You Can't Cheat an Honest Man - James Walsh [133]
There’s a slight benefit to this more difficult standard. If a burned investor can establish that a lawyer or accountant has made a material omission, positive proof of reliance is not necessary if the investor can show that (1) the withheld facts were material, and (2) defendant had a duty to disclose the facts. The two charges are often so closely linked that both—or either—can be made by a burned investor. For that reason, many make both claims. The courts are left to sort through somewhat confusing law and absolutely confusing facts.
As one court noted: “Like standing dominoes, however, one misrepresentation in a financial statement can cause subsequent statements to fall into inaccuracy and distortion when considered by themselves or compared with previous statements.”
In the end, the courts themselves aren’t clear about the distinctions between misrepresentations and omissions. In the federal appeals court decision Little v. First-California Company, the court stated:
The categories of “omission” and “misrepresentation” are not mutually exclusive. All misrepresentations are also non-disclosures, at least to the extent that there is failure to disclose which facts in the representation are not true. Thus, the failure to report an expense item on an income statement, when such a failure is material, ...can be characterized as (a) an omission of a material expense item, (b) a misrepresentation of income, or (c) both.
One of the issues that kept the Home-Stake Mining Ponzi scheme in the courts for more than 20 years was whether its lawyers could be held liable. Even the question was complicated. One of the appeals courts asked whether the lawyers:
aided and abetted the fraudulent conduct...in the preparation of registration statements...either with actual knowledge as attorneys of the misrepresentations and the omission of material facts set forth in the registration statements and prospectuses in which their names appeared, with their consent, or, in the alternative, under circumstances where in the due exercise of their professional responsibilities these attorneys should have known of such....
The answer, in either case, turned out to be “yes.” The professional liability insurance companies for several of the firms settled with the burned investors to make the case go away.
How Two Young Ponzi Perps Conned Lots of Accountants
Barry Minkow was a decade-of-greed oddity who started an unlikely company—it cleaned rugs—when he was 16 and crashed before he was 25. His company, called ZZZZ Best Carpet Cleaning, was nothing more than a particularly aggressive Ponzi scheme. But it stands as a testament to how easily greedy professionals can be convinced to lend an air of legitimacy to a bogus enterprise.
ZZZZ Best started out cleaning carpets in people’s homes in the suburban San Fernando Valley, north of Los Angeles. For a short time, it was a legitimate business—driven by Minkow’s cloying boyish chutzpah. In the mid 1980s, Minkow started talking about big contracts he was signing to clean carpets for L.A.’s biggest companies and for insurance companies rehabilitating fire-damaged buildings.
The high-margin insurance work was all fiction. Minkow and a handful of advisers (who may have had organized crime connections) borrowed money from loan sharks, repaid it with money borrowed from investors and sloshed the whole thing around several corporate bank accounts to make ZZZZ Best look bigger than it was.
The company expanded its Ponzi scheme by selling shares to the public (at one point, it had a market capitalization of more than $200 million). This is where the craven accountants came into play.
Mark Morze, the financial architect of the ZZZZ Best scam, said the insurance restoration division was a good example of how accountants are willing to be misled about a scam. “No one ever checked those receivables. Not the auditors. No one. Think about that. If you were having construction done on your home, you’d check the contractor’s references and you’d ask about licenses