The Zzzz Best Case: Ask Some Red Flags

By fabricating over 20,000 documents Barry Minkow, Mark Morze, and a few other insiders were able to fool investors, auditors, banks, and whoever else that was interested in the success of a small carpet cleaning company that made it big. Like all frauds they eventually get blown wide open. In this case it was a young female journalist writing a filler piece on Barry Minkow’s success. When tying the story up she decided to make a call to the city just to verify their contractor’s license number, which never existed. The ZZZZ Best case is relevant for getting into the field of auditing and forensic accounting work because, it is important to conduct due diligence and keep professional skepticism no matter how inept a client may come off. Ask
the tough questions and do not answer the question for the client. At the time it was considered to be one of the largest frauds ever committed on the West Coast. The red flags existed and people involved showed signs laid out in the fraud triangle. In the following research the history of the ZZZZ Best carpet cleaning will be examined. Along with how the fraudulent activity was finally uncovered and what happened to those individuals prosecuted. How can auditors and regulating bodies in the accounting realm constantly be improving to help prevent the next Barry Minkow and large frauds like ZZZZ Best. Just a decade later other major frauds have occurred that has caused for the launch of Sarbanes Oxley. Barry Minkow and ZZZZ Best carpet cleaning did not start out as a dishonest fraudulent company, but how did it go from a small carpet cleaning company to deceiving thousands of people.
This history of ZZZZ Best Carpet Cleaning started in Reseda, California by a Sixteen year old Barry Minkow. Barry Minkow realized that carpet cleaning was a difficult way to earn a livelihood. He learned all the basics at the age of twelve by his mother. Barry learned that in the carpet industry there are essentially no barriers to entry, no licensing requirements, minimal startup capital, and that very little previous experience was required to be successful. Not long after starting ZZZZ Best Barry Minkow struggled with lack of capital, bad checks, and vendors demanding payment. Barry was very young and ZZZZ Best not proving to be very profitable, banks refused to finance his business. He at a young age began feeling “Pressure” one of the parts of the Fraud Triangle. He also saw the “Opportunity” to exploit the system easily. He began check kiting, credit card forgery, and staging thefts to fund his insurance company. The insurance company was fake and set up with a close friend by the name Tom Padgett.
ZZZZ Best decided to take the next big step any company could take, that is to go public. ZZZZ Best was pressured by the companies investment broker to obtain a big eight accounting firm to give credibility to the financial statements for the public offering. The original local auditor George Greenspan had given all the audits prior to the switching to a national audit firm. They decided to bring in Ernst and Whinney for the audit of the fiscal year ending April 30th, 1987. Barry Minkow’s company profits were built by 90% restoration contracts. To prove authenticity of the restoration contracts the auditors insisted on visiting a multimillion dollar contract in Sacramento, California. Barry had sent Mark Morze to find a large building under construction that would be plausible site for the restoration. Prior to the auditors attending the work site, they were required to sign a confidentiality agreement that stated ridiculous rules. “We will not make any follow-up telephone calls to any contractors, insurance companies, the building owner, or other individuals involved in the restoration contract.” This would be considered a red flag too many that went unquestioned. Barry Minkow’s “Sky is the limit” philosophy is another red flag of a fraudster. His willingness to grow and increase profits without having the means or reality of the industry was never questioned by the auditors Ernst and Whinney. On June 2nd, 1987 Ernst and Whinney had decided to resign after a number of questionable events. Ernst and Whinney resigning from the audit with the claim that assets were misappropriated, meant everything was coming unraveled.
Journalist writing a filler piece for the Los Angeles Times, brings down Barry Minkow and ZZZZ Best by a last call to check on their contractors ID number. Much to the journalists surprise she discovered that ZZZZ Best did not have one in the system. Also, a woman who was overcharged a few hundred dollars a couple years back that was denied a refund from Barry Minkow. She had decided to keep a diary and track down others who had been defrauded in a diary she gave to the Los Angeles times. The story broke and Barry Minkow’s success fell as quickly as it had boomed. A few days later the Los Angeles Police Department raided ZZZZ Best headquarters and Barry Minkow’s home. They found evidence that supported the laundering of money and fraudulent activity. Barry Minkow and ten others were indicted on 54 counts of racketeering, securities fraud, mail fraud, tax evasion, and bank fraud. Those charges included dummy companies set up by Barry Minkow, phony invoices that were prepared in the basement of homes, and conducting a fake tour of the restoration site in Sacramento. Barry Minkow was ordered to pay $26 million in restitution and serve 25 years in a federal prison. He served only seven and half years before being released. The company at its height had reached $200 million in market capitalization, its assets were sold off at about $60,000 dollars and the stock had dropped to be worthless.
Some Red Flags and aspects of the fraud triangle have already been mentioned, but as the auditors missed many others that if identified appropriately would have been able to detect the fraud sooner.
Barry Minkow the boy wonder who had purchased a red Ferrari, an expensive new home, and appeared on hit shows like Oprah. His personality fit the stereotype of a fraudster, his hard working attitude, the anything to succeed, his way or the highway mentality, and the list of traits goes on. The largest area of revenue for ZZZZ Best was with insurance restoration contracts, the contracts made up to 90% of the company’s profits. The amounts in the contracts were unrealistically large. The number of multimillion dollar restoration contracts ZZZZ Best was reporting outnumbered the total possible amount nationwide. The contracts themselves that were fictitious failed to identify common items, such as job location. Many of the contracts were only a page in length. Most multimillion dollar contracts over multiple pages in length and would include specifics on what was to be done. The Internal Controls of ZZZZ Best were almost nonexistent. Since, Frauds like ZZZZ Best internal controls have become a very important factor of an audit. Internal controls need to be evaluated by auditors and suggestions are made in areas lacking adequate controls. If the auditors or anyone reviewing ZZZZ Best would have followed through with some of the red flags identified the fraud would have been uncovered much
earlier.
As usual when a major fraud or accounting issue arises usually a new standard is set. The American Institute for Certified Public Accountants at time were still in charge of setting auditing standards. It’s relevance to ZZZZ Best in this case was that for the first time ever the word “fraud” was used in a standard and increased the responsibility of the auditor’s to detect fraud. The case of Barry Minkow and ZZZZ Best helps remind the importance of accountants in the auditing world to always maintain an attitude of professional skepticism. Barry Minkow had successfully limited the scope of the auditors of Ernst and Whinney to be able to perform their due diligence properly. They should have never signed off on a controversial confidentially document to visit a restoration site. However, Ernst and Whinney did fail to follow SAS No. 7 (Since been superseded by SAS No. 84 1998), which requires the new auditors to communicate with the successor auditor. It is important to note that Ernst and Whinney was sued over the case and was eventually found not liable for not uncovering the fraudulent activity of ZZZZ Best. The rules and guidelines for auditors is not to find fraud, but to get “limited assurance” that the financial statements have been fairly presented.
Barry Minkow and his carpet cleaning company had all the looks of America’s next big success story. Barry Minkow and insiders like Mark Morze created over 20,000 fraudulent documents, set up a fake restoration site, and committed credit card fraud. In just six years the company had gone public and was estimated to be worth in the hundreds of millions of dollars. Auditors, investors, and many more were deceived the entire time on what had been occurring. The selfish acts performed led to many out of jobs, investors losing everything in the stock, and lawsuits. The ZZZZ Best Company and Barry Minkow has taught many lessons to auditors and many others to always keep professional skepticism. The accounting profession has continued to improve its rules, standards, and regulations over the years and will continue to improve. Fraud is inevitable, the only thing we as accountant’s can do is prevent, detect, and control weaknesses as they occur over time.