David Brooks had it all.  He’d taken a small company on the verge of bankruptcy and turned it into one of the world’s largest manufacturers of bulletproof vests.  Those vests were used by U.S. soldiers in the War on Terror, so Brooks was hailed as an American hero, and he made a fortune in the process.  There were luxury cars, shopping sprees, vacations on a private jet…Brooks even threw a $10 million party for his daughter, with live performances by Aerosmith and Fifty Cent.

But while Brooks’ daughter was singing a duet with Steven Tyler, the SEC was conducting an investigation.  There were problems with the company’s accounting for inventory, and when the auditors pointed out these issues, Brooks threatened to kill them.  Oh yeah, we’ll get to that.

But inventory was just the tip of the iceberg.  The SEC said Brooks used investors’ money to pay for millions in personal expenses, including prostitutes for employees and pornographic videos for his son.  Yes, for my younger listeners, there was a time where you had to pay to watch porn.  The government brought criminal charges, but Brooks maintained his innocence.  This case was going to trial.

I’d love to tell you a heartwarming story about how David Brooks got into the business of selling bulletproof vests.  Like that he was a soldier wounded in battle, and decided to start making body armor.  But that’s not what happened.

Brooks started out as a stockbroker, and he only got into the body armor industry after he was banned from the securities industry.  Brooks had been working at his brother’s company, Jeffrey Brooks Securities, when one of the company’s brokers was busted for insider trading.  The SEC concluded that Brooks and his brother had failed to establish policies or procedures to prevent insider trading. And so, on December 18, 1992 David Brooks was banned from the securities industry for 5 years.

But Brooks’s career was far from over.  He’d made a lot of money as a stockbroker, and now he was ready to buy a company.  On 10/22/92, Brooks created a holding company called DHB Capital Group.  He later changed the name to DHB Industries, with DHB standing for “David H. Brooks.”

A couple weeks after forming, DHB acquired its first company: Protective Apparel Corporation of America, a company that had been making armored vests in Norris, Tennessee since 1975.  In 1997, DHB acquired a second manufacturer of body armor, a Belgian company it soon renamed Point Blank Body Armor.  DHB now owned two companies that made bulletproof vests, but the company’s financials were far from bulletproof.  Sales were flat, and in 1999 DHB lost $32 million.

Brooks didn’t know it, but the company was about to catch a major break.

The terrorist attacks that occurred on September 11, 2001 prompted President Bush to declare a “War on Terror.”  The U.S. subsequently launched wars in both Afghanistan and Iraq, which led to a massive increase in military spending.  All those soldiers needed body armor, and DHB was eager to provide it.  Brooks negotiated a deal to be the exclusive provider of body armor for soldiers in Iraq.  From 2000 to 2004, DHB’s sales increased by 385%, and its profit increased fivefold.  DHB’s stock price soared, and so did Brooks’s compensation.

Brooks went from making $525,000 in 2001 to $72.6 million in 2004.  That’s one heck of a pay raise.  Now most of Brooks’s compensation came in the form of stock options.  And when Brooks sold millions of shares in late 2004, he reaped $185 million.  What would you do with all that money?  Well, being the selfless guy that he was, Brooks donated it all to charity.

I’m just kidding.  Brooks did what many wealthy people do; he took his family on vacations to southern France and treated them to shopping sprees at Gucci and Versace.  He also bought a $100,000 belt buckle.  Yes, you heard me right, it was $100,000 for a single belt buckle.  But it was just any belt buckle; it was diamond-studded and shaped like the American flag.  And don’t forget, it also helps you hold up your pants.  Oh, and Brooks really liked horses, so he acquired ownership or control over hundreds of race horses.

But Brooks’s most lavish spending was on a party for his 13-year old daughter.  Brooks spent $10 million on her bat mitzvah, which took place in November of 2005.  Brooks wanted to make it a truly special night, so he rented out two floors of the Rainbow Room in New York City and had Jumbotrons and special carpeting brought in.  You might think that’s excessive, but I know someone who brings special carpeting when he goes tent camping.

Now Brooks also hired Aerosmith, Don Henley, 50 Cent, and Nelly to perform live.  Brooks’s daughter sang a duet with Steven Tyler and his nephew got to play the drums.  And get this: everyone who attended the party received a free gift bag with over $1,000 of electronics, including an iPod and a digital camera.  It was one heck of a party, and you can see pictures of it online.  And yes, Brooks was wearing that belt buckle.  Hey, if I paid $100,000 for a belt buckle, I’d wear that thing everywhere but the shower.

Now while Brooks was busy living it up, DHB’s stock price was sinking.  As early as 2002, customers had raised issues about the quality of DHB’s product.  And in May of 2005 the Marine Corps said it was recalling over 5,000 DHB vests.

So why the recall?  Well, a story in the Marine Corps Times showed DHB vests failed to stop 9 mm bullets.  That’s a pretty serious product flaw.  I mean, it’s one thing if the vests were ugly, or they weren’t comfortable to wear…but if they can’t stop a bullet? That seems like it should be a fundamental quality of a bulletproof vest.

Now the Marines weren’t the only ones complaining; the U.S. Army decided to recall DHB vests as well, and the military started using other suppliers.  There were also problems with the vests DHB sold to police officers.  In January of 2005, a Florida police department filed a class-action lawsuit that questioned the effectiveness of DHB’s vests.  DHB settled the case, and it ultimately stopped using Zylon in the vests it sold to police, as there were problems with the material breaking down and the vests failing.  But complaints about product quality continued.

Now you might think that customers complaining about whether the bulletproof vests actually worked would be DHB’s main issue.  But there are a lot more problems here.  As Al Pacino once said, “I’m just getting warmed up.”

DHB was also being investigated by the SEC.  In 2003, a union had filed a complaint because Brooks hadn’t disclosed that one of DHB’s suppliers was actually owned by his wife Terry.  A union also raised questions about $12 million of non-salary payments made to Brooks.  The SEC was thus investigating whether Brooks was using related-party transactions to siphon money from the company.

But that’s not all; there were sketchy things going on with DHB’s inventory accounting.  The controller for Point Blank, one of DHB’s subsidiaries, told his bosses that inventory was overstated by millions of dollars.  The executives refused to act, so the controller submitted his resignation and informed DHB’s auditors.  When the auditors asked Brooks about this, he marched into the controller’s office shouting obscenities. Brooks called the controller a snake, confiscated his inventory analysis, and “violently ejected him from the premises.”

When I read that, it had me wondering what the words “violently eject” meant.  I mean, did Brooks physically throw this guy out of his office?  You might be thinking, “No, that’s crazy” but hold that thought, as you haven’t heard how Brooks dealt with the auditors yet.

DHB went through 4 sets of auditors in a 3-year period, so right off the bat you know there were problems.  Here we go.

On May 29, 2002 DHB dismissed its auditor and hired Grant Thornton.  But Grant Thornton quit after just one year, having found material weaknesses with DHB’s internal controls and a failure to disclose related-party transactions.

So with Grant Thornton out, DHB hired Weiser LLP.  But then Weiser also identified internal control deficiencies.  Things got so heated between Brooks and the auditors, that Brooks actually went ahead and filed DHB’s 10-K against Weiser’s instructions.  I didn’t think Brooks was the type of guy who’d have trouble with premature release.

Okay, that wasn’t a very good joke.

Weiser later resigned, so Brooks hired a fourth set of auditors, Rachlin Cohen & Holtz, to do the audit for the 2005 fiscal year.  But in March of 2006, Rachlin Cohen & Holtz refused to issue an audit opinion.  The reason?  DHB “had no support for many of the figures in the company’s books and records.”  In other words, the financial statements looked like they were simply made up.

When the auditors questioned some of DHB’s journal entries, Brooks lost it.  He told DHB’s CFO he was going to have his friends “pay a visit” to the audit partner, and “if she were not careful, she would be wearing cement blocks on her feet in the Atlantic Ocean.”

That’s right, Brooks just went full gangster.  I think this is a good time to mention that when Brooks graduated from NYU back in 1976, he majored in accounting. And unfortunately his professors never told him that it’s wrong to threaten to kill an auditor.

Now you might be thinking, “Hey, that’s an isolated incident, we all say stupid things sometimes” or “we’ve all threatened to kill an auditor” but consider this:  Brooks told one of the audit partners for Rachlin Cohen & Holtz that someone should “put a bullet” in the brain of the partner who worked on the previous year’s audit.  Brooks also told the auditors for Rachlin Cohen & Holtz that their legal counsel should get “a bullet to the brain.”  I could go on…Brooks called one of the auditors’ attorneys an obscenity and said he wanted to shoot him…but I think you get the point.

Ultimately Rachlin Cohen & Holtz said they had discovered an accounting fraud, so Brooks responded by secretly hiring another auditing firm to see if they would give him a clean opinion.

This insanity couldn’t go on forever.  In April of 2006, DHB told investors they couldn’t rely on the quarterly financial statements from 2005.  The board asked DHB’s CFO, Dawn Schlegel, to resign, and it hired forensic accountants to figure out DHB’s true inventory and profit figures.  It took the forensic accountants an entire year to reconstruct DHB’s financials.

The end result was bad.  DHB had to restate its financials for 2003 and 2004, and its profits were wiped out.  DHB had reported $15 million of net income in 2003, but it actually lost $28 million. Thus, it had overstated its 2003 net income by $43 million (154%).  In 2004, DHB had reported net income of $30 million, but it actually lost $73 million. Thus, it had overstated its 2004 net income by $103 million (141%).

On 7/7/06, the board put Brooks on paid administrative leave “pending the outcome of federal, state and internal investigations.” A week later he resigned as chair and CEO.

But the bombshell came on August 18, 2006: DHB’s former COO, Sandra Hatfield, and former CFO Dawn Schlegel were charged with insider trading and fraud.  They allegedly made $8.2 million selling stock before investors knew DHB’s true financial situation.  Surprisingly, it would be more than a year before the government came for Brooks.

I suspect the delay was because they wanted to build a stronger case against him by getting Hatfield or Schlegel to take a plea deal.  This worked, as they convinced Schlegel to plead guilty and testify against Brooks.  Brooks was arrested by FBI agents on October 25, 2007 and charged with securities fraud, tax evasion, and insider trading

The government’s case against Brooks had 4 main components. Brooks was accused of:

• Overstating inventory and thus overstating DHB’s profits
  
• Using company funds to pay personal expenses
  
• Engaging in related-party transactions to transfer money from DHB to himself
  
• Selling stock based on material, nonpublic information (aka insider trading)
  

Let’s discuss the inventory fraud first.  From 2003 to 2005, the government said DHB overstated its inventory by:

• Overstating the amount of raw materials, as well as labor and overhead costs, by creating bogus, unsubstantiated bills with fake prices
  
• Reclassifying production costs as R&D costs
  
• Falsifying journal entries to account for nonexistent inventory
  
• Failing to write down obsolete inventory
  

Let’s dig into the specifics; we’ll start with the reclassification of costs from cost of goods sold to R&D.  You might be wondering why Brooks would even bother to reclassify these costs, since both cost of goods sold and R&D expense reduce the company’s net income.  But here’s the thing: analysts watched gross profit carefully, and they expected gross margins of 27%.  Thus, from 2003 through 2005 Brooks made sure DHB reported gross margins of at least 27%; but in reality, DHB’s gross margins were never higher than 18% during that time frame.

So how did Brooks inflate the gross margin?  He had Schlegel make journal entries to reclassify production costs as R&D under the pretext that these were “sample” vests that were provided to sales staff and customers.  However, this clearly wasn’t true as it was “tens of thousands” more sample vests than the company actually needed.  We’re talking about a large amount of costs being reclassified here:

• $8.8 million in 2003
  
• $7.1 million in 2004
  
• $10.9 million in 2005
  

But that’s just one part of the fraud.  Brooks also had Schlegel and Hatfield put nonexistent inventory on the books.  They were literally making stuff up.  When Brooks was discussing inventory values with a DHB manager, Brooks said that Hatfield was, “going to have to make up some number in 2005.”

And that’s exactly what happened!  In the first quarter of 2005, Hatfield and Schlegel added 63,000 nonexistent bulletproof vest components to DHB’s inventory records.  But now you’ve got a problem; you’ve got a bunch of fictitious inventory on the books, and sooner or later the auditors are going to ask about it.  Brooks thought he had a clever way for dealing with this.

Remember how DHB stopped using Zylon in its vests due to the quality problems?  Well DHB took a $60 million writedown for that, and Brooks asked Schlegel to include some of the nonexistent inventory in the writedown.  This got $7.1 million of fictitious inventory off the books so the auditors wouldn’t ask questions about it.

But the auditors did ask questions about it.  They requested supporting documentation for the writedown and wanted to know why the vest components were written off.

Brooks must have panicked because what happens next is ridiculous.  First, Brooks told the auditors that DHB wrote off the vest components because the U.S. Army decided it wanted a different color.  He must have thought that was a stupid thing to say because later he changed his story and said the vest components were damaged in a hurricane.

When Brooks told Schlegel the story he gave the auditors, she got upset and asked Brooks why he would make something like that up; the auditors would obviously ask for more details and there was no way to back up the hurricane story.  I mean, you can’t just invent a hurricane!  Except that’s exactly what Brooks did; he hired a team of scientists to create a hurricane.

I’m just kidding.  The only things Brooks was good at creating were expensive parties and accounting fraud.  When the auditors asked for proof of the hurricane story, Brooks changed his story again, this time throwing Hatfield and Schlegel under the bus. Brooks said they made up the numbers and that he just found out himself that the numbers were false.  It was the old, “I’m just as surprised as you are” routine.

But Brooks clearly knew what was going on; Schlegel had told him there was “no support for the numbers DHB was using” but Brooks approved the SEC filings anyway.

As crazy as all this was, remember that the inventory fraud was only part of this scheme.

The government said Brooks “systematically looted company coffers” by using DHB funds to pay for millions in personal expenses

Here’s a partial list of what Brooks had the company pay for:

• $7,900 for his wife’s facelift
  
• $10,000 for his kids’ summer camp
  
• $11,420 for acupuncture treatments for his family
  
• $36,000 for his son’s bar mitzvah
  
• $101,500 to buy an armored vehicle for personal use by Brooks and his family
  
• $122,000 for iPods and digital cameras for attendees of his daughter’s bat mitzvah
  
• $194,000 for a Bentley
  
• Horse-racing expenses
  
• Jewelry
  
• Family vacations (Las Vegas, Aspen, Mexico, St. Barthelemy, St. Maarten, southern France, and other locations)
  
• Textbooks for his daughter
  
• A monthly porn allowance for his son
  
• A “brothel tent” with prostitutes for his employees at a company party in Florida
  

If you’re thinking, “Hey, some of this stuff sounds distasteful but it’s his company” remember that this wasn’t a privately-owned business anymore.  Brooks had taken DHB public, so when DHB paid Brooks’s personal expenses without authorization this was stealing money from DHB’s investors.

But having DHB pay for personal expenses wasn’t the only way Brooks stole money.

Remember the accusations about related-party transactions?  Brooks had set up a company called Tactical Armor Products, or TAP for short, and had DHB buy things from it.

For example, TAP assembled the armor plates for DHB’s vests and performed sewing services that were “identical to the services DHB performed in-house.”  So why would Brooks have DHB pay TAP for services that DHB could do itself?  Because Brooks could have TAP mark up the price and pocket the difference.  Brooks had TAP inflate its labor costs; it was charging double the reasonable amount.  These excess costs allowed Brooks to funnel $10 million out of DHB.  Brooks hid DHB’s relationship with TAP until 2003, when auditors learned about it and forced Brooks to disclose it.

But even then, Brooks still didn’t admit that he personally controlled TAP.  He said that his wife was the CEO of TAP and that it was her company.  But in reality, Brooks controlled TAP.  He controlled the prices that TAP charged DHB.  He made decisions regarding TAP’s personnel and capital expenditures.  He authorized, reviewed, and signed the checks and had Schlegel sign his wife’s name.  DHB was TAP’s only customer, so TAP only existed as a means for Brooks to loot DHB.

This has been a lot to take in, so relax and take a deep breath.

Now what’s the worst thing you could possibly do if you’re about to be accused of accounting fraud?  Sell your stock.

Brooks sold the majority of his DHB stock (9.5 million shares) when it reached an all-time high in late 2004.  The government said this was a clear case of insider trading because Brooks had material, nonpublic information: he knew there was a fraud going on at DHB and that the stock price would plummet if word got out.  And that’s exactly what happened; DHB’s stock price was around $20 when Brooks sold his shares, but it would fall to $5 by early 2006 when the bad news started leaking out.  Brooks received $185,893,750.

So I’ve laid out the government’s case, but Brooks was entitled to his day in court.  And you know with a guy like Brooks this trial isn’t going to be boring.  Brooks put up a $400 million bond so he wouldn’t have to sit in jail during the trial, but he screwed that up before the trial even began.

Prosecutors said Brooks was hiding money in offshore accounts and transferring assets to family members. Scotland Yard saw one of Brooks’s family members walk out of a London bank with a duffle bag stuffed with millions in cash.  The judge responded by revoking Brooks’s bail and putting him behind bars.

But after the trial started, Brooks got in trouble again.  The judge hit him with contempt of court after he tried to smuggle anti-anxiety pills into jail not once but twice.  A friend had placed the pills near Brooks’s seat in the courtroom, but prison officials found the pills during a body cavity search.

Now let’s get to Brooks’s legal defense.

Brooks’s lawyers said he was a patriot whose bulletproof vests saved American lives.  They didn’t deny that DHB had paid Brooks’s personal expenses, but claimed those payments had been approved by DHB’s board.  Brooks’s lawyers pointed to a corporate resolution that had supposedly been filed in 1997.  The resolution said Brooks had the right to be reimbursed for any personal expenses up to 10% of DHB’s annual net income.

But the government said the corporate resolution was a fraud.  DHB’s two-person compensation committee supposedly approved it, but the member who signed the document was Brooks’s personal friend.  The other member of the compensation committee said they never even heard of the document, and Dawn Schlegel said she didn’t hear of it until Brooks received a subpoena about the company paying his personal expenses in 2004.  According to Schlegel, the resolution, “magically appeared among a box of board materials she had previously compiled.”  None of DHB’s auditors had ever heard of the document and it hadn’t appeared in any of DHB’s public filings.

Brooks’s lawyers made other attempts to defend his behavior, like claiming that some of the personal expenses were actually business expenses.  For example, they said that paying prostitutes could be a legitimate business expense if Brooks “thought such services could motivate his employees and make them more productive.”

I think this is a pretty weak argument. Even if you believe prostitutes made DHB’s employees more productive, what about the monthly porn allowance for Brooks’s son?  That clearly was a personal expense.

In all fairness, I don’t think Brooks’s legal team had much to work with.  I think even Brooks knew he was done; a veterinarian that cared for Brooks’s racehorses testified that Brooks repeatedly asked him about getting a memory-erasing pill to erase the memory of Schlegel, DHB’s former CFO.

Man, you know your company’s accounting is sketchy when you’re asking a horse doctor to wipe out the memory of your CFO.

Unfortunately for Brooks, Schlegel’s memory was working fine and she testified against him for 23 days.  In total, jurors listened to 7 months of testimony from more than 70 witnesses.  On September 14, 2010 a jury convicted Brooks of securities fraud and insider trading.  Brooks was sentenced to 17 years in prison.  And worst of all, they wouldn’t let him take the $100,000 belt buckle to prison.

Hatfield, DHB’s former COO, was also convicted; she was sentenced to 7 years in prison and ordered to pay $1.8 million.  Schlegel was sentenced to time served and ordered to pay restitution of $92 million.

DHB Industries changed its name to Point Blank Solutions on October 2, 2007 and it moved from Long Island to Florida. But the change of scenery didn’t help, as sales fell by nearly 50% from 2007 to 2008 and the company lost over $5 million.  The company filed for bankruptcy in 2010.

Now the salacious details of this case make it stand out among corporate frauds.  There’ve been plenty of accounting scandals over the years, but the CEOs usually don’t threaten to kill the auditors or erase people’s memories.

How did Brooks get away with such egregious behavior for years?

Two reasons:

1. No internal controls
   
2. Weak corporate governance
   

Let’s start with the internal controls.

The SEC described DHB’s accounting department as “woefully understaffed.”  I guess you don’t need that many accountants if you’re just making numbers up out of thin air, but in theory you should have a fully-staffed and well-trained accounting team.  Worse yet, Brooks micromanaged the accounting practices at DHB, and he threatened, demoted, or fired anyone who questioned the company’s finances.

As a result, DHB had weak internal controls for inventory, maintained “minimal inventory records”, and didn’t do accurate inventory counts.  Now the board of directors should have been a check against Brooks’s power, since the board’s job is to safeguard the interests of investors.  But Brooks packed the board with his friends and neighbors, and he served as chair.  This allowed Brooks to exercise complete control.

According to the government, Brooks “regularly interrupted board meetings, rushed votes without discussion and acted in a threatening manner whenever questioned.”  At one board meeting, Brooks told a board member: “you know what we do to outsiders…you know what we do to people that aren’t on the team.”

Brooks surrounded himself with sycophants and ruled through fear and intimidation.  People who were loyal to Brooks got lavish perks and bonuses, while people who dared to defy him got steamrolled.  The board was so ineffective that on Februrary 28, 2011 the SEC actually charged three board members (Jerome Krantz, Cary Chasin, and Gary Nadelman) with “facilitating the company’s fraud.”

The government said they had no business being board members because they couldn’t be impartial; Chasin’s family had dinner with Brooks’s family two to three times a month, while Krantz used to be Brooks’s insurance agent.  The SEC said they knew Brooks was paying for personal expenses like prostitutes; they had discussed it at board meetings but left it out of the meeting minutes.  And all three of these board members were on the audit committee, so they heard frequently from DHB’s auditors. The auditors told them 3 times in less than 2 years that DHB had weak internal controls for inventory, but they didn’t do anything.

The board members ended up settling with the SEC, agreeing to pay $1.6 million and be permanently banned from serving as officers or directors of a public company.  By packing the board with friends who were loyal to him, Brooks was able to run DHB as his personal fiefdom.  He got to steal money from the company, while his friends got stock options and skybox tickets at Madison Square Garden.

It’s crazy to think that Brooks went from throwing million-dollar parties and taking vacations around the world to living in a jail cell.  I’d like to say something positive about him, so I’ll say this: he cared a lot about his kids.  I mean what dad gives his son a monthly porn allowance?

In 2016, Brooks died in prison at the age of 61.  Had he lived to hear this podcast, he might have threatened to shoot me.  And if I’d been wearing one of his bulletproof vests it wouldn’t have helped, due to the issues with product quality.