Back in the news after 42 years
On March 6, 1973, Ray Dirks got an unexpected phone call in the morning from an ex-employee of a West Coast life insurance company he was following called Equity Funding Corporation of America. Dirks, 39, was the top insurance analyst on Wall Street at the time and EFCA was its hottest stock.
The caller was Ron Secrist, a controller of the company who had just been fired for belly-aching about his tiny Christmas bonus. Secrist told Dirks that he had just met with the New York State Department of Insurance and wanted to tell him something important about EFCA. He would not do so on the phone, however, and asked to meet in person.
At Dirks’s suggestion, they met that afternoon for lunch. Secrist told Dirks that most of EFCA’s life insurance policies were complete fabrications. The policies were being created out of whole cloth solely to inflate the company’s revenues and pump up the price of its stock. EFCA management owned a large chunk of EFCA stock and intended to take advantage of the steady rise in its market value. The fraud had been going on for almost ten years and EFCA’s top brass – who Secrist claimed had Mafia connections in Chicago – were physically threatening company employees participating in the scam to keep their mouths shut. Secrist wanted Dirks to verify his claims and then notify large EFCA shareholders who Secrist hoped would dump their stock and create a significant imbalance in market orders that would trigger a full-scale investigation of the company.
From that call unfolded the biggest financial scandal of its day and, ten years later, a landmark Supreme Court decision on insider trading that has shaped — and now shaken — our understanding of the crime.
A massive pyramid scheme
Based in Beverly Hills, EFCA had risen to prominence in the life insurance industry by packaging its policies with equity mutual funds. Under its innovative program, policyholders could make annual fund investments and then borrow against them to pay their policy premiums. If the stock market rose (as expected), policyholders could later sell their fund shares to pay off their loans and pocket the difference.
Secrist told Dirks that EFCA picks names at random from telephone directories at late-night “phonebook parties” and turns them into insureds.
At lunch, Secrist told Dirks that EFCA picks names at random from telephone directories at late-night “phonebook parties” and turns them into insureds. The phony policies are then sold to re-insurance companies that do not verify the existence of the policyholders. When the re-insurers are due the premiums from their policies, EFCA simply fabricates new policies, sells them to different re-insurers and passes the proceeds on to the prior-round re-insurers. In other words, EFCA was a massive pyramid scheme.
Secrist also gave Dirks the names of four other EFCA employees who could vouch for his allegations. The employees were based at the company’s headquarters in Beverly Hills, so, over the next few days, Dirks spoke with each of them by phone. All four corroborated Secrist’s claims about the company and added color on the lavish lifestyles of its top brass.
Given how rapidly EFCA had grown into a major player in the insurance industry, Dirks was astounded by Secrist’s charges. He had been following EFCA since the company’s founding (when he was just starting out as an analyst at Goldman Sachs) and, as EFCA evolved into a Wall Street darling, was keeping an even closer eye on it at Delafield, Childs, the New York broker-dealer where he was working when Secrist called.
EFCA had gone public in 1964 and, Dirks says, its stock had become a “high-flyer . . . like a dotcom in the late ‘90s.” By 1973, EFCA had $500 million in assets, $26 million in annual earnings and 64,000 (bogus) life insurance policies face-valued at more than $2 billion. Fortune magazine called EFCA the fastest growing company on the New York Stock Exchange.
The alleged “tip”
Over the next few days, Dirks found out which institutions owned large positions in EFCA – mostly hedge funds as it were – and told more than 20 of them about the fraud allegations. The majority of investors, such as The Boston Company, sold their stock immediately, but a few, like Lawrence Tisch of Loews Corporation, disbelieved the story and held onto theirs. One hedge fund manager, Michael Steinhardt, actually increased his EFCA position after Dirks’s call.1
Dirks also got in touch with Bill Blundell who managed the Los Angeles bureau of the Wall Street Journal and failed to persuade him to investigate the story. Blundell thought the claims were too fantastic to go undetected by EFCA’s outside auditors. Dirks also got nowhere with Barron’s and the LA regional office of the SEC.
Since no one else would check out Secrist’s story, Dirks decided to do it himself.
Since no one else would check out Secrist’s story, Dirks decided to do it himself.
“Don’t worry, the windows are locked”
The CEO of EFCA was a man named Stanley Goldblum whom Dirks had met before at an insurance industry event and for whom he had later hosted an investor luncheon. Goldblum had co-founded EFCA in 1960 with a hot-shot mutual fund salesman by the name of Michael Riordan who died five years later in a Los Angeles mudslide.2 After Riordan died, Goldblum picked Fred Levin, an EFCA staffer and experienced insurance investigator, to head EFCA’s insurance operations. Together, Goldblum and Levin had (ostensibly) grown EFCA into the tenth largest insurance company in California.
After speaking with the EFCA stockholders, Dirks called Goldblum, told him what he had heard from unnamed EFCA employees and asked for a face-to-face meeting. Goldblum told Dirks he was aware of the rumors Dirks was spreading among institutional investors and warned him not to interfere with the company’s 1972 audit which was ongoing. Goldblum agreed to meet with Dirks the following week in Los Angeles and suggested they have breakfast together at the Beverly Wilshire hotel where Dirks would be staying. Afterwards, Goldblum would take Dirks over to EFCA’s offices in Century City to meet with the auditors.
Over six feet tall, solidly built and nattily attired, Stanley Goldblum cut an imposing figure.3 Ray Dirks, on the other hand, is a much smaller man, less expensively dressed and then known on Wall Street as the ”hippie analyst” because of his long hair and sideburns.
They also demanded that Dirks stop spreading nasty rumors about EFCA in such a threatening tone that Dirks was reminded of Secrist’s comment about the Mafia.
Goldblum arrived at the hotel in his Rolls-Royce. He was joined by Levin in his Bentley. Dirks had spent the previous few days in Los Angeles confirming their stories with the EFCA informers. Goldblum and Levin started right in grilling Dirks about the fraud allegations. They also demanded that Dirks stop spreading nasty rumors about EFCA in such a threatening tone that Dirks was reminded of Secrist’s comment about the Mafia.
At the end of the meeting, Goldblum told Dirks he would drive him to EFCA’s offices to meet the auditors. Dirks asked what floor Goldblum’s office was on and was told the 28th. Dirks must have reacted palpably since Levin’s parting words to him were “don’t worry, the windows are locked.”
Exposing the scam
Stanley Goldblum’s office took up almost the entire 28th floor of a Century City skyscraper, and two of its walls were made entirely of glass. As he entered the office, Dirks admits to being intimidated. Levin and three other EFCA executives joined Goldblum and the group spent the next several hours brushing aside the fraud allegations and pressing Dirks for the names of his informers, which Dirks never gave up. Goldblum also warned Dirks not to “spook” two insurance company deals EFCA was engaged in.4 Unbeknownst to Dirks at the time, Goldblum’s long-range plan was to exit the pyramid scheme by buying other life insurers and gradually legitimizing the company.
Dirks did not get to meet EFCA’s auditors that day because Goldblum told him “they were too busy closing the company’s books.” The next day, he returned to EFCA’s offices and met the outside auditors, Seidman & Seidman. Dirks thought the company’s auditors were a Big-8 firm called Haskins & Sells, but Goldblum told him that EFCA had recently acquired another life insurer and had replaced H&S with its auditors, S&S. At the meeting, S&S refused to discuss their client’s affairs with Dirks or delay their 1972 audit report while Dirks investigated the fraud allegations. Dirks later spoke directly to H&S who told him that they had resigned their audit engagement (which Dirks presumed was because they were suspicious of what was going on at the company).
Convinced now more than ever that EFCA’s books were cooked, Dirks reported his findings to Bill Blundell at the WSJ who thereupon arranged a conference call with Stanley Sporkin, head of the enforcement division (the “top cop”) at the SEC. The Sporkin call prompted a meeting in Blundell’s office with two officials from the LA office of the SEC and one from the NYSE. Shortly thereafter, both the SEC and the California Department of Insurance began investigations of EFCA.
Barron’s, the WSJ and The New York Times all broke the EFCA story that same week and the NYSE suspended trading in EFCA stock on March 27th, just three weeks after Secrist’s call.
Barron’s, the WSJ5 and The New York Times all broke the EFCA story that same week and the NYSE suspended trading in EFCA stock on March 27th, just three weeks after Secrist’s call. The stock never traded again. It took only a few more weeks for the regulators to uncover EFCA’s pyramid scheme and the company to be placed in receivership and eventually liquidated. The shareholders were wiped out in what the press reported to be a $2 billion fraud, the biggest swindle of its day by far. Stanley Goldblum, Fred Levin and 20 other EFCA executives were indicted for accounting fraud and every one of them pled guilty or was convicted.6 Goldblum and Levin were sentenced to five and four years respectively in the federal prison at Terminal Island in San Pedro, California.7
Hero or goat?
Instead of paying him a whistleblower’s bounty or even thanking him for his good citizenship, the SEC turned on Ray Dirks and charged him with rumor-mongering and aiding and abetting insider trading.8 Unfortunately for Dirks, G. Bradford Cook, the recently-appointed chairman of the SEC, had just made insider trading on Wall Street his top enforcement priority.
Dirks was convicted on both counts at his SEC administrative hearing, but his punishment was reduced to an SEC censure because of the role he played in exposing the EFCA fraud. He was nevertheless barred from association with a NYSE member firm and lost his job at Delafield, Childs. The big investors who sold their stock on his tips were also sanctioned by the SEC as co-conspirators.
Dirks was determined to overturn his conviction even if he had to take his case all the way to the Supreme Court and announced to his wife and everyone he met that “I’m growing my beard until I’m cleared.”
While the regulators thought they were done with Dirks, however, he was not done with them. Dirks was determined to overturn his conviction even if he had to take his case all the way to the Supreme Court and announced to his wife and everyone he met that “I’m growing my beard until I’m cleared.” Though well-meant, that gesture was pretty fanciful since Dirks had nowhere near enough money to finance such an appeal.
On to the Supreme Court
Dirks’s first call was to Ralph Nader, the public interest lawyer he thought would be best positioned to attack the SEC’s ruling. A couple of years earlier, Dirks had helped Nader try to scuttle a merger between Hartford Fire Insurance Company and ITT. Nader didn’t like the deal because he was from Hartford and ITT had the reputation of an ‘asset-stripper.’ Dirks also questioned ITT’s earnings in his research reports and opposed the merger on the ground that it was being financed by overpriced stock and excessive debt. Knowing Dirks’s negative view of ITT, Nader engaged him to testify as an expert witness in what turned out to be an unsuccessful lawsuit to block the deal.
Dirks flew down to Washington, D.C. to meet Nader in his office. Nader told Dirks that none of the lawyers in his firm was right for his case, so he introduced him to Harry Huge and David Bonderman9 at the Washington firm of Arnold & Porter. The lawyers told Dirks that his appeal might cost as much as a million dollars and Dirks told them that he’d be lucky to come up with “ten grand.” Fatefully for Dirks and legal history, Huge and Bonderman found Dirks’s case sufficiently interesting to take it on a pro bono basis.10
Dirks’s lawyers initially appealed his censure to the SEC administrative law court that had convicted him. They argued that Dirks should be acquitted because Ron Secrist had received no personal benefit from tipping Ray Dirks about the EFCA scam and therefore did not breach a fiduciary duty to the company’s shareholders, a key element of the crime of insider trading (to this day). They claimed that, since there was no breach of duty on Secrist’s part, Dirks’s subsequent tips to his clients did not constitute insider trading. The court rejected that argument and affirmed Dirks’s conviction.
According to Dirks, both the SEC and the D.C. Circuit Court at the time construed insider trading as applicable to anyone who either trades on or passes along a known insider tip to the disadvantage of public stockholders.
The next stop was the D.C. Circuit Court of Appeals which also rejected Dirks’s argument in an unwritten, 2-1 opinion. According to Dirks, both the SEC and the D.C. Circuit Court at the time construed insider trading as applicable to anyone who either trades on or passes along a known insider tip to the disadvantage of public stockholders. It didn’t seem to matter that neither Dirks nor Secrist bought or sold EFCA stock or benefitted in any way from telling others about the scam.
It took exactly ten years to the day from Dirks’s meeting with Stanley Goldblum at EFCA’s offices in Beverly Hills to the start of his hearing before the Supreme Court. Bonderman argued the case and succeeded in convincing the Justices, 6-3, that Dirks had no duty to refrain from passing on the tip from Secrist because Secrist had no duty to keep it confidential in the first place. Secrist received no personal benefit for the disclosure and was motivated solely by the desire to publicly expose EFCA’s fraudulent pyramid scheme and bring its perpetrators to justice. Dirks was finally exonerated.
Still sharp as a tack at 81, Dirks is no longer researching insurance stocks but is now sourcing acquisition opportunities for a cutting-edge cloud computing company.
Today, Ray Dirks lives in exactly the same four-story Greenwich Village townhouse he bought when his career on Wall Street was at its peak. The place is over a hundred years old and is reached by passing through a little tunnel abutting the building for which it once served as a gatehouse. Dirks lost his wife to a sudden heart attack earlier this year and now lives with his daughter, her boyfriend, two dogs and a cat. He loves to compare his somewhat musty digs with Goldblum’s glitzy office, relishing the thought of a pesky little insurance analyst bringing down a world-class financial fraudster. Still sharp as a tack at 81, Dirks is no longer researching insurance stocks but is now sourcing acquisition opportunities for a cutting-edge cloud computing company. He still remembers virtually every detail of his dramatic encounter with EFCA, which he faithfully recounted in his book, The Great Wall Street Scandal (McGraw-Hill 1974).
Recently, the 1983 Supreme Court case that absolved Ray Dirks served as the basis for a Second Circuit decision, Newman, in which two previously-convicted downstream tippees were exonerated on the ground that neither knew the circumstances of the original tip. Unlike Dirks, however, the Newman tippees were hedge fund managers who actually traded on the inside information they received and made millions of dollars for their funds.
Many in the legal community are up in arms over that decision because they do not see why professional money managers who get inside information from a chain of analysts — information they believe to be reliable and trade on — need to know whether the original tip was paid for by the original tippee. Newman also opens the door to future gaming of insider information by canny traders who are able to insulate themselves from initial tippees. Because of the controversy Newman has aroused, the personal benefit test in Dirks is now likely to be reconsidered by the Supreme Court or possibly even written out of the law altogether by an act of Congress. However that critical issue is resolved, we have Ray Dirks to thank for courageously bringing it to light.
1 Dirks chuckled when he told me how Steinhardt had reacted to his call.
2 Goldblum had been a butcher in Pittsburgh before founding EFCA with Riordan.
3 Dirks described him as someone who “obviously spent a lot of time at the gym.”
4 New York-based Executive Life and Fidelity Life Insurance of Virginia.
5 Bill Blundell of the WSJ was later nominated for a Pulitzer Prize for his coverage of the EFCA scandal.
6 Hundreds of EFCA’s 4,500 employees apparently knew of the scam but were not indicted. Three of the S&S auditors, however, did serve time in jail.
7Each of their sentences would probably be more than ten (or even twenty) years today. Think of Bernie Madoff.
8 Dirks claims the SEC simply couldn’t decide which of the two securities violations applied to his client warnings.
9 David Bonderman later gave up the practice of law and founded a highly-successful private equity firm called TPG Capital from whose investment activities he has become a billionaire.
10 It was later reported that Dirks’s legal fees, if charged, would have come closer to $100,000 than $1 million.