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Zzz Best Carpet Cleaning Company

Essay by   •  April 9, 2011  •  Research Paper  •  3,833 Words (16 Pages)  •  2,562 Views

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In a recent interview with Steve Kroft of CBS News (60 Minutes), Barry Minkow, the founder of ZZZZ Best Carpet Cleaning Company said "I started with the best of intentions, really I can say that. And when economic pressure reared its ugly head and I couldn't make payroll, I lied and stole and cheated." Prior to declaring bankruptcy, ZZZZ Best was one of the hottest stocks on Wall Street and Barry Minkow was known as the boy wonder of Wall Street. As the youngest CEO of a $300 million company Barry Minkow was the American Dream come true: a self-made teenage millionaire, the subject of flattering magazine profiles and a guest on Oprah Winfrey Show. At its peak, ZZZZ Best had 1400 employees at 23 locations in three states. What went wrong?

In 1981, Barry Minkow started the ZZZZ Best at the age of 15 while he was a sophomore in high school in his parent's garage. He was introduced to the carpet cleaning industry at the age of twelve by his mother, who worked as a telephone solicitor for a small carpet cleaning firm. Due to the lack of barriers to entry in this industry (no licensing requirements, no apprenticeships to be served and only minimal start-up capital needed), it is not hard for anyone to start a carpet cleaning company. But at the same time, no barriers to entry meant that there was a cutthroat competition within the industry and it was not that easy to run a profitable company. In the early months, Minkow realized that though it was not easy to start a carpet cleaning company, it was even harder maintaining the business due to customer complains, collections, bad checks and impatient vendors demanding payment. At that point Minkow knew that if he wanted to survive in the industry, he would need working capital. He went to various banks, but due to his age and the fact that ZZZZ Best was only marginally profitable, local banks refused to loan him any money. As a result, Minkow decided to come up with his own ways to finance the growth of his business: check kitting, credit card forgeries, and staging of thefts to fleece his insurance company. So when he could not meet payroll, he would steal checks and deposit them in his bank account. He would kite checks, overbill customers and overdraw his checking account. He would do whatever it took to stay afloat. His age and his personal charm allowed him to get away with a lot of things. What actually made him believable was his verbal ability. Minkow was a smart kid and he realized from early on the benefits of an extensive social network of friends and acquaintances. For example, he became friends with Tom Padgett, an insurance claims adjuster, for his own benefits. He promised to pay Tom $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 which included minor remodeling work on properties damaged by fire, storms or other catastrophes.

The majority of the fraud was concentrated in ZZZZ Best's sales and receivables. Initially, these contracts, which were totally fictitious, helped generate paper profits and overstate the revenues to convince bankers to loan him money. Thanks to his phony financial statements he successfully got the money he needed from the banks and expanded his operations by opening several carpet cleaning branches across the San Fernando Valley. Minkow soon realized that the insurance restoration business was the segment that dictated the profitability of the company, so in a short period of time, insurance restoration, rather than carpet cleaning, became the primary revenue source for the business. During 1985 and 1986, ZZZZ Best reported undertaking several large insurance restoration projects. The company reported high profits from these restoration jobs.

Minkow's defamations did not stop there. He started using the phony financial statements to attract private investors, but even that was not enough for his "the sky is the limit" philosophy, so he decided to take his company public on the stock market in 1986. The public stock offering in 1986 stated that 86 percent of ZZZZ Best business was in the insurance restoration area. Though going public allowed Minkow to tap the bank accounts of investors nationwide, it also meant that he could no longer his firms financial statements. Since registering with SEC required audited financial statements, a full-scope independent audit of its financial statement for the twelve month ended April 30, 1986 was performed by George Greenspan. In his audit, Greenspan confirmed all the major insurance restoration jobs with Tom Padgett, the principal officer of Interstate Appraisal Services and an active participant in Minkow's fraudulent activities. It was Minkow who established Interstate Appraisal Services and Assured Property Management for the sole purpose of generating fake insurance restoration contracts for ZZZZ Best. According to Greenspan, he performed all the necessary analytical procedures and determined that the company's key financial ratios were in line with industry averages. However, Greenspan had not inspected any of the insurance restoration sites. Greenspan was later dismissed and Ernst & Whinney was hired to perform the following year's audit. The change was requested by the company's investment broker who recommended to Minkow to hire a Big Eight accounting firm to enhance the credibility of the company's financial statements. It was during this time that Minkow hired a high-profile Los Angeles law firm to represent ZZZZ Best as its legal counsel. Ernest & Whinney were engaged to perform the following: 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 addressed to the company's underwriters; and a full scope audit for the fiscal year 1987. Though Ernst & Whinney completed the review, provided the comfort letter and assisted the company in preparing the registration statement for the SEC, the auditors never completed the 1987 audit. Ernst & Whinney resigned on June 2, 1987 due to various concerns the company's financial statements were grossly misstated.

Furthermore, Ernst & Whinney did insist on visiting some of the insurance restoration jobs and even though at first Minkow attempted to discourage the visits, he agreed to allow the auditors to inspect various sites, knowing full well that none of the sites actually existed. To convince the auditors that the jobs were real, Minkow and some of his most trusted executive did extensive work to create fake job sites. One of the most elaborate schemes was a multi-dollar contract in Sacramento. For this job, Minkow found a large building under construction

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