Jury’s $38 Million Verdict Reveals Convoluted Scheme

By Cortney Fielding
Daily Journal Staff Writer
This article appears on Page 1.

      LOS ANGELES - Six years ago, a 25-year-old entrepreneur flew from California to Taiwan in search of a manufacturing deal that would kick-start his new venture.
      At a trade show packed with anxious vendors, Kenneth Tsai was introduced to a pair of middle-aged Germans with specifications for a state-of-the-art DVD player. The men had obtained a sizable contract with Fry's Electronics and were about to secure a deal with Wal-Mart.
      Tsai, a Chinese citizen and UCLA graduate, and his business partner, Johnny Huang another Chinese citizen who graduated from USC saw potential.
      But that was before a convoluted series of transactions resulted in the men attempting to collect from a German national living out at sea with no assets, then losing millions in an alleged "bust-out" scheme.
      Last week a Los Angeles Superior jury found Ralph Heiss, Arthur Biancone and two electronics wholesalers liable for $38 million, payable to their young counterparts' company, GBM Logistics Services.
      The civil trial provided a rare glimpse into the business-fraud arena of bust-outs. The schemes, which usually involve shell businesses, rarely reach civil or criminal court and rarely result in a verdict or conviction. Defense lawyers strongly dispute their clients' involvement in any kind of illegal scheme.
      In 2002, Tsai's father was an executive for a huge Chinese conglomerate, GBM Group, which manufactures a third of the world's athletic sneakers. He recently had helped Tsai set up an umbrella corporation, GBM Logistics.
      Tsai and Huang would be partners in the new company, and executives from GBM would oversee the entire operation.
      "These were not two kids out on their own," said Nick Hornberger of Hornberger & Brewer, the lead attorney for the pair. "GBM is one of the largest companies in China."
      After several follow-up meetings with Heiss and Biancone, Tsai and Huang agreed to an initial deal. GBM Group would manufacture the DVD players and sell them to GBM Logistics, which would export them to the United States and Germany.
      Biancone and Heiss called their company Y-USA. The four men agreed that all profits from Y-USA sales to retailers would be placed in a "lock box," which only GBM would be able to access. They would dole out profits to Y-USA.
      Heiss and Biancone initially fulfilled their end of the deal, shipping 30,000 DVD players to Fry's and asking the retailer to put the payment in the lock box.
      But the sweet deal quickly went sour.
      In October 2002, satisfied with the way business was going, Tsai and Huang signed formal contracts with Y-USA .
      "All the profits had been accounted for," Hornberger said. "[Y-USA] said, 'We're doing fine; these other big companies are really interested.'"
      From October 2002 to January 2003, GBM shipped $23 million in product - at a price of $63 per unit - on boats to Long Beach and Germany.
      According to Hornberger, the German partners claimed they would sell the new electronics to Wal-Mart and Costco.
      But as court documents later revealed, the shipments were sold, at slashed prices, to two other electronics companies: E&S, a large Woodland Hills-based company, and Fiberline, a German operation. It was Fiberline that initially sold Y-USA the specifications for the DVD player and introduced Tsai and Huang to Heiss and Biancone at the Taiwanese trade show.
      The money from those sales was not placed in the lock box. Instead, Heiss and Biancone allegedly instructed the companies to send checks to an account in their names.
      Both sides agree that, when Tsai and Huang began demanding their money, Heiss and Biancone delivered some startling news: They had sold Y-USA to Uwe Steuernagel, a German business associate who had been responsible for shipping the items.
      Steuernagel was able to placate Tsai and Huang for 20 days, showing them purchase orders that confirmed he had sold the items for the agreed-on $63 per unit. He sent the pair wire transfers for hundreds of thousands of dollars. The only problem was that he owed them millions.
      "He said, 'Don't be so jumpy; you just have to wait. Don't file a suit, don't stop the shipments,' etc.," Hornberger said. "That only works for a series of days."
      Hornberger said, "All the stuff hits the fan on March 23," 2003, when the plaintiffs gave Y-USA 24 hours to pay up.
      The money never came, so Tsai and Huang sued Y-USA and Steuernagel for breach of contract. Steuernagel, who lived on a boat with a German passport and had no visible assets, quickly filed for bankruptcy.
      "Certain aspects are just classic," said John Hueston, a former federal prosecutor now in private practice at Irell & Manella, who was not involved in the case.
      Although taking many forms, the "bust out" is generally implemented when the person receiving the goods declares bankruptcy to get out of repayment.
      "Someone's left holding the bag who says, 'Sorry, I'm not to blame,'" Hueston said.
      Such schemes involve the creation of shell companies that do business for a short time, then close down and divert the funds once creditors try to collect.
      Although Hueston believes the term is too often used to lump together different genres - "each turn on their own individual facts" - "it's not unusual to have financial fraud cases where they have sufficient sophistication to move money internationally."
      Fairly common, the scheme is detailed on the U.S. Department of Justice's Web site and has even been the focus of an episode of HBO's "The Sopranos," which featured worthless phonecards.
      "These schemes have been going on forever," said Leonard Lyons, a principal for valuations, litigation and forensics firm Stonefield Josephson Inc.
      Lyons, an expert in bust-out schemes, testified for the plaintiffs.
      "A lot of product is delivered cheaply and out the door, while cash goes out the other door, in and out of the bank account," he said.
      Although they are quite common, bust-out schemes are rarely prosecuted, Lyons said.
      "Most of the time, these acts are concealed or conspired with other people. It's very hard to prove that fraud has been committed and prove that conspiracy," he said. "These people are able to do it over and over again.
      "It's expensive to try the case and the money is moved already, anyway. What's rare is proving it up and getting a judgment."
      The plaintiffs decided to try.
      A four-year legal battle followed as the plaintiffs attempted to trace funds from Heiss and Biancone to Steuernagel, and vice versa.
      GBM took Steuernagel, the supposed owner of Y-USA, to civil court in Los Angeles, where a jury found him liable for $17 million. In bankruptcy court, the plaintiffs argued that Steuernagel had committed fraud and therefore couldn't be freed from the verdict. A judge initially ruled in the plaintiffs' favor, than reversed the decision. The case is on appeal.
      Next, the plaintiffs went after Heiss and Biancone, successfully arguing that Y-USA was just an alter ego for the two men. Paper trails showed funds diverted among Heiss, Biancone and Steuernagel, who continued to do business after the supposed sale of Y-USA.
      A plaintiffs' investigation found money from the DVD players dispersed around the world to Hong Kong, Macao, Germany and the men's companies, including a beauty salon belonging to Biancone's wife.
      "It's just a blur," Lyons said. "It's really hard to follow because it's supposed to be."
      Biancone's attorney, Douglas Pettibone, of Anaheim, strongly disputes Y-USA's involvement in any form of a bust-out.
      The defense contended that GBM and Y-USA had never settled on a price for which each DVD player would be sold. It also claimed that GBM had made an oral agreement that allowed Y-USA to sell the players for less, and the sale to Steuernagel was completely legitimate, Pettibone said.
      But Tuesday, after a 42-day trial in Judge Victor Chavez's courtroom and five days of deliberation, the jury returned a verdict totalling $38,592,500, including $23 million against Heiss and Biancone, millions against the men's related Los Angeles companies. An additional $6.3 million were levied against the men in punitive damages, which typically cannot be discarded in bankruptcy.
      In trial, E&S was found to have paid $43 per unit for some of the DVD players and nothing for 133,000 units. Fiberline paid nothing for a majority of their units and received a $1.2 million check from Y-USA, according to court documents.
      Fiberline networks was hit with a $4.4 million verdict, and E&S was found liable for $3.2 million. The plaintiffs had requested up to $10 million from the two companies, which they accused of knowing they were getting a deal they shouldn't have.
      They were not able to prove conspiracy charges.
      Pettibone said Biancone hasn't decided whether he will appeal the ruling.
      Heiss' lawyer, Steven Colby of Peters Verny in Palo Alto, was unavailable for comment. Pettibone said Colby is working on a motion for a new trial for his client.
      Tsai and Huang are splitting time between China and the United States and have moved on to different ventures.
      As for the defendants, they came up with a very good piece of equipment, Hornberger said.
      "It was a great DVD player. It was too good. It hardly had any returns," he said. "If they were straight, they could have done well."
     

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