cont->SEE NO EVIL. Regulators do not always act so swiftly, or at all. For example, in 1992 and 1993 the NASD became aware of possible payoffs to a 150-broker California firm called LaJolla Capital. According to an internal NASD memorandum obtained by BUSINESS WEEK, NASD examinations found that the brokerage had accepted ''due diligence fees'' and ''investment banking fees'' from companies for which it was a market maker. But the NASD never acted on those findings--which officials suspected were illegal payoffs. A LaJolla spokesperson, Janet Frazier, denied LaJolla had ever accepted payments for making a market in companies, but said the company continued to accept due diligence fees--in return for carrying out due diligence on companies.
The NASD's Goldsmith says that he does not know why the LaJolla case was not pursued. But he observed that a federal appellate court ruling in 1994--on alleged payoffs to another firm--required the NASD to issue a formal rule banning such conduct before prosecuting payoffs to brokerages. The rule was not issued until last July. In the interim, he noted, the NASD did not pursue such cases. Goldsmith pointed out that the NASD fined LaJolla in September for violating penny-stock sales rules, in a decision that LaJolla says it is vigorously contesting. However, the recent action makes no mention of payments from companies.
Payoffs to brokers and brokerages by corporate officials and stock promoters are some of the most invidious practices in the chop-stock business. How widespread are they? Regulators at the NASD minimize their prevalence. ''When you're talking about payments or bribes--we take that very seriously. But to characterize that as widespread, as sort of the practice or the norm, or as endemic, even to the small, micro-cap stocks--we just don't see that,'' says the NASD's Goldsmith.
But former chop-house execs maintain that such payoffs are pervasive throughout the world of micro-cap stocks. Chop-house brokers say that corporate officials, directly or through intermediaries, frequently pay off brokers to drive share prices upward, or to obtain offerings of their shares for listing on the OTC Bulletin Board. At one brokerage, a former chop-house manager maintains, every OTC Bulletin Board stock offering involved a payoff. ''It's a very thin market, usually there's very little on the buy side initially--that's why they have to enlist the help of a lot of brokers to get the buyers for these things,'' says one former chop-house broker. The brokers have the whip hand--and thus can demand payoffs. In one case, according to the former chop-house official interviewed by BUSINESS WEEK, even NASD examiners are not immune from accepting payoffs. However, NASD officials contend that they have heard no such allegations--which, they say, they would promptly refer to law enforcement.
One problem the NASD does pursue fairly vigorously is common at chop houses--excessive commissions and markups. But the cases they handle appear to be the tip of the iceberg--and point up the sensitive role served by the Wall Street firms that process trades for chop houses. The firms often process trades that appear to show excess markups and commissions--but insist that they are in no position to monitor the activities of the firms that trade for them. Regulators are studying ways of chipping away at this long-established, legally sanctioned ''see no evil'' policy--for often, there is a lot of evil that passes through their trading systems.
A LOT OF HEAT. In its recent prosecution of Euro-Atlantic, markups of as much as 63% were alleged. The NASD complaint does not specify when the trades took place, but they appear to have been in the latter half of 1996--at a time when the trades were processed by Schroder Wertheim. A Schroder spokeswoman declined comment on whether the firm was aware of the overcharges or even whether Schroder processed the trades--though the spokeswoman said the firm ''apparently'' did so.
One firm that has been subject to substantial heat for its chop-house clearing activities--particularly at the now-defunct A.R. Baron--is Bear Stearns. Bear has been the clearing agent for a host of chop houses, including PCM Securities, Meyers Pollock, and another major dealer in small-company stocks--Paragon Capital--where, regulators have been told by a former Paragon employee, massive overcharges have taken place. These charges are significant because Paragon is believed to be one of the largest dealers, possibly the biggest, in OTC Bulletin Board stocks.
Internal Paragon trading records from late 1994, which were recently submitted to the NASD and were obtained by BUSINESS WEEK, show apparently massive commissions. Some were as high as 25% or more. One trade went as follows: On Aug. 19, 1994, one customer bought 17,700 shares of Environmental Technologies USA Inc. for $13,275. According to the trading records furnished to the NASD, as shown above, he paid a commission of $3,982.50--30%. Similar high commissions were charged for trades that took place on other days that month.
According to the trading records supplied to the SEC by a former Paragon employee, customers were similarly overcharged in a host of other stocks--Evro, Paramark Enterprises, Apogee Robotics, La-Man, Eco2, First Standard Ventures, and quite a few others. There was no indication that the firms had any knowledge of the overcharges. Repeated calls to Paragon President Danny Levine for comment on these allegations were not returned.
The trading records were routinely churned out by Bear Stearns, which could have noted the size of the commissions at Paragon by making a simple calculation. Two former Paragon officials, who were unacquainted with the former Paragon employee who submitted the records to the NASD, said that the trading records show the magnitude of the commissions clearly and that they would be obvious at a glance. However, an official of a rival clearing firm--no friend of Bear--notes that there is ''no obligation of a clearing firm to look at anything like that.'' Bear Stearns's position is that it simply processed the Paragon trading records and did not review them. Asserts Bear Stearns's general counsel, Mark E. Lehman: ''It is our view that the responsibility for determining markups and commissions is that of the introducing firm and not the clearing firm.'' According to Lehman, Bear Stearns is still clearing trades for Paragon.
''GRAVY.'' One former Paragon manager observed a nefarious practice that, he maintains, has been common at the New York headquarters of Paragon in recent years. According to this ex-manager, who personally witnessed the practice, Paragon would postdate and predate time stamps of trading tickets, to make markups as large as possible. According to this ex-manager, the scheme worked like this: A customer would buy 10,000 shares of a Bulletin Board stock when the market was $5 bid and $6 asked. If portions of the order were filled at a lower price, the order was supposed to be time-stamped to reflect that, and at the end of the day the orders are submitted to NASDAQ. The former manager maintains that Paragon would accumulate the stock during the day--paying, say, $5 for the first thousand, $5.50 for the next, and so on--and show the entire order at the highest price. ''Everything else is gravy for the broker,'' says the ex-Paragon manager.
No one seems to have sopped up the gravy that flows from chop stocks more than Jordan Belfort, who founded the Stratton Oakmont penny-stock brokerage in the 1980s. Just 35, he is believed to be a millionaire many times over. ''Investment banker'' was how Yachting Magazine characterized him in its May issue, in detailing the sinking of his 150-foot yacht, the Nadine. A publicity release from United Film Distributors, one of Belfort's many enterprises, calls him a ''private investor.'' The Queens (N.Y.) native is the executive producer of several of United's movies, which have titles such as Santa With Muscles.
But there is another side to Belfort. According to numerous chop-house execs and traders interviewed by BUSINESS WEEK, Belfort has remained a hidden power whose influence in the chop-stock world has hardly waned since he sold his stake in Stratton and was barred for life from the securities industry by the SEC, nearly four years ago. (Belfort agreed to the ban without admitting or denying the SEC's allegations of securities fraud.) He has managed to retain his power and wealth while apparently remaining within the letter of his agreement with the SEC. Indeed, his name does not appear on a single scrap of paper associated with any brokerage--except Stratton.
After he left Stratton, Belfort continued to draw vast sums from the firm--something that is currently being investigated by Stratton's bankruptcy trustee, Harvey Miller. Under a ''noncompete'' agreement that he signed with Stratton in March, 1994, Stratton agreed to pay Belfort a staggering $180 million, payable in monthly installments of $1 million. In return, Belfort could not open a competing brokerage. The timing of the deal was fortuitous, to say the least--it was signed one week before Belfort was banned from the securities business. The SEC ban, one state regulator observes, was no doubt pending at the time the noncompete was signed. Belfort and the former attorney for Stratton who negotiated the deal, Ira L. Sorkin, declined comment, with Sorkin citing attorney-client privilege.
Belfort kept up his side of the bargain by keeping out of the securities business--at least on paper. Sources on Wall Street assert that Belfort continues to exert control, through intermediaries, of some of the leading brokerages in the micro-cap stock business. Among them are D.L. Cromwell Investments, Monroe Parker Securities, and Biltmore Securities. Allegations of Belfort control are not new for Monroe Parker--they were raised in 1992 by the NASD when the firm applied for membership, notes Monroe Parker attorney Bill Singer. But Singer says that the NASD was satisfied that Belfort had no hidden role at the firm. Attorneys for Biltmore and D.L. Cromwell deny that Belfort has any tie to the firms.
FRONT MAN. But Amr ''Tony'' Elgindy, head of a Fort Worth-based firm called Key West Securities Inc., has alleged in court papers that Belfort bought a silent partnership in his firm early in 1997. He maintains that the relationship fell apart after he resisted pressure by Belfort to open up an office in New York City to sell stock to the public in the time-proven way, by high-pressure cold-calling. According to Elgindy, Belfort bought into his firm using a trusted associate named Robert LoRusso as a ''front man.'' LoRusso and Belfort vigorously deny Elgindy's allegations.
LoRusso and Belfort both maintain that Elgindy is no angel. Indeed, in September, Elgindy settled NASD charges of alleged trading abuses by consenting to a fine and a one-year ban as principal of a brokerage firm. He neither admitted nor denied the charges. The NASD complaint alleges that ''Elgindy was suffering from severe mental illness'' at the time of the trading abuses. Elgindy maintains that was a reference to severe depression. LoRusso also asserts that Elgindy misappropriated funds and failed to disclose regulatory problems, which resulted in a suit by LoRusso to rescind his deal to buy into the firm. LoRusso's allegations are denied by Elgindy, who settled the suit by agreeing to rescind the deal.
PASSIVE? Although Elgindy is anything but an unbiased observer, his allegations support the assertion of chop-house brokers and traders that Belfort remains a powerful presence in the chop-stock business. According to Elgindy, Belfort is a well-capitalized short-seller of chop stocks--an adventurous brand of trading that is Elgindy's specialty. But, say Elgindy and other sources familiar with Belfort's activities, Belfort also has had access to cheap stock in numerous companies and has pushed a host of stocks through retail firms-- particularly Monroe Parker, D.L. Cromwell, and Biltmore. In a phone conversation with Elgindy in December, 1996, that Elgindy taped, Belfort seems to imply that he is more than just a passive observer of activities on the Street. Referring to one stock deal, Belfort told Elgindy: ''I have access to a lot of small firms.''
Elgindy and others familiar with Belfort's activities maintain that Belfort has been a hidden power behind the retailing of a host of stocks. Among the stocks that Elgindy says were Belfort favorites were Big City Bagels, Luma Net, Grand Havana Enterprises, and the company that was the subject of the possible Paragon overcharge--Environmental Technologies. Elgindy says Belfort would sometimes supply brokers with cheap stock in the firms, which would be sold to customers at huge markups. Belfort says he legitimately owns shares in some of those companies but denies having access to ''cheap stock'' in any. The chief executive of Grand Havana, Harry Shuster, says that he knows of no Belfort involvement in the company for the past two years. Officials of the other companies did not return phone calls.
STARTLING REVELATION. Elgindy maintains that Belfort sometimes would wax sentimental about the good old days at Stratton. And taped excerpts of those conversations, which Elgindy shared with BUSINESS WEEK, are revealing. In one conversation in December, 1996, Belfort speculated why one particular stock both men were shorting was doing so well. ''They're paying people off,'' said Belfort. ''They're definitely paying people off with stock. I know. I owned a very large OTC firm.... I made a zillion dollars off my deals.''
In another taped conversation, Belfort made a startling disclosure. According to Belfort's taped account, a company called Builders Warehouse Association Inc.--which since has become a unit of Osicom Technologies Inc.--once offered him a huge bribe in return for Stratton selling the stock. Said Belfort: ''This guy came to me, this...kid from Utah came to me....He offered me three shares in Switzerland for every share I sold....I had like 500 brokers,'' Belfort continued. ''I could have sold a zillion shares.'' Belfort declined to discuss the alleged bribe offer. Osicom and Barry Witz, former chief executive of Builders Warehouse, did not respond to requests for comment.
Whether Elgindy is a whistle-blower or a sore loser, one thing is sure: The conduct that he describes is common in the world of chop stocks. In their efforts to clean up the world of micro-cap stocks, the regulators have always seemed to be a day late and a dollar short--or perhaps more accurately, years late and billions of dollars short. Their efforts to crush micro-cap fraud are well-intentioned, sometimes vigorous--but they have failed to put more than a dent in the problem. Driving brokers out of the industry does little good when they stay active behind the scenes. Shutting firms does little good when other firms open to take their place. The money is simply too good: The indictment on Nov. 25, which alleges the involvement of four ranking Mob figures in pushing a single chop stock, proves that. And it is coming from a seemingly bottomless pit--the pockets of small investors.
Anatomy of a 'Chop-Stock' Deal
Stock of XYZ Corporation is trading at $9.60 bid, $10 asked.
1. THE STOCK PROMOTERobtains 100,000 shares of ''cheap stock''--either issued overseas under Regulation S of the securities laws, or issued to insiders under Rule 144. The price: 25 cents a share, or $25,000.
2. STOCK PROMOTER sells the stock to the CHOP HOUSE at $9.60 a share, or $960,000.
3. COLD-CALLERS at the CHOP HOUSE sell the stock to the CUSTOMERS at $10 a share, or $1,000,000.
4. CUSTOMERS deliver $1,000,000 to CHOP HOUSE.
5. CHOP HOUSE delivers $960,000 to STOCK PROMOTER.
6. STOCK PROMOTER delivers the stock to CHOP HOUSE.
7. CHOP HOUSE delivers stock to CUSTOMER's account.
8. STOCK PROMOTER'S profits--$960,000 minus $25,000, or $935,000--are wired to an OFFSHORE BANK.
9. OFFSHORE BANK wires half the profits-- $467,000--to CHOP HOUSE's OFFSHORE BANK, or STOCK PROMOTER gives CHOP HOUSE its split of the profits in cash.
Are Brokers Being Paid Off to Sell These Stocks?
Here are some of the stocks that sources say have been the subject of payoffs
to brokers within the past few months. Company officials who could be reached
for comment denied knowledge of any payoffs.
COMPANY PRICE 52-WEEK
DEC. 1 HIGH
APPLETREE ART 3 3/4 10
AXXESS 2 1/2 8 3/4
HARVEST RESTAURANT GRP. 1 7/8 8 1/4
IMMEDIATE ENTERTAINMENT 4 3/4 7
JUNGLE STREET 4 1/8 7 1/2
LEGEND SPORTS* NA 8
SCOTTSDALE CIGAR 41 5/16 9 1/2
TCP RELIABLE 5 1/8 7 3/4
TELLURIAN 5 9/16 7 1/2
TTR 9 11/16 16 23/32
*Not trading
DATA: BW; BLOOMBERG FINANCIAL MARKETS
HOW BRIBES WORK--FROM ONE WHO'S BEEN THERE
Bribes grease the wheels of the chop-stock business. How does bribery work? How commonplace is it? What follows are excerpts from an interview between BUSINESS WEEK Senior Writer Gary Weiss and a veteran of the chop-stock business, who has worked for five chop houses since 1993.
Q: When corporate officials are confronted with charges of market manipulation, they protest that they don't know anything about it. What's the real situation?
A: In my experience, there has been an incestuous relationship between the small, unproven, speculative corporation and the broker backing his company.... Say Company A needs to get its stock up for many reasons: (1) to allow insiders to sell their own positions at a handsome profit; (2) to make an acquisition; or (3) to remove fear of a declining stock. It's not rare for a corporate officer to approach a broker and, in nonincriminating language, ask: ''What will it take to have you recommend my shares?''
Q: What is that supposed to mean?
A: Compensation. The corporate representative might suggest to the broker there might be additional compensation to the broker if he can ''put away'' [sell to customers] so many shares of the company's stock. It could be 10,000, 100,000, 1 million shares. The payoff occurs as the broker can document the amount of shares he put away. Usually, the broker is asked to supply a copy of each transaction sheet, each customer confirmation, showing the amount of shares that were purchased. And on that basis, a forum would be arranged in which the broker would be paid off in cash or in near-cash items. Near-cash items would be a trip to Hawaii, maybe a luxury car, and so on.
Q: Would payoffs come direct from the company?
A: It could be either way. A cautious company, of course, would always use intermediaries. It could be another broker at the same firm. It could be the brokerage firm itself.
Q: How much are the payoffs?
A: That depends on the amount of shares put away and the price of the shares. Say the stock is 2 [bid] 2 1/2 [asked]. The company wants the stock to go from 2 1/2 to 5. They find a corrupt broker...[and pay] maybe a $5,000 cash payment up front and maybe $5,000 for every half-point the broker can show he lifted the stock.... The deal calls for the broker to buy, say, 100,000 shares of the stock, 200,000 shares of the stock. The broker shows copies of customer confirmations. That way, the intermediary is convinced the broker is doing what he said.
Q: How knowledgeable were officials you encountered from the National Association of Securities Dealers (NASD)?
A: I would say very weak in their knowledge--not in the rules and regs of the NASD but in the actual goings-on in the brokerage firms. They didn't have a clue as to what was going on! When I was there, my experience was that they were easily deceived by the broker-dealers, particularly chop shops. The chop shops would work overtime just to cover the books. They're not fools. They're notified by the NASD that they're going to be examined, so they know when to prepare. They know which trades to eliminate from the books. They know how to work the capital out.
Many brokerage firms were in a rush to get into the business. New brokerage firms, in many cases an offshoot of a firm that had gone out of business, would need a PMI--that is, a ''pre-membership interview''--by the NASD. This can be a long process because each of the principals' backgrounds is thoroughly examined, [they] have to be in compliance with rules and regs, proper forms have to be filed, and so forth.
And in many cases, there were certain members of the regulatory authorities who were known to approve the PMIs in a relatively short period of time. So in many cases, those officials might have been short of cash, and intimations were made that the PMI process would be speeded up if certain things were done.
Q: Such as?
A: Some kind of cash gratuity, usually $10,000, $15,000, as high as $25,000. Remember, what you're talking about here, you're talking about the entrance of a hot broker-dealer into these markets. The quicker they can make it, the faster they make money.
Q: Do you know of specific instances where this has happened?
A: Yes, I do.
Q: Did you see it happen?
A: I was there.
MOB IS BUSIER THAN THE FEDS THINK
How prevalent is the Mob on Wall Street? It's a question that was first raised a year ago, when BUSINESS WEEK revealed widespread Mob infiltration (BW--Dec. 16, 1996). The issue has again reared its head in the aftermath of the Nov. 25 securities fraud indictment of 19 people, including four alleged Mob figures. At the press conference announcing the indictment, the U.S. Attorney in Manhattan, Mary Jo White, maintained that the Mob presence is ''isolated.'' But is it?
BUSINESS WEEK's chop-stocks investigation shows that the Mob is far more active on Wall Street than might appear from the public pronouncements of regulators and law enforcement officials. Among the firms that have allegedly been subject to Mob influence or ownership are the New York office of Brauer & Associates Inc., a Florida-based brokerage where stock promoter James P. Minsky was briefly employed, and Adler Coleman Clearing Corp., a former clearing firm. Adler went out of business in 1995, after the demise of Hanover Sterling & Co., a noted chop house.
The alleged Mob connection to Adler apparently had its genesis three years ago. In a deal brought together by Stratton Oakmont Inc., Adler Coleman was funded through a company called Atrium Holding Co. According to private-placement documents obtained by BUSINESS WEEK, one of Atrium's largest investors was Philip Barretti Sr., an alleged associate in the Gambino crime family. In July, Barretti pleaded guilty to charges that he participated in a cartel that controlled New York City's trash-hauling business and agreed to a prison sentence of 4 1/2 to 13 years and $6 million in fines and court costs. Edward J. Cohan, chief executive of Atrium and Adler, says he was unaware of Barretti's involvement in the financing. Barretti was unavailable for comment.
The Mob has also allegedly found its way into short-selling of chop stocks. According to traders and chop-house officials, Barry Gesser, a close friend of Stratton founder Jordan Belfort, has systematically shorted chop stocks. He has allegedly demanded cash from chop houses in return for not shorting the stocks, or has demanded cheap stock to cover his shorts, threatening to ''crush'' the stocks if he doesn't get his way.
The alleged Mob link is a Gesser associate--a 28-year-old native Long Islander named Michael Reiter. Reiter's very presence at Gesser's side gives him clout by dint of Reiter's link to the Gambino crime family, Street sources say. Reiter's father, Mark Reiter, is a friend of former Gambino boss John Gotti and is serving two life terms in a federal prison for narcotics trafficking.
FAMILY TIES. Michael Reiter and Gesser both deny that they have ever engaged in anything that smacks of extortion. ''The conversations that you're referring to--I'm not going to say it's a figment of everyone's imagination when you're saying people come to us or we go to people about cheap stock,'' says Gesser. As Gesser tells it, he is often approached by chop houses whose stock he has shorted and asked: '''What will it take for you guys to go away--to drop the stock?' That kind of conversation takes place.'' Gesser asserts his answer is: ''You can't buy me.'' But he says that if he has shorted a stock and is offered cut-rate stock to cover it, he takes it. That, he maintains, is not extortion.
Brauer's alleged ties to the Mob are being examined by investigators. According to sources familiar with the FBI's probe, federal agents have identified Brauer's New York office as being controlled by elements of the Colombo crime family--notably Joseph M. Baudanza, a broker there who is described by a law-enforcement source as an associate in the Colombo crime family. Law-enforcement officials say Joseph Baudanza is a son of a reputed Colombo family member and a cousin and close associate of 27-year-old John Baudanza, an alleged up-and-coming member of the Colombo family. John Baudanza is described by law-enforcement sources as working with his cousin and other kinfolk on the Street. Neither John nor Joseph Baudanza returned
BUSINESS WEEK's calls. John Kiefner, an attorney for Brauer, denies organized crime involvement in the firm and says the New York office is independently owned.
The Baudanza ascendancy is in sharp contrast to the fate of another alleged Mob figure from recent Wall Street history--reputed DeCavalcante family capo Philip Abramo. Abramo, who was jailed on tax evasion charges in January, allegedly held sway over several brokerages in New York and Florida. But since his release from prison a few weeks ago, he has been studiously avoiding his old haunts in Manhattan's financial district and in the glitzy office complexes of South Florida. And that makes sense--the feds are starting to turn up the heat. Abramo may be gone, but he won't be missed. There are plenty of his colleagues who are only too happy to take his place. |
