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ZZZZ Best: A Case Study in Fraud

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Presentation on theme: "ZZZZ Best: A Case Study in Fraud"— Presentation transcript:

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 9/18/2018

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 9/18/2018

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 9/18/2018

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 9/18/2018

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


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