WHAT THE HECK IS A `PRIME BANK' NOTE?
When Lawrence Gerschel received his M.D. in 1978, his grandfather, legendary financier Andre Meyer, couldn't have been prouder. The Lazard Frres & Co. chief and adviser to the rich and famous, including the late Jacqueline Kennedy Onassis, admired great physicians and donated huge sums to medical research. In 1979, Meyer died at the age of 81, leaving a fortune conservatively estimated at $90 million to his wife, Bella, Lawrence, and three other grandchildren. About three years later, Gerschel, then reputedly worth at least $30 million, chucked his medical career for the business world. If Meyer knew what regulatory and law enforcement authorities allege about his grandson, he might turn over in his grave.
BUSINESS WEEK has learned that the Securities & Exchange Commission and the Manhattan District Attorney's office have launched investigations into Gerschel's New York-based Trust Group, which he set up in 1991 with two partners. Sources close to the D.A.'s probe say that a grand jury has recently issued subpoenas to Gerschel and his partners to determine whether the firm has trafficked in the netherworld of phony "prime bank" instruments, including notes, debentures, and guarantees.
MUSHROOMING. The sale of prime bank instruments, according to authorities, is a mushrooming but little-publicized financial scam that has hoodwinked hundreds of investors, many of them financial professionals. The instruments are marketed by promoters as debt or similar obligations purportedly issued by the "world prime banks," as some offering materials put it. They promise often outlandish, risk-free returns--typically 25% or more per year. Accompanying documents look official and often use the letterheads of real banking institutions, particularly foreign ones, such as Deut-
schebank and Barclays.
In fact, authorities say, documents purporting to represent such investments are bogus, with no connection to any bank. After selling the paper and perhaps making a few interest payments, promoters usually move the money offshore--where investors can't retrieve it--and disappear.
In recent months, the Comptroller of the Currency, the SEC, and other U.S. and foreign agencies have issued many warnings to financial institutions about "illegal or dubious schemes" involving prime bank instruments, as one release put it. James E. Byrne, a law professor at George Mason University, estimates that over the past few years, investors worldwide may have lost $500 million or more in these transactions, which he believes are being perpetrated by as many as 1,000 "hard-core pushers."
Promoters often assure would-be investors skeptical about the high returns that prime bank investments are a secret wholesale market to which only governments, big banks, and other insiders normally have access. Even reputable institutions have been taken. Numerous investors lost hundreds of millions of dollars in a scam involving $1.2 billion in bogus prime bank guarantees issued by the Czech Republic's Banka Bohemia. That episode triggered the April collapse of the bank and left the National Council of Churches $8 million poorer. The Salvation Army in Britain and the government of Nauru lost millions in earlier swindles. "We've only seen the tip of the staggering losses we'll see in the next couple of years," says Byrne.
The Trust Group's activities, authorities say, show how some prime bank schemes operate. They are looking into a recent transaction where they claim the Trust Group nearly duped officials of several counties in Kentucky and their advisor, then known as Shearson Lehman Brothers, out of as much as $150 million. The Trust Group, they say, hoped to move the money to Fossbankin, a small, now-defunct bank in the Faeroe Islands, a semi-autonomous territory of Denmark in the North Atlantic.
"FRAUD." The Trust Group, which operated out of a modest Manhattan apartment, has not been charged with any wrongdoing. But John Shockey, special assistant to the Comptroller of the Currency, referring to prime bank instruments, says: "I've never seen any evidence that they engage in any legitimate buy-sell transaction." A spokesperson for Deutschebank--which Trust Group Managing Director Jeffrey M. Moritz cited in a deposition as a prospective issuer--says: "We don't have a product like that. Those things are a total fraud." Moritz denies that either he or the Trust Group committed any wrongdoing.
In promoting themselves, say authorities, Trust Group officials liberally played on Gerschel's involvement. Authorities believe that Gerschel, who relatives and acquaintances say is naive about financial matters, may have been seduced by those involved with the Trust Group into letting them exploit his name and fortune. Gerschel, 45, who is the Trust Group's senior partner, denies any illegal actions: "I know by any stretch of the imagination I've behaved well, and I don't have to justify that to anybody." He also denies that the Trust Group committed any wrongdoing.
The Trust Group's prime mover, say authorities, was Sandi Kalez, a self-described securities trader who once arranged car loans, acquaintances say. According to Moritz's deposition, she convinced Gerschel and Moritz, a lawyer and former tennis instructor who had been Gerschel's business partner, to move into the prime bank business, in which she claimed, according to documents at U.S. District Court in Frankfort, Ky., to have achieved great success. Kalez did not respond to repeated telephone messages.
An account of the Trust Group's Kentucky deal, which would have been the firm's largest, can be pieced together from the court records. In late 1991, through intermediaries, the Trust Group contacted James M. Hatfield, a former college basketball coach and a broker at Shearson's Lexington (Ky.) office. One of his clients was the Kentucky Association of Counties (KACO), which administered a huge pool of cash for most of the state's 120 counties. Says a Smith Barney Inc. lawyer: "The attempted transaction happened over a year before Smith Barney acquired the retail offices of Shearson. As a result, we're not prepared to comment on the specific facts of the attempted transaction."
One of the intermediaries was Denver attorney T. Robert Hughes, who sold Hatfield and KACO on the Trust Group's "rolling trades" program. According to court records, the pitch went this way: Using KACO's money, the Trust Group, through intermediaries, would buy tranches of $10 million face value of "prime bank guarantees" yielding 7.5%, at a discounted price of $8.3 million. The Trust Group would then sell them for $8.9 million to unspecified buyers, generating for KACO a gross profit of 1% of the face amount for each trade. Documents show that the Trust Group represented to KACO that it could execute at least four transactions per month for each tranche, implying a minimum annual return of 48%. Hatfield later said in a deposition that he was satisfied that the program assured that the "risk is zero." Hughes replies: "I do not believe that the Trust Group committed any wrongdoing or that the KACO transaction was fraudulent or in any way illegal."
In July, 1992, the first slug of about $32 million began moving to Shearson's account at Chemical Bank in New York. The Trust Group hoped that KACO's investment would balloon to as much as $150 million over the next few months. Court documents indicate that the money was to move to an account at a branch of Sanwa Bank California and then possibly to Fossbankin, where it would have been beyond KACO's reach.
Fortunately for KACO, a clerical glitch at Shearson stopped the money flow, Hatfield says. A Shearson manager, according to his deposition, became alarmed when he learned of the transaction. Unable to find an authorizing letter from KACO, he halted the deal. KACO executive Fred Creasey says the prospect of what might have happened to KACO's money "scares me to death."
DISARRAY. The glitch precipitated a complex flurry of legal battles. The Trust Group sued KACO for default in U.S. District Court in Frankfort. The case moved to arbitration, and--in another surprising twist--the American Arbitration Assn. in Los Angeles awarded the Trust Group $625,000 in lost profits plus legal expenses. KACO is challenging the award. The arbitrators issued no reason for its ruling and declined to discuss the case. But court records and interviews with participants indicate that the arbitrators apparently did not consider evidence of the possible illegality of the prime bank instruments. The arbitrators also refused to consider information from KACO lawyers that the SEC was investigating the Trust Group. Said KACO attorney Phil Williams, "Until we learned of the SEC investigation and became aware of some of the bulletins the federal regulators were putting out, we were unaware that all of these types of transactions were fraudulent on their face." Hatfield now has second thoughts about the deal:. "I've not been able to find one person who believes [prime bank instruments] exist."
Despite the award, the Trust Group has fallen into disarray, mainly because of intensifying local and federal probes. Moritz says the firm is no longer "an operating company." Indeed, Gerschel, Moritz, and Kalez appear to have gone their separate ways.
In a luncheon interview, a visibly distressed Patrick Gerschel, a New York investor and former partner at Lazard Frres, reflected on his brother's predicament. "People who are motivated by money usually breathe it 24 hours a day. That's not the Larry Gerschel I grew up with," he said. "[Larry] should have stayed a doctor."Phillip L. Zweig in New York