In 1998, American Bank Note spun off part of its business in an IPO.  Investors were excited. American Bank Note had been making products to prevent counterfeiting since the 18^th century. This was a chance to invest in a company with a long tradition, and that made products which prevented fraud. But just 6 months after the IPO, the company said it needed to restate its financials. A company that had been created to prevent fraud had lied about its revenue. The stock price dropped 80% in just two days, and investors lost millions.

The company’s executives were put on trial and convicted, but then nothing happened for an entire decade. Would these con artists ever face justice?

I’m Michael McLaughlin, and this is Scheme.

American Bank Note was founded in 1795 to print money for the U.S. government. But by the 1990’s it had expanded into a variety of products. It made counterfeit-resistant checks, money orders, credit cards, passports, and stock and bond certificates.

This expansion led to a lot of debt, and the company needed to pay off some of its loans. So in 1998, it spun off part of the company as American Bank Note Holographics. This company specialized in making holograms, which are very helpful in determining whether something is counterfeit. Holograms are useful because they’re made with lasers, not ink, and they feature depth and movement when viewed from different angles. This isn’t possible with a two-dimensional image. American Bank Note was the leader in holographic technology, and it raised over $100 million from the IPO in July of 1998.

Now a lot of work goes into preparing for an IPO; the company needs to make extensive disclosures, such as filing prior periods’ financial statements with the SEC. Investors want to see that the company’s profits are rising. Would you want to invest in a company with flat or declining profits? Investors want to see growth, so American Bank Note Holographics was under pressure to show increasing profits in the years leading up to the IPO. This is where things got ugly.

Two years before the IPO, the company’s president Joshua Cantor received the financials for the 1996 fiscal year-end and they didn’t look good. The company had missed both its revenue and earnings targets. But rather than accept the bad news, Cantor decided to get creative.

He had the company book revenue for two “bill and hold” sales and pretend they had taken place in 1996. Bill and hold sales are sketchy to begin with. You’re essentially saying that you made a sale even though you’re still holding the inventory. But under strict circumstances, companies can recognize bill and hold sales.  You’re supposed to separate the inventory and make it clear that title for that inventory has passed to the customer.  American Bank Note Holographics didn’t do this, and one of the sales kicked out and had to be reversed.  But it’s a moot point; the 1996 fiscal year was already over, so there was no way the company should have been recognizing revenue for 1996.  This was clearly fraud.

Cantor had the company book $800,000 of revenue for a customer in Japan. Now the customer had asked the company to develop holograms for a game called Pachinko. While American Bank Note Holographics did do some work on this, the customer had said it would only pay contingent on approval from the Japanese government…which it never received. But Cantor was desperate, so he booked the revenue anyway.

Thanks to the fraud, the company met its profit targets for 1996.

Things were looking good, until the end of 1997. The company once again failed to meet its profit target. Cantor had to be furious with the company’s sales team. ‘You mean I need to commit fraud again? Come on!’ Or, maybe Cantor enjoyed the fraud…because he got really creative.

In December, Cantor set up a legitimate bill and hold order with MasterCard, one of the company’s largest customers. To book the revenue for 1997, he needed to produce the holograms by the end of the year. Problem was, the company didn’t have the production capacity to make all the holograms. So Cantor hired another firm, Crown Roll Leaf, to help make the holograms. But that firm couldn’t finish the holograms in time either.

Cantor didn’t care, and he booked the revenue for 1997 anyway. Then the auditor, Deloitte, started asking questions. To cover his tracks, Cantor had employees backdate and change the receiving documents to make it look like Crown Roll Leaf had delivered the holograms in time. Cantor even convinced Crown Roll Leaf’s security firm to say that their employees had personally witnessed the holograms being picked up on time.

Cantor got away with this, but he knew he couldn’t overuse the bill-and-hold strategy. The auditors were clearly on to him. He had to physically ship some product so he could show the shipping confirmations to the auditors. But how do you ship product when customers don’t want any?

There are lots of ways…

In some cases, Cantor sent customers more product than they needed and told them just to return it.  Then he booked revenue for the entire shipment. He also started shipping out products to customers who hadn’t even submitted an order. On New Year’s Eve, Cantor showed he would truly do anything to make the numbers. He had employees box up unfinished products and ship them to a customer. Then he booked $1.3 million of revenue and celebrated the New Year.

If you’re wondering, “Won’t customers return unfinished products, or products they didn’t order?” The answer is yes, absolutely! But Cantor didn’t care, he just wanted to make the numbers for 1997.  He’d figure out 1998 when he got there. And that’s the trouble with stealing from next year’s sales. You constantly have to keep the fraud going. 

Thus, after American Bank Note Holographics went public, Cantor continued the fraud. He booked $4 million of revenue after shipping one customer pieces of scrap material and empty boxes. Yes, I’m serious; he literally shipped empty boxes to a customer. Cantor shipped test materials to another customer who hadn’t ordered anything at all.

Customers were no doubt getting upset about receiving all this garbage.  Thus, Cantor rented a warehouse and began shipping the products there instead. Customers didn’t know about the warehouse or order the products shipped there, so these were completely bogus sales. But Cantor booked another $5.8 million of revenue this way.

This is a lot of fraud, and the company went several years without being caught. One way Cantor avoided detection was by keeping two sets of books. The accounting records were stored in a computer, which the auditors checked. The actual records were written out by hand in a ledger; like the old days. Thus, auditors never saw the real accounting numbers.

Now if you know about auditing, you might be thinking, “The auditors should have sent confirmations to customers, to see if the amounts owed matched the company’s records.” Well, the auditors did send those confirmations…but Cantor convinced the customers to lie and confirm the false account balances. Thus, this fraud involved a lot of people. But a fraud that is dependent on so many people telling lies is bound to break down eventually.

When the auditors were doing the audit for the 1998 fiscal year, they didn’t just ask customers to confirm their balances. Instead, they asked customers to forward the invoices they’d received from the company. The customers’ invoices were identical in every way to the invoices that the auditors received from American Bank Note Holographics; except for one thing: The sales totals were different.

The auditors reported this to the audit committee, and it triggered an investigation and a phone call to the SEC. Everyone in the C-suite resigned or was fired.

On January 19, 1999, American Bank Note Holographics announced it would be restating its financials. The stock price plummeted, going from $16/share to $1.80/share. Investors lost $190 million.

When the restated financials came out, they showed that revenue had been overstated by 34% in 1997. But profit had been overstated by 167%. Cantor was arrested and charged with securities fraud. He was also charged with violating the Foreign Corrupt Practices Act by bribing a Saudi Arabian official. Apparently he had transferred a $239,000 “consultancy fee” to a Swiss bank account to try and win a contract.

But the government wasn’t satisfied with only convicting Cantor; it wanted to take down the company’s CEO, 59-year old Morris Weissman. So on July 18, 2001 Weissman was indicted. Cantor testified against his former boss, saying Weissman had approved the fraud. The trial lasted 5 weeks, and the jury had no verdict after the first day of deliberations.

But halfway through day 2 the jury returned a verdict: guilty of securities fraud, conspiracy, and lying to auditors. Weissman was going to prison for a long, long time…or was he?

Weissman was supposed to be sentenced in 2003…but it didn’t happen. It wasn’t until a decade later that Weissman was finally sentenced. In 2013, he was sentenced to time served. Since he had been free on bond that whole time, this means Weissman spent a grand total of one day in jail.

He was ordered to pay $64 million of restitution, but I think he got off easy. I tried really hard to find out why it had taken so long to sentence him, and all I could find was some articles about Weissman doing classified work for U.S. intelligence. That reminded me of the movie “Catch me if you can” about Frank Abagnale, who got a reduced sentence for teaching the government how to catch other fraudsters.

But you know what’s really weird? Cantor wasn’t sentenced for more than a decade either.

In May 2014, the court sentenced him to time served. This made slightly more sense though. The government said Cantor had cooperated with them for 15 years and met with them 40 times. His testimony was critical in convicting Weissman because some of the case documents had been lost in the 9/11 attacks. Thus, the government couldn’t have convicted Weissman without Cantor.

Now you might be wondering what happened to the company, American Bank Note Holographics? It got off pretty easy. The firm settled with the SEC and didn’t admit guilt, paying just a $75,000 fine. But the parent corporation declared bankruptcy in December of 1999. American Bank Note Holographics hung around though, and in 2007 it was acquired by JDS Uniphase for $138 million.

So what can we learn from all this? One lesson is that it’s absolutely critical to question transactions occurring at the fiscal year-end. In 1996 and 1997, the company didn’t commit fraud throughout the entire year; it was just a few weeks at the very end when Cantor saw they weren’t going to meet the earnings targets. It’s easy to blame the auditors for not catching this, but it’s hard to detect fraud when there’s collusion of so many people.

Cantor convinced customers and even a third-party security agency to lie to the auditors. My first thought was that the guy must have been exceptionally charming. Then I remembered that he was convicted of bribing a foreign official, so he probably just paid everyone kickbacks to go along with the fraud. In any event, it’s not possible for a single person to do what Cantor did. It truly takes a village to commit this kind of fraud.

But I found it shocking that Weissman and Cantor didn’t receive long prison sentences. Fortunately Sarbanes-Oxley was passed in 2002, and it ensured that executives like Jeff Skilling of Enron received long prison sentences.

By the way, did you know Skilling is out of prison now? He’s trying to start an energy company, and he’s looking for investors. And no, I’m not kidding. Those former McKinsey consultants, they’re the best…