A federal grand jury charged 46 commodities traders Wednesday with systematically cheating hundreds of customers in Chicago`s futures markets in the first indictments from one of the most sweeping financial fraud investigations in history.
Fourteen of those charged have agreed to plead guilty and cooperate with the still widening inquiry into alleged fraud at the Chicago Board of Trade and the Chicago Mercantile Exchange, the world`s largest futures exchanges, authorities said. Eight of the 14 also have signed civil consent decrees barring them from ever again holding membership in the exchanges.
Federal prosecutors believe the testimony of the 14 could implicate dozens of other traders at the exchanges, which play a vital role in the Chicago and world economies by permitting corporate and individual customers to hedge against financial risks.
The indictments tarnish the credibility of the exchanges at a time when Congress is considering tighter regulation of them and they are facing increasing competition from overseas. Their position is weakened by the scale of this investigation, which rivals the Wall Street insider-trading scandal.
The indictments are the culmination of an extraordinary 2 1/2-year FBI undercover operation that prosecutors said revealed ”wide-ranging” abuses of federal racketeering, tax and commodities laws.
Wendy Gramm, chairwoman of the Commodity Futures Trading Commission, which regulates the exchanges, called the indictments the ”first results of the most extensive and aggressive law enforcement effort in the financial area, ever.”
Atty. Gen. Dick Thornburgh said the probe ”is only part of an expanding Department of Justice crackdown on white-collar crime, in all its various guises, from Wall Street to LaSalle Street to Main Street, with all the stops in between. The activities uncovered at these exchanges, the largest of their type in the world, simply cannot, and will not, be tolerated.”
Thornburgh, Gramm and FBI Director William Sessions traveled to Chicago for the announcement of the indictments, to underscore the significance of the case.
U.S. Atty. Anton Valukas, who supervised the investigation, said at a packed press conference, ”What we are talking about here are hundreds of customers and thousands of trades in which fraud was perpetrated and losses incurred by those customers because of this scheme.”
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The four indictments, totaling 1,276 pages, charged that the 46 traders-including a handful of the wealthiest and most influential at the
exchanges-used a variety of schemes to steal money from clients and evade federal income taxes on their own trading profits.
The indictments charged the fraudulent activity occurred repeatedly in four trading pits. Hit hardest by the indictments were the Merc`s Japanese yen pit, where 21 people were charged, and the Board of Trade`s soybean pit, where 19 people were charged. Three defendants each were named in the Merc`s Swiss franc and Board of Trade`s Treasury bond pits.
Among other things, the indictment charges that many commodities brokers rigged trades with other traders in ways that prevented their customers from buying and selling contracts at fair market prices. The brokers then sent false receipts to the customers to hide the fact that they had overcharged them in buying contracts or had raked off part of the customers` profits in selling them, the indictment alleged.
It charged that the brokers typically paid their confederates, known as
”bagmen,” by making cash kickbacks or passing profits to them through phony trades.
”We are not talking about technical trading violations,” Valukas said. Futures contracts are obligations to buy or sell a specific quantity of a commodity, such as soybeans, by a certain date at the price agreed upon in a trading pit.
The array of charges brought by the government included allegations of racketeering, mail fraud, commodities fraud, filing false tax returns and lying to federal agents.
The most prominent defendants in the Merc`s yen pit include Sam A. Cali, one of the exchange`s most influential brokers and a member of the committee that settles disputes between members of the pit; John M. Baker, a millionaire known for wearing colorful suits and ties to catch the attention of other traders; and Joseph P. O`Malley, a major floor broker.
Those charged who are the most successful in the soybean pit include Martin Dempsey; James D. Nowak, who was charged with 240 counts, more than any other trader; and trader Bruce Mittelstadt.
The Tribune attempted to contact all of the traders named in indictments, as well as their attorneys. Most were either unavailable or declined to comment.
Mittelstadt`s attorney, James Montana, described his client as honorable and said he will be found innocent of the government`s charges.
Of the 46 charged, 18 were accused of violating federal racketeering laws, which carry the stiffest penalties, up to 20 years in prison, and could involve forfeiture of expensive trading seats and any assets derived from illegal transactions.
”We are seeking forfeiture of exchange seats for all those who have been indicted for . . . racketeering conspiracy charges,” said Valukas. ”In six instances we have also sought to seize the trading profits of certain individuals.”
The 14 traders who agreed to cooperate apparently did so to avert charges under the federal Racketeer Influenced and Corrupt Organizations act, known as RICO. The statute, originally designed to go after organized crime figures, is being used increasingly by federal prosecutors in cases ranging from judicial to political corruption.
Wednesday`s charges are likely to bolster calls for Congress to increase regulation of the nation`s free-wheeling futures markets.
Officials of the exchanges acknowledged that the indictments would harm the image of their markets. But they said they would reserve judgment until reviewing the charges.
”The exchange and its members will not tolerate a single instance of trading abuse in our markets,” said Karsten Mahlmann, chairman of the Board of Trade.
The Board of Trade, during a board meeting Wednesday afternoon, voted to take way floor privileges from the eight traders who have signed consent decrees with the Commodity Futures Trading Commission.
In a range of interviews, traders who are not involved in the case said the indictments mostly implicate small-level traders, as opposed to the most powerful members of the exchanges.
”The people indicted are relatively low-level foot soldiers,” said Doug Bragan, who trades in Japanese yen. Bragan was not charged.
In undercover operations, the federal government typically tries to indict lower-level individuals first, to help determine if any more powerful individuals engaged in wrongdoing.
The traders who have agreed to cooperate with the investigation could begin appearing before federal judges to enter guilty pleas as early as next week, sources said. Prosecutors and defense lawyers believe that the testimony of these witnesses, combined with thousands of secret FBI tape recordings, will vastly increase the government`s knowledge of fraud at the exchanges and lead to additional indictments.
Valukas, who once represented commodities traders as a defense lawyer, would not comment on the number of defendants who have agreed to work with the government, except to say the level of cooperation was ”substantial.”
In disclosing the existence of the operation in January, The Tribune reported that the massive undercover investigation was focusing on as many as 100 brokers, floor traders, and commodity firm executives.
FBI Director Sessions said the bureau ”recognized from the start that its investigation would require special measures and a long-term commitment.” Federal officials said the undercover operation was the only way to gather tape recordings and other evidence that would pierce the arcane world of commodities and develop evidence that could hold a trial jury`s interest.
”Today it is common knowledge that the FBI used extraordinary means to detect extraordinary fraud,” Sessions said, acknowledging for the first time that the bureau enrolled four agents in commodities trading school before sending them out to pose as traders at the exchanges, and ultimately spending more than $1 million to purchase seats that enabled the undercover agents to obtain trading privileges.
Indeed, the operation, known by the code names Operation Sour Mash and Operation Hedgeclipper, showed just how far law enforcement has gone since the days when such inquiries were aimed at small-time drug dealers.
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The sources said the FBI began planning the operation in the fall of 1984, and that the first agent began trading undercover in late 1986.
The agents wore hidden recorders and won the confidence of traders by entertaining them at posh restaurants and health clubs. They also used the most modern surveillance technology to record thousands of conversations in hectic trading pits where millions of orders change hands each day.
By Sessions` account, once the inquiry became public, FBI agents fanned out and conducted 500 interviews and handed out 500 subpoenas. The
investigation eventually came to involve investigators of the Internal Revenue Service, the Postal Service and the CFTC, Sessions said.
The indictments for the first time provide the real names of the FBI agents who went undercover. As it turned out, Richard Carlson, the agent known as a sophisticated scotch drinker with a Rolex watch, was actually special agent Richard Ostrom; Randy Jackson was really agent Randall G. Jannett; Peter Vogel was really Dietrich Volk; and Michael McLoughlin was really Michael Bassett.
Traders began learning the full impact of the charges last Friday, when some of the city`s best-known defense lawyers assembled in Valukas` office for an extraordinary closed-door session with the Justice Department`s top RICO expert, Paul Coffey.
During that meeting, the government explained how the RICO statute would be used and reminded the attorneys of the harsh penalties involved, including loss of exchange seats and other property.
Following that meeting, several traders took the government up on its offer to plead guilty to charges that did not involve RICO.
The eight traders who signed consent decrees with the CFTC, and agreed to cooperate with the government, are David Skrodzki of Chicago; Brian and James Sledz of Naperville.; Mark Fuhrman of Wheeling; Kenneth Gillen of Naperville; Thomas Braniff of Wood Dale; Harry Patten of Western Springs; and John Eggum of Oak Park.