On the morning of December 16, 1938, as two federal marshals drove up to a mansion in Fairfield, Connecticut, to arrest the president of McKesson & Robbins, Philip Musica locked himself in a bathroom and shot himself; they found him in the bathtub. He had run the company for twelve years under an invented name, F. Donald Coster, after two earlier convictions: in 1909 for bribing New York dock officials to under-weigh his family's shipments of imported cheese and spices, and in 1913 for passing floor sweepings off as human hair to defraud banks of $600,000 in loans.
Musica's auditors for Girard & Co., the cosmetics company he founded in 1923, were Price, Waterhouse & Co., then the country's most respected accounting firm; he noticed they never counted inventory or wrote to a customer. Two years later he traded on their name to buy control of McKesson & Robbins, a century-old drug wholesaler, and kept the auditors. Inside it, he built a division that bought crude drugs, on paper, from five Canadian suppliers, sold them abroad through an agency, W. W. Smith & Co., and banked the proceeds at Manning & Company, all three later revealed as dummy organizations run in collusion with company insiders, Musica's brothers among them.
Until 1934 the auditors worked from inventory sheets signed by the company's employees; after that, with the crude drugs nominally moved to the Canadian suppliers' storage, they switched to confirmations arriving by mail. They checked the arithmetic, compared prices to trade journals, and discussed confirming the receivable ledger with customers, a step called circularization. Coster asked that it not be done, and the auditors agreed: the foreign accounts, they testified, looked to be in excellent condition and were guaranteed up to $900,000 by W. W. Smith & Co. By the close of 1937, the books carried inventories of $44,254,735.70 and receivables of $25,791,604.19 — roughly $10 million and $9 million of it fictitious.
The fraud came apart the way most do: somebody asked a question the paperwork could not survive. In 1937, with debts rising, Coster tried to get the treasurer, Julian Thompson, to take out a loan rather than raise cash himself by liquidating the crude-drug inventory. Attesting to the financial statements that loan required, Thompson found that the crude drugs supposedly sitting in Canadian warehouses were not insured at all. A board investigation followed, and found the warehouses themselves did not exist.
The Securities and Exchange Commission's hearings ran past three thousand pages of testimony. Within months, the profession's new Committee on Auditing Procedure made physical inventory observation and receivables confirmation mandatory; neither had been required in 1937. The Commission's own final report, in December 1940, found that Price, Waterhouse & Co. had not shown the care the evidence called for, and that confirming the accounts independently would likely have caught the fraud sooner. A year before the scandal broke, in his farewell address as the Institute's outgoing president, Robert Montgomery told the profession the opposite was true: it needed no such change.
Nobody had yet shown accountants what standing still could cost. A confirmation that arrives by mail is only as honest as the hand that wrote it, and for as long as those confirmations kept arriving, nobody had thought to ask whose hand had written them.