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Fraud Cases Show Gaps
In Bankruptcy System
By JOHN R. EMSHWILLER
Staff Reporter of THE WALL STREET JOURNAL
NEW YORK -- Frank Carone found a lucrative supplement to his work as an auctioneer and seller of pizza ovens: stealing from the federal bankruptcy system.
In connection with the latter pursuit, the 69-year-old Mr. Carone pleaded guilty in November to five counts of grand larceny in a New York state court. He had been the lead defendant in an 82-count indictment filed in 2002 that charged him and eight others with misusing their positions as corporate "workout" specialists and asset auctioneers to steal more than $27 million from more than a dozen troubled companies.
Over the course of nearly eight years, prosecutors allege, Mr. Carone and his colleagues pillaged firms ranging from a cigar bar and a miniblinds maker to publicly traded companies such as Jamesway Corp. and Oneita Industries Inc. Unknown to creditors or bankruptcy-court officials, the defendants "systemically looted money and assets from the failing businesses" and covered up their thefts "by falsifying business records and, if needed, bribing employees," according to the indictment.
Mr. Carone's activities raise questions about oversight of the federal bankruptcy system, which handles billions of dollars of assets. Bankruptcy cases are heard by a separate branch of the federal-court system with its own judges and its own set of safeguards to protect against fraud. That system handles "more money ... than any court in America," says Samuel Gerdano, executive director of the American Bankruptcy Institute in Alexandria, Va.
In the Carone case, the system didn't work. Mr. Carone was caught almost by happenstance when he reported a separate crime to the Manhattan district attorney. The fact that it was state, and not federal, officials who charged Mr. Carone "has got to be treated as a shock to the bankruptcy-court system," says William A. Brandt, Jr., president of Development Specialists Inc., a Chicago firm that does corporate restructuring and liquidation work nationwide.
CORPORATE CRIMES
Some of the alleged pillaging done by Frank Carone, Michael Sherman and colleagues after they were hired to help financially troubled companies:
* At Jamesway, a discount retailer in Secaucus, N.J.. The Carone firm allegedly raised more than $5 million selling off the company's assets, but only reported taking in $860,000 for dispersal to creditors.
* At Oneita, a Charleston, S.C., apparel maker, Mr. Carone's auction firm was brought in and undervalued Oneita's inventory by $5 million, according to the bill of particulars.
* At a collection of New York-area fast-food restaurants, Messrs. Carone and Sherman were brought in to operate and eventually sell the eateries. The group stole about $3 million that should have gone to the bank, according to prosecutors.
Happenstance also helped nab Robert Pryce Jr. Mr. Pryce, a Southern California attorney, was one of several hundred court-appointed bankruptcy trustees who oversee corporate-liquidation cases. In August, he pleaded guilty to charges that he accepted $300,000 in kickbacks over four years to steer bankruptcy-related business, such as property repairs, to certain contractors. People familiar with that case say the fraud was discovered as a result of a municipal-corruption investigation in the small Southern California city of Carson. Mr. Pryce also pleaded guilty to charges in the corruption case. He awaits sentencing on both matters.
Punishing trustees and other professionals who commit fraud is particularly important because those people have "great power" to do mischief, said John Hueston, the lead federal prosecutor on the Pryce case. "And there are insufficient investigative resources to police such people."
Federal bankruptcy officials say their system is sufficiently rigorous and has kept the bankruptcy courts relatively free of fraud. "If you look at the billions of dollars that these professionals handle, there have only been a handful of problems," said Maureen Tighe in an interview while serving as the U.S. Trustee for Los Angeles, which helps oversee bankruptcy-court activities. (She recently became a federal bankruptcy judge.)
Ms. Tighe added in the interview that the detection system relies largely on accurate records of activities such as asset sales. While unfamiliar with the specifics of the New York case, she said the type of wrongdoing alleged there -- where the defendants are accused of filing false records with creditors and the court -- "probably wouldn't be caught by our current procedures, unless someone tipped us off."
If anyone provided a tip-off, it would logically be a creditor. Creditors generally have the biggest stake in the honest handling of cases and tend to pay close attention to the proceedings. But in many cases creditors don't actively monitor the sale of a debtor's assets because they expect only a small payment, says the American Bankruptcy Institute's Mr. Gerdano, whose organization does bankruptcy-related research and education.
According to the indictment, Mr. Carone worked closely from the mid-1990s with New York businessman Michael Sherman, now 56. A specialist in workouts, or fixing troubled companies, Mr. Sherman was often tapped by the Bank of New York Co. to work with companies that had loans with the bank, say Manhattan-district-attorney officials. The bank was a creditor in some of the companies allegedly looted by the scheme. A spokesman for the Bank of New York declined to comment, as did an attorney for Mr. Carone.
Mr. Sherman has pleaded not guilty. In a written statement, Laura Brevetti, an attorney for Mr. Sherman, declined to discuss the specific charges against him. "But I can tell you generally that in a bankruptcy, which is supervised by a federal bankruptcy judge, every party in interest has access to the bankrupt's financial records and account information," Ms. Brevetti wrote. "Michael Sherman was and is widely viewed as one of the best in the industry in making sure creditors receive the maximum recovery possible." In court filings, Mr. Sherman's attorneys have contended that the state has failed to meet basic minimum legal requirements for alleging criminal activities. The attorneys have moved to dismiss the indictment. Among other things, Mr. Sherman's attorneys argue that prosecutors haven't adequately identified any victims. The judge hasn't yet ruled.
According to court filings by the Manhattan district attorney's office, Mr. Sherman would be brought in to a company by its creditors or its board to help it sell off assets. He allegedly would bring in Mr. Carone and his team to do the liquidation work. Once the assets were sold, prosecutors claim, Mr. Carone's operation would under-report the proceeds and split the loot with Mr. Sherman.
The group's biggest alleged theft was at Jamesway, a discount retailer that was based in Secaucus, N.J., and had annual sales of more than $650 million. By the mid-1990s, it was in the process of liquidating. Jamesway hired Mr. Sherman and put him in charge of the company's bankruptcy proceeding. According to the state's criminal filings, he fired Jamesway's remaining executives and brought in Mr. Carone. The Carone firm allegedly raised more than $5 million selling assets but only reported taking in $860,000 for dispersal to creditors. "The defendants stole and possessed over $4 million," according to a bill of particulars filed by the district attorney's office.
Mr. Sherman allegedly siphoned off an additional $11 million partly by falsely treating defunct companies that he controlled as secured creditors of Jamesway. He and an assistant then "wrote large Jamesway checks to those companies as if they were secured creditors," asserts the bill of particulars.
In their court filings, Mr. Sherman's attorneys say that because he was handling large amounts of Jamesway business, "there could be any number of justifications for specific checks."
As part of his plea, Mr. Carone said Mr. Sherman helped one of his companies, Consolidated Auctioneers & Liquidators Inc., get auction work at Jamesway. Mr. Carone said he subsequently stole more than $1 million of the auction proceeds and never accurately reported the results to the bankruptcy court. Mr. Carone also said he gave part of the stolen money to a company controlled by Mr. Sherman and another defendant. The Carone plea didn't say whether Mr. Sherman knew the money was stolen.
Sometimes the defendants allegedly did more than just falsify records to hide purported crimes. In the bankruptcy case of Oneita, a Charleston, S.C., apparel maker, the creditors hired Mr. Sherman in 1999 to help reorganize the company. He dismissed all but one of Oneita's employees and again brought in Mr. Carone's auction firm, which proceeded to undervalue Oneita's inventory by $5 million, according to the bill of particulars. The defendants paid the only remaining Oneita executive $196,000 to "buy his silence," the filing said.
Mr. Sherman's attorneys, in a court filing, argue that others had the opportunity to submit a higher bid than Mr. Carone's firm on Oneita's inventory, but none did. The filing also said the prosecutors had failed to show that Mr. Sherman had any role in the alleged bribe.
When a collection of New York-area fast-food restaurants was unable to service loans to the Bank of New York, Messrs. Carone and Sherman were brought in by the bank to operate and eventually sell the eateries. The group stole about $3 million that should have gone to the bank, according to the district attorney's office.
The alleged tactics included skimming cash from the restaurants, paying members of the scheme salaries for "no-show" jobs and even running a $300,000 insurance scam after a fire at one of the restaurants. The alleged scam included the supposed purchase of replacement equipment from another Carone company, Bari Restaurant & Pizzeria Equipment Corp. Mr. Carone sometimes uses the name Frank Bari, authorities say.
In court papers, Mr. Sherman's attorneys argue that the alleged restaurant-related crimes were simply commercial disputes. They added that Mr. Sherman was merely a consultant on the restaurant matter and had no control of the eateries.
Bari Restaurant operates out of a large and gleaming store, full of cooking equipment on Manhattan's Lower East Side, at the same address as Consolidated Auctioneers. When investigators raided Mr. Carone's operation in late 2001, Dan Castleman, chief of the district attorney's investigations division, said they found a safe containing $820,000 cash "in neat white paper wrappers labeled for each bankruptcy case."
Under Mr. Carone's plea agreement, he will serve two to six years in prison and pay $5 million in penalties, though he hasn't yet been sentenced. The seized cash will go toward paying that tab.
Write to John R. Emshwiller at john.emshwiller@wsj.com
Updated January 20, 2004