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`THE SYSTEM WAS PERFECT'
One day in May, 1989, Michael H. Borlinghaus, president of a small Wall Street trading firm, picked up an intriguing tip: Jerrico Inc., which owns a seafood restaurant chain, would soon be taken over by a New York investment group. He told his partner Heinz F. Grein and suggested their firm, Frost & Sullivan Holding Corp., acquire a position in Jerrico. Three months later, Jerrico agreed to the takeover at 24 1/4 a share, up from 16 when Frost & Sullivan started buying in.
Where did the tip come from? Borlinghaus denies any illegal activities, but Grein claims Borlinghaus made it clear to him that the tip had come from someone with access to inside information.
Over the next two years, Frost & Sullivan became the center of a far-flung insider-trading network--perhaps the largest since Ivan F. Boesky pleaded guilty in 1986. The firm invested in at least two dozen deals, including the takeover of Motel 6, Norton, Square D, and Birmingham Steel and asset sales by Time, AmBase, General Signal, and MissionResource.
From leads provided by Grein and after its own four-month investigation, BUSINESS WEEK is now able to flesh out the dimensions of the ring and identify individuals who appear to have been its major participants. Most of Grein's leads have been corroborated by independent sources, including investors and such documents as trading and bank records.
Besides Grein and Borlinghaus, the evidence suggests that the alleged ring also included: Christopher M. Garvey, a young legal assistant who worked for two years at Skadden, Arps, Slate, Meagher & Flom, a large New York law firm specializing in financial deals; Leonard S. Bellezza Jr., a high executive at R.H. Macy Co.; and David J. Simon, a private investor in takeover deals. Simon's lawyer and Bellezza deny any wrongdoing, while Garvey's lawyer did not offer a response.
DETERRENCE? The alleged ring functioned through an ingenious trading system that stretched from New York to Panama to Luxembourg and Switzerland. Much of the trading was channeled through BfG:Luxembourg, the Luxembourg branch of Frankfurt-based Bank fur Gemeinwirtschaft (BfG), the seventh-largest commercial bank in Germany. BfG advanced loans to many of the dozens of well-heeled U.S. and European investors who put money in the ring's stocks. German law-enforcement officials familiar with the operation estimate that at least $20 million was invested in insider-trading-related transactions.
These activities raise questions whether the massive publicity of insider-trading prosecutions during the late 1980s has had any deterrent effect. On June 4, the Securities & Exchange Commission brought charges against seven prominent East Coast executives and investors who allegedly passed tips back and forth with seeming abandon.
Some of the Frost & Sullivan deals, notably Motel 6 and Norton, are being probed by the SEC, which has also been checking into the activities of the former Skadden legal assistant. German prosecutors have been looking into possible tax-evasion violations by some of the European investors. But U.S. prosecutors seem unaware even of the existence of the Frost & Sullivan ring, let alone its broad scope. No charges are known to have been filed by U.S. prosecutors against any of the alleged participants.
Many details about the network came from Grein, an intense, powerfully built, 40-year-old private investor who came to the U.S. from Germany in 1987. Grein decided to tell his story to BUSINESS WEEK after the ring fell apart following a series of investments that went sour. Frost & Sullivan is now out of business. Grein claims he had become increasingly uncomfortable with participating in illegal activities. His lawyers have held preliminary discussions with federal prosecutors about a plea bargain under which he would admit to a reduced set of charges and agree to testify against others in the ring. The lawyers have not yet divulged to prosecutors any details of the ring.
`WE GOT LUCKY.' According to Grein, who oversaw Frost & Sullivan's trading, Borlinghaus was the chief contact for information sources. A trained chef who operated an institutional food-service business, Borlinghaus has portrayed himself to federal investigators as being only nominally involved with Frost & Sullivan's operations. Borlinghaus says his investment tips came from casual conversations. "You can't call it insider trading," he adds, "though we sometimes got lucky." But Werner Scheele, a commodities trader based in Luxembourg who invested in Frost & Sullivan deals, claims Borlinghaus told him in 1991 that the investments were made on the basis of inside information.
When Grein first came into contact with what he believed was inside information in the Jerrico deal, he was initially ambivalent. "My opinion was quite split," he recalls. "It was quite clear to me that we did something illegal. But the excuse was, everyone does it." Soon, though, he threw himself into insider trading. There had been no inquiries from law-enforcement agencies after Jerrico, which Grein says seemed to substantiate Borlinghaus' assurance that, as Grein says Borlinghaus told him, "there's no problem if we do it the right way."
Grein had already established a complex trading arrangement designed to permit European investors to evade taxes. After Jerrico, he carefully studied the trading methods of convicted insider trader Dennis B. Levine, which had proved relatively easy for prosecutors to penetrate. Levine actually operated under his own name when he traded in the Bahamas. Grein realized his tax-evasion system, especially its network of Panamanian-registered companies, would be much more effective than Levine's system in shielding investors from insider-trading inquiries.
It worked this way: Frost & Sullivan's European investors owned or leased at least 15 Luxembourg subsidiaries of the Panama-registered companies, which the investors used as trading vehicles. The companies had accounts at BfG:Luxembourg and were administered by Charles Ewert, a professional trustee who also nominally headed Frost & Sullivan Holding Corp., the U.S. firm's parent.
When Frost & Sullivan received a tip, Grein would inform his network of wealthy European investors, who would deposit funds in their Panamanian companies. Often, they would borrow the money or draw on credit lines from BfG. Grein would then transfer the money to other Panamanian companies that he controlled. Through those entities, Grein would issue trading instructions to BfG, which would route the orders to U.S. brokerage houses such as Merrill Lynch & Co. and Shearson Lehman Brothers Inc. for execution. If the deal was successful, Grein would then transfer half the profits to the investors' companies and would retain the rest in his companies for Frost & Sullivan.
Under Grein's system, law-enforcement authorities could trace trading to Frost & Sullivan. But the firm could say it was merely executing orders for clients. Unless the authorities could identify the real owners, which was impossible under existing Panamanian and Luxembourg law, they couldn't bring charges. "The system was really perfect," Grein says with pride. "You couldn't break it."
To further frustrate prosecutors, Grein assembled extensive files of brokerage reports, news clippings, and oth-er public-information sources that he could claim were the basis for his trades. And to throw prosecutors off the trail, he often traded directly in New York through Wagner Stott & Co., a securities firm from which Frost & Sullivan leased office space. When he was sending orders through BfG based on inside information, he would at the same time make New York trades that were inconsistent with insider trading.
Grein says he asked Borlinghaus to shield him from Frost & Sullivan's information sources so that if he were questioned by prosecutors about sources, he could truthfully disclaim any knowledge. When problems arose with the quality of the deal information, however, Grein was forced to talk directly to some sources.
Much of the investment money for the ring was solicited by Heiner Wille, a Dusseldorf-based investment adviser who represented Frost & Sullivan, and Lothar Poschmann, a senior executive at BfG:Luxembourg responsible for private investors, who also arranged loans and credit lines. The investors included Friedebert Schaubert, a Frankfurt commodities trader who invested $3 million; Juergen Kaape, a real estate broker in Hamburg who put in $1.3 million; Antoine Teillagory, a French businessman who invested $2.8 million; and Werner Scheele, the Luxembourg trader, who put in $1.3 million.
SURE THINGS? There seemed to be little mystery to investors about why Frost & Sullivan was a good place to put one's money. Certainly, the opportunity for tax evasion may have been a selling point. The key, however, was what Frost & Sullivan hinted at as its inside track on takeover deals. "Everyone at BfG who knew Grein, including myself, was sure his deals were based on inside information," says Poschmann. "That was his bait for investors."
The inside information originated from and was transmitted by a wide range of sources. But apparently by far the most important originator, according to BUSINESS WEEK's probe, was Christopher M. Garvey, who went to work as a legal assistant at Skadden Arps's Manhattan headquarters in the summer of 1989 following his graduation from Harvard University. Garvey left Skadden in August, 1991, after officials from the SEC and the Manhattan U.S. Attorney's office, who were conducting an insider-trading probe, expressed interest in Garvey's activities. There is an overlap between deals mentioned by law-enforcement authorities that Skadden had worked on and those in which Frost & Sullivan invested. BUSINESS WEEK was unable to reach Garvey. His lawyer, Debra Grobman, was asked for a response, but she did not provide one.
How did Garvey's information reach Frost & Sullivan? BUSINESS WEEK was unable to determine the method. There is substantial evidence about one apparent link inthe chain: Leonard Bellezza, 45, senior vice-president with Macy's Northeast Inc. Bellezza has been an occasional business partner and close neighbor of Michael Borlinghaus in Middletown, N.J., where Grein also lived. But how would Bellezza have gotten the information?
One curious event is a dinner in August, 1991, presumably before Christopher Garvey left Skadden, at Peter Luger Steakhouse, a popular Brooklyn restaurant. At the dinner were Werner Scheele, Borlinghaus, Bellezza, and an individual introduced to Scheele as "Lieberman." One purpose of the dinner was to persuade Scheele to invest in a new network similar to Frost & Sullivan's that would operate through the Luxembourg branch of Bank Leu Ltd., which is based in Zurich. "Lieberman" was the selling point: Scheele says he was told that he was the father of the Frost & Sullivan insider-trading network's "ultimate source," an individual who had graduated not long ago from Harvard. There was a discussion about the ultimate source's future educational plans. Scheele says it was clear to him that "Lieberman" was not the individual's real name. Scheele's account of the dinner is buttressed by Grein, who says Borlinghaus briefed him.
Christopher Garvey's father is William P. Garvey, senior vice-president for Grey Advertising Inc., one of New York's largest ad agencies. Yet BUSINESS WEEK found no evidence linking him to the ring. The elder Garvey declined to comment on the record. Debra Grobman, Christopher's lawyer, told BUSINESS WEEK that any allegation that William Garvey may have been involved with inside information was "totally untrue."
Leonard Bellezza denies any participation in an insider-trading scheme and says he never heard of the Garveys or Skadden Arps. He says he took positions in a "couple of" the stocks traded by Frost & Sullivan, but only on the basis of information from Borlinghaus.
MONEY MAZE. At least one of Bellezza's investments may have been quite profitable. In March, 1990, Bellezza traveled to Luxembourg to pick up money that Grein says was his cut of the profits from a trade related to inside information. Bank documents (page 62) show that on Mar. 26, 1990, two BfG:Luxembourg checks for $15,000 were drawn on one of Grein's Panamanian companies payable to Anthony J. Penta, Bellezza's father-in-law, and United Counties Trust Co., Bellezza's bank. Grein also withdrew $320,000 in cash, which, he says, he also gave to Bellezza.
Grein says the checks and cash represented Bellezza's share in profits from an investment in Norton Co., an abrasives maker whose stock jumped sharply when it received a takeover bid from London-based BTR PLC on Mar. 15. Skadden represented BTR. Frost & Sullivan had purchased call options between 2 1/4 and 5 from Mar. 9 to Mar. 13 and sold out its position at as high as 20 on Mar. 19-20, for a profit of $3.9 million. The SEC contacted Frost & Sullivan in connection with an insider-trading investigation involving Norton.
Bellezza confirms receiving the checks, but he denies that they were linked to insider-trading profits. He says the checks were a repayment of a loan he had made to Borlinghaus. He denies receiving any cash. Borlinghaus could not be reached for comment on these transactions.
In November, 1990, Bellezza was allegedly involved in an insider-trading discussion. Friedebert Schaubert, in an interview with BUSINESS WEEK, and Lothar Poschmann, in sworn testimony related to a legal proceeding in Germany against Grein, say they met with Bellezza at Grein's house in New Jersey after several Frost & Sullivan investments had fizzled. Bellezza, they say, reassured them by revealing he had information that Schneider, a French electrical-engineering company, would make a takeover bid in January, 1991, for Square D Co., a U.S. electrical-products maker. At the time, Skadden was representing Schneider, which did make the bid in February. Schaubert agreed to kick in an additional $800,000, while Poschmann contributed over $1 million from several BfG clients, who were not told about their investments. Bellezza says he attended a party with Schaubert and Poschmann but denies discussing Square D.
A second conduit of inside information, according to Grein, was David J. Simon, 41, a private investor who trades on takeover deals and special situations for his own account under the name of Twin Securities in midtown Manhattan. Lee Richards, Simon's attorney, says any allegations that Simon was involved with inside information are "totally false." Simon has never been charged with wrongdoing.
Simon, however, is apparently someone in whom the SEC has taken an interest. The commission denied a Freedom of Information Act document request submitted by BUSINESS WEEK on the grounds that materials concerning "the investigation of David J. Simon" were "investigatory records compiled for law-enforcement purposes, the release of which could reasonably be expected to interfere with enforcement proceedings." Lee Richards says he and Simon are "unaware of any investigation currently against Mr. Simon."
Simon's name first surfaced publicly in connection with the prosecution in the mid-1980s of the so-called "Yuppie Five," an insider-trading ring of young Wall Street professionals. Simon was a friend and high school classmate of Andrew Solomon, one of the yuppies who testified against his compatriots. In one of the trials, Solomon testified that he had given "material nonpublic information" to Simon on Revco D. S. Inc. and MGM Pathe Communications Inc. He also said Simon had given him inside tips on Macy's, Occidental Petroleum, MidCon, and Jack Eckerd. At the time, Simon was a research analyst in the risk-arbitrage department of the investment firm of Spear, Leeds & Kellogg.
Simon's main contact to Frost & Sullivan was through Joseph P. Greenwald, an options trader on the American Stock Exchange and president of Greenwald Securities Trading Inc., whose offices adjoined Frost & Sullivan's at 2 Rector St. Greenwald and Simon are business partners, and Simon manages some of Greenwald's money. According to Grein, Greenwald often discussed trading strategies with Joseph Latona, Frost & Sullivan's trader.
MOTEL DEAL. According to Grein, Simon played a central role in one of Frost & Sullivan's most successful insider-trading plays: the acquisition in July, 1990, of Motel 6 Corp. by Accor, the French hotel and tourism concern. The SEC, in its Freedom of Information Act letter, said its records show "no relationship" between the Motel 6 probe and its investigation of Simon. Yet Grein says he was told by Latona, as Grein puts it, that "Simon initiated this deal" and that "Simon had the contact with the information source." Grein says Simon's name was mentioned frequently by Greenwald and Latona in discussions about Motel 6. He also says he was told that Simon and his family invested heavily in Motel 6 before the deal was announced.
Richards, Simon's lawyer, says there is not "a shred of evidence" that his client traded on inside information on Motel 6 and that reports of his involvement are "wildly inaccurate." Stephen E. Kaufman, Greenwald's attorney, says his client "unequivocably denies" any allegations of insider trading. Latona couldn't be reached for comment.
According to BUSINESS WEEK's investigation, the source of the information was a senior executive at Motel 6. He disclosed details of the negotiation to a close friend, who was ill with AIDS and later died. The friend sold the information to Frost & Sullivan for $200,000. Grein says he has firsthand knowledge that a check for $200,000 was sent to the source.
Extensive predeal trading in Motel 6 sparked a broad SEC probe, which is still under way. The SEC declined to charge the Motel 6 executive on the grounds that he had not intended the information to be disseminated. Nor did it charge his friend because of his health.
According to Grein and German sources, there was also a two-way information flow between Frost & Sullivan and Luxembourg, where insider trading was then legal. It still is legal in Germany. BfG officials, he claims, invested in Frost & Sullivan deals such as Norton, Motel 6, and Square D. "Every deal was discussed with the bank's top management," says Grein. "In fact, many of my trades spread all over Europe." In return, says Grein, BfG officials gave Frost & Sullivan tips on such companies as Ultimate, Kay Jewelers, Contel, and NCR. A BfG spokesman at the bank's Frankfurt headquarters says an internal inquiry "has found no improprieties in management's own accounts."
For a time, the Frost & Sullivan network worked spectacularly. In addition to Motel 6, Norton, and Jerrico, Frost & Sullivan made big profits for its investors on Birmingham Steel and Time. But in mid-1990, a time when Wall Street's deal mania was subsiding, things started to deteriorate. Frost & Sullivan suffered its first big loss. Bellezza, says Grein, had passed along information that British media baron Robert Maxwell, who had tried to take over Harcourt Brace Jovanovich Inc. and then backed away, was preparing a new bid. Skadden Arps was, at the time, working for Maxwell. But no deal ever materialized, and Frost & Sullivan's investors ended up with losses of $2.7 million.
WIPEOUT. Things got even worse. There were more losses on Mission Resource, AmBase, and General Signal. The losses were exacerbated by the fact that many of the investments were in options that expired unexercised, wiping out investors' total stakes. In most cases, deals under consideration were dropped. In other cases, says Grein, information from Christopher Garvey, who was a novice to Wall Street dealmaking, was garbled or incomplete.
The string of setbacks produced growing strains within the network. Grein and Borlinghaus began arguing about who was to blame and who should have to eat the losses. The European investors became ever more restive. "People were getting unhappy," agrees Grein. Having been reassured by Bellezza of a big killing on Square D, many were angry when the Schneider bid was postponed beyond the expiration of nearly all of the options that investors had acquired. Many of the investors, whose cash had been put into deals without their permission, complained to BfG:Luxembourg and threatened to go to the bank's headquarters. Poschmann says he had discretionary power over those accounts, but the bank denies that he did.
By April, 1991, the network was disintegrating. Frost & Sullivan effectively shut down. BfG fired Poschmann, replaced the entire top management of BfG:Luxembourg, and sued Grein for defrauding the bank. Grein and BfG have also been sued by several of his investors. They claim Grein had guaranteed their investments would be profitable. Although he has not been formally accused of wrongdoing, Grein ended up spending three short stints in jail in connection with these actions. In Europe, the targets of private suits often are jailed briefly for procedural reasons.
All of this has taken its toll on Grein. "I went through hell," he says. His marriage has collapsed, and he is deep in debt. But he is now looking forward to writing a book about his experiences. He says that by admitting his misdeeds, he hopes to rebuild his now-strained relationship with his three young children. "Now, the pressure is off," he insists. The same cannot be said for those people who gave him information.Chris Welles in New York and Igor Reichlin in Bonn