Dynasty In Distress

Billionaire Leonard Stern played hardball building his Hartz empire. Now, one son has been nailed in the mutual-fund scandal. The other has blown a major real estate deal. No wonder Dad worries about his legacy

Leonard N. Stern, a legendary tough guy in business, grips his third cup of coffee in less than an hour. He percolates with intensity. One of the 100 richest men in America, who built a $3 billion-plus fortune on doggie chews, birdseed, and real estate, he is edged slightly forward on a linen-covered couch. His antique-filled, oak-paneled offices on the 26th floor of 667 Madison Ave. have pricey views of Central Park and the Manhattan skyline. Rents in the exclusive building, which he owns, are as lofty as $120 a square foot, second only to the General Motors building. It is the domain of someone who has long since arrived. Still, Stern, 65, can't seem to skirt controversy.

Long gone is the sign that used to hang in his office: "Once you've got them by the balls, their hearts and minds will follow." These days, it's Stern who's feeling the pain.

Stern -- "call me Leonard" -- former chairman of pet-supply giant Hartz Mountain Inc., is eager to talk. His family just can't keep out of the headlines. In September, his younger son, Edward J., 38, who still oversees the family money, became embroiled in the spreading mutual-funds scandal. Eddie, who ran the Canary Capital Partners LLC hedge fund, was the first manager to be charged by New York Attorney General Eliot Spitzer for "fraudulent" late trading and market timing of mutual funds. He continues to meet with Spitzer, says a source close to the investigation, and is dishing the dirt about mutual-fund companies he dealt with.

Last year, Leonard's 40-year-old elder son, Emanuel T., known as Manny, who runs the family's real estate business, lost a $1.3 billion deal to redevelop a sports and entertainment complex in New Jersey's Meadowlands. Because the Sterns are the largest real estate developers there, the loss was a major blow to the family's pride and pocketbook. And Leonard has had his own share of headaches in recent years. A director of drugstore chain Rite Aid Corp. (RAD ) during its devastating accounting scandal, he was the target of several lawsuits, including a class action that claimed, among other accusations, that the board breached its fiduciary duty to shareholders.


For Stern, whose name adorns New York University's Leonard N. Stern School of Business, nothing less than his legacy is at stake. With his dynasty in distress, he seems determined to let the world know one thing: He is an "honest man," a man of the highest ethical standards. So, he insists with tears welling in his eyes, are his sons. "If I have taught my sons anything in life, it is to have integrity -- to always tell the truth, and I believe they have," he tells BusinessWeek in an exclusive interview, his first in five years. If he hasn't taught that, he says, he has failed. Both sons repeatedly declined to be interviewed.

It's not that the family fortune is in jeopardy. Leonard is chairman and chief executive officer of Hartz Mountain Industries Inc., a private company that holds mainly real estate and financial investments. (The family sold the pet-supply company for an estimated $250 million in 2000.) Hartz is the country's largest private owner of commercial property. Most of it is located in New Jersey, where Hartz owns and operates some 38 million square feet of offices, hotels, malls, and other buildings. The Sterns' real estate holdings alone are estimated to be worth as much as $2 billion. They also have an investment portfolio worth more than $1 billion.

Fighting back is the name of the game, and Leonard Stern still has a sharp left hook. Just 5 feet 6 inches tall, with a tawny, sculpted face and salt-and-pepper temples, he can morph from a seductively charming gentleman -- "I'm a toucher, emotionally and physically," he says -- into a shrewd, tough-talking businessman. Leonard is no stranger to scandal himself. In the 1970s, the Hartz pet-supply business was slammed with an antitrust suit and later a federal grand jury investigation. Although Leonard wasn't personally charged, the company pleaded guilty to bribery, perjury, and destruction of documents. Leonard explains that he has always been a business pioneer, routinely taking risks and forging into areas where rules are either nonexistent or murky. Says Leonard: "You don't build a fortune like this by being a pussycat."

Now, grappling with his sons' missteps puts Leonard in a heart-wrenching bind. "I brought my sons into the business to extend my working life, so I could keep my hand in the business," says Leonard. "I have put them behind the eight ball. The thought that I might, at some time, have to at the very least correct their mistakes is very, very stressful." Then he quickly adds: "But I haven't. And I never would have brought them in if I hadn't believed in them 100% -- their ability, their intelligence, and above all...their integrity."

Critics say Leonard's often hardball tactics and compulsion for control created an aggressive culture at Hartz that persists under his sons. "Eddie and Manny desperately want to please Leonard," says a family friend. "At the same time, they're terrified of him." Investigators say that may help explain why Eddie stepped over the line at Canary. Eddie settled with Spitzer for $40 million in September without admitting or denying wrongdoing. Leonard says he is particularly distressed about Eddie's involvement in the scandal. "It is a sad chapter for Canary," he says. "I'm very, very close to Eddie and as helpful to him as I can be emotionally."

No matter how hard he's pressed, Leonard won't reveal exactly how or when he learned of Eddie's trading practices. ("I can't go there," he says.) But two former Hartz employees believe that little took place at the company that Leonard didn't know about. "I'm sure Leonard knew [how Eddie was trading], because they had legal opinions O.K.'ing late trading and market timing," according to James Nesfield, a former consultant at Canary. "Eddie Stern didn't go to the bathroom without Leonard knowing," says another. But Leonard says: "I had nothing to do with Canary."

Still, Eddie wasn't shy about using the family fortune when it came to making deals with fund companies. An internal Banc of America Securities memo claims he dangled the prospect of financing opportunities with two of the family's ritziest hotels, along with other enticements, in exchange for trading in and out of their funds.

BusinessWeek has learned from sources close to the mutual-fund investigation that Eddie was introduced to trading mutual funds in the mid-'90s by Robert Simpson, a brother-in-law who runs Simpson Capital Management Co., a small money-management firm. "Eddie was trading mostly his own money at the time and was hanging out with [Bob], who devised these market-timing algorithms and formulas," says a former co-worker of Eddie's. The Stern family also invested money with Simpson, according to former Hartz employees.

Simpson's biggest deal was with PBHG Funds, managed by Pilgrim Baxter & Associates, which allowed him to do fast in-and-out trading of their mutual funds. When Eddie started Canary in 1998, he made his first mutual-fund trades through PBHG, using Simpson's connection. Soon after, there was a "big family rift," says a mutual-fund investigator, when the Sterns withdrew all their capital from Simpson and Eddie muscled Simpson out of PBHG. "Eddie said to the top brass at PBHG, 'I've got the $1 billion -- let me do all the trading,"' says the investigator. Simpson has not yet been named in the investigation. He did not return repeated phone calls. The Securities & Exchange Commission and Spitzer have filed a civil suit against Pilgrim Baxter and co-founders Gary Pilgrim and Harold Baxter alleging that they engaged in market timing, despite explicit restrictions in their fund prospectuses.

For a time, at least, Eddie's market timing and late-trading strategy worked brilliantly. "During the bear market, mutual funds desperately needed new ways to make money," says Selva Roselli, a lawyer and hedge-fund expert. "For a hedge fund like Canary, [the strategy] was practically a no-lose proposition." In 1999, Canary showed an eye-popping 110% net gain, according to Spitzer's complaint. By 2002, Canary's assets had grown to $730 million and gained 15% that year, vs. a 23% drop in the Standard & Poor's 500-stock index. BULLY ON THE BLOCK

BusinessWeek has learned that Canary attracted some top-drawer clients -- though they could have been passive investors, with little insight into what Eddie was doing. According to people familiar with the fund, investors included Millennium Partners, headed up by Israel Englander and the Tudor Group, run by famed investor Paul Tudor Jones. A Tudor spokesman declined to comment. Millennium did not respond by press time.

Leonard defends his son. "Eddie at no time knew that he was doing something illegal," he says. "I know this because I asked and he told me. He's an outstanding young man. I can't remember one time when he told me an untruth." Hedge-fund legend and longtime friend Michael Steinhardt backs Leonard up. "I really feel that there's a wonderful innocence to [Eddie]. I would trust him on any level." But a longtime business associate says: "You have to realize that Eddie grew up in a no-holds-barred business environment. The apple didn't fall far from the tree."

Leonard himself was a pretty tough apple. In 1959, at age 21, he joined his father Max's pet-supply business. Associates remember Leonard, who grew up in Manhattan, variously as "fast-talking," "dogged," "incredibly intelligent," and almost "hyperly aggressive." By 1973, he had built Hartz into the No. 1 pet-supply company in the country, with 75% of the market. Hartz offered a wide range of products, such as the popular "2-in-1" flea collar.

But the real key to the company's success was Leonard's intense involvement at every level. In a 1984 article about Hartz by writer Connie Bruck in The American Lawyer -- an article Leonard calls "the most unfair piece ever written about me" -- a former Hartz employee recounted that once when Leonard stopped by a small grocery store in Portland, Ore., he noticed to his dismay that there were no Hartz products on the shelves. His district manager, when confronted, told him: "That store is just a mom-and-pop gunboat." Leonard's reply: "I don't care if it is a f---ing rowboat. Go get it!"

It wasn't long before Hartz gained a reputation as the bully on the block. In the mid-1960s, a number of small distributors and competitors vociferously alleged that Hartz engaged in a number of unfair business practices such as threats, bribery, and special deals. "[Hartz] gives away free merchandise to get exclusives on the condition it be kept quiet," a former employee told Bruck. "Whole truckloads of cat litter just disappear into the twilight zone." Three Justice Dept. antitrust investigations followed, all fruitless. After an inquiry in 1973, the Federal Trade Commission made Hartz promise to stop using such strong-arm tactics as threatening some distributors while cutting special deals with favored ones.

Then came a mammoth antitrust suit: In 1978, A.H. Robins Co., parent of archrival Sergeant's, sued Hartz, alleging commercial bribery, destruction of documents, perjury, and subornation of perjury by Hartz officials. The case became particularly salacious when a Hartz vice-president, Walter Albuquerque, testified in a deposition that he had helped hire women to entertain clients at a trade show and submitted their fees in phony credit memos. "[Stern] came up with the wording that we call these prostitutes 'hostesses,"' Albuquerque testified. Says Leonard: "I never knew about it and would never condone such a thing."

All the allegations were denied by Hartz. But the next year, the company paid A.H. Robins $42.5 million out of court -- one of the largest antitrust settlements to date. Months later, the government launched a grand jury investigation into Hartz's business practices. After three years, Hartz agreed to plead guilty to perjury, subornation of perjury, and obstruction of justice, and paid a $20,000 fine. Neither Stern nor his two top officials were directly charged with any crimes -- which rankled the U.S. district judge handling the case, Robert R. Merhige Jr., who at the time called it "the biggest miscarriage of justice I have encountered in 40 years at the bar." Today, Leonard says: "I was never indicted, and the fact is, I wasn't aware of any of this corruption when I was heading the company. The bottom line is that they didn't have the goods against us." Then, moments later, Leonard says: "It's not that I never made mistakes running the company. I was extremely young. I talked and acted like a young man."

There is a uncanny parallel with his son Eddie's current tribulations. When faced with legal troubles, Leonard usually settles cases quickly -- paying up and moving on. Leonard says that on learning of Spitzer's July subpoena in the Canary case, "I told Eddie to tell the attorney general 100% of the truth -- to vomit it out. Don't filter it." It was Leonard, say sources close to the investigation, who had a hand in hiring respected securities attorney Gary P. Naftalis to defend Eddie. "There's no detail in Hartz that Leonard is not involved in, and the more serious it is, the more he gets involved," says Ronald Simoncini, the Sterns' public-relations representative.

Likewise, Leonard was intensely engaged in his role as a board member of Rite Aid in the mid-to-late '90s when the drugstore chain was involved in accounting shenanigans. (Rite Aid admitted to overstating net income by $1 billion over two years.) Leonard was named in a class action in which investors claimed that he and other directors had breached their fiduciary duty to shareholders. The company settled in 2000. A separate lawsuit, filed by Kevin Mann, a former Rite Aid executive vice-president, alleged that Leonard used his influence to increase shelf space in Rite Aid stores for Hartz's pet products at the expense of competitors. Rite Aid settled that suit in 1999 for $11 million. Leonard, who resigned from the board in late 2001, brushes all of this aside: "We saved that company from bankruptcy. We threw out the old management and brought in the new and set it on its turnaround," he says. Still, how did this accounting mess happen on his watch? "Outright fraud can only happen when someone trusts," he says. A GOOD RIDE

Leonard can't bear to contemplate that Eddie might have done anything fraudulent or even untoward at Canary. "If I ever thought that my son did anything knowingly illegal or dishonest -- whew, I couldn't live with that," he says, wiping imaginary sweat off his brow. However, prosecutors believe Eddie may have used tactics to hide what he was doing. Spitzer's complaint against Canary alleged that Eddie set up shell funds through which he contacted mutual funds, seeking the right to trade. In a separate complaint against Theodore C. Sihpohl III, a broker at Banc of America Securities, Spitzer alleges that Eddie devised a well-planned scheme in which Canary would e-mail or fax proposed trades to Banc of America before 4 p.m. and have BofA time-stamp the trades at that time so they falsely "bore the pre-4 p.m. time stamp." Canary would then phone the bank, telling it "which of the proposed trades Canary wanted it to place," according to the complaint. Sihpohl, faced with criminal and civil charges, has pleaded not guilty. Says a source close to the investigations: "I think [Eddie] was clearly aware there were shenanigans going on."

Eddie was also essentially shorting mutual funds, normally illegal, Spitzer's complaint against Canary alleged. He worked with mutual-fund companies to create derivatives, or clones, of various funds. That way he could short them, rather than the funds directly, and so get around the law. (Even so, a fund's performance would suffer because the stocks it contained were being shorted.) A former senior Hartz investments officer, Noreen Harrington, told Spitzer's office that when she questioned Eddie about his trading, he replied: "If I ever get in trouble, they're not going to want me, they're going to want the mutual funds."

To say that the Sterns abhor Harrington -- the first person to blow the whistle on Canary's unorthodox trading -- may be an understatement. When her name is brought up, Leonard clasps his hand to his heart theatrically and says: "Oh, her -- please -- she was such a big fan of Eddie's returns that she had money with the fund after she left the company." Harrington admits she was invested in Canary until March, 2003, but says: "All the other senior officers did as well." The Stern family initially claimed that Harrington was "terminated." But BusinessWeek has viewed a Hartz document signed by Chief Financial Officer Ronald J. Bangs, dated Apr. 11, 2002, stating that Hartz agreed that Harrington "resign [from Hartz]...and amicably terminate their relationship." She says she stayed on until August, 2002, at Hartz's request. A Hartz spokesman now says: "Eddie was displeased with her performance and asked her to leave, so they struck an agreement."

In October, 2002, Eddie began cashing out Canary's outside investors. And on May 2, 2003, he wrote in a final letter to them: "We hope that you considered the ride to be a good one." In fact, the ride was so good, the Sterns decided to keep the fund to themselves. A former co-worker says the money was returned to investors when some began to question how Eddie got his blockbuster bear market returns. "If Eddie believed what he was doing was legal and O.K., why wouldn't he just tell his investors?" asks Harrington. In 2003, when the market started heading up, Eddie's strategy suffered. He gained only 1.5% before shutting Canary down in June, before news of Spitzer's investigations broke.

Eddie may have been ill-suited to cope with the pressures of the family business. An art history major at Haverford College in Pennsylvania, he had always been more of a philosophical type. Says Leonard: "The head of the classics department at Haverford took me aside and begged me not to tempt Eddie to go into the business world. He said he was the brightest student he ever taught." In 1987, Eddie won a Thomas J. Watson Fellowship to study fiction writing in Italy. According to Leonard, "Eddie tried in vain to return the stipend," ostensibly feeling bad about it because he came from a wealthy family. Eddie started writing under a nom de plume, Julius Lowenthal. Once stateside, he became a writer for Spy magazine, then run by Vanity Fair Editor-in-Chief Graydon Carter. According to Carter, "Eddie was one of the most engaging, thoughtful kids ever to work at Spy. I just admired the way he carried himself and all that that entails."

Eddie next tried his hand as business manager for the Village Voice, the New York weekly newspaper his father had bought in 1985 from Rupert Murdoch. In 1989, he married a doctor; the couple have three children. That same year, telling Leonard he wanted to make more money, he went to work for Hartz Mountain. He became company president in 1997. How well he did is a matter of dispute. "When Eddie ran Hartz, it was a disaster," says a former rival, who concedes that the pet-supply industry was reeling as the power of mega-discounters such as Wal-Mart Stores Inc. (WMT ) and Petco Animal Supplies Inc. (PETC ) grew. "It lost 30% to 40% in market share." Leonard disagrees: "Eddie was very talented at merchandising. He just decided the business wasn't enough to attract his interest." In December, 2000, Hartz sold the business to a private equity firm, J.W. Childs Associates. "A HUGE MISTAKE"

All the while, Leonard's older son, Manny -- stocky, occasionally bearded, whom a rival describes as "a younger Leonard on steroids" -- was hitting pay dirt in the family real estate business. Manny -- married with three children -- has developed scores of successful New Jersey properties. In the '90s, he started building glamour properties such as Manhattan's Soho Grand Hotel and Tribeca Grand Hotel. Says Simoncini, the Sterns' spokesman: "Manny usually gets what Manny wants."

Never has Manny's moxie been more evident than in the Meadowlands brawl. Losing out on the $1.3 billion project, called Xanadu, to redevelop the Meadowlands sports arena area with offices, hotels, stores, movie theaters, and other entertainment, isn't just a missed opportunity. "It could cost the Sterns millions of dollars," says a source close to the company, because it could take a large chunk of business from their existing stores in the area. (They own the Harmon Cove Outlet Center in Secaucus, N.J., and two other shopping malls.) In mid-2002, Mills Corp. (MLS ), a mall developer in Arlington, Va., asked Hartz if it wanted to go 50-50 to bid on the project and Manny turned it down. Mack-Cali Realty Corp. (CLI ), based in Cranford, N.J., partnered with Mills instead, and the duo won the contract in early 2003. "In retrospect, Manny made a huge mistake," says a rival. "Now he's getting nothing, and his father is furious at him."

Manny recently filed suit in New Jersey's appellate court in an attempt to stop the project. "If Xanadu goes through, there would be disastrous daily traffic jams, severe damage to local merchants and the environment, among other things," says family spokesman Simoncini. In the past year, Manny and his partner Forest City Ratner Cos. have taken full-page ads in national and local newspapers trumpeting their case. Bruce C. Ratner, president and CEO of Forest City Ratner, did not return phone calls. Manny also made a video, sending an undercover film crew to one of Mills's shopping malls in an attempt to prove it was a retail venue, not the entertainment venue Mills has proposed for Xanadu. A Mills spokesman holds they are abiding by the proposal: "It will draw together recreation, sporting, and amusement concepts" such as indoor skiing and mini auto racing.

Hartz's rivals says they won the deal fair and square. "Our proposal showed extraordinary sophistication, creative effort, and responsibility," says Mack-Cali spokesman Robert Sommer. Adds George R. Zoffinger, president and CEO of the New Jersey Sports & Exposition Authority, the agency that handled the Xanadu proposals: "The process was extremely fair, and we chose the proposal which benefited the economy the best. The Stern family needs to step back and consider what's good for the region."

Perhaps the bigger question, say people in the industry, is whether the Sterns' family business is finding it hard to compete in the new world of sophisticated real estate investment trusts such as Mack-Cali, and megamall developers such as Mills. A rival claims Hartz's proposal was unprofessional: "It looked like crayon on construction paper."

A large part of the Sterns' problem, contends another developer, is that they consider themselves "the preeminent family out here" -- the Mayflowers of the Meadowlands. Indeed, they have accumulated some 1,800 acres since 1968 -- "before," says Leonard, "anyone ever even thought of buying land there." Recently, Leonard ran into William L. Mack, Mack-Cali's chairman of the board and head partner at Apollo Real Estate Advisors LP, at a Manhattan charity benefit. Sources familiar with the conversation say that Mack told Leonard: "Face it, you guys have already lost the Meadowlands project. But maybe we can work something out." To which Leonard apparently retorted: "You can't just discount our interests over there. We'll beat you." Asked about the exchange, Leonard says bluntly: "We are in this to win."

Leonard Stern is a man who has not lost his edge. But friends say he has evolved. "There's a very human side to Leonard," says longtime friend Wilbur Ross, the bankruptcy expert. "He's not just a beady-eyed accountant and tough negotiator. He's multidimensional." Adds Francesca Stanfill, a writer and friend: "Leonard is leagues above others when it comes to intellectual acumen and heart. He has a real understanding of life and all of its complexity."

His second wife, Allison, 54, whom he married in 1987, has a lot to do with his transformation, say friends. (Leonard divorced his first wife, Judith, a therapist who consults families on wealth and business matters, in the mid-'80s.) A former model and TV producer, Allison grew up "dirt-poor," as she has described it, in Kentucky. She is immortalized on vintage Jaws movie posters as the comely swimmer about to meet her fate with a shark. Friends say Allison and Leonard have, unlike some society marriages, a real romance. Says Stanfill: "There's real warmth and supportiveness between them. You feel it."

The Sterns live in one of the only freestanding mansions -- five stories tall -- on Fifth Avenue. A friend says it is tastefully decorated -- "not too over the top," with a sweeping marble staircase leading to the first landing, where one encounters works by Van Gogh, Modigliani, and others. "He loves his art," says Ross. "He's particularly knowledgeable about Greco-Roman art and has a very extensive collection."

Leonard is notoriously tightfisted in business, often refusing to budge a penny in negotiations. "I'm fair," he says, "but I don't like people who try to put their hand in my pocket." Still, he gives millions to charity each year. In 1984, just three years after he had settled with the Justice Dept., Leonard, who earned his MBA from New York University in 1957, at 19, made a $30 million donation for the right to name NYU's graduate school of business after himself. Leonard's supporters insist he wasn't attempting to buy respectability but was approached by NYU. Says Carol B. Kellermann, former executive director of Stern's foundation, who now heads the September 11th Fund: "You can always denigrate people who put their names on things, but with Leonard, it's always from the heart." Ironically, Leonard is no fan of B-schools. "I think business school is a waste of time. You learn on the job," he says. OOHING AND AAHING

There are no raised eyebrows when it comes to his pet charity, Homes for the Homeless, which he started in 1985. Leonard says he donates money and "a big chunk of time" to it. Allison, a formidable player on Manhattan's social circuit, is a trustee and vice-chairman of the Wildlife Conservation Society, the parent of the Bronx Zoo. She hosts the society's annual fund-raising bash, held this past fall at the Central Park Zoo. His children are not in the social scene. Leonard says they are devoted to their families and jobs. "I always wanted my children to go to bed at night and feel tired and good about what they did." His daughter, Andrea C., 36, is a photographer.

A little over a year ago, Leonard and Allison hosted an evening Hudson River cruise on their 152-foot yacht, Lady Allison. About 50 guests attended -- names that fill the society columns. Some of the guests assembled on one side of the boat where Leonard began conducting an impromptu tour of the Stern's vast New Jersey landholdings. "Unlike a lot of moguls, Leonard has his feet on the ground," says David Patrick Columbia, editor of NYSocialDiary.com. Still, he says, "this was an awesome show of how powerful the family is. People were oohing and aahing."

Of course, those were halcyon days -- before the Sterns lost the mammoth Meadowlands deal and before the mutual-fund scandal. Today, Eddie is still cooperating with Spitzer's office. "We continue to be surprised by the depth and breadth of this scandal as well as the amount of money that is involved," says David D. Brown IV, chief of the investment-protection bureau for the New York Attorney General. Eddie faces several civil suits and a class action filed by fund investors. As for Manny, his fight for the Meadowlands property may be futile, unless there's a surprise ruling in his favor in his upcoming court case. Whatever happens, says Wilbur Ross, the Sterns will get past this. "Leonard is an incredibly smart decision maker," he says. Leonard remains undaunted: "People who get a reputation for being tough are those who succeed. When you fail, you get pity."

Speaking of tough, whatever happened to that "got them by the balls" sign? Leonard says he can't remember, exactly. But it's not around anymore. Almost 20 years ago, when a BusinessWeek writer asked him that same question, he replied: "Oh that. I gave it to my son."

By Marcia Vickers

With Susann Rutledge in New York

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