ZZZZ Best Case Places SEC Procedures Under Scrutiny
The stunning fall of youthful millionaire Barry Minkow and his ZZZZ Best rug cleaning empire amid charges of massive fraud points to serious flaws in the nation’s financial reporting system, congressmen said Wednesday.
Minkow was 15 when he founded ZZZZ Best in his parents’ garage in suburban Los Angeles, 18 when he made his first $1 million and 21 earlier this month when he and 11 others were charged with swindling nearly $70 million from banks and investors.
Minkow took the Reseda company public in 1986, attracting investors on the strength of soaring revenues reported from restoring fire-damaged buildings for insurance companies. The stock became a Wall Street darling, rocketing from $4 to $18 a share before ZZZZ Best’s bubble burst.
Fabrications Alleged
Despite independent audits that certified the authenticity of the company’s financial statements, nearly 85% of ZZZZ Best’s business was a complete fabrication, according to Rep. John Dingell (D-Mich.), chairman of the House Energy and Commerce Committee.
“Where were the independent auditors and others who are paid to alert the public to fraud and deceit?” Dingell asked at a hearing before his oversight and investigations subcommittee.
Minkow and his co-defendants have pleaded innocent in federal court. Before his fall, the boy wonder’s seemingly Horatio Alger-like rise was chronicled by newspapers and magazines. He wrote a book and appeared on television’s “Oprah Winfrey Show.”
Subcommittee members watched a videotape in which Minkow vowed to make ZZZZ Best “the General Motors of carpet cleaning” and told Winfrey his philosophy of life: “Think big, be big. End of story.”
Their questions focused on three areas:
- Securities law provisions, which allow independent auditors to wait six weeks before revealing publicly why they resigned. ZZZZ Best’s auditor, Ernst & Whinney, quit June 2, suspecting that one of the company’s major contracts did not exist. The auditing firm did not disclose its suspicions to the Securities and Exchange Commission until July 16. Meanwhile, unwitting investors continued to buy ZZZZ Best stock.
- The process ZZZZ Best used to go public, which Dingell called a “backdoor maneuver.” It purchased a dormant shell corporation in Utah for only pennies a share, changed its name and sold stock. That method allowed ZZZZ Best to avoid some of the requirements imposed by the SEC on newly registered public companies.
- Possible rough spots in the relations between the SEC, which brings civil actions to enforce federal securities laws, and local and federal law enforcement agencies, which bring criminal charges.
Robert C. Bonner, U.S. attorney in Los Angeles, said auditing firms ought to be required to contact law enforcement authorities when suspicions arise.
Ernst & Whinney, he said, “simply said, ‘Let’s get the hell out of here’ and resigned.”
‘Out of the Barn’
By the time it disclosed the reason, Bonner said, “the proverbial horse was already out of the barn.” According to the most recent accounting, investors in ZZZZ Best lost $60 million and banks loaning money to the company lost $9 million, he said.
Rep. Ron Wyden (D-Ore.) said the SEC’s system for reporting changes of auditors “has more holes than Swiss cheese.”
While praising the Los Angeles office of the SEC, Bonner said SEC procedures in some regions make no provision for automatically referring cases for criminal prosecution. Sometimes cases are not referred until the SEC’s civil charges are resolved and by that time “these cases are extremely stale,” he said.
Mike Brambles, the Los Angeles police detective who coordinated the ZZZZ Best investigation, said, “The SEC could have been streamlined somewhat in their bureaucratic structure.”
The agency’s performance was good once the investigation got rolling, but a requirement that subpoenas be approved by the commission in Washington caused a “substantial delay” in beginning the probe, Brambles said.
Mary McCue, an SEC spokeswoman, said subpoenas are approved by the commission, rather than staff members, as a safeguard. She said the SEC staff has discussed changing procedures for reporting the dismissal or resignation of an auditing firm but has not presented the commission with its recommendations.
Minkow, through his attorney, declined an invitation to testify before the committee, Dingell said.
S. George Greenspan, whose Englewood Cliffs, N.J., firm audited ZZZZ Best’s initial public offering, defended his performance.
“I was satisfied that these jobs existed--from six different sources--including payment for the job. What more can you want?” he said. “I am as much aghast as anyone. Every night I sit down and say, ‘Why didn’t I detect that fraud?’ ”
