Key events surrounding the case
Barry Minkow learned the carpet-cleaning business from his mother and proceeded to establish his own company, ZZZZ Best Co., at the tender age of 16. However, the capital was a major issue and he soon started undertaking credit card forgeries alongside other frauds that provided his initial capital. As a charismatic individual, he was able to make friends with many professionals including Tom Padgett who was a claims adjuster. With Tom’s services, he was now able to fraudulently acquire insurance restoration contracts that immensely boosted his carpet business.
Before the company went public, George Greenspan conducted an audit but did not fully inspect the restoration contracts. This gave the company a clean sheet to go public and was able to acquire massive funding from the public. The overnight success saw Minkow become famous with his company receiving positive reviews from investment analysts among other professionals. Greenspan was dropped and in his place, Ernst & Whinney was contracted as ZZZZ Best audit firm. Even though the latter failed to contact the former about the authenticity of the restoration contracts, It went ahead to visit one of the sites that were identified in the contract which the sly Minkow stage-managed the events by hiring a third party building leading to Ernst & Whinney’s innocent approval.
But after a series of events related to Minkow’s integrity, Ernst & Whinney resigned especially after the company released a false statement of its earnings. It however failed to give reasons for its decision as is required and only did so after the allocated time had expired exposing the company’s fraudulent activities. But by this time, ZZZZ Best had already filed for bankruptcy protection that shielded it from creditors. Ernst & Whinney was accused of overlooking gross errors in conducting audits for which it was absolved from any wrongdoing as it only issued a review but not opinion that banks utilized in issuing loans.
The key auditing topics
The ZZZZ Best case is one of the most complex accounting frauds to have been undertaken as it managed to bypass even the watchful and credible Security Exchange Council. However, there are still some auditing issues that can be identified from the case.
The independence of Tom Padgett is at stake and a clash of interests can be identified when he knowingly seeks his interests at the expense of issuing true opinion of ZZZZ Best restoration contracts. He also acted unethically more so in his involvement in misrepresenting banks and other creditors that relied on his opinion to advance credit to the company.
The first auditor, George Greenspan, failed to comply with standards as well as to objectively conduct audits of ZZZZ Best. He failed to obtain sufficient evidence concerning the authenticity of restoration contracts that could have prevented the company from going public and swindling public investors.
Ernst & Whinney also did not comply with standards by its failure to extensively consult the former auditor after it was contracted. It failed in its legal obligations as an audit firm by not giving reasons for its decision to quit as it is required by law. It also failed on its obligations to the public by only reviewing and not issuing an opinion on the firm’s status despite having been the official auditor. Furthermore, had it raised the flag on ZZZZ Best integrity, it could have averted losses from those investors that purchased stocks after it had been made aware of the company’s fraudulent conduct just before filing for bankruptcy. This was also against the exemptions to rule on confidentiality that requires audit firms not to seek clients’ consent in publicizing information concerning their professional malpractices.