When he was a sophomore in high school, Barry Minkow founded a carpet cleaning company – ZZZZ Best Company in his parents’ garage. At that time, the carpet cleaning industry has few entry barriers and all Minkow needed was a small amount of start-up capital. However, he soon found out that his firm was actually tough to survive in the industry as the ease of entry means fierce competition.
The young man encountered a series of trouble: bad checks, complaints from customers, urge for payment from suppliers and finally the shortage of working capital. Not surprisingly, the bank refused to loan money to his low profit margin company. Minkow would like to try any method to expand his company and he came up with his own creative idea of financing the business including check kiting, credit card forgeries, committing insurance fraud and stealing grandma’s jewelry.
Minkow met the insurance claims adjuster Tom Padgett at a swanky Los Angeles health club and began to step into the field of insurance restoration. With the promised payment of 100 dollars per week from Minkow, Padgett told any interested third parties that Minkow was the recipient of insurance restoration contracts which allowed Minkow to do repairing work on damaged properties. They also set up a fake company, Interstate Appraisal Services, to verify the details of restoration to Minkow’s bankers. In the late 1985, Morze joined the company as a part-time consultant to ask for loans around the country’s banks.
At that time, he enticed mainly private investors of any kind: an elderly lady who ran the cigarette concession at a Las Vegas hotel, the wife of singer Tony Orlando, even a reputed local crime figure who delivered 25,000 dollars cash in a brown paper bag. In this way, the ZZZZ Best Company began to be flushed with bank loans expand and several carpets cleaning outlet were established in Southern California. The insurance restoration business, originally the sideline of company, gradually began to play an important role and finally accounted for 86 percent of the whole revenues on the financial statement.
The seemingly main business of the company, the carpet cleaning work, actually became the cloak of the lies. As a young man with personal charm, Minkow managed to escape the legal sanction which encouraged him to further exploit such a benefit. “The sky is the limit” There is no end to human’s greedy desire. Minkow began to entice some wealthy people to invest in his company and soon became not satisfied with the small scale of investment. To maximize the profit, he decided to take his company public.
This idea began to be rooted in Minkow’s mind after he had hooked up with a guy from Encino, Maurice Rind–a convicted stock swindler but also a man with a reputation as a financial wizard. He helped ZZZZ Best merge with a publicly held Utah shell corporation while at the same time making it possible for the company going public. Taking the company public means that the firm will be under the supervision of SEC and there must be enough profit on the financial statements. In addition to the invention of new restoration jobs, Morze, whose earlier bookkeeping work involved only rudimentary accounting, did new tricks – check knitting.
He jotted down notes on every insurance job ZZZZ Best supposedly did. He cut and pasted checks together–taking the name of a bank from one, a signature from another–then smoothed out the edges with blobs of White Out and a copying machine. “If you saw me at the end of the night making checks, I’d look in the mirror and I’d have little white dots all over me,” he later remembered. i The finished copies made it look as though ZZZZ Best was paying carpet and lumber suppliers for restoration materials. He drew up phony invoices to coincide with the checks and drafted two years’ worth of detailed bank statements.
In January 1986, ZZZZ Best Company gained a spot on NASDAQ and Minkow, raising 13 million dollars in the IPO and holding 53 percent of the company’s shares, making himself a millionaire overnight and youngest person ever lead an IPO in history. Minkow became a billionaire and an American success story. By February 1987, on paper, the company — which Minkow claimed had about 1,300 employees in some two dozen offices — was worth nearly 300 million dollars. Minkow’s personal worth reportedly topped $100 million. He began to live a luxury life including driving a red Ferrari with a “ZZZZ BEST” license plate and appearing on Oprah.
Minkow’s business had been clearly a Ponzi scheme. He promised investors highly returns on the insurance restorations business, but in reality, investors were being repaid with money from new investors. Some of the loans were negotiated at outrageous rates of interest so that they were obtained fast enough to pay off earlier loans. ZZZZ Best did operate its carpet-cleaning business which differed itself from a typical Ponzi and the carpet-cleaning division won high marks for its quality. iii However, its insurance restoration division was totally a phony department and little real business existed. Fooling the auditors
As the company went public, ZZZZ Best was subjected to the audit of its financial statement. George Greenspan, the performer of the audit, reviewed the copies of the insurance restoration jobs and then confirmed its existence in the report to SEC. He also calculated various kinds of ratios of the company and concluded that they were in line with the industry averages. However, the auditor did not visit any of the insurance restoration sites where actually located many mailboxes. Later on the court, Greenspan explained to the congressman the reason for not making the on-site inspections was that it was not required.
Minkow fired the former auditor Greenspan after he completed his audit to ZZZZ Best Company and retained Ernst & Whinney, a reputable accounting firm, to increase the credibility of the company’s financial statements. iv According to the rule, the new accountant should get in touch with the old accountant to acquire the information of the company. As AU section 311. 04 put it, “Procedures that an auditor may consider in planning the audit usually involve review of his records relating to the entity and discussion with other firm personnel and personnel of the entity.
However, as Greenspan later spoke to the congressman, it was a mystery that Ernst & Whinney did not contact him. Ernst & Whinney argued back that they did communicate with Greenspan but failed to provide the evidence. This shows that Larry Gray, the engagement audit partner for ZZZZ Best of the Ernst & Whinney Company, was lack of the basic knowledge and understanding of the client’s operations and business even from the beginning. Larry Gray insisted on inspecting the sites of the company’s insurance restoration business, which accounts for nearly 90 percent of its profit.
ZZZZ Best claimed in an SEC filing that it had a 7 million dollars refurbishing contract in Sacramento. As the whole operations were totally fictitious, Minkow tried to discourage the trip but ended up allowing him a visit under the repeatedly requests. To deceive Gray and convince him that the business really existed, Minkow and his conspirators devised a scheme. Two of the associates of Minkow were sent to Sacramento in the late fall of 1986 to find a construction that would be reasonable site for the insurance restoration contract.
Coincidently, while visiting Sacramento himself two weeks earlier, Gray thought the same building would most likely be the insurance restoration site. The two confederates also convinced the supervisor of the construction site to provide keys of the building for a weekend using the excuse of “a tenant wished to tour the facility” and bribed the building’s security officer to greet the visitor. iv Gray recorded his visit to the insurance restoration site in Sacramento in his memo and it was clear that he was totally fooled by Minkow.
He was informed by the building manager Mark Roddy, whom was hired by the Assured Property Management insurance company to oversee the renovation activities, that the releasing of water from the water storage on the roof caused the damage of the building. Though noticing that some of the work in the building was not finished by ZZZZ Best, he believed it was not the company’s responsibility. v What Gray failed to realize was that the Assured Property Management Company was fabricated by Minkow for the sole purpose of generating fake insurance restoration contracts for ZZZZ Best.