Former Drexel Trader, 5 Others Indicted Under Racketeer Law

Opening a new front in the government’s efforts against Wall Street corruption, a federal grand jury here indicted a former trader with the Drexel Burnham Lambert investment bank and five ranking officials of an investment firm based in Princeton, N.J., and Newport Beach.

Facing counts of racketeering, fraud, and conspiracy were Bruce L. Newberg, a former bond trader in Drexel’s Beverly Hills office, and four general partners and the comptroller of Princeton/Newport Partners, a specialty investment firm. The 35-count indictment says Princeton/Newport and Drexel employees took part in phony, prearranged stock trades to give Princeton/Newport $13 million in tax benefits and to enable Drexel to manipulate stock prices and avoid regulatory requirements.

The indictment marks a further expansion of federal prosecutors’ use of the potent weapon of anti-racketeering charges, which can carry huge financial penalties and long prison sentences. It also marks the first time that an investment firm has been named as a racketeering enterprise and thus suggests that federal prosecutors wish to escalate possible punishments for insider trading and related securities violations.

Attorneys for the defendants immediately charged that the indictments represent an unwarranted use of the anti-racketeering statute, called RICO, or the Racketeer Influenced and Corrupt Organizations Act.

They said the indictments’ purpose was primarily to force cooperation from Princeton/Newport officials against others and thereby regain momentum in the insider trading investigation, which many observers believe has encountered serious obstacles. The government is believed to be seeking additional testimony against such figures as Michael Milken, head of Drexel’s high-yield “junk bond” operations, and Robert Freeman, head of arbitrage at the Goldman, Sachs & Co. investment house.

Firm Not Named

“It’s clear to us that we’re the target of these charges only because the government is after bigger fish,” said Theodore Wells, attorney for James Sutton Regan, a managing general partner of Princeton/Newport. “We’re pawns in their big chess game.”

The indictments came at a time of suspense in the insider trading investigations because of a general expectation that the Securities and Exchange Commission many file long-awaited charges against Drexel any day.

The investment firm itself was not named in the indictment. But the indictment of Newberg is expected to add to the pressure already on Drexel as it awaits the unfolding of the government’s case.

The grand jury did note that Newberg, of Santa Monica, reported directly to Milken before Newberg voluntarily left the company last April.

In a statement, Drexel said the indictment of a former employee was “deeply disturbing.” It declined to comment beyond that except to note that Newberg intends to plead not guilty.

The Merrill Lynch investment firm was also cited as having taken part in sham trades with Princeton/Newport. But neither the firm nor its employees were named in the indictment, and Rudolph W. Giuliani, U.S. attorney for Manhattan, lavished praise on the firm for its cooperation in the matter.

Merrill’s behavior was “precisely the way a good corporate citizen should behave when a major investigation is under way,” Giuliani said. Left unsaid was that Princeton/Newport has resisted the government’s efforts since the investigation began with a dramatic raid of the firm’s Princeton offices last December.

The defendants from Princeton/Newport are James Sutton Regan, 46, a managing general partner; Jack Z. Rabinowitz, 41, a general partner and head of the firm’s financial and accounting operations; Charles M. Zarecki, 40, general partner and chief trader; Paul A. Berkman, 41, general partner and chief trader for the firm’s Princeton/Newport Arbitrage Partners unit, and Steven Barry Smotrich, 33, the company’s comptroller. No employees in the firm’s California operations were named.

All six defendants were charged with one count of conspiracy, one count of racketeering and one count of racketeering conspiracy. The five Princeton/Newport employees were each charged with 32 counts of mail and wire fraud; Newberg is charged with 26 counts of mail and wire fraud.

The indictment cites sham stock trades made between November, 1984, and February, 1986, in which Princeton/Newport allegedly “sold” a block of stock to Drexel, then “repurchased” it later to create the fiction of a trade and a tax loss. Under the arrangement, Drexel was allegedly paid for the cost of handling the stock.

In return for these favors, the indictment alleges, Princeton/Newport once “shorted” the stock of a Minneapolis merchandiser called COMB to help Drexel drive down its price at a moment when Drexel was about to underwrite a COMB convertible debenture. “Shorting” is the practice of selling a borrowed stock in the hope that the price will decline before the investor must repurchase it to return to its owner.

A lower price for the COMB stock would make the issuance of convertible debentures less expensive for the company.

The evidence against the defendants includes hours of taped phone conversations between the Drexel and Princeton/Newport employees. In one snippet of conversation included in the indictment, Berkman is quoted as asking a Merrill Lynch trader to allegedly set up a phony trade.

Giuliani strongly denied that the indictment was brought to force cooperation out of the defendants or to frighten other potential witnesses in the case. The indictment “stands on its own,” he said.

He also said the RICO charges are used only in the most serious cases, those involving a pattern of crimes and that engender wide “economic consequences.”

If the government had not brought the charges, “we would have been derelict. . . . We would have been giving benefits to billionaires and millionaires that we don’t give other people,” Giuliani said.

The decision to bring the RICO charges was approved by his superiors in the Justice Department, he added.

The defendants face a maximum of 20 years in prison on each of the two RICO counts and five years in prison on each of the remaining counts, as well as fines of up to $250,000 on each count. “The fines could total as much as $18.7 million,” the U.S. attorney’s office noted.