Jewelry merchant Peter Morlock makes it his business to keep an eye out for precious gems on the cheap, and last winter he found a deal he couldn't resist: A group of men offered to sell him the same $1.2-million Burmese ruby that was stolen from him in 1990.

Forget profit. Morlock was just hoping to get even.

So he called police--and in a sting operation last month five men were arrested on suspicion of conspiring to sell the 6.76-carat stone prized for its large size and deep blood-red color.

Among those arrested was jewelry broker Ali Reza Paravar of Woodland Hills, who had the stone in his pants pocket when police stopped him in an Encino parking lot.

The case of the ruby--which apparently passed from hand to hand to hand before completing the circle back to Morlock--now is the talk of the close-knit cluster of jewelry markets in downtown Los Angeles. Scheduled for a hearing next month, it provides a rare glimpse inside the nation's second-largest jewelry district, a place where handshakes are the preferred way of doing business and where police and prosecutors are often loath to intercede, insiders say.

"It's an interesting, interesting group of people you don't want to mess with," said Andrew Vorzimer, an attorney who has represented dozens of jewelry district clients, including Morlock. "There's a lot of sleaze that goes on down there and causes legitimate business people to suffer."

The saga of the ruby began in 1990, when Peter Morlock was sent to Los Angeles to represent his father's Germany-based jewelry business. He was 23 at the time.

Morlock declined to comment for this article, but the ruby's twisted journey is described in FBI records, court papers and other public documents.

With the ruby and other gems in tow, Morlock opened an office in the International Jewelry Center, the 16-story centerpiece of Hill Street's jewelry district, bent on making his father proud. "He was trying to make a name, trying to make a reputation," Vorzimer said.

According to the lawyer, Morlock soon became friendly with Ron Levi, a charismatic former diamond store salesclerk--also 23 at the time--who had recently opened his own gem shop a block away.

As an outsider in the district, Morlock needed contacts and trusted Levi, who bragged about having "connections to Israel" that would make it easy to move even hard-to-sell gemstones.