's not a cruel accounting at that point.

Caleb: Right. Exactly.

Greg: That screws that up. So, the idea of percentage of completion was, okay, in this particular period, whether it's a year, a quarter, whatever, we completed this percentage of the work. So, we're going to recognize that percentage of the costs, and we're going to recognize that percentage of the final profits that we will... well, that we will receive at the end of this project. So that way, you won't have these, we made nothing, we made nothing, we made nothing, we made everything kind of a balance sheet and profit and loss. So that's why they do that. And at one point... And with that, you're looking at a lot-

Caleb: That was more. I just want to know for the record that that was more than two sentences. But go on.

Greg: That was like 20. My sentences increased by 10-fold in mere minutes. The other thing though is... Well, here's what I was getting at. There's tons of assumptions involved in that. Because what you have to do is you have to say, "Okay, everybody stop. We're at the end of the period. How much of this job did we do this year?" And somebody has to go, "I don't know, 30%?" And everybody goes, "Yeah, yeah, yeah, 30%. Yeah."

Caleb: Looks like 30%.

Greg: Yeah. Look out the window. Yeah. It looks like 30%. We're good. Say 30%. And I think you're going to get into this. Weren't they forced to change it to-

Caleb: Yeah. I can talk about that a little bit. So, Four Seasons would for example recognize 20% of the profit the project that was 20% complete at the end of a given year, just like you were describing, right? Well, assuming that the project also was started in that year, right? Okay

Greg: Right. Or alternately, you can say... Again, if it's a multi-year project-

Caleb: Multi-year project. Right.

Greg: ... you'd say, "Well, this year we did 20% of it." So even if it wasn't started that you just go, "How much did we do this year?"

Caleb: Right. And so, in 1969, the company switched their revenue recognition method from... Well, they switched to, excuse me, they switched to the cost-to-cost percentage of completion method. And under that method, the percentage of profit recognized on a long-term construction contract in a given period is equal to the proportion of the total expected cost for the project incurred during that period. So, for example, if 80% of the total expected costs for a project were incurred in a given year, the same portion of the total expected profit for that project should be recognized that year. So, Greg, how about a brief explanation of the difference.

Greg: It's so close to the same. It's ridiculous. Because-

Caleb: It sounds really close to the same thing to me.

Greg: Right. Because before, they were just saying, "Oh, we did about 20% of that job this year. So, we'll recognize 20% of the income." But then the costs that they have incurred on that project to date, they would just use the actual cost. So wouldn't necessarily be a proportional amount of the revenue to the cost. This way, they're locking that in. They're saying, "Okay. How much did you spend on the project this year compared to the total amounts that you think you're going to spend on the project in total?" Then that proportion is the same amount of revenue that you get recognized in that year.

But again, you boil it all down. It's all subjective. Again, you go, "Oh, we spent 125 million on this job this year." And I was like, "Cool. How much are we going to spend for the whole job." And they got to go, "I don't know. I mean, we're kind of thinking 500,000. But I don't know. Who knows? Maybe there's going to be some supply chain disruption due to a global pandemic, and it's going to be 700,000. You don't know what's going to happen. So, it's still based on a lot of subjectivity.

Caleb: So what's important about this switch of method is that the guy who prosecuted these guys, this guy by the name of Gary P. Naftalis, who is a US attorney, Southern district in New York, he insisted that the switch in the county methods was made because Four Seasons management realized their profit in 1969 was going to be less than they expected. So, by switching to the costs-to-cost percentage of completion, they could manipulate the profit recognized by distorting the expenditures. And so, as you said, I mean, kind of seems to me that they could have distorted it under either method. But fun fact about this little switch in the footnote of this case study that I found, and Greg, you kind of enjoyed this.

Greg: I did.

Caleb: Let me find it here. The SEC was at least partially responsible for them switching the methods. They had actually complained to the company that they were overestimating the physical state of completion on the projects, and as a result, they were recognizing too much profit during the early years. So, they said, "Wait, you're being too aggressive. Switch to this other method, which we'll think you'll actually be more accurate." And this Naftalis, Naftalis. I don't know if I'm saying his name right, I'm sorry. [crosstalk]-

Greg: You are. You're nailing it.

Caleb: Okay. Right. But anyway, he contends that actually, no the switch allowed them to be more aggressive than they were being. And so, it's just kind of a weird little contradiction that happened between the perspective of the SEC and then the perspective of the prosecutor who eventually was prosecuting this case.

Greg: Right. Well, and if you think about it too, that would be awesome, because I could see where the perception from the SEC would be like, "This is a tighter method. This is math. So, you got to tell us how much costs you think you're going to have for the whole project and how much costs you've had this year." And then the funny thing is that almost gets to be like cash accounting because then you go, "Oh, you know what we're going to do? We're going to buy all of our supplies for this six-year project right now. And then we can show that we had tons of costs in this period, and we can recognize almost the entire profit right now."

So, I mean, there's ways to manipulate stuff like that. And if you've got smart accountants, there's two things that there happen. One, they're going to know, they're going to think through that pretty easily on, oh, this is what you want me to do, cool, because here's how I can totally use that to change my numbers to my benefit. The other thing that smart managerial accountants are going to be able to do is they're going to know the different ways that you can expense jobs or recognize revenue, and they will know which one is going to be more advantageous for them in terms of the presentation of the financial statements. So, they will definitely argue with their auditor to go, "No, this one makes a whole lot... No, LIFO makes way more sense for us than FIFO. So, we got to do it this way. Oh yeah, and also we're going to have an amazing year this year, but it also totally makes sense."

Caleb: That's right. Right. So that's the inflated revenue. That's what was going on.

[00:26:35] Counting intercompany transactions as revenue

Caleb: Now, there was another thing that was also part of what appeared to be untoward activity, and that was these intercompany transactions that they were calling revenue. So, it was intercompany sales transactions on their income statement. And this guy, Naftalis, the prosecutor said that from 1968 to 1974 seasons controlled the operations of its principal customer, which was Four Seasons Equity that we had talked about a little bit earlier.

And in Jack Clark, one of the founders, his guilty plea that he eventually when we get to the charges and things, we'll get to this, but he ended up pleading guilty to conspiracy to violate securities laws. He admitted that the major decisions by Four Seasons Equity's management were dictated by key executives of Four Seasons, i.e., him. And so basically, they were selling these projects to themselves, and they were calling it revenue, and that's not revenue.

Greg: Right. Yeah. And some of the articles you sent me about this case that I read; it was really interesting because they were like it was a total secret that Four Seasons Nursing Homes was a related entity to Four Seasons Equity. Who would have thought that those two companies-

Caleb: Who would have put that together?

Greg: ... with almost identical names were somehow owned by the same people or in any sort of relationship. That's so fucking weird.

Caleb: Yeah. All right. So shall we move on to-

Greg: Yeah.

[00:28:28] Trials and convictions

Caleb: ... some of the trials, convictions, et cetera?

Greg: Yes. Well, yes. Yeah, let's do that. Okay.

Caleb: Yeah. So, there were eight people indicted in December 1972 after a 10-month investigation. They returned a 65-count indictment, which is a lot. But as we have found over the course of this podcast or just reading lots about frauds, anyone that reads a lot about frauds, anytime that you kind of manipulate accounting results, all of a sudden, you get an indictment that's like a thousand pages long because almost every single person that you've defrauded is like a separate count. And I'm only slightly exaggerating, I think.

So, there's many, many counts of mail fraud, many, many counts of securities fraud, and that's why these indictments, they ended up with so many counts. But in this case, it was a 65-account indictment, but the gist was they manipulated the results that misled investors into paying higher prices for the stock in the company.

Greg: Yeah. Financial statement fraud to inflate stock prices so that the owners and executives with a bunch of stocks could get rich.

Caleb: You got it, man.

Greg: That's it.

Caleb: You got it.

Greg: Again, so basic. Geez.

Caleb: Tried and true. Tried and true

Greg: Yeah. Okay. Tried and True.

Caleb: So, let's run down who the defendants in this case. So, we mentioned Jack Clark. He's one of the founders. He's the chairman and the president. Tom Gray. He's co-founder, half-brother, and then another gentleman by the name of James Lin of Oklahoma City. He was president of Four Seasons Franchise Centers. And then the bank was Walston and Co., Walston and Company, and the two guys with Walston that were indicted were Glenn Miller. He was the executive vice-

Greg: Had a great orchestra. He had a great orchestra.

Caleb: Tremendous orchestra.

Greg: Amazing.

Caleb: He was the executive vice-president in his spare time, and he was... As I recall, he was like third in the company at this investment bank. So, he was high up there. And then another gentleman by the name of Gordon McCollum. So, both those guys were indicted, and finally, we had four people. No excuse me, three, I'm sorry, three people indicted that were with Arthur Anderson. Two partners, Kenneth Warman, Edward Balka. They were both partners. And then I don't know this... I couldn't find what level this third person was, but his name is Jimmie Madole, or it's maybe it's Madole. I don't know. But he was the third person indicted and-

Greg: Is a Madole. Is Jimmie Madole.

Caleb: Possibly. Yeah.

Greg: [inaudible] the books.

Caleb: And so, three people from Arthur Anderson, three people from Four Seasons, and two people from Walston, so a total of eight people. And in this New York Times article that talked about the indictment, a four-page statement was issued by Arthur Anderson. And its chairman, Harvey Kapnick, stressed that no charges were made against the firm of Arthur Anderson. But what he didn't mention but was true is that Arthur Anderson was an unindicted co-conspirator. So that's not nothing.

Greg: No, that's not. But it is interesting because what they're saying is, "Okay, hey, yeah. Three of our people, two partners and one of our CPAs, yeah, they were indicted. But the company itself wasn't. So, we're good. We're cool guys. Don't worry about us."

Caleb: But hold your horses, my friend. The statement went on to say, with specific regard to our personnel, it read, the indictment alleges a misstatement of Four Seasons earnings for the fiscal year ended June 30th, 1969, as to which Arthur Anderson had given its opinion based on its regular examination for such fiscal period. We completely and categorically deny such allegations. So, Anderson stood behind its guys. Whereas the Walston guys, the banking guys, they were no longer at Walston when they were indicted.

Greg: Do you know, did they get fired, or did they walk or-

Caleb: I don't think I read precisely what happened, but my hunch would be is that they were probably asked. They probably were pushed out, resigned, or whatever. But these three Anderson guys were still at the firm throughout this whole ordeal, and we'll get to what happens to them in just a little bit. But what's interesting in this article was that the partners in this case, they had voluntarily taken lie detector tests to prove their innocence, but the US attorney refused to permit the lie detector examiner to testify to the grand jury. And part of that is weird because it seems like at a time because these days people are like, "Lie detectors, they're bullshit. It's basically like voodoo, essentially in a court of law." So, the fact that at this time apparently, they had some credence, they had some credibility, I don't know. But-

Greg: No. But I think you're absolutely right.

Caleb: ... I think Anderson was standing behind its people.

Greg: Well, back in the late 1960s, they didn't have countless YouTube videos that would train you on how to beat a lie detector test and meet the parents who hadn't come out yet either, where all of us learn how to beat a lie detector test. So-

Caleb: Just don't be Ben Stiller.

Greg: Exactly. Ben Stiller's, he's really the guy that brought down the lie detector industry as a whole. And there's still a lot of angst in that industry directed towards Ben Stiller and his father.

Caleb: True Story.

Greg: Look at-

Caleb: Jerry Stiller. Jerry Stiller.

Greg: Look at that.

Caleb: Jerry Stiller.

[00:34:43] Arthur Anderson avoided any fines or punishment

Caleb: Okay. All right. So just a few kind of more tidbits that were kind of... At the time of the indictment, they were accused of... And this is kind of reading for the Times Article. There were sham sales of nursing homes, phony construction costs, fictitious franchises, and false financial statements. And Arthur Anderson ignored the fictitious figures and certified the accuracy of the financial statements for Four Seasons. And the Four Season defendants, when the corporation's financial position became precarious defendants who had purchased large amounts of stock began secretly selling it to the public through confidential numbered brokerage accounts at Walston, and the profits exceeded $21 million

Greg: Which all that stuff, I mean, nobody labelled that in anything that I read or anything that you put together, no one labelled that specifically as insider trading, but it's basically insider trading where it's like, "Guys, we totally blew up the stock price on this, and we've got to ditch these shares now because we know that our house of cards is crumbling sometime within the next 25 months, give or take, 25 months."

Caleb: No kidding. In the case study which was really a gem of a piece of research that I found; they had a kind of a quote from... I don't remember which of the defendants. but it was one of the Four Seasons guys. He said, "Let's get Walston the bank. Let's get their opinion as when we could sell a sizable portion of our stock while the stock is at a good price to guard against having to sell after the public realizes that nursing homes will not meet profit expectations."

Greg: Yeah. There you go. That's 100%. So, you guys at Walston, you tell us when you think we peaked. When did we peak, and then-

Caleb: And we'll dump it.

Greg: ... we're going to sell, sell, sell, sell. But again, because they don't want to raise suspicions, they've got to do it from the secret number to count rather than something that has these executives' names attached to it.

Caleb: Right. Just a couple other little tidbits that factored in these financial statements that were manipulated, falsified, whatever, they were used to secure a $4 million loan that they secured essentially from the state of Ohio. So that got wrapped up into it, and they celled $15 million in bonds to investors in Europe. So that was all wrapped up in this as well. So-

Greg: Right. So, when we say that investors lost $200 million in this fraud, that doesn't include, the what, almost $20 million of loans that were defaulted.

Caleb: I think that's right.

Greg: That the company defaulted on. So-

Caleb: Yeah, I think that's right.

Greg: ... it's closer to 220 million, the losses between the investors and the creditors that got hosed. So, what happened to these guys?

[00:37:37] What happened to the 8 indicted people involved in this case?

Caleb: What's happened to these guys?

Greg: What happened to them? The eight dudes who got indicted?

Caleb: Right. So, we'll start with the bankers. So, the guys from Walston, this is Glenn Miller and Gordon McCollom. They both pleaded guilty to... All I could find was certain charges. So-

Greg: Right. It was not any kind of uncertain charges.

Caleb: Right. So, they pleaded guilty, and they were each fined $40,000. That's what I found for their punishment. No jail term.

Greg: And just to reference that, in 1973, $40,000 could buy you all the cocaine. It's like-

Caleb: All of it?

Greg: Yeah. What's the movie? Say Hello to My Little Friend. That much cocaine

Caleb: Oh, okay. Got it.

Greg: Yeah. Who's that? I know the movie.

Caleb: Scarface. Anyway, James Lynn, he was one of the Four Seasons guys. He was acquitted on all charges. So, he was the guy that was the president of the Four Seasons Franchise Centers, acquitted on all charges.

Greg: Okay. You're good. I know you put together all these fake franchises but forget it. We like you. You're good. You're good, kid. Get up there and just knock it off, you.

Caleb: Yep. Don't ever do it again. Tom Gray, one of the co-founders. He was sentenced to a year in prison and a $10,000 fine. So those were kind of the pretty straightforward I guess sentences and/or acquittals for those guys. Jack Clark, probably kind of the main guy in this particular story, he pleaded guilty to conspiracy to violate conspiracy law... excuse me, to violate securities laws, and he was sentenced to a year in prison. No fine, but he ended up being eligible for parole in like four months. So-

Greg: That's crazy. So, he was the main guy-

Caleb: It's crazy.

Greg: ... and he got hit harder than his cousin and harder than the bankers. No, no. Sorry.

Caleb: No, no.

Greg: The cousin and the bankers got hit harder than him. He only got a year in jail and no fine at all?

Caleb: No fine that I could find.

Greg: Crazy.

Caleb: Yep. And so, to be fair, the prosecutors were definitely looking for more severe punishment. So, here's a couple other things. Yeah. Yeah.

Greg: Wait, wait, wait, wait. Didn't Jack Clark, didn't he get like 9 million bucks from dumping his shares?

Caleb: So, when we talked about them selling those socks from those secret accounts at the bank, yes, he personally benefited. I saw both nine million, and I said 10 million. Somewhere between $9 million and $10 million is what he personally made from the sales.

Greg: So, he goes to jail for one year, and he gets to keep all his $9 million of insider trading cash.

Caleb: I mean, you have to believe that a lot of that money ended up going to lawyers. But yes, I mean, he was really rich

Greg: Okay.

Caleb: Yep. Geez.

[00:40:38] Prosecutor pushed for harsher sentencing

Caleb: So just to give you an idea of how the prosecution felt about all this from the New York times during the two-hour session in which the sentence was imposed, Gary Naftalis who was the prosecutor, he asked Judge Thomas P. Griesa, I don't know if I'm saying that right, to melt out a sentence that-

Greg: You are. Nailed it.

Caleb: Thank you. Would melt out a sentence that would inform the public that there is no special privilege for people of the wealth and prestige of Jack Clark. Well, it turns out there absolutely is. There a special privilege. The prosecutor added that Clark represented a challenge to the criminal justice system at a time when court critics were complaining that white-collar criminals receive better treatment than common criminals who committed street crimes. So, I know what you're thinking. Nothing has changed-

Greg: Kind of.

Caleb: In 50 fucking years. And here's a couple of bits from Jack Clark's defense lawyer. The defense lawyer contended that Clark had previously led a blameless life and had built a nursing home business that made substantial contribution to the care of the elderly, adding that he was a devoted family man who coached baseball and football for youngsters. Clark succumbed to committing a crime, the lawyer said because Four Seasons had suffered financial difficulties. I mean you could put 2022 on this, and no one would fucking bat an eyelash. I mean-

Greg: Right. Right. Yeah, that's-

Caleb: Am I wrong about that? I mean, what do you think?

Greg: Well, I don't know. I mean, the stuff about coach and baseball and football for youngsters, that does seem pretty mid-century kind of thing where it's like, "This guy, don't put him to jail. He's a family man. See, he coaches baseball and football for the youngsters in town. He can't be all that. But he helped your grandma through her tough time when she was in a nursing home. What? Did you want to take care of her? No, you didn't, but he did it for you. He's a good guy. Let's not put him to jail."

[00:42:41] Was AA duped into this scheme?

Caleb: Right. So, I think in the Anderson trial, the judge again seemed very kind of convinced that this was very much just a stock manipulation scheme and that Anderson's role was... They were kind of duped into this, right? And again, going back to the memo that was written by a Four Seasons executive, let's get the bank's opinion is when we can sell this. That was the crux of the whole thing. And so that's what basically made the case. And whether Anderson was accomplices, that's why they did this trial of the Anderson guys is to see to what degree their culpability was. So, during the criminal-

Greg: Yeah, sure.

Caleb: ... trials of these guys, Kenneth Warman and Edward Balka, Jimmie Madole.

Greg: Madole.

Caleb: The prosecutor proved that Four Seasons included huge amounts of fictitious construction expenditures in its cost report. So, we mentioned that. And to your point is there's a lot of estimation involved. And so, they were probably being generous with those estimates, and thereby, they amount to fictitious expenditures, right? And so that resulted in these illicit profits. And the prosecutor said that while Arthur Anderson was aware of all this, and that they were...

So that made them party to the conspiracy to defraud by the financial statements. But the attorneys for Ken Warman and these other guys, they disputed this because they... and they disputed it by submitting evidence of copies of work papers from the engagement and these work papers indicated on several occasions that the auditors challenged fictitious costs, they discovered, and persuade the client to make proper financial statement adjustments for those costs. And so-

Greg: Right. Which is crazy.

Caleb: Yeah, go ahead.

Greg: I think that's crazy because-

Caleb: Go on.

Greg: Well, because it seems like, again, like an auditor who's just trying to cover their ass, where it's like, "Hey, let's make sure that we push back on some stuff here so that we can put it in our work papers that we pushed back on stuff." So, if anything ever comes back, we say, "Yeah, we told them. We said we weren't cool with this. And we pushed, and we made them make some changes." And it's like, "Yeah, but it was still totally wrong." And it's like-

Caleb: Right. Well, so that's-

Greg: ... but we found what we found, and we made them change that.

Caleb: Right. And so that's what's interesting about that is when you say, "Okay, you found the made-up numbers." And they said, "Well guys, you got to make some adjustments to not include those made-up numbers." And it's like, "All right, we won't include the made-up numbers." But I think your point is, but they made the numbers up. Right?

Greg: Right. It was still way wrong.

[00:45:47] Should auditors have more responsibility to find fraud?

Caleb: Right. That is wrong. That in and of itself should... I don't know if it constitutes a crime, but the auditors, there should be some... Kind of makes you wonder, it's like, why aren't auditors given more kind of tools to be like, "We found fake numbers, and we just had them adjust the numbers, and it was fine." And that conclusion is kind of weird.

Greg: Well, and I think it goes back to the tight rope the auditors have to walk with their clients, where it's like, "Hey, you're hiring us to call bullshit on your numbers, and if we call bullshit on your numbers, you can totally fire us." Right. So, okay. I think your numbers are cool. So yeah. Like I said, it's like this tight... It's a tight rope of the fact that you're not really independent even though you're trying to show that you're independent, but you're not because you're getting paid by the people who wants you to give an unqualified opinion of their financial statements, so-

Caleb: Right. So that was the inflated revenue. The prosecution also attempted to prove that these guys knew and were aware of the bogus nature of those intercompany transactions where Four Seasons was essentially selling stuff to themselves.

Greg: To Four Seasons. A completely unrelated Four Seasons.

Caleb: Right. Yeah. I mean, if you're an auditor, and you're saying, "Oh," and you're inquiring about these transactions like, "Oh, so who's this?" It's like, "Oh, that's our biggest customer." And it's like, "Oh, I noticed that your biggest customer has a very similar name to you. They have to know. They have to know. Right?

Greg: Right. Right. If I was prosecuting Arthur Anderson, I would have just spent the whole time going, "So you didn't know that Four Seasons was related to Four Seasons? Say it out loud. Say it out loud so that the stenographer can put it in the record. Say that you didn't... Say it." That would've been my whole argument.

Caleb: Yeah. And I think you would have made them... They would've crumbled on the stand, Greg.

[00:48:00] Hung jury

Caleb: So, two of the Anderson defendants were actually found innocent of the fraud and conspiracy charges. However, there was a hung jury for the partner, Kenneth Warman. But then nine months later, a judge dismissed the indictment on the advice of the prosecutor. And so, no Anderson employees were convicted of the charges that they faced from this particular case.

Greg: Yeah. Do you know what that means that the judge on the advice of the prosecutor dismissed the indictment? Is that kind of like the prosecutor just saying, "Hey, we're not going to pursue this anymore?" But just doing a different-

Caleb: Right. Essentially, I mean, that's my... When you read about cases like that, where there's a hung jury, because like a lot of times, when it comes to criminal cases, judges really impress upon juries. If it's a jury case, I should say, sometimes judges decide these cases. But they really impress upon jurors to reach-

Greg: A verdict.

Caleb: Right. Because a hung jury means nothing happens, and you're still left with the situation. It remains unresolved. And in this case, it sounds as though... Something I found the research. The federal government spent a million dollars, again, this is the early '70s, by this point, they spent a million dollars prosecuting these Anderson defendants. Andersen spent millions more defending these guys.

And so, I think if you're the prosecution, you've gone through this trial, two people are acquitted, one person, you had a mistrial. If you're a prosecutor, and you're just like, "Are we really going to invest more of our very limited time in going after this guy when the chances of success are probably pretty low?" And they probably just said the judge like, "Judge, we're going pass on this one, and that's probably."

Greg: Right. We don't want to put another million dollars in for another hung jury. So how about we let them walk?

Caleb: Right. To probably lose. Because essentially, the mistrial is a win for the defendant, right?

Greg: Right. Yeah. Absolutely.

Caleb: It's a straight loss for the prosecution, even though it's technically... I don't know. There's no ties in the court of law, I suppose. But it's one of those... Yeah. The prosecution is definitely unhappy with a mistrial, the hung jury.

Greg: Right. Yeah. Wow.

Caleb: So, we talked about what they spent on the trial, what they spent defending. Oh, interesting note. The managing partner of the Oklahoma City office of Arthur Anderson was named as an unindicted co-conspirator. And he was included because of the supervisory kind of nature of a position like that. And that was important because we mentioned this guy a little while ago, but a guy by the name of Harvey Kapnick, he was the chairman of Arthur Anderson during this time.

And he kind of out this warning at the time that this was a sign that auditors in future cases, this is what they could expect. So, if you're a managing partner of an office and an audit blows up in your office and you run that office, whether or not you set foot in that audit room at any given time, you can bet that your name is going to be all over that thing. Or maybe not all over it, but you will be a target, or you will have to deal with those repercussions.

Greg: And do you think his forecast was accurate?

Caleb: Oh, yeah. Yeah.

Greg: But I don't feel like there's a lot of a lot of accountants or accounting firms that are actually indicted in a lot of this stuff. They're hand slapped-

Caleb: Well, unindicted.

Greg: ... and they're dragged through it.

Caleb: Unindicted. Don't forget. Yeah, no. This guy was an unindicted co-conspirator. And Arthur Anderson, the firm was an unindicted co-conspirator. Again, because of kind of the audit methodology of a firm, right, belongs to the entire organization, the entire entity, I suppose. And so, from that standpoint, a prosecutor could say, "Yeah, I mean, they weren't party to the crime, but their methods were implemented, and they were abused or they were misused in the further ends of this crime." Right? And so that's probably at least part of the reasoning that someone would have and say, "Well, they're a co-conspirator, but we can't charge him with a crime." Right.

Greg: So, he's saying that just being dragged through it is what's in the future.

Caleb: Yeah. Well, and that's-

Greg: Not so much the indictments that happened to his people, but the indictment. Although, I guess-

Caleb: Exactly. Well-

Greg: ... since they all got acquitted or dismissed, that they kind of were just dragged through it themselves too. So-

Caleb: So, I think this is something that we can get too into the lessons part of it. But that's the issue, right, is what do you make of? You have these three Arthur Anderson employees. They are acquitted of all the charges. But the damage to the reputation of them and the firm, that is very real, right? And so that I think is what this warning that the chairman of the firm at the time, Harvey Kapnick was saying was every time this happens, it will tarnish our reputation. And Arthur Anderson has a spotless record. And this will tarnish this firm every time that happens.

Greg: Right. At least until 2002.

Caleb: Right.

Greg: And then there won't be a firm anymore to tarnish because there'll be tarnished too much.

Caleb: Right. So that's what happened. That's the case.

Greg: Voila.

[00:54:10] Lessons learned - external auditors are not responsible for finding fraud

Caleb: Okay. Four seasons Nursing Home Centers of America. Greg, is there anything to learn from a 50-year-old fraud? Anything? Anything at all?

Greg: Yeah. I feel like there's a lot-

Caleb: Oh, good.

Greg: ... that's highlighted by this case that's still true today. And the first thing that comes to mind is that external auditors are not in the business of detecting fraud, and they will go to their grave saying that that's not... They will direct you back to their engagement agreement that they had with you, the engagement letter that says right here in paragraph four, it says, "We're not responsible for finding fraud inside you. If we do, awesome. But if we don't, that's on you at that point." And the other thing is just specifically an audit is not an internal control. And there's a lot of things that we can see with that.

The ACFE report to the nation. They publish that every two years, and it seems like every time, the percentage of frauds that are detected by the external auditor is like 3% of the... And who knows what the margin of error is on that? Maybe 3%. So, there's not a lot of fraud that's detected by your external auditor. And like I said, they're trying their very best to cover their butts and say, "We were trying to say that these financial statements were presented fairly. We weren't out to find your fraud in your business. That's not our job? And what did our guests say, McKenna?

Caleb: Francine? Francine.

Greg: Yeah, Francine McKenna. Yeah. Because that was her big thing was that auditors should be detecting fraud, that they constantly say that they do not and will not.

Caleb: Yes, that is essentially her position. I mean, I think what is interesting about this is that nothing has changed in 50 years.

Greg: No. Right. Yeah. They weren't detecting fraud then, and they aren't detecting fraud now, and they're trying to get out of it both 50 years later.

Caleb: Right. And in this particular instance, it seems as though that auditors, they were on the winning side. I don't know. Do I have a dog in this fight? Do we have dogs in these fights, Greg?

Greg: No, I don't. I don't.

Caleb: Not really. I mean, Francine, you'll probably be disappointed [crosstalk].

Greg: I've got opinions. I got opinions.

Caleb: Yeah. But I think I don't want to say Arthur Anderson won. They were on the winning side this time. But there's plenty of examples where juries find a different result, right, where they said, "No, y'all didn't do your fucking jobs, and you're going to pay." And so, I know there were some... We didn't get into the civil cases around this, and I don't know if Arthur Anderson had some civil litigation to contend with here." But there are countless examples of where auditors are held responsible for failure to detection of fraud.

And so, you have one side saying, "No, not our job." But then you have the court of public opinion that says, "No, sometimes it is your job, and you didn't do your job. And so, we're going to hold you responsible." And that is such a like... It sounds like an impasse to me, because if the auditors finally said, "You know what guys, we've been wrong. We'll change our tune on this." They're finished, right?

Greg: Right. Absolutely.

Caleb: That'd be the end of it. And so, they just have to stick to their guns. And to their credit, these firms are not human beings. They're just organizations. And so yeah, they can say this forever. They can hold out.

[00:58:12] Financial statement fraud

Greg: Yeah. Right on. Yeah. So that was one thing that stuck out to me. Another one of the things that I think this case highlights is when it comes to financial statement frauds, management estimates of whatever thing that they can estimate and that gets reflected on the financial statements, that is fertile ground for committing fraud all always and forever will be. And we even know that in the auditing standards it says anytime there's a management estimate, that's going to be relied upon, and it's going to be reviewed, and it's going to be harped on until we can make sure that it's right.

Again, I know every year, when I read the engagement letter for the CPA firm that does the review of the financial statements that I prepare, it very specifically says in there that it says, "We know that financial statements rely heavily on the subjective estimates of the management, and that's going to have a major effect on these financial statements, and that's... And it basically says there's only a limit to which we can enforce those and that the reliability of the financial statements really is dependent upon the reliability of the management's estimates in those cases where they have to estimate stuff.

Caleb: So, if I may. If I understand what you're saying, and I think that I do, what you're saying is depending on who you're dealing with, it could be an estimate in the true spirit of what the word estimate means. Or if you're dealing with Jack Clark, an estimate is a euphemism for maybe a wild-ass guess at best and completely fucking made up at worst.

Greg: Right. Let's leverage this as much as we can to inflate our financial statements and to inflate the results that our investors were expecting so that we can hit our targets, and we can make our profits on the stock side of stuff. Absolutely.

Caleb: Yeah. And I think that's the thing about... Like you say, estimates is kind of a... It's a very sophisticated thing. There's a lot of thought that goes into this, and we have formulas and muddles, and then we come up with an estimate. Or there's just a guy in a fucking office pulling a number out of his ass.

Greg: Right. Well, and the real smart guys are the ones that say, "What's the number that we want, and how can we reverse engineer an explanation for that number that we can sell to the auditors. That's the smart guys who do that. And I'll tell you, again, so with my companies, we just have reviews, not full audits for our financial statements. And I can pinpoint three estimates that I make every single year that never once have even been remotely questioned by the CPA firm that does our review, my wages payable estimate, my interest payable estimate, and my interest receivable estimate.

And I know a lot of why that goes on questions because I believe those are going to... They can't tell me specifically what their materiality threshold is because that violates audit standards. But I'm confident that the reason why they don't bug me about those estimates is because all of them fall below the materiality threshold for our company. But at the same time, I know that I've got bank loan covenants that I've got to meet every year, or else the bank could call our loans, and I'm pretty confident that if I needed to, I could use those three estimates to be able to tweak the numbers to be where I wanted them to be and probably still fall underneath the materiality threshold for that review. So, there's estimates that happen all the time, and they may or may not be questioned at all. So-

Caleb: And if I understand this correctly, whereas auditors are kind of malleable, right?

Greg: Yeah.

Caleb: Right. Where they're open to your maybe wild-ass guesses or sophisticated engineered estimates, loan covenants aren't those things that you can really like-

Greg: No.

Caleb: No. A bank goes just like, "No, you violated. We're taking the money."

Greg: You can't bullshit a loan company. It's a math problem.

Caleb: No, you can't. Right. Yeah. And so, it's interesting because that is I think in businesses of all sizes, right. From small mom and pops to some of the biggest corporations in the world. So much of it revolves around meeting their loan cabinets.

Greg: Yeah. So true.

Caleb: And it's the difference between you being in business or the bank coming by to turn out your fucking lights.

Greg: Yeah. Exactly. And again, in terms of the justification for the estimates, I send my CPA firm basically the work papers that I use to create my estimates. And again, I think they just go, "Oh, does he have a justification for this number? Yes, he does. Cool. Move on to the next thing. Because they don't analyze the math that I did to get to my estimate. They just are wanting to know if there's anything more than just, like you said, pulling a number out of my ass and throwing it on the financial statements. And that seems to placate them.

Caleb: All right. Good stuff. What else you got?

[01:03:26] Don't use the same company name for your related party

Greg: The other thing. Related parties. If you need to commit financial statement fraud, make a related party that can just take all the losses off of your books. Because again, it's very-

Caleb: Or just be the source of all your revenue.

Greg: Right. Exactly. Exactly. So yeah. Well, and that's the thing is that it was kind of both with Four Seasons because they had Four Seasons Equity that was buying their shit properties at an inflated price. So, they got a bunch of revenue from Four Seasons Equity, and Four Seasons Equity just got the stinkers of the assets. So, it was kind of both. They were able to move their losses and see a lot of profits from given somebody the bad and getting the good on all that stuff. And again, the goal was to inflate those stock prices with that.

But the big thing, unlike we've harped on already in this case, it should have been pretty straightforward to say Four Seasons was selling to Four Seasons. They're related parties. Related parties are incredibly easy to obfuscate to any kind of auditor or regulator. Because even if you do this, you say, "Okay. We've got company A, and we've got company B, and we're trying to say that they're not related at all." So, the next thing that anybody trying to dig into these companies is going to look at is they're going to look at, okay, what's the ownership of these two companies.

But then what you can have is you can create LLCs to be the owners of that other company. So, you can create nested LLCs to where someone would have to do this very extensive research into, okay, this LLC is owned by who and this by another LLC. Well, who owns that LLC? Well, it's this guy. And you can just bury the actual ownership beyond just layer like a Russian nesting doll of LLCs. And everybody's just going to get worn out before they go through all the hassle that trace down who the actual owners are above them. And then even at that point, you could say, "Okay, I'm going to have my son own that one and not..."

Or even better yet, my daughter who's now married and has a different last name than me, she's actually going to be the owner of that related. There's ways to just bury it. So, if you're not disclosing the related parties, nobody's even going to know. So again, if you're trying to commit financial statement fraud, 100%, set up related party, bury the actual owners deep as you can and don't disclose it, and likely, you'll be able to leverage that much to your benefit, and maybe you two get $9 million of profits off of your stock and receive no fine and four months in jail. It's a dream.

Caleb: That's a great deal.

Greg: Reach for the stars.

[01:06:21] The fraud triangle is BS!

Caleb: So, your final lesson, Greg. I think is a fun one. So, please.

Greg: Yeah. This is my soapbox, and it's controversial.

Caleb: Get on it. Please, get on it.

Greg: The fraud triangle that we all know and love is basically bullshit from top to bottom. Because the thing that we learned about the fraud triangle is that three things must be present for a fraud to happen. You must Opportunity. You must have pressure to commit the fraud. And you must be able to rationalize the fraud to yourself. And I go not true because... Well, I guess it's not true in the case that if you're looking at opportunity. Because in my mind, I always go, "Okay, opportunity, that you either have it or you don't have it." And so that must be present for you to commit a fraud.

Now, if you look at anybody who's an executive or in a management position, this is something that we learn when we're learning about audits is you have to really analyze those people's transactions in the books because they can override the internal controls. So, therefore, you've got this presupposition that management and executives always have opportunity to commit fraud. It's there. It's always there. And you can help to minimize it or help to put some things in place to where it's going to make it harder to override those controls. But that's all. The opportunity is always going to be there.

The biggest one I think of that's bullshit is the pressure side of things because pressure, what does that mean? I mean, because a lot of times we like to think of pressures, this is where it's like, "Well, there's this poor accounting knucklehead who's at the bottom of the pole who everybody above them saying, "Hey, we got to meet our numbers or else you're going to get fired." And then they go, "Oh no, I'm going to get fired, so I have to change these numbers." And so, they do it. Or when it comes to an embezzlement case. Great pressure story is, "Oh no, I'm a gambling-holic. I've got all these gambling debts. And Jimmie Madole is going to come, and he's going to break up my legs if I don't pay him my gambling debts." That was Jimmie Madole. He was the CPE from Arthur Anderson We talked about him earlier.

Caleb: Yes, he was.

Greg: Yeah. So, seems like a good mafia name. Anyways, so those are the things we think about with pressure. But I call bullshit on that because everybody's always got pressure because A, more money is always better than less money, and that's pressure. And everybody's got greed in them somewhere. Nobody's got zero impulse to get more shit, specifically more money. I mean, some people to greater degree than other people. But at the same time, everybody has got some greediness in them.

So that's complete bullshit. And then the last one was the rationalization. It says, again, the fraud triangle posits, that all three components have to be around, and the third component is rationalization, but you get sociopaths. Sociopaths don't need a rationalization to do bad stuff. They just go, "Yeah, I could do it, so I did it." And that's the rationalization. So why did you do it? Because I could. Okay. Then that's it. So-

Caleb: Right. And as you pointed out in preparation for this podcast, it matters not that not every person who commits fraud is not a sociopath. Because-

Greg: Because again, what the fraud triangle posits is that all of those have to be present for a fraud to occur. And we have the counterexample of sociopath.

Caleb: When a sociopath shows up, which they do from time to time.

Greg: Well, and studies show that sociopaths and psychopaths are in greater numbers in the executive area of business. So, they have a particular skill set that helps them rise to the top, and that is, they've been genetically predisposed to Machiavellian ladder-climbing. So again, research has shown that you have more sociopaths and psychopaths as executives than you have in the general population So yeah. So again, you have executives who can override controls. You got executives who...

And obviously, not all executives are sociopaths, much to the chagrin of all of their... but they're not all sociopaths. but there's a higher percentage that are. and rationalization, I don't... I mean, not rationalization, pressure I think really kind of isn't a thing, and it wasn't for these guys. We couldn't find any... Nobody was going to get their Ford F-150 repossessed if they didn't hit a stock price of $181 per share. They just wanted money because money is great.

[01:11:27] Thanks for listening, please rate and subscribe

Caleb: Yeah. All right. So that's it for this episode. Remember, if you're going to commit fraud in Oklahoma, you can bet that some hack will throw some musical theatre references around.

Greg: And also remember the best defense is being rich.

Caleb: Greg, where can people find you on the internet?

Greg: I am easily findable on Twitter, @gregkyte, and also another great place to find me is on LinkedIn, Greg Kyte, CPA. What about you, Caleb? Where can people connect with you?

Caleb: Yeah. Same. Twitter, @cnewquist, and LinkedIn, my full name, Caleb Newquist. Oh My Fraud is written by Caleb Newquist and Greg Kyte. Our producer is Blake Oliver. Music supervision, sound design, editing and mixing by Zack Frank. If you like the show, leave us a review or share it with a friend and be sure to subscribe on Apple Podcasts, Stitcher, Spotify, or wherever you listen. Join us next time for more at-risk swindlers and scams from stories that will make you say Oh My Fraud.

Greg: Oh My Fraud.

Creators and Guests

Caleb Newquist
Caleb Newquist
Writer l Content at @GustoHQ | Co-host @ohmyfraud | Founding editor @going_concern | Former @CCDedu prof | @JeffSymphony board member | Trying to pay attention.
Greg Kyte, CPA
Greg Kyte, CPA
Mega-pastor of @comedychurch and the de facto worlds greatest accounting cartoonist.
The Golden Girls Rush | The Case of Four Seasons Nursing Centers of America
Broadcast by