On a crisp Sunday last November, an official of the ZZZZ Best carpet-cleaning company took the firm's lawyer and accountant on a tour of an office building in Sacramento, a final inspection before they gave their go-ahead for a public stock sale that would bring the company into the Wall Street limelight.
The lawyer and accountant were there to see how ZZZZ Best's most profitable line of business worked. Although the Reseda company founded by Barry Minkow was best known for its service to homeowners--it would clean two rooms of carpeting for $39.95--its ledger books showed that 86% of its revenue was from insurance jobs, repairing buildings damaged by fire or water.
The books listed a series of multimillion-dollar insurance contracts. But the crown jewel was a $7-million job in Sacramento, supposedly sprucing up a building damaged when a water main burst and its sprinkler system went off.
And so Mark Morze, 36, a former UCLA linebacker in charge of ZZZZ Best's insurance projects, showed off the office tower to Larry D. Gray, a partner with the Big Eight accounting firm of Ernst & Whinney, and Mark R. Moskowitz, an attorney from Hughes Hubbard & Reed, a New York-based firm with an office in Los Angeles.
Gray and Moskowitz toured several floors of the 18-story building, Morze recalled. Although there were no workers around on a Sunday, anyone could see what a good job ZZZZ Best had done: new carpeting had been laid, wiring and ceiling tiles were ready to be installed and trash and paint cans were ready to be carted away. It was almost like there had never been any water damage.
In fact, there hadn't been any damage, Morze said recently. ZZZZ Best had nothing to do with the office building. It was simply a new high-rise with space for lease that ZZZZ Best used as a prop in an expensive ruse.
Called a Charade
ZZZZ Best did not have a multimillion-dollar insurance job in Sacramento--or anywhere else, for that matter, Morze said. The insurance business was, in effect, a charade and the Sacramento trip was the grand performance.
"I couldn't believe it would work. I was expecting catastrophe," Morze said. He said he was thinking, "These are smart guys, they'll catch on."
But they didn't. After the tour, the attorneys and accountants gave their blessing and two weeks later ZZZZ Best sold $13 million worth of stock. Within months, the company was a hot pick on Wall Street. Its stock quadrupled, creating paper fortunes for many, including the 21-year-old Minkow, whose holdings grew to $100 million.
Since then, ZZZZ Best has collapsed like the house of cards it was. Minkow resigned, the compa ny entered Chapter 11 bankruptcy proceedings and the firm's board of directors is suing Minkow, Morze and others for $25 million, alleging fraud and theft.
Los Angeles Police Chief Daryl F. Gates has announced that Minkow and ZZZZ Best are under investigation for allegedly being part of a money-laundering conspiracy linked to organized crime.
While police are investigating what crimes may have been committed, ZZZZ Best investors are asking another question: How were the professionals fooled?
The accountants, attorneys, stock brokerage firms and ZZZZ Best's board of directors were all supposed to provide checks and balances before the public financing.
"I screamed at my broker and cried hysterically, 'How could you allow this to happen?' " said Jenny Raphael, who owns a fabric firm in New York. She bought ZZZZ Best stock at the urging of her broker when it was $16 a share, then sold at $1 a share, losing $50,000.
She is among a group of investors eager to join class-action lawsuits--some already filed in U.S. District Court in Los Angeles--against the company. Lawyers in those cases said they expect to sue ZZZZ Best's accountants, attorneys and its board of directors as well.
Asked Raphael: "What kind of checking did they do?"
Before a company sells stock to the public, the Securities and Exchange Commission requires "full disclosure." It is a lengthy process and a team effort, led by the stock brokerage firm that will actually sell the stock. In ZZZZ Best's case that was Rooney, Pace, a New York firm with a history of run-ins with the SEC. Rooney, Pace went out of business in January due to financial problems unrelated to ZZZZ Best.
Over several months, three accounting firms, including Ernst & Whinney, checked ZZZZ Best's numbers. Hughes Hubbard & Reed, ZZZZ Best's law firm, made sure the necessary documents were filed with the SEC. The brokers, accountants and lawyers all helped write the 48-page stock prospectus that went to potential investors.
James C. Van Horne, professor of finance at Stanford Business School, said the investing public has a right to expect "that the numbers are accurate, and the underwriters and accountants have dug a little more deeply."