1. ZZZZ Best: A Case Study in Fraud
Dr. Donald K. McConnell Jr.
9/18/2018

2. The Major Conspirators
Barry Minkow
Boy “genius” started a carpet cleaning business in family garage at age 16
Charming con artist from day one
Multimillionaire by age 21
Mark Morze
Most lettered UCLA athlete in history
Majored in physical sciences at UCLA
Had a small bookkeeping practice in L.A.
Small time business consultant hired by Minkow to obtain loans
Self described master manipulator
“Virtuoso” of the copy machine
Neither were very well versed in accounting and finance
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3. Facts of the Case
Working capital shortages in “rug sucking” business motivated:
Credit card forgery
Check kiting schemes
Thefts
Age and charm allowed Minkow to escape early brushes with the law
Mark Morze secured small-business short-term loans on a commission basis*
Morze induced to go to work full-time for Minkow securing loans for commissions
9/18/2018

4. Facts of the Case (con.) Minkow: A/R an amazing thing!
To obtain bank loans against fictitious accounts receivable:
Paid an insurance claims adjuster $100 per week to confirm bogus minor restoration work to lenders
Led adjuster to believe such was to circumvent bureaucratic red tape and insurance industry
This led to increasingly large amounts of bogus insurance restoration business
Fictitious insurance restoration became major revenue source
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5. Facts of the Case (con.)
Tiring of being one step ahead of creditors, Minkow decided to take ZZZZ Best public
“You have to pay back loans. You don’t have to pay back stockholders.”
9/18/2018

6. Scamming the Auditors: Barry Minkow
Minkow bragged about steering the auditors to do 90 % of their work in the 10 % of his business (carpet cleaning) which was legitimate
When pressed for information:
“You guys are just grinding me.”
“I’ll bet Coopers would love to have our account.”
Intimidation techniques
Middle management out of the loop, so fewer had to lie
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7. Scamming the Auditors: Mark Morze
Says he never outsmarted the “triumvirate” (CPA’s, securities lawyers, underwriters); he manipulated them
When asked a tough question for which he had no answer:
Caused fake cell phone to ring
Buying time to research the issues
Allowed uncomfortable silence to give him “wiggle room” when asked about an unusual circumstance:
Auditors would often ultimately suggest an explanation, resulting in a, “That’s it!”
Morze: “Don’t help the fraudster!”
Look for the truth, not the accuracy
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8. The IPO Showdown
Auditors insisted upon physically examining several major restoration locations before signing off on IPO
These did not exist!
Minkow, in a rage, contends unnecessary and proclaims on a Friday afternoon, “ The deal is off”
Intentional manipulation to let underwriting syndicate stew over the weekend: big underwriting fees were “flying away”
9/18/2018

9. The Showdown (con.) Underwriting meeting following Monday morning
Minkow, sheepishly, “You guys were right, and I overreacted.”
“You can observe, but only one location.”
Experts manipulated and accepted scope restriction to save the deal
Now, how could Minkow find a building to be observed?
9/18/2018

10. Auditors Manipulated and Scammed Again
Morze found a building under original construction in Sacramento
Posed as a corporate leasing agent seeking rental of several floors of the six floor building
Fictitious building had 16 floors!*
From outward appearances,could have appeared to be a restoration
Auditors were asked to tour building on a weekend
9/18/2018

11. Auditors Scammed Again (con.)
Auditors toured the single allowed facility on the weekend, as required
Security guards had been bribed $100 each to warmly greet Minkow, as if they knew him
Workers were wearing ZZZZ Best T-shirts
Phony signs were hung in the building: “Another ZZZZ Best restoration in progress.”
Satisfied, the auditors were in and out in 15 minutes
9/18/2018

12. Auditors had signed a Conditional letter of acknowledgement
Not to disclose location of building to any third parties
Not to make any follow-up telephone calls to contractors, insurance companies, building owner, etc.
Only one auditor was allowed to tour the phony restoration project
Incredible scope restrictions imposed by client!
9/18/2018

13. Other Problems in the Audit Process
Entire $7 million plus contract contained on a single 8.5x11 page!
Should have been hundreds of pages of building and construction permits, specifications, etc.
Contract reflected sales tax of $301,000.
California didn’t impose sales tax on such
66% profit on a competitive bid job? Morze: “Put away your calculators, and look beyond the numbers!”
9/18/2018

14. Other Problems in the Audit Process (con.)
Inadequate industry knowledge: ZZZZ’s restoration revenue > total restoration revenue in entire U.S. for previous 3 yrs.
Sixteen story building shrank to six floors!
Warning sign: Auditors consistently only given copies of documents
There were no original documents; these had to be fraudulently prepared
Incredible reported profits, but no cash
9/18/2018

15. The House of Cards Collapses
Questioning Minkow’s integrity after several events, auditors resigned
L.A. Times article: housewife previously scammed on rug cleaning complains
ZZZZ Best issued press release of record profits without notifying auditors
Anonymous letter to auditors warns of the fraud
Letter signed: “Very truly , B. Cautious”
Audit evidence confirmed some of anonymous allegations *
9/18/2018

16. ZZZZ Best: Aftermath
Barry Minkow was convicted of securities fraud; sentenced 25 yrs.
Later paroled, becoming a fraud consultant, and preacher in L.A.
Mark Morze refused to implicate CPA’s, lawyers, and Underwriters, though govt. attys. were convinced conspirators lacked sophistication to have acted alone
Morze now lectures, and is an ethics professor at Pepperdine University
9/18/2018