Joe Watt, an ambitious 22 year-old, started an entertainment business called Grand Club after he graduated from Connecticut State University. Grand Club was initially a business failure because Joe ignored day-to-day operations and cost controls. One year later, Joe was heavily in debt. Despite his debt, Joe decided to open another location of Grand Club. He was confident that Grand Club would bring him financial success.
However, as his expenses increased, Joe could not meet his debts. He turned to insurance fraud to save his business. He would stage a break-in at a Grand Club location and then claim a loss. In addition, he reported fictitious equipment to secure loans; falsified work order contracts to secure loans, stole money orders for cash, and added zeros to customers’ bills who paid with credit cards. Joe was living the “good life,” with an expensive house and a new sports car.
Two years later, Joe decided to make Grand Club a public corporation. He falsified statements to greatly improve the reported financial position of Grand Club. In order to avoid the SEC’s scrutiny of his financial statements, he merged Grand Club with Purple House, an inactive New York computer firm, and acquired Purple House’s public owned shares in exchange for stock in the newly formed corporation. The firm became known as Purple House, and the Grand Club name was dropped. Joe personally received 79 percent of the shares. He was now worth $24 million on paper. Joe was continually raising money from new investors to pay off debts. A few months later, Purple House’s stock was selling for $21 a share and the company’s book value was $310 million. Joe was worth $190 million on paper. A short time later, he met Peter Jason, president of GH Firm, an advertising service. Jason agreed to raise $100 million, via junk bonds, for Purple House to buy out Sun Travel, a travel service.
Afterward, with television appearances, Joe became a “hot figure” and developed a reputation as an entrepreneurial genius. However, this reputation changed after an investigation report was published in a major newspaper. The report chronicled some of his early credit card frauds. Within two weeks, Purple House’s stock plummeted from $21 to $5.
After an investigation, Joe was charged with insurance, bank, stock, and mail fraud; money laundering and tax evasion; and Purple House’s shares were selling for just pennies. A company once worth hundreds of millions of dollars dropped in value to only $48,000.
Required:
From this case, identify:
1. The pressures, opportunities and rationalization that led Joe to commit his fraud(s).
2. The signs that could signal a possible fraud.
3. Controls or actions that could have detected Joe’s behavior.