NEW YORK — A federal grand jury Wednesday indicted two government securities traders on charges of generating more than $511 million in phony tax losses for investors in a series of partnerships by arranging sham trades valued at $38 billion.
Federal prosecutors said it was the largest tax fraud case ever brought in New York, in terms of the amount of tax losses actually passed on to investors, and one of the largest in the country.
The 32-count indictment accused Jon Edelman, 43, and Bernhard F. Manko, 48, of conspiracy to defraud the Internal Revenue Service, subscribing false tax returns, and aiding and assisting others in filing false tax returns. The two traders allegedly ran 10 partnerships that invested in government securities and generated tax writeoffs for wealthy investors.
Edelman is the brother of Asher B. Edelman, a noted corporate raider. He is also the former head of an options trading firm that reportedly folded after massive losses suffered in the 1987 stock market crash.
The indictment contained a partial list of investors in the partnerships, including Perry Ellis, the late fashion designer, and John W. Kluge, a billionaire who founded the Metromedia broadcasting chain. Kluge and his wife, Patricia, allegedly deducted $4.2 million in false losses from two of the partnerships on their 1983 tax returns. Kluge couldn't be reached for comment Wednesday.
Benito Romano, the acting U.S. attorney in Manhattan, said the investors are neither accused nor suspected of criminal wrongdoing. But he said they may face demands for back taxes and penalties from the IRS. Romano declined to say whether the investors should have known that the deductions might be suspect.
Romano said the indictment caps a three-year investigation focusing on activity that took place in 1983-84.
The partnerships involved had names such as Universal Arbitrage Trading Co., Federal Arbitrage Co. and World Option Trading Co. All are listed in the Manhattan telephone directory with the same phone number and address. But a recording Wednesday said the number had been disconnected, and directory assistance operators said they didn't have a record of any new number.
A housekeeper at Edelman's home in Rye, N.Y., said he was out of town. But in a statement released by his lawyer, Edelman said: "Any charge that I filed false tax returns, conspired with others to file false tax returns or aided others in filing false tax returns is unfounded, unfair and unjust." He said he planned to fight the charges, which he called "groundless," and predicted that he would be exonerated in a trial.
In a separate statement, Asher Edelman said: "This is a distressing and difficult time for our family." He said he doesn't believe that his brother engaged in any illegal activity, adding: "I will do everything in my power to assist my brother."
Pamela Chepiga, a lawyer for Manko, said her law firm hadn't had an opportunity to study the indictment. But she said that "based on what has come to our attention during the course of this long investigation, we believe Mr. Manko will be entirely vindicated."
The scheme alleged in the indictment is similar to a number of big alleged tax frauds prosecuted in recent years. Many provided big deductions to wealthy and famous investors. For example, in 1987, Charles A. Atkins was convicted in a nearly identical scheme of providing $350 million in false tax writeoffs to investors including Laurence A. Tisch, president and chief executive of CBS Inc.; Tisch's brother, Preston, who at the time was U.S. postmaster general, and the late pop artist Andy Warhol.
Atkins is appealing the conviction.
Other well-known tax fraud cases include those of Edward A. Markowitz, a Washington businessman who pleaded guilty in 1985 to selling $445 million in phony tax deductions to more than 100 wealthy investors and show business personalities, and commodities trader Marc Rich, who was charged with evading $48 million in income taxes on illegal profits from trading oil in violation of federal price controls in the early 1980s. Rich is a fugitive in Switzerland.
According to Wednesday's indictment, Edelman and Manko set up a series of partnerships that ostensibly were dealers in government-backed securities that could provide significant tax benefits for investors who came in as limited partners. Investors officially promised that, if later called upon, they would put up an additional amount equal to three times their original investment. Under the tax laws, this gave the investors the right to deduct an amount up to four times the size of their original investment on their tax returns for any losses incurred by the partnerships.
But, the indictment charges, Edelman and Manko had the partnerships carry out rigged, prearranged trades with a company called TSM Holding Corp. that carried no risk, wouldn't make a profit and had no legitimate economic purpose. The indictment charges that the real purpose of the trades was to create fraudulent interest expenses that were then passed along to the investors as tax deductions.
Edelman and Manko are due to be arraigned in U.S. District Court in Manhattan on Feb. 16. If convicted on all counts, Edelman theoretically faces a maximum sentence of 80 years in prison and $130,000 in fines. Manko could be sentenced to up to 77 years in prison and pay $125,000 in fines.