Stock Scams: Caveat Entrepreneur
For Nick Morf, it was the classic entrepreneur's dilemma: a great big idea and very little money. An avid venturer from Lighthouse Point, Fla., Morf had developed a CD-ROM database enabling actors to hook up with talent agencies and studios. But his fledgling company, Global Talent Guild (GTG), had consumed $500,000, much of his savings.
In mid-1994, though, Morf says he was introduced through a mutual friend to Grant R. Curtis, who presented himself as an "investment banker." Curtis was interested in a deal. He put Morf in touch with a colleague, Leo J. Mangan, who said he would help take GTG public by merging it with Alter Sales Co., a troubled Miami auto parts wholesaler that already had a public listing. Mangan and a third partner, Timothy H. Masley, promised investment capital from Comprehensive Environmental Systems Inc., a West Babylon (N.Y.) environmental remediation firm that they controlled.
Although he says he had zero securities experience, Morf, 53, became the titular CEO of Alter Sales. That was no problem, he says, because the business was being guided behind the scenes by Mangan, Curtis, and Masley. Morf, though, missed some warning bells. According to Morf, his new partners paid for everything, including houses, with cash or wire transfers from offshore accounts. They also avoided putting personal assets or phone numbers in their names and frequently changed beeper and cell-phone numbers.
Not until months later did Morf suspect he might unknowingly be part of a stock fraud. In fact, half a dozen sources who have been interviewed by federal investigators believe Curtis, Mangan, and Masley are the leading players of what the feds claim is an unusually elaborate stock scheme that could be a model for a new breed of 1990s chicanery. According to sources close to the probe, the Alter Sales network may have pocketed as much as $7 million.
Teams from the Securities & Exchange Commission and the U.S. Attorney's office in Brooklyn as well as U.S. Postal inspectors are looking at several companies and individuals for evidence of possible securities fraud, money laundering, income tax evasion, and mail and wire fraud. Asked about the probe, the SEC and the U.S. Attorney's office in Brooklyn said they do not comment on ongoing investigations.
Stock fraud schemes have mushroomed in recent years, and scamsters have developed increasingly sophisticated ways of gulling unwary investors and companies. Back in the 1980s, the days of penny-stock fraud, investors were hoodwinked into buying stock in dubious initial public offerings. The phony companies would quickly go out of business. Nineties-style hustlers employ much of the old hype and hard-sell tactics. But they play a more deadly, longer-term con game that is harder to detect and prosecute.
HARD TO TRACE. To mask the scheme, hustlers hide behind securities laws designed to help companies raise capital without excessive red tape. Abuses of two such rules, the SEC's Regulations S and Form S-8, are rampant. They allow companies, in certain circumstances, to issue big blocks of stock without filing lengthy registrations or publicly disclosing the deals. The regulations also make it easy to conduct hard-to-trace stock transactions with foreign investors and use overseas tax havens to shelter ill-gotten gains.
These swindles highlight weak regulation of thousands of small public companies by an understaffed SEC and superficial monitoring by the NASDAQ stock market of its listing requirements. Frauds often go undetected because hustlers are shrewd enough to work not through sham businesses, but apparently legitimate companies. They file the required SEC reports, conduct audits, and supply necessary documentation for transactions and stock transfers. "Unless you really start digging, everything looks on the up-and-up. And these guys have all the right answers," says a securities regulator.
The current SEC-Justice Dept. investigation of the Alter Sales case had its genesis in a federal inquiry into possible securities violations by TV commentator Dan Dorfman and his stock-promoter friend, Donald Kessler (BW-Nov. 6, 1995). On Aug. 29, Dorfman's employer, cable network CNBC, said an internal review of Dorfman's financial records showed no violation of securities laws or network policies. Sources confirm that Dorfman is still a part of the ongoing criminal and civil probes, but only as a bit player in what has since become a much larger alleged fraud. A spokesman for Dorfman had no comment.
ROLLER COASTER. The modus operandi of the new breed of stock fraud is deliberately complex and obfuscated. Ringleaders will target a small, nonpublic entrepreneurial outfit with offers of capital. They then assume effective operational control--often by putting cohorts on an unwitting board of directors--and arrange a merger with a failing or moribund company that has public stock outstanding. This allows the target company, in effect, to go public through the back door, without the regulatory scrutiny that accompanies the usual registration process for initial public offerings.
But more important, the hustlers can use various regulatory loopholes essentially to loot the newly merged company by issuing millions of new shares. The stock is covertly distributed to the ringleaders as well as accomplices, such as brokers and promoters. They then hype the stock by releasing bullish information and getting brokers to ballyhoo the stock. The young company's shares begin a roller-coaster ride, which may last only a year or two. The hustlers rarely follow through on promises of financial assistance to the entrepreneurs, whom they often force out of the company. Soon, the company's revenues and earnings fail to meet optimistic forecasts, and the stock takes a dive. But by that time, the hustlers have sold their stock at a hefty profit.
Indications that Alter might have been the nexus of what investigators believe was a fraud scheme were lost on Morf in 1994. Curtis, Masley, and Mangan came off as smart, knowledgeable, personable, and successful. "They were all big spenders, drove expensive cars and boats, and carried wads of $100 bills," recalls Morf. "These guys were really slick. They had all the moves," he says.
Morf says Curtis, 36, was the brains behind the alleged scheme, and Masley, 35, was the bank expert. The two studiously avoid public disclosure of their management role in companies, according to former employees and associates.
Each may have had reasons for keeping a low profile. In June, 1994, Curtis, who started out in the securities business as a broker and consultant, was convicted of conspiracy to defraud Dallas-area banks of over $1.1 million after they granted him loans secured by worthless letters of credit. If Curtis were involved in stock fraud, that would violate the terms of his five-year probation, which requires him to live in a San Francisco-area apartment and attend chiropractic school. His parole officer, Vilma Bonifacio, declined comment, saying Curtis' record is sealed.
Masley is a former broker with North American Investment Corp., a controversial Hartford brokerage firm that ceased operation in 1988 amid stock-manipulation investigations and a class action by investors. BUSINESS WEEK has no evidence he was implicated in wrongdoing. But his record with the National Association of Securities Dealers shows disciplinary problems, including a suspension.
RAP SHEET. Mangan, 40, is the only member of the Curtis group who had a publicly disclosed management role: He became chief operating officer of Comprehensive Environmental Systems in mid-1993. But the company has not disclosed any part of his long criminal record, a violation of SEC rules. According to his rap sheet, Mangan has been arrested eight times, dating back to 1972, mostly for drug possession and dealing. He was sentenced to prison twice, most recently in 1991 in Denver to a four-year term.
In a letter to BUSINESS WEEK, Curtis denied any involvement in stock fraud and said he has been a full-time student in a chiropractic school. "I am unaware of any current investigation of Comprehensive or ICIS [as Alter was late renamed] for any reason and certainly not regarding myself and any fraudulent acts." Mangan in a brief letter declined a point-by-point response to questions. "Many of your allegations are demonstrably false," he said. Masley did not respond to detailed questions.
Morf, though, was unaware of his compatriots' backgrounds. He went along with their plan to merge GTG into Alter in February, 1995, which gave the merged entity a public listing, and arranged for Comprehensive to invest $1.2 million in Alter. In what investigators think was a maneuver to enhance Alter's attractiveness as a stock play, the Curtis group formulated plans to slowly withdraw Alter from the parts business and absorb another fledgling but enticing company called ADTV. It was patenting a cable box that inserted advertising logos in the corner of television screens during programs. ADTV became Alter's new marketing focus.
One further step was required to get Alter ready to attract investor interest: a reverse stock split to boost the stock price and reduce outstanding shares. On Mar. 20, 1995, the company gave shareholders 1 new share for 20 old ones. The number of shares outstanding dropped from 10 million to about 500,000, while the price automatically rose to nearly $7, from 34 cents.
FLAGRANT. For companies with low stock prices, reverse splits can serve several purposes. Investors are attracted to a company with fewer shares outstanding because earnings per share are higher. And after a merger, NASDAQ requires that the company's stock must sell for at least $3 to retain its public listing.
After the split, Alter, in a seemingly paradoxical move, authorized the issuance of 10 million shares for acquisitions and for paying employees and consultants. The move was approved by Alter's three-member board of directors, which was now heavily influenced by the Curtis group. Sources close to the probe say board members outside the Curtis group are not under investigation. Within two months, shares outstanding ballooned from 500,000 to 3.6 million. According to the sources, the stock issuance was the crucial and most flagrant step in the alleged fraud, which may have channeled millions of shares into the pockets of Curtis, Mangan, Masley, and their confederates. That, investigators believe, gave them control of Alter.
Normally, potential issuance of so many new shares would have drastically shrunk Alter's stock price. But investors didn't learn about the new shares until months later, when the moves showed up in the company's quarterly SEC reports. During this period, the stock continued trading above $6.
Federal authorities are exploring whether the Curtis group used regulatory loopholes--designed to reduce red tape for companies--to register the newly issued stock so it could be traded in public markets. And they are looking into whether stock might have been fraudulently siphoned to the Curtis group.
The group, investigators suspect, might have used Form S-8. Most companies must make extensive disclosure when they issue stock. But S-8, which pertains mainly to employees and consultants, allows companies to register shares with a short, boilerplate filing. "Disclosure is so minimal they could probably do it on the back of a napkin, and regulators would never look at it," says an SEC official, referring to the rule.
At the direction of Curtis and Mangan, according to Morf, Alter registered 500,000 S-8 shares on Mar. 23. Regulators were informed that the shares were used generically for an "employee benefit plan." According to internal company documents, nearly all the shares were given to entities and individuals who investigators suspect may have been illegal proxies for the Curtis group. Documents say Ray Irangy, a stock promoter from Brooklyn, N.Y., who worked closely with Masley, received 280,000 shares. And 50,000 shares were given to Irangy's affiliated entity, Habib Capital.
An additional 100,000 shares, according to company documents, were given to Pedro Gomez and Venezuela-based Rang Tuck Morgan Ltd., of which Gomez is president. Several sources describe Gomez as Masley's gofer and sometime limousine driver. Irangy and Gomez could not be reached for comment.
Investigators are looking at whether profits from the sale of most of those S-8 shares ended up in the bank accounts of Curtis, Masley, and Mangan.
A second registration method involves the SEC's Regulation S. It allows companies to sell shares to foreign investors without detailed registration statements. The shares need only be held for 40 days before the foreigners can begin trading them back in the U.S. market, compared with two years for restricted stock held by U.S. investors.
Investigators believe the Curtis group employed Reg S to fraudulently acquire 1 million shares of Alter stock owned by Marc A. Osheroff, who had been president of Alter before it was merged with GTG. Investigators suspect Osheroff may have been involved with the alleged fraud. Curtis and Masley allegedly arranged for Osheroff to sell his shares for $150,000, or 15 cents a share, a fraction of the market price. In what authorities think was a series of devices to distance the Curtis group from the transactions, the buyers were three foreign entities--Principal, B&H, and Piedmont Securities--that were supposedly based in Dublin, Ireland, and on Guernsey in the Channel Islands. Sources believe the accounts were controlled by Curtis, Mangan, and Masley. Sometime after the 40-day wait, the shares, now allegedly controlled by the three men, were sold in the U.S. at prices between $6 and $7. Osherroff did not respond to requests for comment.
ETHICS PROBE. A trust at the Guernsey address is at the center of another complicated Reg S transaction. It allegedly had two goals: to put an additional million shares of Alter stock in the hands of Curtis, Mangan, and Masley, and to buy a headquarters building for Alter. That would buoy the company's bottom line and help it maintain its NASDAQ listing.
In March, 1995, Alter issued 1 million Reg S shares to Millennium Environmental Corp., a shell company with no operations. In return, Millennium paid Alter $250,000. The money ostensibly came from 20 European investors. The $250,000 was then used as a downpayment to buy a former Ethan Allen Interiors Inc. furniture showroom in Lighthouse Point, Fla., to serve as Alter's headquarters. Investigators are said to believe the $250,000 actually came from Curtis and his allies. And they suspect that, through Reg S, the shares ended up with the Curtis group, where they could be sold at much higher prices. Morf says Alter never received verification that the 20 investors actually existed.
According to company documents, the attorney handling the deal was James W. Nearen, a former SEC enforcement attorney. Nearen, 43, started doing work for Comprehensive Environmental and Alter in early 1995. Nearen was investigated by the SEC in early 1995, for allegedly fraternizing with the owner of a Colorado brokerage he had investigated as an SEC attorney, says a source close to the investigation. The SEC doesn't comment on ethics probes. In October, 1994, he pleaded guilty to third-degree assault in an incident in which he grabbed his ex-wife by the throat. In addition, the Florida Bar Assn. says that Nearen is not licensed in the state.
Nearen says he had nothing to do with the Millennium deal. He declined to respond to other questions about the SEC probe, his arrest record, or his attorney's license.
By the end of April, 1995, after the various Reg S and S-8 deals, Curtis, Mangan, and Masley may have accumulated upwards of 2 million shares, according to sources close to the investigation. The Curtis group then apparently decided it was time to promote Alter as a hot stock. The trio tried to get brokers to push the stock. Federal authorities are looking at whether brokers were paid off to push Alter stock.
Mangan hired stock-promoter Donald Kessler, an acquaintance, who was reputed to have an ability to get plugs from his close friend Dan Dorfman. On Apr. 18, Dorfman gave a positive CNBC report on Alter, highlighting the potential for its ADTV cable-advertising subsidiary. About that time, Kessler became CEO of Comprehensive and later a director at Alter.
Ironically, Alter began unwinding in the summer of 1995, soon after the Dorfman report. Garrett was fired as president of ADTV for poor performance. Morf, meanwhile, says that he became frustrated that he had received none of the promised additional funding to expand his operations. In May, he tried to assert control of Alter. But Morf says Comprehensive drained Alter's coffers and froze an escrow account. He signed a severance aggreement and left in August.
From a high of nearly $8 a share in March, Alter's stock had plummeted to less than $1 a share by the end of August. Investigators are exploring trading records to see whether the Curtis group unloaded large quantities of stock while it was still high.
After BUSINESS WEEK raised questions with the principals of Alter and Comprehensive, Mangan said in a letter that he had resigned from Comprehensive and Kessler had left Comprehensive and Alter. Last fall, Alter's name was changed to ICIS Management Group Inc., Nearen was made president, and the board approved issuance of 50 million new shares. To remake the company, ICIS acquired Champion Auto Works, which manufactures vintage car kits. Shares of both ICIS and Comprehensive still trade on NASDAQ.
Federal authorities say they're stepping up prosecutions of the new breed of stock operators who prey on naive entrepreneurs and investors. That push, though, may have come too late for Nick Morf.