Barry Minkow: 3 Lessons from Fraud-Fighter's Fraud Arrest

Last Updated Mar 27, 2011 11:00 PM EDT

Americans love a reformed sinner and that's just what they thought they'd gotten in Barry Minkow, the con artist turned minister and fraud-fighter. But it turns out that Minkow was much more interested in his own economic salvation than that of his "flock" -- regardless of whether you consider his flock the parishioners of the San Diego church where he served as a minister or the wide array of investors who followed the stock-selling advice of his "Fraud Discovery Institute."
Minkow agreed to plead guilty to securities fraud charges last week following a federal probe into the facile-tongued two-time crook. His story, the subject of a self-financed motion picture, should serve as a wake-up call for investors.

Here are three things Barry Minkow's tale should tell you:

1. Do Your Own Research: Minkow's latest foray into securities fraud involved his supposed investigation of Lennar Homes, a company that he described as "a fraud in progress." Minkow's purported revelations caused the company's stock price to drop nearly 20% in a matter of days in early 2009.

Yet Lennar financial statements indicated that, while struggling with the rest of the home building industry, the company was strong and appeared to be turning the corner. If you sold Lennar based on Minkow's word, you would have unloaded the company's shares when they were going for about $7.50. If you did your own research, you likely bought more stock-- or at least hung on-- and profited handsomely for keeping your own counsel. Lennar shares were selling for $20 on Friday -- up 167%.

Minkow's motivations aside, getting bad investment advice on "tips" whether they come from Mad Money's Jim Cramer or 50 Cent is the rule, not the exception. You can save yourself a lot of frustration and economic loss by checking a few key figures before you buy or sell a stock. If you need help figuring out what to look for, check out any one of a number of books on investing from my own Investing 101 to Eric Tyson's Investing for Dummies. The lessons are the same -- and simple.

The lesson here is also straightforward: If you rely on some one's "tip," your economic future is in their (sometimes larcenous) hands. Don't take chances with your wealth. Do your own research.

2. Character counts: In addition to evaluating the numbers, pay attention to the ethics of the people running a business. It makes sense to buy shares in companies like Berkshire Hathaway, where the character of the top executives is above reproach. And it makes sense to stay as far away from crooks as you can.

Minkow first went to prison in the late 1980s, after purporting to be the founder and proprietor of a fast-growing carpet cleaning operation called ZZZZ Best. It was probably where he learned the art of a convincing lie. Convincing liars weave a thread of easily-verifiable truth into facts that are harder to check to get people to believe the bigger lie. Minkow did have a carpet cleaning business and did clean some carpets. The rapid growth of his company was harder to verify because Minkow said his client list was "proprietary." In reality, it was fabricated. By lying he managed to sell shares of ZZZZ Best to investors and become an overnight millionaire. He was found out, convicted and sent to prison.

Minkow supposedly "reformed" and became a minister while in the federal pen. When he was released, he decided to fight fraud, exposing other people who did precisely what he'd done at ZZZZ Best. He quickly launched the "Fraud Discovery Institute." Like the carpet cleaning business, FDI did uncover some frauds.

But Minkow also had an angle. He was short-selling -- selling borrowed shares with the expectation that he would repurchase the shares later for less money. In a suit filed in Florida, Lennar accused Minkow of libel and extortion. The company said Minkow was falsely trashing Lennar stock to extort the company into paying money to his business partner, too.

Can crooks ever reform? Maybe. But don't bet your financial future on it. Barry Minkow's street smarts taught him that if you're a good enough talker, you can swindle people out of millions, regain their trust and swindle them again. It's the hustler's credo. In all financial transactions -- arguably, in all of life -- deal with people who value their own reputation as much as your money.

3. Believe Your Eyes: Warren Buffett doesn't get taken in by scams like Minkow's ZZZZ Best for a simple reason: He believes his eyes. Berkshire Hathaway buys easily understandable businesses -- companies that sell valuable products for a reasonable price, like GEICO insurance and the railroad company Burlington Northern Santa Fe. There are no "hot" stocks in his portfolio. No companies engaged in businesses that you wouldn't understand. You can see what they do and how they do it with your own eyes. He verifies the numbers; looks carefully at the business; and is suspicious of companies that grow by leaps and bounds because he knows how hard it is to maintain the proper quality control when you're growing like Topsy. In other words, he uses his eyes and his common sense when evaluating a stock.

If you want to buy individual stocks, that's a worthwhile model to follow. Buy shares in companies that produce products that you like and would recommend to a friend. Watch the companies carefully. Evaluate both the words and actions of their managers.

When you buy shares, you're buying a piece of a business. Make sure it's a business you can see, understand and support -- and that it's operated by people you respect and trust with your hard-earned savings.

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