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 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 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.
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.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.”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 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.Answer each question in 3-5 sentences, demonstrating your understanding of fraud examination principles.1. The Nature of the Fraud
Compare the types of fraud committed by Barry Minkow (ZZZZ Best) and Bernie Madoff. How were their schemes structured, and what made them successful for a period of time?
2. The Role of Auditors & Due Diligence
Why did auditors fail to detect fraud in both ZZZZ Best and Madoff’s Ponzi scheme? What red flags were missed, and what should have been done differently?
3. Ponzi Scheme vs. Fake Business Model
Bernie Madoff operated a Ponzi scheme, while Barry Minkow created a fake business (phantom carpet cleaning jobs). Explain how each scheme worked and why investors trusted them.
4. The Fraud Triangle Application
Using Donald Cressey’s Fraud Triangle, analyze the Pressure, Opportunity, and Rationalization that led both Minkow and Madoff to commit fraud.
5. The Role of Reputation & Deception
Both Minkow and Madoff built reputations that made their frauds believable. What specific tactics did they use to gain trust and credibility with investors, regulators, and the public?
6. Impact on Victims
Describe the impact of ZZZZ Best’s collapse and Madoff’s Ponzi scheme on investors, employees, and financial markets. Which scheme had the greater financial impact, and why?
7. SEC & Regulatory Failures
The SEC (Securities and Exchange Commission) had opportunities to stop Madoff’s fraud but failed. What mistakes did regulators make, and how did these failures compare to the lack of oversight in ZZZZ Best’s fraud?
8. Legal Consequences
What were the legal consequences for Barry Minkow and Bernie Madoff? How did their sentences compare, and what factors influenced their punishments?
9. Lessons for Auditors & Fraud Examiners
What are three major lessons that fraud examiners and auditors should learn from the ZZZZ Best and Madoff fraud cases to prevent future fraud?
10. Ethical Considerations & Whistleblowing
Were there any whistleblowers in the ZZZZ Best or Madoff cases? If so, why weren’t they listened to sooner? If not, what ethical obligations should insiders have followed?
Reference: Michael C. Knapp, Contemporary Auditing, Twelfth Edition. © 2022 Cengage.