Question

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.

Answer 1

1.

Pressure: Joe was saddled with a heavy debt

Opportunities: Complexities in insurance policy which boosted the confidence of joe to commit insurance fraud and claimed the losses by illegal means. He took the advantage of his managerial positions and stole money orders for cash and also charged extra from the customers by adding zeros in their bills .By his "enterpreneurial talent" he falsified his financial statements and consequently raised the market price of shares at a very high level.

Rationalisation: Even after the failure of his business and saddled with a heavy debt, he was very confident in Grand club's future potential to bring him financial success and so he decided to open another location of it.

2.

Some of the fraud symptoms are: There were no equipments and work order contracts on the basis of which he secured loans, no money orders were found in his records or books of accounts, unusual zeroes were added on the bills of the customers .He was living a very standard life with an expensive house and with a new sports car

3.

Control or actions that might have detected the fraud are: The offices of the insurance company might have done the independent check on all the loss clamied by the joe. Investigators might have done the investigations on the bill books and registers of the Joey on the basis of complaints made by the customers of being charged too much ,investigations of the financial statements of the company have been made because of the apparently rapid growth of the joe's business in a short period of time.