ZZZZ Best Case

On May 19, 1987, a short article in theWall Street Journalreported that ZZZZ Best Company, Inc., of Reseda, California, had signed a contract for a $13.8 million insurance restoration project. This project was just the most recent of a series of large restoration jobs obtained by ZZZZ Best (pronounced "zee best"). Located in the San Fernando Valley of Southern California, ZZZZ Best had begun operations in the fall of 1982 as a small door-to-door carpet cleaning operation. Under the direction of Barry Minkow, the extroverted 16-year-old who founded the company and initially operated it out of his parents' garage, ZZZZ Best experienced explosive growth in both revenues and profits during the first several years of its existence. In the three-year period from 1984 to 1987, the company's net income surged from less than $200,000 to more than $5 million on revenues of $50 million.

When ZZZZ Best went public in 1986, Minkow and several of his close associates became multimillionaires overnight. By the late spring of 1987, the market value of Minkow's stock in the company exceeded $100 million, while the total market value of ZZZZ Best surpassed $200 million. The youngest chief executive officer in the nation enjoyed the "good life", which included an elegant home in an exclusive suburb of Los Angeles and a fire-engine red Ferrari. Minkow's charm and entrepreneurial genius made him a sought-after commodity on the television talk show circuit and caused the print and visual media to tout him as an example of what America's youth could attain if they would only apply themselves. During an appearance onThe Oprah Winfrey Showin April 1987, Minkow exhorted his peers with evangelistic zeal to "Think big, be big" and encouraged them to adopt his personal motto, "The sky is the limit."

Less than two years after appearing onOprah, Barry Minkow began serving a 25-year sentence. Tried and convicted on 57 counts of securities fraud, Minkow had been exposed as a fast-talking con artist who swindled his closest friends and Wall Street out of millions of dollars. Federal prosecutors estimate that, at a minimum, Minkow cost investors and creditors $100 million. The company that Minkow founded was, in fact, an elaborate Ponzi scheme. The reported profits of the firm were nonexistent and the large restoration contracts, imaginary. As one journalist reported, rather than building a corporation, Minkow created a hologram of a corporation. In July 1987, just three months after the company's stock reached a market value of $220 million, an auction of its assets netted only $62,000.

Unlike most financial frauds, the ZZZZ Best scam was perpetrated under the watchful eye of the Securities and Exchange Commission (SEC). The SEC, a large and reputable West Coast law firm that served as the company's general counsel, a prominent Wall Street brokerage firm, and an international public accounting firm all failed to uncover Minkow's daring scheme. Ultimately, the persistence of an indignant homemaker who had been bilked out of a few hundred dollars by ZZZZ Best resulted in Minkow being exposed as a fraud.

How a teenage flimflam artist could make a mockery of the complex regulatory structure that oversees the U.S. securities markets was the central question posed by a congressional subcommittee that investigated the ZZZZ Best debacle. That subcommittee was headed by Representative John D. Dingell, chairman of the U.S. House Committee on Energy and Commerce. Throughout the investigation, Representative Dingell and his colleagues focused on the role the company's independent auditors played in the ZZZZ Best scandal.

The ZZZZ Best prospectus told the public that revenues and earnings from insurance restoration contracts were skyrocketing but did not reveal that the contracts were completely fictitious. Where were the independent auditors and the other that are paid to alert the public to fraud and deceit?

Like many other daring financial frauds, the ZZZZ Best scandal caused Congress to reexamine the maze of rules that regulated financial reporting and served as the foundation of the U.S. system of corporate oversight. However, Daniel Akst, a reported forThe Wall Street Journalwho documented the rise and fall of Barry Minkow, suggested that another ZZZZ Best was inevitable. "Changing the accounting rules and securities laws will help, but every now and then a Barry Minkow will come along, and ZZZZ Best will happen again. Such frauds are in the natural order of things, I suspect, as old and enduring as human needs."

The Early History of ZZZZ Best Company

Barry Minkow was introduced to the carpet cleaning industry at the age of 12 by his mother, who helped make ends meet by working as a telephone solicitor for a small carpet cleaning firm. Although the great majority of companies in the carpet cleaning industry are legitimate, the nature of the business attracts a disproportionate number of shady characters. There are essentially no barriers to entry: no licensing requirements, no apprenticeships to be served, and only a minimal amount of start-up capital is needed. A 16-year-old youth with a driver's license can easily become what industry insiders refer to as a "rug sucker," which is exactly what Minkow did when he founded ZZZZ Best Company.

Minkow quickly learned that carpet cleaning was a difficult way to earn a livelihood. Customer complaints, ruthless competition, bad checks, and nagging vendors demanding payment complicated the young entrepreneur's life. Within months of striking out on his own, Minkow faced the ultimate nemesis of the small business person: a shortage of working capital. Because of his age and the fact that ZZZZ Best was only marginally profitable, local banks refused to loan him money. Ever resourceful, the brassy teenager came up with his own innovative ways to finance his business: check kiting, credit card forgeries, and staging of thefts to fleece his insurance company. Minkow's age and personal charm allowed him to escape unscathed from his early brushes with the law that resulted from his creative financing methods. The ease with which the "system" could be beaten encouraged him to exploit it on a broader scale.

Throughout his tenure with ZZZZ Best, Minkow recognized the benefits of having an extensive social network of friends and acquaintances. Many of these relationships he developed and cultivated at a Los Angeles health club. After becoming a friend of Tom Padgett, an insurance claims adjuster, Minkow devised a scheme to exploit that friendship. Minkow promised to pay Padgett $100 per week if he would simply confirm over the telephone to banks and any other interested third parties that ZZZZ Best was the recipient of occasional insurance restoration contracts. Ostensibly, Minkow had obtained these contracts to clean and do minor remodeling on properties damaged by fire, storm, or other catastrophes. Minkow convinced the gullible Padgett that the sole purpose of the confirmations was to allow ZZZZ Best to circumvent much of the bureaucratic red tape in the insurance industry.

From this modest beginning, the ZZZZ Best fraud blossomed. Initially, Minkow used the phony insurance restoration contracts to generate the paper profits and revenues he needed to convince bankers to loan him money. Minkow's phony financial statements served their purpose, and he expanded his operations by opening several carpet cleaning outlets across San Fernando Valley. Minkow soon realized that there was no need to tie his future to the cutthroat carpet cleaning industry when he could literally dictate the size and profitability of his insurance restoration "business." Within a short period of time, insurance restoration, rather than carpet cleaning became the major source of revenue appearing on ZZZZ Best's income statements.

Minkow's "the sky is the limit" philosophy drove him to be even more innovative. The charming young entrepreneur began using his bogus financial statements to entice wealthy individuals in his ever-expanding social network to invest in ZZZZ Best. Eventually, Minkow recognized that the ultimate scam would be to take his company public, a move that would allow him to tap the bank accounts of unsuspecting investors nationwide.

Going Public with ZZZZ Best

Minkow's decision to take ZZZZ Best public meant that he could no longer completely control his firm's financial disclosures. Registering with the SEC required auditors, investment bankers, and outside attorneys to peruse ZZZZ Best's periodic financial statements.

ZZZZ Best was firm subjected to a full-scope independent audit for the 12 months ended April 30, 1986. George Greenspan, the sole practitioner who performed that audit, confirmed the existence of ZZZZ Best's major insurance restoration contracts by contacting Tom Padgett. Padgett served as the principal officer of Interstate Appraisal Services, which reportedly contracted the jobs out to ZZZZ Best. By this time, Padgett was an active and willing participant in Minkow's fraudulent schemes. Minkow established Interstate Appraisal Services and Assured Property Management for the sole purpose of generating fake insurance restoration contracts for ZZZZ Best.

In testimony before the congressional subcommittee that investigated the ZZZZ Best scandal, Greenspan insisted that he had properly audited Minkow's company. Greenspan testified that while planning the 1986 audit he had performed various analytic procedures to identify unusual relationships with ZZZZ Best's financial data. These procedures allegedly included comparing ZZZZ Best's key financial ratios with industry norms. Regarding the insurance contracts, Greenspan testified that he had obtained and reviewed copies of all key documents pertaining to those jobs. However, Greenspan admitted that he had not inspected any of the insurance restoration sites.

Congressman Lent: Mr. Greenspan, I am interested in the SEC Form S-1 that ZZZZ Best Company filed with the SEC....You say in that report that you made your examination in accordance with generally accepted auditing standards and accordingly included such tests of the accounting records and other auditing procedures as we consider necessary in the circumstances....You don't say in that statement that you made any on-site inspections.

Mr. Greenspan: It's not required. Sometimes you do; sometimes you don't. I was satisfied that these jobs existed and I was satisfied from at least six different sources, including payment for the job. What could you want better than that?

Congressman Lent: Your position is that you are an honest and reputable accountant.

Mr. Greenspan: Yes, sir.

Congressman Lent: You were as much a victim as some of the investors in this company?

Mr. Greenspan: I was a victim all right....I am as much aghast as anyone. And every night I sit down and say, why didn't I detect this damned fraud.

Retention of Ernst & Whinney by ZZZZ Best

Shortly after Greenspan completed his audit of ZZZZ Best's financial statements for fiscal 1986, which ended April 30, 1986, Minkow dismissed him and retained Ernst & Whinney to perform the following year's audit. Apparently, ZZZZ Best's investment banker insisted that Minkow obtained a Big Eight accounting firm to enhance the credibility of the company's financial statements. At approximately the same time, and for the same reason, Minkow retained a high-profile Los Angeles law firm to represent ZZZZ Best as its legal counsel.

The congressional subcommittee asked Greenspan what information he provided to Ernst & Whinney regarding his former client. In particular, the subcommittee wanted to know whether Greenspan discussed the insurance restoration contacts with the new auditors.

Congressman Wyden: Mr. Greenspan, in September 1986 Ernst & Whinney came on as the new independent accountant for ZZZZ Best. What did you communicate to Ernst & Whinney with respect to the restoration contracts?

Mr. Greenspan: Nothing. I didthere was nothing because they never got in touch with me. It's protocol for the new accountant to get in touch with the old accountant. They never got in touch with me, and its still a mystery to me.

Representatives of Ernst & Whinney later testified that they did, in fact, communicate with Greenspan prior to accepting ZZZZ Best as an audit client. However, Ernst & Whinney did not comment on the nature or content of that communication. (Greenspan was not recalled to rebut Ernst & Whinney's testimony on this issue.)

The engagement letter was signed by Ernst & Whinney and Barry Minkow in September 1986. The engagement letter outlined four services that the audit firm intended to provide ZZZZ Best: a review of the company's financial statements for the three-month period ending July 31, 1986; assistance in the preparation of a registration statement to be filed with the SEC; a comfort letter to be submitted to ZZZZ Best's underwriters; and a full-scope audit for the fiscal year ending April 30, 1987. Ernst & Whinney completed the review, provided the comfort letter to ZZZZ Best's underwriters, and apparently assisted the company in preparing the registration statement for the SEC; however, Ernst & Whinney never completed the 1987 audit. The audit firm resigned on June 2, 1987, amid growing concerns that ZZZZ Best's financial statements were grossly misstated.

The congressional subcommittee investigating the ZZZZ Best fraud questioned Ernst & Whinney representatives at length regarding the bogus insurance restoration contractscontracts that accounted for 90 percent of ZZZZ Best's reported profits. Congressional testimony disclosed that Ernst & Whinney repeatedly insisted on visiting several of the largest of these contract sites, and that Minkow and his associated attempted to discourage such visits. Eventually, Minkow realized that the auditors would not relent and agreed to allow them to visit certain of the restoration sites, knowing full well that none of the sites actually existed.

To convince Ernst & Whinney that the insurance restoration contracts were authentic, Minkow plotted and carried out a series of sting operations that collectively cost millions of dollars. In the late fall of 1986, Larry Gray, the engagement audit partner for ZZZZ Best, told client personnel that he wanted to inspect a restoration site in Sacramento on which ZZZZ Best had reported obtaining a multimillion-dollar contract. Minkow sent two of his subordinates to Sacramento to find a large building under construction or renovation that would provide a plausible site for a restoration contract. Gray had visited Sacramento a few weeks earlier to search for the site that Minkow had refused to divulge. As chance would have it, the building chosen by the ZZZZ Best conspirators was the same one Gray had identified as the most likely site of the insurance restoration project.

Minkow's two confederates posed as leasing agents of a property management firm and convinced the supervisor of the construction site to provide keys to the building one weekend on the pretext that a large, prospective tenant wished to tour the facility. Prior to the arrival of Larry Gray and an attorney representing ZZZZ Best's law firm, Minkow's subordinates visited the site and placed placards on the walls at conspicuous locations indicating that ZZZZ Best was the contractor for the building renovation. No details were overlooked by the two co-conspirators. They even paid the building's security officer to greet the visitors and demonstrate that he was aware in advance of their tour of the site and its purpose. Although the building had not been damaged and instead was simply in the process of being completed, the sting operation went off as planned.

Congressional investigators quizzed Gray regarding the measures he took to confirm that ZZZZ Best had a restoration contract on the Sacramento building. They were particularly concerned that he never discovered the building had not suffered several million dollars in damages a few months earlier, as claimed by ZZZZ Best personnel.

Congressman Lent: Did you check the building permit or construction permit?

Mr. Gray: No, sir. That wouldn't be necessary to accomplish what I was setting out to accomplish.

Congressman Lent: And you did not check with the building's owners to see if an insurance claim had been filed?

Mr. Gray: Same answer. It wasn't necessary. I had seen the paperwork internally of our client, the support for a great amount of detail. So, I had no need to askto pursue that.

Congressman Lent: You understand that what you saw was not anything that was real in any sense of the word?....You are saying you were duped, are you not?

Mr. Gray: Absolutely.

Before allowing Ernst & Whinney auditors to visit a bogus restoration project, Minkow insisted that the firm sign a standard confidentiality agreement. Members of the congressional subcommittee were troubled by the following stipulation of the confidentiality agreement: "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 restriction effectively precluded the auditors from corroborating the insurance restoration contracts with independent third parties.

Resignation of Ernst & Whinney

Ernst & Whinney resigned as ZZZZ Best's auditor on June 2, 1987, following a series of disturbing events that caused the firm to question Barry Minkow's integrity. First, Ernst & Whinney was alarmed by aLos Angeles Timesarticle in mid-May 1987 that revealed that Minkow had been involved in a string of credit card forgeries as a teenager. Second on May 28, 1987, ZZZZ Best issued a press release, without consulting or notifying Ernst & Whinney, that reported record profits and revenues. Minkow intended this press release to restore investors' confidence in the companyconfidence that had been shaken by the damagingLos Angeles Timesstory. Third, and most important, on May 29, Ernst & Whinney auditors discovered evidence supporting allegations made several weeks earlier by a third-party informant that ZZZZ Best's insurance restoration business was fictitious.

The informant had contacted Ernst & Whinney in April 1987 and asked for $25,000 in exchange for information proving that one of the firm's clients was engaging in a massive fraud. Ernst & Whinney refused to pay the sum, and the individual recanted shortly thereafter, but not until the firm determined that the allegation involved ZZZZ Best. (Congressional testimony disclosed that the individual recanted because of a bribe paid to him by Minkow.) Despite the retraction, Ernst & Whinney questioned Minkow and ZZZZ Best's board of directors regarding the matter. Minkow insisted that he did not know the individual who had made the allegation. On May 29, 1987, however, Ernst & Whinney auditors discovered several cancelled checks that Minkow had personally written to the informant several months earlier.

Because ZZZZ best was a public company, the resignation of its independent auditor had to be reported to the SEC in an 8-K filing. This requirement alerts investors and creditors of circumstances that may have let to the change in auditors. At the time, SEC registrants were allowed 15 days to file an 8-K auditor change announcement. After waiting the maximum permissible time, ZZZZ Best reported the change in auditors but, despite Ernst & Whinney's insistence, made no mention in the 8-K of the fraud allegation that had been subsequently recanted.

The SEC requires a former audit firm to prepare a letter to be filed as an exhibit to its former client's 8-K auditor change pronouncement. That exhibit letter must comment on the 8-K's accuracy and completeness. In 1987, formed audit firms had 30 days to file an exhibit letter, which was the length of time Ernst & Whinney waited before submitting its exhibit letter to the SEC. In that letter, Ernst & Whinney revealed that ZZZZ Best's insurance contract might be fraudulent.

The congressional subcommittee was alarmed that 45 days had passed before the charges of fraudulent misrepresentations in ZZZZ Best's financial statements were disclosed by the public. By the time the SEC released Ernst & Whinney's exhibit letter to the public, ZZZZ Best had filed for protection from its creditors under Chapter 11 of the federal bankruptcy code. During the period that elapsed between Ernst & Whinney's resignation and the public release of the 8-K exhibit letter, ZZZZ Best obtained significant financing from several parties, including $1 million from one of Minkow's close friends. These parties never recovered the funds invested in, or loaned to, ZZZZ Best. As a direct result of the ZZZZ Best debacle, the SEC shortened the length of time that registrants and their former auditors may wait before filing auditor change documents.

The congressional subcommittee also quizzed Ernst & Whinney representatives regarding the information they disclosed to Price Waterhouse, the audit firm that Minkow retained to replace Ernst & Whinney. Congressman Wyden wanted to know whether Ernst & Whinney had candidly discussed its concerns regarding Minkow's integrity with Price Waterhouse.

Congressman Wyden: I am going to insert into the record at this point a memo entitled "Discussion with successor auditor," written by Mr. Gray and dated June 9, 1987. Regarding a June 4 meeting, Mr. Gray, with Dan Lyle of Price Waterhouse concerning the integrity of ZZZZ Best's management, you stated that you had no reportable disagreements and no reservations about management integrity pending the results of a board of directors investigation. Then you went on to say that you resigned because, and I quote here: "We came to a conclusion that we didn't want to become associated with the financial statements."Is that correct?

Mr. Gray: That is correct.

Mr. Wyden: ...Mr. Gray, you told the committee staff on May 29, 1987, that when you uncovered evidence to support allegations of fraud that you decided to pack up your workpapers and leave the ZZZZ Best audit site. How did your leaving without telling anybody except the ZZZZ Best management and board of directors the reasons for leaving help the public and investors?

A final twist to the ZZZZ Best scandal was an anonymous letter Ernst & Whinney received one week after the firm resigned as ZZZZ Best's auditor. At that time, no one other than Ernst & Whinney and ZZZZ Best's officers was aware of the firm's resignation. The letter contained several allegations suggesting that ZZZZ Best's financial statements were fraudulent. According to the congressional testimony, Ernst & Whinney forwarded this letter to the SEC on June 17, 1987.

Collapse of ZZZZ Best

TheLos Angeles Timesarticle published in mid-May 1987 that disparaged Barry Minkow ultimately doomed the young entrepreneur and his company. Several years earlier, a homemaker had fallen victim to Minkow's credit card forgeries. Minkow had added a fraudulent charge to a credit card slip the woman had used to make a payment on her account. Despite her persistence, Minkow avoided repaying the small amount. The woman never forgot the insult and tracked down, and kept a record of, individuals who had been similarly harmed by Minkow. At the urging of this woman, a reporter for theLos Angeles Timesinvestigated her allegations. The woman's diary became the basis for theLos Angeles Timesarticle that, for the first time, cast doubt on the integrity of the "boy wonder" that was the talk of Wall Street.

The newspaper article triggered a chain of events that caused ZZZZ Best to collapse and disappear less than three months later. First, a small brokerage firm specializing in newly registered companies with suspicious earnings histories began short-selling ZZZZ Best stock, forcing the stock's price into a tailspin. Second, Ernst & Whinney, ZZZZ Best's law firm, and ZZZZ Best's investment banker began giving more credence to the allegations and rumors of financial wrongdoing by Minkow and his associates. Third, and most important, the article panicked Minkow and compelled him to make several daring moves that cost him even more credibility. The most critical mistake was his issuance of the May 28, 1987, press release that boldly reported record profits and revenues for his firm.

EPILOGUE

Among the parties most vilified for their role in the ZZZZ Best scandal was Ernst & Whinney. The transcripts of the congressional testimony focusing on the ZZZZ Best fraud included a list of 10 "red flags" that the audit firm had allegedly overlooked while examining ZZZZ Best's financial statements. Ernst & Whinney officials flatly rejected assertions that their firm was even partially to blame for the ZZZZ Best fiasco. In his congressional testimony, Leroy Gardner, the West Coast director of accounting and auditing for Ernst & Whinney, maintained that when all of the facts were revealed, his firm would be totally vindicated:

The ZZZZ Best situation proves at least one thing: a well-orchestrated fraud will often succeed even against careful, honest, hard-working people...The facts that have begun to emerge establish that Minkow, along with confederates both inside and outside ZZZZ Best went to extraordinary lengths to deceive Ernst & Whinney. For example, Thomas Padgett, an alleged conspirator, revealed in a recent televised interview that Minkow spent $4 million to deceive Ernst & Whinney during a visit to one of ZZZZ Best's job sites....Ernst & Whinney never misled investors about the reliability of ZZZZ Best's financial statements. Ernst & Whinney never even issued an audit opinion for ZZZZ Best....We are not part of the problem in this case. We were part of the solution.

In one of the largest civil suits stemming from the ZZZZ Best fraud, a court ruled that Ernst & Whinney was not liable to a large California bank that had extended ZZZZ Best a multimillion-dollar loan in 1986. The bank alleged that in granting the loan, it had relied upon the review report issued by Ernst & Whinney on ZZZZ Best's financial statements for the three-month period ending July 31, 1986. However, an appellate judge ruled that the bank was not justified in relying on the review report since Ernst & Whinney had expressly stated in the report that it was not issuing an opinion on the ZZZZ Best financial statements. "Ernst, because it issued only a review report, specifically declined to express an opinion on ZZZZ Best's financial statements. The report expressly disclaimed any right to rely on its content."

In the late 1980s, ZZZZ Best's former stock-holders filed a class-action lawsuit against Ernst & Whinney, ZZZZ Best's former law firm, and ZZZZ Best's former investment banker. An Internet publication reported in March 1996 that this lawsuit had been settled privately. The defendants reportedly paid the former ZZZZ Best stockholders $35 million. However the contribution of each defendant to the settlement pool was not disclosed.

Barry Minkow was released from prison in late 1994. Minkow secured the reduction in his 25-year prison sentence for "good behavior and efforts to improve himself." These efforts included earning by correspondence bachelor's and master's degrees in religion from Liberty University. Shortly after being paroled, Minkow married a young woman introduced to him by a fellow inmate. That inmate was a former subordinate of Charles Keating, the principal architect of the massive Lincoln Savings and Loan fraud.

In early 1995, Minkow began serving as the associate pastor of an evangelical church in a community near his hometown of Reseda. Two years later, Minkow was appointed the senior pastor of a large nondenominational church in San Diego. Besides his pastoral duties, Minkow serves as the spokesperson for an Internet company, the Fraud Discovery Institute, which markets various fraud prevention and detection services.

Minkow regularly presents lectures and seminars across the United States that focus on his "experience" with corporate fraud. He has spoken to groups of CPAs, educational institutions, and, most notably, the FBI Academy at Quantico, Virginia. Minkow, who typically delivers his lectures while dressed in an orange prison jumpsuit, often chastises he accountants and auditors in his audience. During one presentation, Minkow noted that, "CPAs are creatures of habit. You're interested in making tick marks and footnotes, not in thinking outside the box." Minkow also chides auditors for being overly willing to accept weak forms of audit evidence, such as client representations. He warns auditors "Don't give up objectivity for convenience."

Journalists frequently interview Minkow and ask for his views on corporate fraud and related issues. In January 2005, Minkow gave the following response when he was asked byCFO Magazinewhether the Sarbanes-Oxley Act of 2002 would likely serve to mitigate or deter corporate fraud: "Let me tell you why this legislation is brilliant. Sarbox hit a common denominator of corporate fraud: bypassing systems of internal control. I would not have been able to perpetrate the ZZZZ Best fraud if I had not been able to bypass the internal controls."

Ten Red Flags that ZZZZ Best's Auditors Allegedly Overlooked.

1. The amounts called for by the insurance restoration contracts were unrealistically large.

2. The number of multimillion dollar insurance restoration contracts reportedly obtained by ZZZZ Best exceeded the number available nationwide during the relevant time period.

3. The purported contracts failed to identify the insured parties, the insurance companies, or the locations of the jobs.

4. The contracts consisted of a single page which failed to contain details and specifications of the work to be done, such as the square yardage of carpet to be replaced, which were usual and customary in the restoration business.

5. Virtually all of the insurance restoration contracts were with the same party.

6. A large proportion of the ZZZZ Best insurance restoration contracts occurred immediately and opportunistically, prior to a planned offering of stock.

7. The purported contracts provided for payments to ZZZZ Best or Minkow alone rather than to the insured or jointly with ZZZZ Best and the insured, contrary to the practice of the industry.

8. The purported contracts provided for payments by the insurance adjustor contrary to normal practice in the industry under which payments are customarily made by the insurance company directly to its insured or jointly to its insured and the restorer.

9. ZZZZ Best's purported gross profit margins for its restoration business were greatly in excess of the normal profit margin for the restoration industry.

10. The internal controls at ZZZZ Best were grossly inadequate.

INSTRUCTIONS:

Give several examples from the case that support the problem and describe how the auditor's lack of industry/client specific knowledge affected the gathering of at two types of audit evidence collected by the auditor: Documentation and Analytical Procedures

For each type of evidence state and define the management assertions associated with each type of evidence. In your discussion of the evidence also describe in detail what makes these pieces of evidence unreliable using any of the five factors of competent evidence. (Five factors of competent evidence: independence of the provider, direct knowledge of the auditor, competence of the provider, strength or weakness of internal control, objectivity of the measurement instrument.)

Requiremements

Definition of evidence, examples from case that support problem of auditor lack of knowledge affected use of evidence, all management assertions (definition too) affected by the evidence, and the competencies of the evidence affected by the auditor lacking knowledge of the audit client and its industry.