Question
ZZZZ Best Company, Inc. ZZZZ Best Company, Inc. On May 19, 1987, a short article in the Wall Street Journal reported that ZZZZ Best Company,
ZZZZ Best Company, Inc.
ZZZZ Best Company, Inc.
On May 19, 1987, a short article in the
Wall Street Journal
reported 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 business. 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 on
The Oprah Winfrey Show
in 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 on
Oprah
, Barry Minkow began serving a 25-year
prison 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
2
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
others 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 regulate financial reporting and serve as the foundation of
the U.S. system of corporate oversight. However, Daniel Akst, a reporter for the Wall Street
Journal who 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 startup 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 businessperson: 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 the staging of thefts to fleece his insurance company.
3
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 work on properties damaged by fire, storms, 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 the 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 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 first 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
3
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 work on properties damaged by fire, storms, 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 the 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 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 first 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
4
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 analytical
procedures to identify unusual relationships in 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 personal 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 obtain a major 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 contracts with the new auditors.
Congressman Wyden:
4
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 analytical
procedures to identify unusual relationships in 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 personal 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 obtain a major 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 contracts with the new auditors.
Congressman Wyden:
5
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 it's
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.)
Exhibit 1 contains the engagement letter 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.
6
Exhibit 1
Ernst & Whinney's ZZZZ Best Engagement Letter
September 12, 1986
Mr. Barry Minkow
Chairman of the Board
ZZZZ Best Co., Inc.
7040 Darby Avenue
Reseda, California
Dear Mr. Minkow:
This letter is to confirm our understanding regarding our engagement as independent
accountants of ZZZZ BEST CO., INC. (the Company) and the nature and limitations of the
services we will provide.
We will perform the following services:
1. We will review the balance sheet of the Company as of July 31, 1986, and the related
statements of income, retained earnings, and changes in financial position for the three
months then ended, in accordance with standards established by the American Institute
of Certified Public Accountants. We will not perform an audit of such financial
statements, the objective of which is the expressing of an opinion regarding the
financial statements taken as a whole, and, accordingly, we will not express an opinion
on them. Our report on the financial statements is presently expected to read as
follows:
"We have made a review of the condensed consolidated balance sheet of ZZZZ BEST CO.,
INC. and subsidiaries as of July 31, 1986, and the related condensed consolidated
statements of income and changes in financial position for the three-month period ended
July 31, 1986, in accordance with standards established by the American Institute of
Certified Public Accountants. A review of the condensed consolidated financial statements
for the comparative period of the prior year was not made.
A review of financial information consists principally of obtaining an understanding of the
system for the preparation of interim financial information, applying analytical review
procedures to financial data, and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an examination in accordance with
generally accepted auditing standards, which will be performed for the full year with the
objective of expressing an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion. Based on our review, we are not aware of
7
any material modifications that should be made to the condensed consolidated interim
financial statements referred to above for them to be in conformity with generally accepted
accounting principles.
Our engagement cannot be relied upon to disclose errors, irregularities, or illegal acts,
including fraud or defalcations, that may exist. However, we will inform you of any such
matters that come to our attention.
2. We will assist in the preparation of a Registration Statement (Form S-1) under the
Securities Act of 1933 including advice and counsel in conforming the financial
statements and related information to Regulation S-X.
3. We will assist in resolving the accounting and financial reporting questions which will
arise as a part of the preparation of the Registration Statement referred to above.
4. We will prepare a letter for the underwriters, if required (i.e., a Comfort Letter), bearing
in mind the limited nature of the work we have done with respect to the financial data.
5. We will examine the consolidated financial statements of the Company as of April 30,
1987, and for the year then ended and issue our report in accordance with generally
accepted auditing standards approved by the American Institute of Certified Public
Accountants. These standards contemplate, among other things, that (1) we will study
and evaluate the Company's internal control system as a basis for reliance on the
accounting records and for determining the extent of our audit tests; and (2) that we
will be able to obtain sufficient evidential matter to afford a reasonable basis for our
opinion on the financial statements. However, it should be understood that our reports
will necessarily be governed by the findings developed in the course of our examination
and that we could be required, depending upon the circumstances, to modify our
reporting from the typical unqualified opinion. We will advise you, as our examination
progresses, if any developments indicate that we will be unable to express an
unqualified opinion. Because our examination will be performed generally on a test
basis, it will not necessarily disclose irregularities, if any, that may exist. However, we
will promptly report to you any irregularities which our examination does disclose.
Our fees will be derived from our customary rates for the various personnel involved plus
outof- pocket expenses. Certain factors can have an effect on the time incurred in the
conduct of our work. Among these are the general condition of the accounting records, the
amount of assistance received from your personnel in the accumulation of data, the size
and transaction volume of business, any significant financial reporting issues that arise in
connection with the SEC's review of the S-1, as well as unforeseen circumstances. Based
upon our current understanding of the situation, the amount of our proposed billing for the
various services which we will be providing are estimated to be:
Review of the July 31, 1986 financial statements
$ 5,000-$7,500
Assistance in the preparation of the Registration Statement
8,000-30,000
Comfort Letter
4,000-6,000
7
any material modifications that should be made to the condensed consolidated interim
financial statements referred to above for them to be in conformity with generally accepted
accounting principles.
Our engagement cannot be relied upon to disclose errors, irregularities, or illegal acts,
including fraud or defalcations, that may exist. However, we will inform you of any such
matters that come to our attention.
2. We will assist in the preparation of a Registration Statement (Form S-1) under the
Securities Act of 1933 including advice and counsel in conforming the financial
statements and related information to Regulation S-X.
3. We will assist in resolving the accounting and financial reporting questions which will
arise as a part of the preparation of the Registration Statement referred to above.
4. We will prepare a letter for the underwriters, if required (i.e., a Comfort Letter), bearing
in mind the limited nature of the work we have done with respect to the financial data.
5. We will examine the consolidated financial statements of the Company as of April 30,
1987, and for the year then ended and issue our report in accordance with generally
accepted auditing standards approved by the American Institute of Certified Public
Accountants. These standards contemplate, among other things, that (1) we will study
and evaluate the Company's internal control system as a basis for reliance on the
accounting records and for determining the extent of our audit tests; and (2) that we
will be able to obtain sufficient evidential matter to afford a reasonable basis for our
opinion on the financial statements. However, it should be understood that our reports
will necessarily be governed by the findings developed in the course of our examination
and that we could be required, depending upon the circumstances, to modify our
reporting from the typical unqualified opinion. We will advise you, as our examination
progresses, if any developments indicate that we will be unable to express an
unqualified opinion. Because our examination will be performed generally on a test
basis, it will not necessarily disclose irregularities, if any, that may exist. However, we
will promptly report to you any irregularities which our examination does disclose.
Our fees will be derived from our customary rates for the various personnel involved plus
outof- pocket expenses. Certain factors can have an effect on the time incurred in the
conduct of our work. Among these are the general condition of the accounting records, the
amount of assistance received from your personnel in the accumulation of data, the size
and transaction volume of business, any significant financial reporting issues that arise in
connection with the SEC's review of the S-1, as well as unforeseen circumstances. Based
upon our current understanding of the situation, the amount of our proposed billing for the
various services which we will be providing are estimated to be:
Review of the July 31, 1986 financial statements
$ 5,000-$7,500
Assistance in the preparation of the Registration Statement
8,000-30,000
Comfort Letter
4,000-6,000
8
Audit of financial statements as of April 30, 1987
24,000-29,000
We will invoice you each month for the time charges and expenses incurred in the previous
month and such invoices are due and payable upon presentation.
Larry D. Gray, Partner, is the Client Service Executive assigned to the engagement. Peter
Griffith, Audit Manager, and Michael McCormick, Tax Manager, have also been assigned.
We greatly appreciate your engagement of our firm; if you have any questions, we shall be
pleased to discuss them with you. Please indicate your acceptance of the above
arrangements by signing and returning the enclosed copy. This letter constitutes the full
understanding of the terms of our engagement.
Very truly yours,
Ernst & Whinney
By Larry D. Gray, Partner
ACCEPTED:
ZZZZ BEST CO., INC.
Barry J. Minkow, Chairman of the Board (signed)
9/16/86
8
Audit of financial statements as of April 30, 1987
24,000-29,000
We will invoice you each month for the time charges and expenses incurred in the previous
month and such invoices are due and payable upon presentation.
Larry D. Gray, Partner, is the Client Service Executive assigned to the engagement. Peter
Griffith, Audit Manager, and Michael McCormick, Tax Manager, have also been assigned.
We greatly appreciate your engagement of our firm; if you have any questions, we shall be
pleased to discuss them with you. Please indicate your acceptance of the above
arrangements by signing and returning the enclosed copy. This letter constitutes the full
understanding of the terms of our engagement.
Very truly yours,
Ernst & Whinney
By Larry D. Gray, Partner
ACCEPTED:
ZZZZ BEST CO., INC.
Barry J. Minkow, Chairman of the Board (signed)
9/16/86
9
The congressional subcommittee investigating the ZZZZ Best fraud questioned Ernst &
Whinney representatives at length regarding the bogus insurance restoration contracts
contracts 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 associates 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 job.
Minkow's two confederates posed as leasing agents of a property management firm and
convinced the supervisor of the construction site to provide the 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.
Exhibit 2 presents
the memorandum Gray wrote describing his tour of the buildinga memorandum
included in Ernst & Whinney's ZZZZ Best workpapers.
10
Exhibit 2
Ernst & Whinney Internal Memo Regarding Visit to ZZZZ Best
Restoration Project
TO: ZZZZ Best Co., Inc. File
FROM: Larry D. Gray
RE: Visit to Sacramento Job
At our request, the Company arranged for a tour of the job site in Sacramento on November
23rd [1986]. The site (not previously identified for us because of the confidentiality
agreement with their customer) had been informally visited by me on October 27. I knew
approximately where the job was, and was able to identify it through the construction
activity going on.
On November 23, Mark Morse accompanied Mark Moskowitz of Hughes Hubbard & Reed
and myself to Sacramento. We visited first the offices of the Building Manager, Mark Roddy
of Assured Property Management, Inc. Roddy was hired by the insurance company (at Tom
Padgett's suggestion according to Morse) to oversee the renovation activities and the
leasing of the space. Roddy accompanied us to the building site.
We were informed that the damage occurred from the water storage on the roof of the
building. The storage was for the sprinkler systems, but the water was somehow released
in total, causing construction damage to floors 17 and 18, primarily in bathrooms which
were directly under the water holding tower, then the water spread out and flooded floors
16 down through about 5 or 6, where it started to spread out even further and be held in
pools.
We toured floor 17 briefly (it is currently occupied by a law firm) then visited floor 12
(which had a considerable amount of unoccupied space) and floor 7. Morse pointed out to
us the carpet, painting and clean-up work which had been ZZZZ Best's responsibility. We
noted some work not done in some other areas (and in unoccupied tenant space). But per
Mark, this was not ZZZZ Best's responsibility, rather was work being undertaken by
tenants for their own purposes.
Per Morse (and Roddy) ZZZZ Best's work is substantially complete and has passed final
inspection. Final sign-off is expected shortly, with final payment due to ZZZZ Best in early
December.
Morse was well versed in the building history and in the work scope for ZZZZ Best. The
tour was beneficial in gaining insight as to the scope of the damage that had occurred and
the type of work that the Company can do.
11
Congressional investigators quizzed Gray regarding the measures he took to confirm that
ZZZZ Best actually 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 confidentiality agreement.
Exhibit 3 presents a copy of that
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 a
Los Angeles Times
article in mid-May 1987 that revealed
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.
12
Exhibit 3
Ernst & Whinney's Confidentiality Agreement with ZZZZ Best
Regarding Visits to Restoration Projects
Mr. Barry Minkow, President
ZZZZ Best Co., Inc.
7040 Darby Avenue
Reseda, California
Dear Barry,
In connection with the proposed public offering (the Offering) of units consisting of
common stock and warrants of ZZZZ Best Co., Inc. (the Company), we have requested a tour
of the site of the Company's insurance restoration project in Sacramento, California,
Contract No. 18886. Subject to the representations and warranties below, the Company has
agreed to arrange such a tour, which will be conducted by a representative of Assured
Property Management Inc. (the Representative), which company is unaffiliated with
Interstate Appraisal Services. The undersigned, personally and on behalf of Ernst &
Whinney, hereby represents and warrants that:
1. We will not disclose the location of such building, or any other information with respect
to the project or the building, to any third parties or to any other members or
employees of our firm;
2. We will not make any follow-up telephone calls to any contractors, insurance
companies, the building owner, or other individuals involved in the restoration project;
3. We will obey all on-site safety and other rules and regulations established by the
Company, Interstate Appraisal Services, and the Representative;
4. The undersigned will be the only representative of this Firm present on the tour.
This Confidentiality Letter is also being furnished for the benefit of Interstate Appraisal
Services, to the same extent as if it were furnished directly to such company.
12
Exhibit 3
Ernst & Whinney's Confidentiality Agreement with ZZZZ Best
Regarding Visits to Restoration Projects
Mr. Barry Minkow, President
ZZZZ Best Co., Inc.
7040 Darby Avenue
Reseda, California
Dear Barry,
In connection with the proposed public offering (the Offering) of units consisting of
common stock and warrants of ZZZZ Best Co., Inc. (the Company), we have requested a tour
of the site of the Company's insurance restoration project in Sacramento, California,
Contract No. 18886. Subject to the representations and warranties below, the Company has
agreed to arrange such a tour, which will be conducted by a representative of Assured
Property Management Inc. (the Representative), which company is unaffiliated with
Interstate Appraisal Services. The undersigned, personally and on behalf of Ernst &
Whinney, hereby represents and warrants that:
1. We will not disclose the location of such building, or any other information with respect
to the project or the building, to any third parties or to any other members or
employees of our firm;
2. We will not make any follow-up telephone calls to any contractors, insurance
companies, the building owner, or other individuals involved in the restoration project;
3. We will obey all on-site safety and other rules and regulations established by the
Company, Interstate Appraisal Services, and the Representative;
4. The undersigned will be the only representative of this Firm present on the tour.
This Confidentiality Letter is also being furnished for the benefit of Interstate Appraisal
Services, to the same extent as if it were furnished directly to such company.
13
Minkow intended this press release to restore investors' confidence in the company
confidence that had been shaken by the damaging
Los Angeles Times
story. 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 led 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 announcement. That exhibit letter must comment on the
8-K's accuracy and completeness. In 1987, former 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
contracts might be fraudulent.
The congressional subcommittee was alarmed that 45 days passed before the charges of
fraudulent misrepresentations in ZZZZ Best's financial statements were disclosed to 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 its 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 Minkow retained to
replace Ernst & Whinney.
Congressman Wyden wanted to know whether Ernst &
13
Minkow intended this press release to restore investors' confidence in the company
confidence that had been shaken by the damaging
Los Angeles Times
story. 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 led 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 announcement. That exhibit letter must comment on the
8-K's accuracy and completeness. In 1987, former 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
contracts might be fraudulent.
The congressional subcommittee was alarmed that 45 days passed before the charges of
fraudulent misrepresentations in ZZZZ Best's financial statements were disclosed to 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 its 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 Minkow retained to
replace Ernst & Whinney.
Congressman Wyden wanted to know whether Ernst &
14
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,
shown in
Exhibit 4, 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:
15
Exhibit 4
Anonymous Letter Received by Ernst & Whinney Regarding
ZZZZ Best
June 9, 1987
Ernst & Whinney
515 South Flower
Los Angeles, California 90021
Dear Mr. Wilson:
I am an individual having certain confidential information regarding the financial condition
of ZZZZ Best Co., Inc. I have read the prospectus and your Review Report dated October 3,
1986, and recognize you have not done an examination in accordance with generally
accepted auditing standards, but that such audit will be forthcoming by you.
I wish to make you aware of the following material facts which require you to confirm or
disaffirm:
1. The electric generators which appear on the balance sheet under Note 6 as being
purchased for $1,970,000 were purchased for scrap for less than $100,000 thru
intermediaries of ZZZZ Best and resold to ZZZZ Best at the inflated value. The sole
purpose was to boost the assets on the balance sheet. These generators have never
been used and have no utility to the company.
2. Note 5 of the balance sheet discusses joint ventures and two restoration contracts.
These contracts are fictitious as are the bookkeeping entries to support their validity.
Interstate Appraisal Service [sic] did not let such contracts although they confirm their
existence. The same is true for the alleged $7,000,000 Sacramento contract and the
$40-100 million contracts with Interstate.
3. Further, checks made and passed between ZZZZ Best, its joint venturers and some of its
vendors are no more than transactions among conspirators to support the validity of
these restoration contracts.
4. Earnings reported by ZZZZ Best are being reported as Billings in excess of costs and
estimated earnings on restoration contracts. These contracts do not exist nor do the
earnings. This can be confirmed directly by contacting the alleged insurance carriers as
well as physical inspections as to the existence and extent of the contracts.
5. Billings and Earnings for 1985 and 1986 were fabricated by the company before being
presented to other accountants for certification.
Confirmation of these allegations can be accomplished by a careful due diligence. Such due
diligence on your behalf is imperative for your protection.
Very truly yours,
16
B. Cautious
Collapse of ZZZZ Best
The
Los Angeles Times
article 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 charge 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 the
Los Angeles
Times
investigated her allegations. The woman's diary eventually became the basis for
the
Los Angeles Times
article that, for the first time, cast doubt on the integrity of the "boy
wonder" who 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 (see Exhibit 5). 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 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, hardworking people. . . . The facts that
have begun to emerge establish t
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