ZZZZ Best's Story

Topics: Audit, Auditing, External auditor Pages: 7 (2742 words) Published: November 11, 2008
ZZZZ Best, Inc.

The start of ZZZZ Best:
ZZZZ Best started as a carpet cleaning company. Barry Minkow founded ZZZZ Best in his parents’ garage in 1982 when he was only sixteen years old. Due to high competition in the industry, low enter barriers, and bad internal control, this young entrepreneur started to have cash flow problems, and a shortage of working capital. Pressure Leads to Fraud:

Under financial pressure, Minkow started to commit fraud. He forged credit card applications, staged theft, used bogus financial statements, and used his networking skills to entice wealthy investors. The most serious fraud he made was inflating the value of the company’s insurance restoration contracts (Knapp, 2006). Inflated Insurance Restoration Contract

Minkow created two property management companies, the Interstate Appraisal Service and Assured Property Management. He also hired a well-known insurance agent, Tom Padgett, to be the principal officer of Interstate Appraisal Service and used these two companies to generate paper profit. The falsified paper profit accounted for almost 90% of ZZZZ Best’s revenue. Deception of Auditors:

1.False confirmations
Since most of revenue came from insurance restoration contracts, George Greenspan, the first auditor of ZZZZ Best, contacted Tom Padgett to confirm the existence of the insurance restoration contracts. Padgett, being in on the fraud, lied and gave Greenspan a positive answer. 2.Misleading auditors:

Barry Minkow dismissed Greenspan after his audit of 1986 financials and hired Larry Gray from Ernst & Whinney. Because the amount of insurance restoration contracts was material, Gray informed ZZZZ Best of his wish to observe the restoration sites to confirm their existence. Since the sites were nonexistent, Minkow temporarily rented an office to pass off as one of the sites. He informed the auditors that the water storage broke in the other offices which were being restored, and the area was inaccessible due to the damage. Minkow also convinced the auditors not to make follow-up phone calls to contractors and insurance companies or disclose the office location due to privacy concerns (Knapp, 2006). The Collapse of ZZZZ Best:

In 1986, Barry Minkow decided to make ZZZZ Best a public company. Its market value soared to $18 in the end of 1986. This market growth did not persist for long. In May of 1987, an article from Los Angles Times exposed Barry Minkow’s integrity problems. Consequent auditor investigations found corroborating evidence to prove the truthfulness of the fictitious insurance restoration rumor. This article triggered a chain of events. First, brokers from small companies started to short sell ZZZZ Best stocks. Later, ZZZZ Best’s law firm began to doubt this young entrepreneur’s honesty and the authenticity of the insurance restoration contracts. These events made Barry Minkow panic and take even more desperate and detrimental actions, further exposing his culpability. As a consequence of these events, ZZZZ Best filed for bankruptcy. ZZZZ Best was auctioned at net asset value $62,000 in July of 1987 which was just three months after its market value reached 220 million dollars. Fraud Assessment:

Auditors can take several lessons away from ZZZZ Best’s fraud. By applying the fraud diamond framework, the auditors can identify the red flags that alert them of trouble in the enterprise. Fraud Diamond

In ZZZZ Best’s case, the fraud diamond framework can be applied to the company and Barry Minkow as below: 1.Incentive:
A popular incentive of fraud is always financial pressure. Barry Minkow established ZZZZ Best with a small start-up capital. In the beginning, the carpet cleaning business was not an easy way to earn a living. This industry has no obstacles to entry. The complaints of customers, tough competition, bad debt from customers, and nagging vendors demanding payment made the company’s life difficult. Because of the youth of the owner, and the bad...

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