The Crazy Eddie Fraud

Compared to today’s frauds in the billions of dollars, Crazy Eddie’s fraud was smaller in size. However, the Crazy Eddie fraud was much more outrageous than most frauds committed because of its time span (18 years), its use of a combination of multiple methods, and the sheer audacity of its perpetrators. As I will detail below, were three main phases to the Crazy Eddie fraud spanning from 1969 to 1987.

(1) 1969-1979: Skimming and under reporting of income (tax fraud) prior to planning to go public

(2) 1980-1984: Gradual reduction of skimming to increase profit growth in preparation for initial public offering, known as committing securities fraud by going legit

(3) 1984-1987: As a public company, overstatement of income to help insiders sell stock at inflated prices by the following means:

• Money laundering to increase revenues and reported profits, known as the "Panama Pump"
• Fraudulent asset valuations to increase reported profits (inflating inventories)
• Timing differences to increase reported profits (accounts payable cut-off fraud)
• Concealed liabilities and expenses to increase reported profits (debit memo fraud)
• Improper financial statement disclosures to cover up crimes (changing disclosures to cover up fraud)

Phase 1: From 1969 to 1979, our primary fraud was income tax evasion and stealing sales tax through skimming cash sales from customers.

In 1971, at the age of fourteen, I began my employment at Crazy Eddie as a stock boy. From the very beginning of my employment at Crazy Eddie, I was involved in cash skimming and overstating insurance loss claims.

From 1975 to 1980, I attended Bernard M. Baruch College and majored in public accounting. Eddie Antar and other family members believed that my formal college education in public accounting would help them execute more sophisticated financial crimes in the future. Therefore, the Antar family paid my tuition and paid me a full time salary while attending college. I continued working at Crazy Eddie at nights, weekends, holiday breaks, and summer vacation.

In 1980, I graduated Bernard M. Baruch College Magna Cum Laude and was on the Dean’s List.

The Antar’s were ready to take full advantage of my accounting education as the de facto Chief Financial Officer of the company to execute even more sophisticated crimes on behalf of the family.

Phase 2: Around 1980, we planned to make Crazy Eddie into a public company so the Antar’s could sell their stock at inflated values to unsuspecting victims.

Gross up "on the books" payroll to compensate employees previously paid "off the books"

To prepare for the future as a potential public company, we needed to “legitimize” the business. All employees who were paid fully “off the books” or partially "off the books" in cash had to be paid “on the books.” We grossed up those employee’s "on the books" compensation to help them avoid a drop in net payroll income.

Both external audit firms (Penn and Horowitz 1980-83 and Main Hurdman in 1984) noticed that many employees, who were previously paid what seemed to be extremely low wages (considering their positions and responsibilities at Crazy Eddie), had received raises in multiples of ten to twenty times their previously reported salaries.

For example, a district manager who was paid $5,200 per year "on the books" and $50,000 per year "off the books" was now paid "on the books" over $75,000 per year on the books, instead of receiving any "off the books" compensation. Therefore, according to Crazy Eddie's books and records such a person's annual salary suddenly went from $5,200 per year to $75,000 per year.

The auditors did not know that Crazy Eddie management was "grossing up" the employee's total compensation to make up for the loss of "off the books" compensation and higher payroll and income taxes. The auditors accepted our silly explanation that such employees had sacrificed many years working at below average wages for the opportunity to be part of what they hoped might become a growing public company.

Around 1980, I helped devise a plan to gradually reduce our skimming to artificially increase the growth of Crazy Eddie's reported profits to create the appearance that it was a thriving growing company. In effect, we planned a "securities fraud by going legit."

That same year, I passed the CPA examination with a 90% and scored in the top 1% in the country.

From 1980 to 1983, while working “off the books” as the de facto CFO of Crazy Eddie, I also worked Penn & Horowitz, the accounting firm that audited Crazy Eddie’s books and records.

I worked at Penn & Horowitz for two purposes:

(1) To fulfill my auditing experience requirement necessary to obtain my CPA license
(2) To learn how to take advantage of auditors, especially if Crazy Eddie became a public company as planned.

In 1984, I left Penn & Horowitz and officially began working for Crazy Eddie again, "on the books." Around the same time, Crazy Eddie replaced Penn & Horowitz with a Main Hurdman, a major accounting firm. (Note: In 1986, Main Hurdman merged with Peat Marwick Mitchell to become Peat Marwick Main. In 1987, that accounting firm became known as KPMG, after another merger). In 1985, I finally obtained my CPA license.

From 1980 to 1984, Crazy Eddie gradually reduced its skimming from approximately $3 million per year in starting in fiscal year 1979 to near zero in fiscal year 1984. As a result of the gradual reduction in skimming, Crazy Eddie’s reported pro forma annual profits grew from $1.709 million in fiscal year 1980 to $7.975 million in fiscal year 1984. If we factor in new store openings during the same period, Crazy Eddie’s pro forma profit per store grew from $219,975.14 per unit in fiscal year 1980 to $617,737.92 per unit in fiscal year 1984.

Without the gradual reduction in skimming, Crazy Eddie’s pro forma profits only grew from $4.709 million in fiscal year 1980 to $7.975 million in fiscal year 1984. Most importantly, Crazy Eddie’s pro form profit per store only grew from $606,122.25 per unit in fiscal year 1980 to $617,737.92 in fiscal year 1984. Therefore, Crazy Eddie's real per unit profitability was hardly growing at all, except in the minds of unsuspecting investors who were unaware that we gradually reduced our skimming to skew our growth. (See table 1 below).

Phase 3: On September 13, 1984, Crazy Eddie had its initial public offering. As a public company our primary fraud shifted from under-reporting income (as a private company to avoid paying taxes) to over-reporting income to help Antar family members to sell millions of dollars of stock at inflated prices to unsuspecting investors.

In fiscal year’s 1984 to 1987, we inflated inventories and under-reported accounts payable to increase reported profits. In addition, we artificially increased our reported sales volume and profits by laundering previous skimmed funds back into Crazy Eddie in a scheme known as the “Panama Pump.” (See table 2 below).

During that same period, Antar family members sold almost $90 million of common stock to unsuspecting investors at inflated prices due to our over-reporting of income in financial reports files with the SEC.

The auditors simply did not observe the inventory counts in all of the Crazy Eddie stores at fiscal year end. In fiscal year 1986 and 1987, the auditors observed the inventory counts in roughly 50% of the stores. We inflated inventory counts in all stores (including both store counts observed by auditors and store counts not observed by the auditors at year end).

Regarding store inventories that the auditors observed, they failed to take copies of the entire store inventory counts with them after leaving the store premises. The auditors only took their "test counts" with them and not copies of the entire store inventory. We monitored their test counts. Therefore, we knew which inventory counts to falsify.

We were nice to our friends and nicer to our enemies. When boxes were stacked really high and deep, we were very courteous to those young kids just out of college who felt that it was beneath their dignity to do physical work. We climbed and counted the inventory for our lazy auditors. The process continued through the night.

We gained our auditors trust by buying them coffee during their breaks or we performed small errands for them. For example. we volunteered to make copies of their audit test counts. The unsuspecting auditors were very happy to have us make copies for them. Afterwards, we inflated inventories in even greater amounts, since we knew what items to inflate and what items to avoid.

By 1987, the warehouse inventory was automated and it was no longer possible inflate those inventories. Therefore, we needed to be more aggressive in inflating the store inventories in greater proportions than in previous years.

We gained access to all of the auditors work papers. The audit work papers were left behind in locked boxes on Crazy Eddie premises during the audits. We knew that the audit manager had left the keys in a small 2" paper clip box and hid it in an unsecured desk. As a result, it was relatively easy for us to falsify store inventories and larger amounts compared to prior years.

Fiscal year 1986: The "Panama Pump"

By fiscal year 1986, the effect on our growth in sales and profits from reducing our prior skimming had run its course and was no longer beneficial. Antar family members wanted to sell even more stock to unsuspecting investors and of course make millions, more.

In the first month (December 2005) of the last quarter of fiscal year 1986, same store sales increased 20% over the previous December. However, in January and February 1986, same store sales only increased 4% over the previous fiscal year period. The analysts, who followed Crazy Eddie, expected at least a 10% increase in same store sales during the January - February 1986 period over the previous year's period.

Eddie Antar and his father Sam M. Antar wanted to sell over $30 million in stock by the first week of March 1986 at the highest possible price. Therefore, to meet analysts' sales expectations, we conceived of a plan known as the "Panama Pump."

Eddie Antar and other family members advanced $1,500,000 to Crazy Eddie from their secret bank accounts in Israel which contained funds skimmed while Crazy Eddie was a private company. Those funds were first wired from Bank Leumi Israel to Bank Leumi Panama (both countries were bank secrecy jurisdictions). 

After the funds were transferred to Panama, another family member withdrew those funds from Bank Leumi in the form of drafts or non-negotiable instruments, to avoid violating disclosure laws on the movement of funds into the country.

The bank drafts were issued in amounts ranging from $25,000 to $100,000 in order to make it easier to deposit such drafts in each comparable store bank account and conceal the phony sales.

On Sunday, March 2, 1986, Crazy Eddie’s fiscal year ended. However, I received those bank drafts a day later. Those bank drafts were deposited into each comparable store's bank account after the last day of the fiscal year, which was on Monday March 3, 1986 and no invoices were generated to backup those deposits.

Since Crazy Eddie’s weekend checks from sales to customers were deposited on Monday anyway, there was no problem including such bank drafts with the weekend sales proceeds. The bank drafts were dated before the fiscal year ended.

Also, another $500,000 in currency from Antar family mattresses that did not make its way to Israel was deposited in the same store sales.

Finally, a sale of $200,000 to another retailer called “trans-shipping” was counted as a retail sale and included in same store sales.

The sum total of $1.5 million in bank drafts, $500k in currency, and $200k from counting a trans-shipping sale as a same store sale, artificially increased same store sales in total by $2,200,000 for fiscal year 1986 and reported profits by $2 million.

In Q4 1986, Crazy Eddie reported a 14% same store sales increase, instead of a 9% same store sales increase, due to the "Panama Pump" and other schemes described above. Likewise, Crazy Eddie reported a 10% same store sales increase for January and February 1986, instead of the 4% same store sales increase due to the “Panama Pump.” As a result of the “Panama Pump” fraud, Crazy Eddie’s reported same store sales for January February 1986, met analysts’ expectations for that period.

Why the auditors failed to find the “Panama Pump”

The auditors failed to test internal controls for sales and conduct a sales cutoff test at year end. If the auditors had conducted such a sales cut-off test, they could have noticed unusually large deposits in transit on the bank reconciliations since the drafts did not clear the bank before fiscal year end.

These large deposits in transit of $25,000 to $100,000 from bank drafts were listed next to normal deposits in transit from legitimate sales ranging from $10 to $1,000 on the bank reconciliations. The auditors did not trace any monies from deposits in transit to actual sales invoice. In addition, the auditors failed to notice that same store sales increased 75 -100% for no apparent reason in the last week of the fiscal year.

Eddie Antar and Sam M. Antar sell $30 million of common stock based on hyped same store sales

On March 7, 1986 Eddie and his father sold over $30 million dollars of stock at inflated prices and I was a hero. The press release issued by Crazy Eddie reported a same store sales increase of 14% for Q4 1986 and everybody was happy with the news.

However, the same store sales report did not include any information about Crazy Eddie’s reported profits. The audited financial statements for fiscal year 1986 were yet to be issued and Eddie Antar and his father wanted no earnings surprises in fiscal year 1986 after they cashed out $30 million in stock to unsuspecting investors at inflated prices.

Fiscal year 1986: inventory inflation

We already artificially inflated our earnings by $2,000,000 from fictitious sales resulting from laundering previously skimmed funds back into Crazy Eddie ($1.5 million from bank drafts and $500k in currency). The $200k trans-shipping sale did not increase profits, since the merchandise was sold at cost to the non-end user.

I helped Eddie Antar and other family member plan and execute overstatement inventories and understatement of accounts payable that taken together with the fictitious sales fraud initial overstated net income by approximately $15 - $18 million.

Inflation of store inventories was particularly easy since the auditors did not supervise the counting of more that 40% of the store units or store inventory values.

In addition, it was quite easy in a company where the family controlled everything to receive merchandise weeks before the auditors arrived without any records or audit trail on Crazy Eddie books and then receive post dated invoices weeks after the auditors concluded their audit.

In the warehouse, our conspirators were very accommodating to audit personnel in helping them count merchandise by volunteering to climb over huge stacks of boxes and count all of the units. In addition, they helped the audit manager make copies of his test count work papers. That same trick was also done in stores in which the auditors supervised the inventory counts. In effect, we committed fraud by accommodation.

Fiscal year 1986: Inclusion of consignment merchandise in  year-end inventory or accounts payable cut-off fraud

A certain vendor from whom we purchased over 10% of our merchandise and whose volume with us was over 35% of their business shipped us merchandise prior to year end. After our external auditors completed their audit, that vendor invoiced Crazy Eddie as if the merchandise was shipped after year end. That scheme resulted in Crazy Eddie's inventories being overstated by another $3 to $4 million in 1986 or accounts payable being understated by a likewise amount.

Why the auditors failed to uncover accounts payable cut-off fraud

The auditors failed to adequately examine internal control procedures for receiving merchandise and paying bills.

Too much earnings inflation in fiscal year 1986

We were so successful in overstating inventory and understating accounts payable that our auditors believed that Crazy Eddie had substantially understated its profits during fiscal year 1986. Crazy Eddie’s gross margins for the year had been computed at close to 40% when historically it never exceeded 25%. Our gross margins for the last quarter exceeded 60%.

Eddie and I had discussions with the auditors regarding this so called dilemma. The issue of accounting fraud never came up.

The auditors felt we were the kind of client they could work with. The partner said, “Nobody got sued for under reporting earnings.” To solve the problem, he set up artificial cushions that he would call “rainy day funds” or “accountants liability insurance.” Therefore, he arbitrarily set up non-GAAP allowances of $8 million to offset his perceived $16 million understatement of earnings, not knowing the con job that Eddie and I pulled over him.

We rewarded Main Hurdman very dearly after the 1986 audit. We awarded them various contracts for computer system implementation, employee benefit compliance, and other work totaling in excess of $1 million per year. However, the annual audit fee was only approximately $150,000. There is a saying, “Keep your friends close and keep your enemies closer.”

Fiscal year 1987: channel switching

Eddie Antar and Sam M. Antar wanted to continue inflating same store or comparable store sales in fiscal year 1987 to prevent any revenue surprises after selling about $30 million in common stock at inflated prices, as detailed above. To continue the same store sales inflation, we devised a scheme to sell (trans-ship) merchandise to non-retail customers who were not end users, such as other retailers and wholesalers, and count such sales as if they originated from those comparable stores. That scheme is known as "channel switching."

Those trans-shipping sales originated from the main office. However, such sales were counted as if they originated from comparable stores as retail end user sales.

The trans-shipper issued a series of checks in small denominations for their purchase of merchandise from Crazy Eddie instead of issuing one large check per order. The small checks (usually in denominations of $10,000 - $20,000) were deposited into the bank accounts of the comparable store sales and treated as a regular “off the street” customer retail channel sale.

In Q1 1987 (March to May), Crazy Eddie reported a same store sales increase of 10% instead of 8% due to $680,000 of trans-shipping sales improperly included in same store sales. In Q2 1987 (June to August), Crazy Eddie reported a sale store sales increase of 15% instead of 5% due to $4.5 million of trans-shipping sales improperly included in same store sales. In Q3 1987 (September to November), Crazy Eddie reported a sale store sales increase of 5% instead of negative 10% due to $7.9 million of trans-shipping sales improperly included in same store sales.

Why the auditors missed the "channel switching scheme"

The auditors failed to test internal controls for sales, failed to examine deposits in transit, failed to examine actual invoices underlying deposits, and failed to make sales cutoff tests for interim periods. Payments from such sales must be examined and merchandised should be traced.

Fiscal year 1987: inventory inflation

From the early 1970’s to 1986, Crazy Eddie was a profitable company. Prior to Crazy Eddie’s initial public offering in 1984, we understated profits to commit income tax evasion and steal sales taxes. From 1984 to 1986, we inflated Crazy Eddie’s reported profits to help Antar family members sell stock at inflated prices. However, in 1987, Crazy Eddie started losing money and our efforts were focused on reducing reported losses. We made desperate attempts to cover past frauds and continue the current fraud.

In the previous fiscal year, we had falsified our store level inventories by $3 to $4 million. However, in fiscal year 1987, Crazy Eddie's store level inventories were estimated to have been falsified by $15 to $20 million.

In stores that existed in both 1986 and 1987, where the auditors observed inventory counts, those gross inventory levels increased from $21.950 million to $37.470 million or about 71%. Meanwhile, in stores that existed in both 1986 and 1987, where the auditors did not observe the inventory counts, gross inventories grew from $7.972 million to $23.530 million or about 195%. Therefore, inventory growth in stores where the auditors failed to supervise the year-end physical inventory counts were more than double in comparison to stores where the auditors did supervise the counting of year-end inventory. (See table 3 below).

Why the auditors failed to find the 1987 inventory inflation

The auditor's left their work papers at Crazy Eddie’s premises overnight until the audit was completed in supposedly secured locked metal trunks. However, the audit manager dutifully left the key to these locked metal trunks in a small 2 inch paper clip box on Crazy Eddie premises.

Therefore, we were able to falsify inventories that the auditors observed at year end in an effort to make the growth in inventory levels in such stores similar to the inventory levels in stores where they were not present to witness the inventory counts.

However, due to our desperate attempt to reduce reported losses, the growth in inventories in unobserved stores almost doubled the growth in inventories of stores observed by the auditors. The auditors never questioned this red flag.

Fiscal year 1987: Debit Memo Fraud

In fiscal year 1987, we could not rely mainly on inflating inventory levels to reduce our reported losses. Instead, we artificially reduced amounts owed to vendors or accounts payable to reduce our cost of goods sold, increase gross profits, and reduce losses.

We conceived of a plan to use phony debit memos or charge backs to reduce our losses. However, up to fiscal year 1986, Crazy Eddies' accounting policy for “purchase discounts and trade allowances” as disclosed in the company’s footnotes to the financial statements were:

"Purchase discounts and trade allowances are recognized when received."

Crazy Eddie did not reduce its accounts payable (thereby increase its profits) until a credit memo was received from a vendor.

Crazy Eddie's accounting principles for trade discounts and allowances was conservative since "earned" discounts and allowances were not recognized as income until the credit memo was received from a vendor. 

Therefore, we were unable to use phony debit memos to reduce our accounts payable, since the vendors could not recognize them as legitimate deductions. Unless a vendor recognized a debit memo or charge back to them as legitimate in the form of a vendor’s credit memo, and such charge backs could not be reflected in our reported income.

To enable the use of phony debit memos in fiscal year 1987, Crazy Eddie's accounting policy for purchase discounts and trade allowances was changed and disclosed in the footnotes to the financial statements as follows:

"Purchase discounts and trade allowances are recognized when earned."

As soon as purchase discounts and allowances were earned, regardless of whether or not Crazy Eddie received the credit memo from the vendor, they were recognized and accrued as deductions from accounts payable. Therefore, we could generate phony debit memos and use them to reduce our accounts payable and reported losses, since we did not have to wait for a vendor’s corresponding debit memo.

The change in accounting policy for purchase discounts and allowances gave us the opportunity to generate $20 million in phony debit memos and $8 million in legitimate debit memos to offset almost $78 million in accounts payable.

Why the auditors missed the phony debit memo scam

In previous years, we generated an accounts payable aging schedule for our auditors. For fiscal year 1987, no accounts payable aging analysis was generated for our auditors. Since the accounts payable aging schedule was not generated in 1987, the auditors were unable to determine the true volume of collectable debit memos.

In some cases, Crazy Eddie had negative accounts payable balances for certain vendors. In other cases, there were large amounts of debit memos offsetting gross accounts payable balances. However, the auditors conducted no analytical tests to the determine the collectability of debit memos.

The auditors believed our false rationale that the reason that accounts payable was lower in relation to inventory compared to previous years was due to Crazy Eddie using short term commercial paper to pay its vendors more promptly.

However, the real reason for the relative percentage reduction in accounts payable in relation to inventory was due to the large volume of non-reconciled bogus debit memos. The true accounts payable excluding those bogus debit memos was about $71 million.

Furthermore, the auditors reconciled the accounts payable of only three major vendors. Each vendor had significant amounts of reconciling items, resulting from the bogus debit memos. For a certain vendor, that had claimed that Crazy Eddie owed them $17 million, we said they were owed them $7 million. A significant factor in the gap between the differing amounts claimed by the vendor and Crazy Eddie was the bogus debit memos.

The auditors never contacted any of the companies they reconciled concerning any discrepancies. The audit staff member responsible for the accounts payable audit had no retail accounts payable audit experience and only six months experience in other audit areas. He first learned about debit memos during the Crazy Eddie audit.

The audit partner approved the so-called audited financial statements for a press release at a board meeting before the accounts payable audit was completed.

The inexperienced audit staff member began his test work on Sony (which contained over $4 million of the $20 million in phony debit memos) on April 28, 1987, the same day our auditors signed off on the audit according to his testimony in a deposition.

In his sworn testimony, he said that his work continued for more than one day. The audit opinion was signed as of April 28, 1987. The partner had approved the release of Crazy Eddie's financial reports to the Board of Directors on the previous day.

An excerpt from the work papers said, "...PMM traced all debit memos into A/P status report as of 03/01/87. No further work necessary."

An A/P Status report simply lists all invoices and debit memos. Therefore, the debit memos were traced to a report listing the phony debit memos and no further work was necessary - garbage in, garbage out.

No efforts were made to contact Sony about the discrepancies in its confirmation of accounts payable. The senior staff member did conduct an interview of Crazy Eddie's Accounts Payable Manager (a co-conspirator) after the staff auditor finished his testing and after the partner signed off on the audit. His work paper is dated May 22, 1987.

There was a similar lack of follow through with other confirming vendors regarding any discrepancies. In addition, the change in the accounting policy relating to the cash discounts and trade allowances required additional computations under Accounting Principal Bulletin 20. No such computations were contemplated or done by the auditors.

Fiscal year 1987: Inclusion of consignment merchandise in  year end inventory or accounts payable cut-off fraud

In fiscal year 1987, we continued to use a certain vendor to shipped Crazy Eddie merchandise prior to year end and after the audit was completed, invoice the company as if the merchandise was shipped after year end. That scheme resulted in Crazy Eddie's inventories being overstated by another $5 to $7 million in 1987 or accounts payable being understated by a likewise amount.

See the tables below for a summary of Crazy Eddie's frauds and their impact on reported financial results or go to Part 4 - The Fall of Crazy Eddie.

Table 1: The effect of the gradual reduction on skimming had a substantial effect on pro forma earnings growth and store unit productivity:

Note: Average number of stores opened during period takes into account new store openings and store closings during the year and the average number of days the stores were operating.

Table 2: Crazy Eddie earnings inflation fraud

Table 3: Analysis of reported store inventories (stores included in included in comparable sales) for fiscal year 1987

See Part 4- The Fall of Crazy Eddie

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