Rose McKenzie, 38, of Mississauga had her California nursing licence revoked in 2008 after being accused of overmedicating and failing to monitor a patient at California’s UCSF Medical Center following a successful, routine neck surgery. She was a temp nurse employed through American Mobile Nurses Inc. at the time.

The patient, Spencer Sullivan, stopped breathing Dec. 27, 2001, due in part to the overdose, which caused brain damage and left him quadriplegic. Less than a year after the incident, McKenzie moved back to Canada and began working at the Oakville Trafalgar Memorial Hospital.

Spencer Sullivan, 51, suffered brain damage and became quadriplegic. (CBC

But it wasn’t until recently that the Ontario nursing regulatory body began examining McKenzie’s past.

No alert system

The case raises troubling questions about the lack of information sharing between regulatory nursing bodies across Canada and abroad.

No formal mechanism exists to require nursing boards in one jurisdiction to alert other jurisdictions about nurses they have disciplined. Nurses in Ontario, for example, are expected to report any issues themselves.

There were several times when McKenzie might have notified Ontario’s College of Nurses over the past decade, including during a civil lawsuit and a disciplinary hearing in the U.S. Neither was under way when McKenzie began working at the Oakville hospital in 2002.

A picture of Rose McKenzie from a 1996 U.S. state nursing licence document.

In 2005, a $6-million civil lawsuit, settled outside court, ascribed McKenzie with 40 per cent of the cost — or $2.4 million — for Sullivan’s botched care.

In 2008, California’s Board of Registered Nursing revoked McKenzie’s nursing licence after ruling that she had “engaged in gross negligence” in her care of Sullivan. The decision was later posted online.

In his lawsuit, Sullivan’s lawyer alleged that among McKenzie’s missteps made during about 10 hours of post-surgery care starting the evening of Dec. 26, 2001, were:

• Overmedicating the patient by administering drugs ordered by two separate doctors without question.
• Failing to regularly check on him as instructed, leaving hours between visits.
• Failing to chart any of her activities with Sullivan until the following day. McKenzie says she made notes on scraps of paper instead of on the chart.
• Failing, along with another nurse, to respond quickly enough when Sullivan stopped breathing.

“Nurse McKenzie’s care and treatment fell below accepted standards of care for a nurse,” said Sullivan’s lawyer Dan Hodes. “It did. There’s no question about that.”

Disciplinary hearing to be held

Last July, the College of Nurses of Ontario charged McKenzie with failing to “provide complete and accurate information to the college” when she was found to have committed professional misconduct in another jurisdiction. A disciplinary hearing is scheduled for May 6.

Disciplinary hearings can result in a reprimand, fine, suspension or restriction in practice or even revocation of licence.

The College of Nurses of Ontario will hold a disciplinary hearing for Rose McKenzie in May. (CBC)

The Oakville hospital said McKenzie is not currently working directly with patients, but wouldn’t say when that began.

McKenzie declined to talk with CBC News. “I’m sorry, I’ve been instructed not to make a comment,” she said over the phone from her home in Mississauga.

Hodes says Sullivan, 51, was a “high functioning, vibrant, charismatic guy” who was a nurse himself and ran a successful temp agency similar to the one that employed McKenzie. “And now he’s a profoundly brain injured quadriplegic.”

“He was let down by his profession,” said Hodes. “And he knows that.”

Sullivan’s parents, Bill and Carol, both in their mid-70s, moved from their retirement home in Atlanta into a house with Sullivan in Laguna Hills, Calif., shortly after the incident and have been taking care of him ever since.

“The nurse was the first line of defence,” said father Bill Sullivan. “She failed her assignment.”

Spencer Sullivan, who can speak but suffers from short-term memory loss, says he’s grateful to be alive. But, he adds, if he could deliver one message to McKenzie, it would be: “Tell her I said ‘Hello.’ And ‘Go to hell.’ That’s where I think she belongs.”

System ‘completely inadequate’

Tips?

If you have more information on this story, or other investigative tips, please email investigations@cbc.ca.

Halton Healthcare Services, which oversees the Oakville hospital where McKenzie works, said in a letter that all its employees are “vetted through a detailed, rigorous application and screening process.”

The letter notes, however, that it’s the college’s role to ensure registered nurses meet requirements to work in Ontario.

Ontario’s College of Nurses said in a written statement that its members are required to self-report within 30 days about any findings of guilt of an offence, professional negligence or malpractice and if any such proceedings are underway.

But the college also acknowledged that the fact “a nurse is name in a civil lawsuit does not have to be reported” if it’s settled out of court, as was the case with McKenzie.

Nurses are required to answer questions about such issues on a “Self-reporting Form ” filled out during the annual renewal of their licence.

In Canada, there is no centralized system for provincial nursing boards to check a nurse’s status in other jurisdictions.

McKenzie began working at Oakville Trafalgar Memorial Hospital after she moved back to Canada. (CBC)

“Each jurisdiction has different legislation and rules about what information is made public,” Ontario’s college of nurses communications manager, Deborah Jones, wrote in an email. “Some provinces are required by legislation to send this information, others are not.”

Michael McBane, national co-ordinator of the advocacy group, Canadian Health Coalition, said reliance on self-reporting is “completely inadequate.”

“It’s not acceptable in this day and age with this kind of technology to not to be sharing information when it’s such critical information,” said McBane.

Ontario’s Health Minister Deb Matthews says that the nurse’s college in Ontario, as a self-regulatory body, is ultimately responsible for ensuring the nurses are qualified. She told CBC news that patients need to feel confident in the credentials of their health care professionals.

“So if we need to strengthen [the system], I’m always looking at ways to make the system better for the people of Ontario,” said Matthews.

WHEN AIR CANADA FLIGHT 88 ARRIVED AN HOUR LATE AT Toronto’s Pearson airport last January 13, a group of officers from the Toronto Police fraud squad were waiting to meet it. They were there to apprehend Weizhen Tang, a 51-year-old native of China who had lived in Toronto since the early 1990s. Tang was accused of perpetrating one of the largest investment frauds in Canadian history: a Ponzi scheme involving up to 200 victims in Toronto, the United States and China. Two weeks earlier, he had agreed to surrender to authorities at Pearson, but he never arrived, prompting police to issue a warrant for his arrest. They feared he’d stay in China to evade prosecution.

As the passengers of flight 88 watched from their seats, the officers entered the aircraft and made their way through the cabin. This time, Tang was on board. They handcuffed him, escorted him into a police cruiser, and drove to 51 Division. As the car pulled up, Tang stared forlornly out the window at the media horde gathered to document his capture. Wrapped from the neck down in a dark coat and scarf, his eyes peering from behind wire-rimmed glasses, he looked small and vulnerable. Inside the station, he was stripped and searched.

High-profile fraud arrests are rare in Canada, but it’s not because we have a shortage of fraudsters. This country has a reputation for being soft on corporate crime, a problem often attributed to the dysfunctional and divided patchwork of regulatory bodies that oversee Bay Street and the traders and investment gurus who earn their fortunes there. In fact, Canada is the only G20 nation without a centralized national securities regulator, but Jim Flaherty’s on the case. Last May, Canada’s finance minister unveiled legislation to replace the 13 independent provincial and territorial agencies now charged with policing the country’s financial markets with a single organization akin to the American SEC. The Supreme Court is expected to rule on the constitutionality of the new so-called Securities Act early next year.

Tang’s improbable rise and public fall is a particularly egregious illustration of our flawed system. More than four years before his arrest, the Ontario Securities Commission was concerned about Tang’s activities but did little to stop him. In those years, his investors lost as much as $30 million.

In 2008, at the height of the worst financial crisis since the Great Depression, word circulated within Toronto’s Chinese community about Weizhen Tang’s extraordinary investment returns. As portfolios of even the best money managers plummeted, Tang seemed to defy gravity, soaring above the carnage like a wire-fu acrobat in a martial arts film. During a year in which New York’s benchmark S&P 500 Index dropped almost 40 per cent, Tang’s Oversea Chinese Fund reported results that were an astonishing 80 points better.

The Chinese media referred to Tang as the “Chinese Warren Buffett”—a sobriquet he encouraged through references to the legendary investor in his 2006 autobiography, How the Buffett Way Took Me to Wealth. The book is both a self-reverential hagiography and an instruction manual for aspiring investors, and it established Tang as a financial guru—a five-foot-two Mandarin-speaking amalgam of Suze Orman and Tony Robbins. Tang wrote articles for on-line news sites and investor message boards, addressed university students and businessmen during a speaking tour in China in the fall of 2006, and organized seminars and charity events in Toronto attended by VIPs and such politicians as Olivia Chow and Michael Chan. These included an annual Chinese Lunar New Year’s gala, and the North American Chinese Wealth Summit—a lavish $230-a-plate investment seminar and dinner at the Metro Toronto Convention Centre in January 2009, which attracted dignitaries from the Chinese consulate and speakers from major Canadian banks and universities, including the CIBC senior vice-president John C. Pattison.

To Tang’s followers, many of whom were immigrants from mainland China with little understanding of financial markets, his message spoke to the difficulties of succeeding in the West. In an article on Tang’s Web site entitled “How Can Chinese Become Rich?” Tang wrote, “[The Chinese] work too hard, and they work too much—yet, at least in terms of wealth, they have very, very little to show for it… Us Chinese must learn to depend on each other, in particular, the common resources of other Chinese who have something to offer.”

Tang’s path to the moneyed corridors of Bay Street was circuitous. Raised in humble circumstances in China’s Hunan province—his father was a carpenter at a local farming machinery plant; his mother worked as a commercial tofu maker—Tang moved to Canada at 32 to earn a masters degree in biology from the University of Waterloo. His first foray into the world of finance came at a Toronto branch of Canada Trust. It was 1993, and Tang was working as a biomedical researcher at the Toronto General Hospital. His wife, Hong Xiao, and daughter, Wenyi, had recently joined him from China (his son Wensi was born a year later), and he wanted to open his first RRSP account. The bank representative asked if he had ever considered investing on his own. “The idea was utterly alien to me,” he writes in his book. “Prior to that, I had never touched stocks; indeed, at the time, I saw little difference between buying stocks and reckless gambling.”

Enticed by the roaring bull market of 1993, Tang soon changed his mind. He transferred his limited savings from safe, low-yielding government bonds to riskier, higher-yielding equities, and when his portfolio grew by 40 per cent in the first year, he developed the zeal of a convert, proselytizing about the merits of the market. Witnessing his success, some of Tang’s colleagues approached him to invest on their behalf. In 1996, although he hadn’t obtained a trading licence from the Investment Dealers Association of Canada or the OSC, he left his research career to focus on investing full time. Over the next year, his clients grew to more than 100 and his assets under management to $4 million. He claimed to have an average return of 30 per cent, and to have never lost his investors a penny.

Even at this early stage of his new career, there were troubling signs. In the late ’90s, the IDA launched an investigation into Tang’s activities with one of his clients, a 42-year-old hotel housekeeper identified in legal filings as YZ. On Tang’s advice, YZ had opened a trading account in February 1999 at Gorinsen Capital, a brokerage firm where Tang’s wife had recently started working as a sales trainee. Until then, Tang had executed trades through his clients’ bank accounts. Mutual funds are designed as long-term investments typically held for months or years; Tang was trading them daily. The banks eventually refused to accommodate him, so he began trading for YZ through her Gorinsen account. When YZ attempted to redeem some of her investment four months later, she discovered that her $50,000 account had decreased dramatically. Tang guaranteed in writing that he would reimburse her in six months if he couldn’t trade her balance to its original level. But soon after, he stopped returning her calls. By mid-October, YZ’s account had dropped to $11,000. She also discovered Tang had executed 356 trades on her account, incurring $25,258 in commission charges. Unlike the banks, which didn’t charge commissions, Gorinsen charged $51 to $99 per trade; YZ was aware of this and had expressly instructed Tang to reduce his trading volume when she opened the account.

The IDA’s investigation concluded that Tang had ignored his client, was a reckless trader and, because of the cost and frequency of his trades, could never have made a profit. In 2004, the IDA fined Tang’s wife $45,000 and imposed a 10-year suspension from the industry. (Because Tang was not registered with the IDA, he was not subject to sanctions.)

Many of Tang’s clients deserted him after the banks curtailed his short-term trading of mutual funds. He also suffered significant losses during the market downturns of 1998, 2000 and 2001, which angered his remaining investors—prompting some to harass Tang’s family and friends to get their money back. Nearly destitute, Tang mortgaged his modest, two-storey house near Bayview and Steeles, lived off credit card loans, and rented out his basement to a boarder.

In 2004, however, he devised the slogan that would transform his fortunes. In a promotional campaign spread through the Chinese media, he rebranded himself as “The King of 1% Weekly Returns”—a seemingly innocuous claim that would result in a gargantuan 52 per cent annual return. Even better, his new strategy promised to involve minimal risk. “Tang keeps 99 per cent of the total investment pool outside the market for safekeeping, while amplifying the remaining one per cent with certain leverage,” he explained. “In this way, Tang is able to put a cap on the maximum loss while generating steady and continuous returns.”

Tang’s articles and marketing materials read like scripts for TV infomercials. But instead of sculpted abs or a clear complexion, Tang offered the ultimate self-help product: wealth. The viral marketing power of the Internet allowed him to publicize his new identity and investment strategy. He posted stock tips and investing advice on the DaQian Stock Forum, an on-line message board. In May 2005, Shanghai’s Dragon TV interviewed Tang in an episode of Meeting the Financial Community entitled “Chinese Elite Challenging Buffett,” and the legend of the Chinese Warren Buffett was born. Tang, a relentless self-promoter, soon created his own blog on his corporate Web site, where he posted hyperbole-filled articles trumpeting his genius. He also gained credibility through his close association with people such as Daniel Xu, an economics professor at the University of Western Ontario, who wrote the preface to Tang’s book and spoke at a Tang event.

While Tang showed few outward signs of his newfound prosperity, he did relocate his investment firm from his home to an office tower at the corner of York and Adelaide. Occupying half of the 33rd floor, the spacious new premises signalled to investors that Tang’s stature on Bay Street was rising.

Chinese immigrants had witnessed first-hand their native country’s economic boom, where double-digit returns were common­place. They were attracted to Tang’s burgeoning reputation and the promise of steady, one per cent weekly returns, and they clamoured to deposit their funds. Between 2006 and 2008, Tang’s Oversea Chinese Fund raised an estimated $60 million.

In 2006, a middle-aged man I’ll call Hui Chan (he spoke on condition of anonymity) began to notice promotional articles about Weizhen Tang in the free Chinese community newspapers at his local grocery. Chan had immigrated to Toronto from mainland China in 1989. Through a succession of jobs as a cashier, restaurant cook and auto assembly-line worker, he had saved $150,000—the minimum investment required for Tang’s fund. He attended one of Tang’s seminars in the auditorium of a Scarborough high school and came away impressed with both the man and his investment strategy. “Tang gave the impression of being a real expert,” says Chan. “The one per cent weekly return was very compelling.” In the spring of 2007, Chan invested his life savings with Tang. Previously, he had bought mutual funds, which fluctuated with the market. Now, he was encouraged to see his balance growing at a steady daily rate of one per cent every time he logged onto his account on Tang’s Web site. Emboldened, Chan invested another $100,000, financed through a home equity loan on his North York condo. By the end of 2008, the balance in his account had more than doubled to $550,000.

Every three months, Tang arranged catered get-togethers for his investors. He told them to ignore the negative reader comments that followed articles about him posted on Chinese Web sites as the jealous ramblings of people without the resources to invest. “You know what I can do,” he told Chan and the others. “You see your account statements.” But as questions and criticisms continued to build, the Toronto-based Chinese community Web site 51.ca published an editorial challenging him to answer his critics by holding a live, real-time display of his trading ability.

Tang complied, announcing a special five-day event at his offices from January 26 to 30, 2009. A dozen or so people gathered each day to watch Tang trade, including reporters from Toronto Star affiliate Sing Tao Daily and other Chinese media. He began with $1 million in a trading account and proclaimed that he would generate a $700,000 profit—one per cent of the total value of his fund, including supposed profits he’d generated to that date—over the course of the week. The demonstration began promisingly, and after the first day, according to witnesses, the account was up $310,000. By the end of the third day, Tang’s profits had reached $650,000. But his luck ran out, and Tang lost $430,000 over the final two days, leaving a return of just 0.3 per cent.

For Chan, what was more troubling was that the account value fluctuated wildly from one day to the next. The event’s results looked nothing like the steady daily returns he was accustomed to seeing in his account. Immediately after the demo ended, Chan asked to withdraw his entire investment. Tang’s wife tried to convince him to keep some of his money in the fund, but he could not be dissuaded. He filled out an on-line redemption request on the spot, using a computer in Tang’s office. He never received the funds. Other investors, already anxious about the collapse of the global economy, attempted to redeem their money, too, but to no avail. When investors contacted Tang’s office, his staff explained the delay was caused by the sheer volume of requests. Investors formed a committee under the leadership of Peter Lin, a business owner and an early investor who spoke English better than many others. In a series of heated meetings, they discussed whether newer investors should get back their principal before the older investors—who in many cases had already redeemed their initial investment.

Under relentless pressure from the investor group, Tang agreed to a meeting in a conference room at a Markham Holiday Inn. On February 27, more than 120 investors showed up to hear him out. The mood was tense, and reporters in attendance were instructed to leave the room. Tang’s wife, an attractive woman with shoulder-length black hair, stylishly attired in a houndstooth coat, took the microphone first. Speaking in Mandarin, she gave an emotional apology to investors. Soon after, Tang entered the room and sat placidly behind the table as investors confronted him about his failure to honour their withdrawal requests. His answer took everyone by surprise: all of their money was gone. Of the $60 million invested in the Oversea Chinese Fund, only $1,400 remained. Tang told them he had paid out $30 million in redemptions and profits to some investors and had lost the remaining $30 million in trading. A wave of emotions swept over Chan, who at the time still believed Tang had kept 99 per cent of his fund outside the market. “I was very angry, very upset,” he says. “My whole life savings were gone. I didn’t know how I am going to go on.” An investor—the only Caucasian in the room—stood up and confronted Tang. He said he had given Tang $170,000 less than a week earlier and wanted it back. How was it possible, he asked, that Tang had nothing left.

At the end of the meeting, Tang signed what amounted to a confession—a transcript, written mainly in Chinese, of his admissions during the meeting. “The daily investment account statements and the annual statements for the years 2006, 2007 and 2008, as produced by Weizhen Tang, are all falsified and forged,” states the document, which was witnessed by Peter Lin and two others. “Weizhen Tang’s conduct amounts to fraud, contrary to the Canadian laws.” Tang would later state that he feared for his safety and was coerced into signing the confession.

The collapse of the Oversea Chinese Fund coincided with what has come to be called the Year of the Ponzi. In 2009, 150 such schemes collapsed in the U.S., with losses totalling more than $16.5 billion. Canadian investors were bilked by Montreal’s Earl Jones, who pleaded guilty to a $50-million Ponzi scheme. Toronto’s Tzvi Erez is awaiting trial for an alleged $27-million fraud. Calgary’s Gary Sorenson and Milowe Brost are accused of stealing as much as $400 million. Named after Charles Ponzi, an Italian-born con artist who plied his trade in North America in the 1920s, the scheme involves using funds from new investors to pay out redemptions and supposed profits to earlier investors. In many cases, the crimes are also affinity frauds, which target members of a particular ethnic group. Just as Bernard Madoff preyed on members of the Jewish community, Tang appealed to the Chinese diaspora.

In some of the recent Canadian cases, the authorities suspected fraud years before the schemes unravelled, yet the fraudsters managed to swindle hundreds of additional investors before they were busted. And when the schemes finally did collapse, it was the fallout of the economic crisis that precipitated their demise—not the proactive efforts of law enforcement.

In Canada, the responsibility for investigating white collar crime falls under multiple agencies, including the municipal police, the provincial police, the RCMP, or some combination of the three, depending on the crime and the jurisdictions in which it was committed. If the public markets are involved in the fraud, one or more of the 13 regulatory commissions join the investigation, as well. “White collar crime is the responsibility of so many agencies that it has become increasingly unclear within each jurisdiction who is responsible for what,” says Larry Ritchie, a vice-chair of the OSC now serving as executive vice-president and senior policy advisor to the Canadian Securities Transition Office—the government entity preparing for the establishment of a national securities regulator. “That’s where the system falls short.”

In 2003, in an attempt to streamline investigations, the federal government created specialized units within the RCMP dedicated to corporate crime. Known as Integrated Market Enforcement Teams, or IMETs, they were composed of RCMP officers, forensic accountants and experienced securities fraud investigators. Seven years into its mandate, however, the IMET program has been universally panned. Cases have dragged on for years, only 26 individuals have been charged, and just five convicted by the end of 2009. Some experts blame its failure on the structure of the RCMP itself. “IMET didn’t work in part because the RCMP is a largely unaccountable, highly bureaucratic organization,” says Edward Waitzer, a partner at the Bay Street law firm Stikeman Elliott and a former chairman of the OSC.

IMET’s mandate is small. It was set up with only nine teams—three based in Toronto—and designed to investigate a handful of cases at a time. The burden to detect white collar crime continues to fall on municipal organizations like the Toronto Police, which are neither equipped nor motivated to deal with it. Lincoln Caylor is a partner at law firm Bennett Jones who is currently involved with five different Ponzi schemes, including Tang’s. “Rob a convenience store of $500, the police will chase you down, the Crown will prosecute you, and you will go to jail,” he says. “But defraud hundreds of seniors of their life savings and it will take years to investigate, the Crown will give it a low priority, and chances of going to jail are zero.”

The cases that do manage to reach the courts are often shepherded by prosecutors with little interest or experience in corporate crime. In the U.S., prosecutors use the district attorney’s office as a stepping stone to high political office (Eliot Spitzer, Rudy Giuliani) or to a lucrative job at a corporate law firm. But the same career paths aren’t available in Canada. “If you go and work for the Crown, there’s no place for you in corporate law,” says a former OSC attorney, now a partner at a major Bay Street firm. Consequently, Crown attorneys focus on personal crimes, such as murder and sexual assault. “I’ve had to teach prosecutors how the stock market works,” says RCMP Superintendent John Sliter, the former national director of IMET. “They were dealing with murder and rape cases, and suddenly they got handed a securities fraud case, which is much more complicated, many more documents. Once they do a securities case, they often never want to do another.”

Neglecting white collar crime comes at a steep cost. Canadians have $1 trillion invested in our capital markets. We rely on these markets to raise funds for new business and to spur economic growth and job creation. The perception that we are soft on white collar crime has a noticeable effect on the value of our holdings. “We are hailed for having one of the world’s most stable banking systems,” says Poonam Puri, an associate professor at Osgoode Hall Law School who specializes in corporate fraud. “Meanwhile, when Canadian companies attempt to raise outside funds, they are forced to pay a premium because of concerns over our ineffective enforcement.”

After the debacle at the Holiday Inn, Tang begged investors not to go to the authorities. He promised to pay them back within a year and threatened to exclude anyone who didn’t remain loyal from future returns. While many investors retained a cult-like devotion to Tang—or a desperate hope that they would get some of their money back—a handful reported him to the OSC and the Toronto Police. On March 12, 2009, an OSC senior investigator named Jeffrey Thomson interviewed Tang at the Queen Street offices of the commission. Tang admitted that in 2006 and early 2007, even as he promoted his one per cent plan in articles and speeches—and claimed annual returns of more than 40 per cent—he had actually lost $15 million in the stock market. To cover his tracks, he falsified the statements purporting to show the daily value of each investor’s account and, in classic Ponzi style, used deposits from new investors to pay withdrawals and supposed profits to earlier investors.

Five days after the interview, the OSC issued a temporary order barring Tang from trading securities. On June 9, they accused him of operating the Oversea Chinese Fund as a Ponzi scheme and charged him with 12 counts of securities fraud and other related offences. Each count carries a fine of up to $5 million, or up to five years in prison.

Meanwhile, the SEC had discovered that Tang had raised $17.3 million from approximately 75 investors in Texas and California through an American subsidiary called WinWin Capital—a feeder fund managed by a woman named Jiehua “Jay” Yu, whose sole purpose was to invest in the Oversea Chinese Fund. On April 3, the American SEC filed separate civil charges against Tang in a U.S. district court in Texas for operating a Ponzi scheme.

As it turns out, the OSC had investigated Tang’s operations between September 2005 and February 2006, soon after he launched the Oversea Chinese Fund. (They declined requests for an interview, stating their policy of not commenting on ongoing cases.) At the time, OSC investigator Michael Ho expressed concern over the wording on Tang’s Web site and directed him to delete claims that the fund was registered with the OSC. Ho also asked Tang to refrain from selling units in his fund to unqualified Ontario residents. Historically, hedge funds have been subject to less stringent regulation than other investment funds on the assumption that their investors are wealthier and thus more savvy. To qualify, investors must earn at least $200,000 per year and have a net worth of at least $1 million, or invest a minimum of $150,000.
When the OSC concluded its first investigation, Tang’s fund had raised less than $6 million. The real damage happened in the years that followed.

While most accused criminals maintain a low profile after their schemes are exposed, Tang has continued to seek the spotlight. Since his arrest, he has portrayed himself as the victim of an overzealous and unwarranted prosecution—even charging that the case against him was racially motivated. On September 9, he made an announcement: he was running for mayor of Toronto. “Before a hostile hovernment…conspired to destroy both my name and business, I, Weizhen Tang, was the most prominent community leader in our hundreds-of-thousands-strong Chinese community,” he wrote in the press release announcing his candidacy. “I am the one who can combine political wisdom, insight and experience with the financial expertise which Toronto and Canada need.”

Tang rebuffed my initial requests to interview him, but a week after he launched his campaign, he invited me to his home at Bayview and Steeles. The red brick house is unassuming, except for two large “Tang for Mayor” banners hanging conspicuously outside.

Tang, dressed in a black suit and striped grey tie, sat at his dining room table, which he’d covered with award plaques, press clippings and cheaply printed campaign posters. On the wall beside him, a giant flat screen TV was tuned to CNN. “I am the anti-fraud,” he told me in fluent though heavily accented English. “If you elect me as the mayor, I will get rid of all the fraud.” Sounding like the kind of man who believes his own spin, he insisted that unlike Madoff and other Ponzi schemers, he didn’t set out to defraud investors. His hedge fund, he said, wasn’t really an investment fund at all. His clients’ investments were loans, he claims, “seed capital” he’d committed to repay. Even though his investors’ account statements didn’t reflect the true value of their investments, he considered them to be “future” values—akin to accrued interest—which he fully intended to repay. But the OSC stepped in and took away his livelihood. “I gave all my money to investors,” he says. “I looked after them much more than my own family.”

Prior to Tang’s arrest, some investors seemed to share this belief. In November 2009, dozens of them petitioned the OSC to lift the trading ban against Tang, and when their petition failed, they sponsored his trip to China so he could resume trading there and recoup their losses. Indeed, Tang claims he didn’t go to China to evade prosecution; he went to trade stocks.

There may have been another purpose to Tang’s trip: fund­raising. Before he was arrested, his reputation in his native country remained intact: in 2007, the managing director of the $200-billion state-owned China Investment Corporation had supposedly asked Tang to draft a proposal for how the newly established fund should be invested; and the Chinese government presented Tang with a credibility award during an elaborate ceremony in December 2008 honouring “wealthy and intelligent” citizens at Beijing’s historic Diaoyutai State Guesthouse.

It appears that Tang viewed the Chinese fund as his salvation—the means to keep his scheme afloat. “I use the investor’s money as a bridge…not as a Ponzi,” he told the OSC. “I was trying to talk to the Chinese government fund…There’s $200 billion.”

So what really happened to the nearly $60 million invested in his fund? One answer may be found in a series of candid, confessional letters Tang posted on his Web site after the second OSC investigation began. Combined with court records, the letters reveal that Tang lost most of his investors’ money chasing risky, short-term returns. In one typical blunder in 2007, he bought thousands of Dow Jones Index futures contracts and lost millions on them. These investments had nothing in common with the philosophy of the man to whom he was being compared. Buffett, a value investor, preaches the idea of searching for undervalued companies and investing in them for the long term.

Following his arrest, Tang spent three months in jail before being released on $150,000 bail. Tang claims he’s destitute and can no longer even afford a lawyer; last summer, he held a barbecue and a garage sale to raise money for his defence. But some investors believe Tang may still have substantial holdings. At the Holiday Inn meeting, they confronted him about a brief trip he made with his wife and son to Bermuda shortly before his fund collapsed. There is speculation among the victims that Tang may have hidden several million dollars offshore. (Tang’s wife denies this, saying that the trip was related to her job at Aimity Financial Group, where she is a “top producer.”)

Tang’s criminal trial will likely go to court next year. In addition, he must defend himself in civil suits from several of his victims, including a wealthy industrialist who invested $500,000 with Tang in October 2008. The industrialist successfully won a court order to seize Tang’s Toronto home, but officials were unable to sell it, granting Tang a brief reprieve.

Meanwhile, the American SEC, which reached a partial settlement with Tang in 2009, has been trying to locate what’s left of his money. Tom Tong, a receiver appointed by the Texas court, froze $1 million in bank accounts that belonged to Tang’s Texas subsidiary, WinWin. In an aggressive maneuver, Tong convinced the Ontario court to recognize his receivership so that he could attempt to recover a $300,000 payment wired from WinWin’s Jay Yu to Toronto investor Peter Lin shortly before the SEC filed charges.

Some of Tang’s victims are considering a class action in Canada in an attempt to recover some of their funds. After Tang’s arrest, they believed the police would fulfil this role but have discovered that law enforcement in Canada has neither the resources nor the inclination to focus on recovering the proceeds of fraud. (The OSC declined to appoint its own receiver in the Tang case, although it has the authority to do so.) Canadian victims intend to challenge the U.S. receiver’s claim in Ontario civil court. If they lose, only Tang’s American investors will get access to WinWin’s remaining funds.

Behind a cloak of anonymity, Tang’s investors vent and commiserate with one another at 4just.ca, a blog set up by a couple of tech-savvy victims. “Wei Zhen Tang’s cynical ways ruined our Chinese community,” reads one post. Another features an image of a man kicking another man off a tall building. Tang’s face is superimposed on the face of the falling man.

Soon after his fund collapsed, Tang sent a letter to his investors. “To a certain extent, the markets of the world often seem like a casino, where any gambler is subject to loss, including myself,” he wrote. “I have learned my lessons, and I profoundly believe that I can make hundreds of people wealthy once more.”

The violence likely was not aimed at the dentist. It was intended instead for his brother-in-law, Tzvi Erez, a 42-year-old former printer who lived around the corner. The bankruptcy of Mr. Erez’s Toronto company, E Graphix, exposed a $27-million Ponzi scheme that would lead to his arrest and to charges of seven counts of fraud, on which he is now awaiting trial. A series of threats had forced him, his wife and three children underground – where he remains – and those responsible for the gunshots evidently believed he was using his sister’s place as a safe house.

Seemingly an unlikely target for gun-toting thugs, Mr. Erez by background and appearance was largely indistinguishable from many young Jewish professionals who call this Bathurst and Lawrence area home. He graduated from two of the city’s most buttoned-down parochial schools, Associated Hebrew School and the Community Hebrew Academy of Toronto, and holds an MBA from York’s Schulich School of Business. The one-time piano prodigy also performed recitals at the city’s most prestigious concert halls, and had released a couple of well-received classical CDs, including Tzvi Erez Plays Chopin.

Pictured on the CD cover, the musician appears a decade younger than his then 36 years. His smooth, round baby face, crowned by a full head of close-cropped brown hair, emerges almost incongruously from his tuxedo, as if it had been Photoshopped. The biography Mr. Erez posted on his website at the time of the album’s release – before he is suspected of launching his scheme – suggests he already possessed the self-confidence, bordering on arrogance, needed to pull it off: “Singularity, originality, and a deep understanding of music inform and define the towering musical talent of Tzvi Erez,” begins the 620-word paean, which concludes with an acknowledgment of his family, “who are destined to share their lives with a charismatic genius.”

“He was a bit nerdy, a bit chubby,” says Aaron Sher (not his real name), one of several creditors who spoke on condition of anonymity. “He presented himself as having this little business, which through his ingenuity produced great returns. It wasn’t rocket science. It was something people could understand.”

But there was a profligate Mr. Hyde to the hard-working, somewhat nebbishe Dr. Jekyll. It emerged that Mr. Erez was secretly a heavy gambler, taking covert trips to casinos and playing high-stakes poker online under an alias. Indeed, he previously had been charged with fraud for writing fraudulent cheques to several Ontario casinos. For many of his 76 creditors, some of whom face financial ruin, the revelations about Mr. Erez’s gambling habit left a host of unanswered questions: Was their money really gone? Could Mr. Erez have used online casinos as a vehicle to conceal it? And how did he manage to deceive them for so long? “Six weeks before all this happened, he was dancing with his baby at his mother-in-law’s retirement party,” says Sheldon Esbin, a close friend of Mr. Erez’s father-in-law who loaned him money because of their family connection. “To look at him, so happy, you would think that everything was fine. But nothing was fine.”

PITCH PERFECT

“I used to thank God for the day I met Tzvi Erez,” says Jamie Gold, his voice choked with emotion. We are sitting at a Starbucks on Avenue Road, a few blocks from Mr. Erez’s former home. All around us, women heavily made up to look as though they just rolled out of bed chat animatedly over non-fat lattes. Mr. Gold had known the Erez family for more than a decade, so when a friend approached him about investing with the printer, he was already predisposed. “This wasn’t just two guys meeting in a coffee shop and one says, ‘Give me your money,’” said Mr. Gold (not his real name), who spoke on the condition that I shield his identity. “I knew this was a good person from a good family that I had a history with.” He began investing with Mr. Erez in 2006, eventually committing the six-figure line of credit on his home. Later he raised another $3-million from close family and acquaintances on Mr. Erez’s behalf.

For Mr. Gold, everything about Mr. Erez’s background conveyed stability. The Erez family was well known among Toronto’s observant Jewish community, who rallied around them after Tzvi’s younger brother Niv was fatally shot during a robbery attempt at the Richmond Hill jeweller where he worked. Mr. Erez’s stepfather, Yehuda, who adopted young Tzvi in his native Israel, was a respectable real-estate developer and lived with Mr. Erez’s mother in a multimillion dollar home near Chabad Gate, the upscale Jewish neighbourhood in Thornhill. While Tzvi drove a late-model BMW and lived in a comfortable home, there was nothing flashy about his dress or demeanour. “He was a fixture,” says Mr. Gold. “The fact that he had a family, roots, gave me confidence he wouldn’t run off with our investment.”

Mr. Erez told investors his business was based on “factoring,” an established financial strategy in which a company borrows money against the value of its accounts receivable. In the case of E Graphix, these ostensibly were purchase orders from customers such as Subway and Movado placed three months in advance of payment. He said he used the loans from investors to pre-pay all his suppliers, enabling him to negotiate steep discounts for paper, printing-press time, and other production costs. As a result, he could claim outsized profits – 20 per cent or more on each three-month contract – which translated into mammoth annual returns of between 80 per cent and 100 per cent. Mr. Erez promised Mr. Gold annual returns of 20 per cent or more on his investment, and at first he didn’t disappoint. “I gave him money,” says Mr. Gold, “and every three months I’d get it back with interest – and there would be a new contract to roll the money into.”

Mr. Gold didn’t realize though that the purchase orders he was supposedly funding were alleged later to be forgeries, and that the returns Mr. Erez paid him would be said to be coming straight from the pockets of other investors – a classic Ponzi scheme in which funds from new investors are used to pay out older ones.

Mr. Erez also cultivated a Bernard Madoff-like air of exclusivity. Periodically, he approached investors with what he called “pops,” rare deals that carried much higher returns. “You felt thankful to him for bringing you in,” says a creditor, “as though you were taking someone else’s place.” So when difficulties arose, including the occasional bounced cheque, investors were quick to dismiss them. “Nobody wanted to rock the boat,” says Mr. Sher. “And the more you got paid, the more you let your guard down.”

Mr. Erez’s alleged method of co-opting existing investors to become brokers was also reminiscent of Mr. Madoff. Sometime in 2007, Mr. Erez approached Mr. Gold to raise more money. E Grafix’s services were in demand, he said, and he wanted to double the $3-million Mr. Gold and a handful of friends already had invested. Mr. Gold secured the additional funds from friends and family, among them seasoned investors with successful track records, including several lawyers and accountants. “They all met Tzvi and did their own due diligence,” he said. For added security, Mr. Erez named the investors as beneficiaries on his life-insurance policy and provided a personal statement of net worth – printed on the letterhead of a respected Toronto accounting firm – valuing his assets at $3.4-million and stating he was the 50-per-cent inheritor of a $57-million trust fund.

Above all, Mr. Erez’s scheme relied on the appearance of transparency, achieved by providing investors expertly forged documents. “He used his expertise as a printer to create documents that fooled a lot of smart people,” said Lou Brzezinski, a lawyer with Toronto firm Blaney McMurtry, who brought a civil lawsuit against Mr. Erez on behalf of a creditor, William Tencer. One supposed deal with Movado, for example, involved printing the booklets that accompany the company’s watches. Mr. Erez provided the purchase order and a sample; invoices from suppliers to show the work had been completed; a copy of the signed check from Movado; and a bank statement from CIBC with the corresponding amount deposited in one of his accounts. The records were convincing enough to secure a $250,000 credit line from CIBC.

None of the creditors anticipated a widely distributed e-mail last February from Mr. Erez’s lawyer Howard Manis, which explained that his client was bankrupt and would not be able to repay their loans. “There were all these names on the e-mail I had never seen before,” says Mr. Gold, who attended a hastily arranged meeting that night at the Bathurst and Lawrence home of one of the creditors. “There was nervous laughter each time someone new walked in the door, saying they were owed $800,000, $1-million, $2-million,” he added, estimating 20 people attended that night, many representing more than one investor. They calculated Mr. Erez owed them more than $25-million – a staggering sum for a small printing business with a single employee. “People were in shock,” says Mr. Gold. “I went to my brother’s house and told him his money was gone, and he started crying. Then I called my largest investor, and he started crying. Everybody said, ‘I’m ruined. I’m ruined.’ And that’s how I spent the next two days – ruining people’s lives.”

Later that night, several creditors tried unsuccessfully to contact the printer, showing up at his business, his house, and family members’ homes. The police eventually posted an officer outside his sister’s house, and later charged a creditor, Gad Elmaleh, with seven counts of threatening death and one count of criminal harassment (he was released after paying a $500 surety and is not a suspect in the shooting). The following day, an e-mail from Mr. Manis informed creditors that, “for the safety of his family, Tzvi Erez has gone into protection until further notice.”

IS HARIS EREZ?

In the spring of 2008, the online poker world was abuzz over the exploits of Steve Haris, a virtual No Limit Texas Hold’em player who wagered enormous stakes – $100,000 or more on a single hand. “Notice the list of hungry sharks awaiting a chance to felt steve haris, its [sic] getting bigger and bigger,” writes someone using the handle Lucoo in the forum on FullContactPoker.com. “This guy is every poker player’s wet dream,” adds JaNnN. “Probs [sic] some rich businessman, apparently stuck 150k in the last week or something,” speculates HighwayStar.

As it turned out, Steve Haris was an alias used by Mr. Erez, according to the report issued by court-appointed receiver Jerry Henechowicz. After Mr. Tencer filed his lawsuit against the printer last February, Ontario Superior Court Justice Colin Campbell granted Mr. Henechowicz’s firm special investigative power to vet creditor claims and locate and seize any remaining assets. Both tasks, however, proved difficult. In his nine-month investigation, Mr. Henechowicz reviewed over 4,000 transactions at a single CIBC branch near the former premises of E Graphix, and found that its owner moved $38.9-million through the bank over the two-year period before his scheme collapsed. As would be expected for a Ponzi scheme, the majority, about $29-million, appeared to go to Mr. Erez’s investors. Most of the remaining $9.9-million was wired to various casino accounts and withdrawn in cash.

But this figure may not reflect the true scope of the alleged fraud. Mr. Henechowicz also uncovered more than 90 other bank accounts Mr. Erez directly or indirectly controlled, 15 of them outside Canada. With limited resources, the receiver couldn’t pursue most of them. Moreover, those close to the case believe some of his creditors chose not to make their claims public in court. “There are a whole group of people owed a ton of money that haven’t declared,” says Mr. Brzezinski, who became the lawyer for the receivership. “The allegation is that they are using alternative means of justice.”

In interviews, Mr. Erez told the receiver he kept almost nothing, and there is some evidence to support this assertion. His house was mortgaged for more than its value, and the receiver only managed to recover $35,000 for his remaining assets. (Mr. Erez didn’t respond to The Globe and Mail’s request for an interview, and his civil lawyer Howard Manis and criminal lawyer Mark Sandler, both of whom no longer represent him, declined to comment.) Mr. Erez said he became indebted to “various parties” – someone close to the case referred to them as “loan sharks” – and hatched the Ponzi scheme in order to extricate himself. While the names of these mysterious “parties” were redacted from the receiver’s report, the title of Mr. Erez’s former home indicates he borrowed heavily in 2006 from an entity called First Mortgage Banx – enough that he had to take out a subsequent $1.3-million mortgage from CIBC to clear the debt.

The alternate theory, held by Mr. Brzezinski and some of Mr. Erez’s creditors, is that his gambling was an elaborate means of concealing his ill-gotten gains. If the poker message boards are to be believed, Steve Haris’s poker style – a combination of feckless and reckless – bears little resemblance to the quick-witted musical prodigy capable of bluffing investors, friends, and family. “Tzvi has rather a high intellect,” says one of his creditors, Wesley Roitman. “If he’s a poker player, he’s a good poker player. I don’t believe he lost all the money.”

According to gaming experts, Mr. Erez could have opened casino accounts under different names and played against himself, thereby transferring phantom losses by one alias to an offshore account registered to another alias. He could also lose deliberately to another player, who surreptitiously would return the money later. (Forensic analysts discovered the Steve Haris alias on Mr. Erez’s laptop, but they also found evidence that he stored large amounts of data on a portable hard drive, which was never recovered.) A third option, posted on the FullContactPoker.com message board, is that Mr. Haris’s loose play was a ploy to present himself as an easy mark – a tactic he could later use to his advantage. “Let’s say… you had $3-million you just didn’t need,” writes Monoatomic. “You hop online and tank like 500K in a few displays of just absolute donkey play where your name gets passed around every poker forum for being a complete whale. Then one day you switch up your play to such extremes where you make back the 500K … plus a whole boatload more.” We likely will never know the true answer. Registered in the Isle of Man, Gibraltar, and other tax havens, online casinos remain largely impenetrable to foreign legal inquiries.

Whether or not they ever recover any of their losses, creditors will soon be on the hook for more. Under Canada’s new bankruptcy laws, all the funds they received as investment payouts from Mr. Erez in the three months prior to the receivership – approximately $1-million – are now considered “preference payments” and must be returned. Mr. Brzezinski says he would like to use them to fund future investigations, perhaps into the offshore casinos. But some of Mr. Erez’s creditors already have accused him of overreaching, racking up fees on an investigation with little chance of success.

ANOTHER VICTIM, ANOTHER COFFEE SHOP

On a cold morning in January, I meet Mr. Erez’s father-in-law, a distinguished university professor, at a Tim Hortons on Steeles Avenue, not far from E Grafix’s former premises. He has offered me an exclusive glimpse inside Mr. Erez’s life, provided I agree to keep his name, and the name of his daughter, private. Although everyone associated with the case insists Mr. Erez’s wife knew nothing of her husband’s activities, her father still fears for her safety and the safety of her children. Last September, the two older ones were asked to leave their school – mere months after they had to leave their home with little more than the clothes on their back. The school had received a few threatening messages, and apparently wanted to insulate itself. “We don’t want anyone’s pity,” says the father-in-law, “but we are victims in this too.”

He tells me the first time he met his son-in-law, Mr. Erez came across as caring, loving, and accomplished. “He was doing his MBA, his piano playing was incredible; it just seemed perfect.” Until news of the scandal broke, he never had reason to suspect anything. “He didn’t drink. He didn’t tell dirty jokes. He was just normal in every way … I was happy to have a nice, normal, stable guy.”

Last January, Mr. Erez told him business was down, and that he had some debts. “We assumed they were business debts, and our confidence in him was such that we assumed he would get through it.” Even when the receiver took over the house and changed the locks, Mr. Erez’s father-in-law believed it was because of business-related debts. “We had no idea about his gambling,” he says.

But once his daughter learned about Mr. Erez’s secret life, the couple separated. “He’s not in the picture,” says the father-in-law. “The Tzvi Erez we knew bears no resemblance to the guy out there now. They are nothing alike. I don’t even know who this guy is.”

Special to The Globe and Mail

While each of these ongoing embarrassments continues to cost the United States power, prestige, and financial security, none of them threatens the safety of the country as significantly as this simple fact: Our nation’s airport-security apparatus still suffers from the same weaknesses it did before the Twin Towers were toppled. For this special investigation, Best Life interviewed a wide range of security experts, airline-industry analysts, and current and former officials at the Transportation Security Administration and the Federal Aviation Administraion. They all agree on one thing: We’re no safer than we were before 9/11.

Since that catastrophic morning, we’ve seen the narrowly thwarted attempt of shoe bomber Richard Reid in 2001; the female Chechen suicide bombers who successfully brought down two Russian airliners in 2004; the foiled plot by British Muslims to blow up as many as seven United States-bound passenger jets with liquid explosives in 2006 (they were sentenced in late summer of this year); and in September 2007, the foiled attempt by Islamic fundamentalists to target Ramstein Air Base and Frankfurt International Airport in Germany. “Terrorists in general—and al-Qaeda in particular—have tended to come back to the same targets and the same methods of attack time and time again,” says Erik Dahl, an assistant professor at the Naval Postgraduate School and a former research fellow at Harvard’s Kennedy School of Government who spent 21 years as a military intelligence analyst. “And the reason they like to attack airplanes is that it is a relatively easy way to kill a lot of people.”

In the aftermath of the 9/11 attacks, checkpoint security became a central focus of a new branch of the federal government, the Transportation Security Administration. The TSA replaced private screeners employed by the airlines with an army of federal transportation security officers (TSOs); invested billions of dollars on new detection equipment; and much to the chagrin and annoyance of passengers, significantly restricted the items that may be carried onto planes. What exactly have we received in exchange for nearly $30 billion of taxpayers’ money, slow-moving security lines, surrendered shoes, and confiscated toothpaste?

“It’s all ’security theater,” says Bruce Schneier, one of the world’s foremost security experts, who actually coined the term in his 2003 book, Beyond Fear: Thinking Sensibly About Security in an Uncertain World. “None of these measures are designed to make us any safer. They are only designed to make us feel safer.”

But as you’ll see, like most charades, the act has begun to wear thin, and the cracks in our national airport-security system are becoming hard to ignore. Here are the 10 security issues that the next administration must address—before it’s too late.

1. Current Screening Methods Can’t Locate Improvised Explosive Devices
As hostilities in Iraq and Afghanistan continue, an extremely powerful homemade bomb has emerged as the insurgency’s weapon of choice: triacetone triperoxide. TATP, as it’s known in counterterrorism circles, is made from acetone, hydrogen peroxide, and hydrochloric or sulfuric acid—all easily attainable at your local hardware store and pharmacy. The explosive device is simple to construct (as illustrated by our photographer Dan Winters’s live bomb on the previous page), lethal (proved by London’s suicide bombings of 2005), and simple to carry past airport security. Indeed, last November, a Government Accountability Office (GAO) report stated that two of its investigators “demonstrated that it is possible to bring the components for several IEDs [improvised explosive devices; read: TATP] through TSA checkpoints and onto airline flights without being challenged by transportation security officers.” GAO investigators obtained the components “at local stores and over the Internet for less than $150″ and concealed them “in their carry-on luggage and on their persons.” Chillingly, the report flatly states that “in most cases, [TSOs] appeared to follow TSA procedures and used technology appropriately.”

What’s more worrisome is that these vulnerabilities are virtually identical to those revealed in a GAO report from nearly two years earlier. In late 2005 and early 2006, undercover investigators brought through checkpoints components that could have been mixed together in an airplane restroom to make a homemade bomb; TSA screeners at 21 airports across the country failed to find them 100 percent of the time. In 2005, then acting inspector general for Homeland Security, Richard Skinner, testified before the Senate that “the ability of TSA screeners to stop prohibited items from being carried through the sterile areas of the airports fared no better than the performance of screeners prior to September 11, 2001.”

All one needs to unlock the secrets of TATP is a free weekend and access to Google. While the dangers of TATP have been reported, the vulnerability of our airport infrastructure to this explosive has not.

2. Outdated Screening Technology
It’s no secret that the metal detectors used to screen passengers cannot detect liquids concealed on passenger’s bodies; they weren’t designed to. That’s why companies such as American Science and Engineering and L-3 Communications have developed new imaging technologies that can see through passengers’ clothes to detect liquid explosives, powders, and virtually anything else. A handful of these screeners are being tested at our nation’s airports, but nowhere is it mandatory for passengers to pass through the machines. The technology has been implemented in less than a dozen airports. America has not rolled out these game-changing machines for two simple reasons: cost and privacy concerns.

The machines that screen checked baggage, CTX scanners, are outdated too. When Best Life took an undercover tour of Terminal 4 at New York’s John F. Kennedy Airport, a TSO we’ll call Wendy (she asked us not to use her real name for fear of retaliation from the TSA) showed us how the machines work. Like CAT scans seeking tumors in the human body, the device scans for explosives in luggage. Unfortunately, while today’s CAT-scan technology can screen your brain in its entirety, the CTX is far less advanced. When a bag pauses inside the CTX, it is screened in cross-sections, much like throwing a tic-tac-toe board over each piece of luggage. As a result, the machine may alarm on an innocuous water bottle while missing a block of C-4 explosive inches away. New technologies can address these inadequacies, but as you’ll soon see, we’re not even using these machines effectively.

3. Chronic Staff Shortages
Another problem with CTX scanners is that things like lead-film shield bags thwart them. However, the machine is equipped with a backup for just such eventualities: It has a monitor that displays objects that might have evaded electronic detection. A lead bag, for example, appears on the monitor as a dark, indistinguishable blob. But at JFK, screeners have been instructed, in the interest of time, to clear every bag that doesn’t “alarm” regardless of what’s on the monitor. “We are so busy,” says Wendy, “that if an item doesn’t alarm, we have to let it through.” Indeed, JFK screeners were so overwhelmed during our visit that nobody was even watching the monitors. “In the beginning, we started off with six people on each machine,” she says. “But now we are down to three, so there’s no time to sit and monitor the screen.”

According to an internal TSA e-mail, dated June 6, 2003, shortages like these throughout the nation’s airports have long been known about. It was written less than a month after Congress capped the number of full-time screeners at 45,000, which resulted in at least 6,000 TSO layoffs. “Each day we screen [fewer] bags,” wrote Scott McHugh, then the federal security director at Washington-Dulles airport, to his counterpart at Harrisburg International Airport in Pennsylvania. “Consequently, we are now screening only 57 percent of all bags with electronic screening. Up to now, we have been able to hide this fact from the public (and any terrorist surveillance teams).” If you’re wondering how the other bags get through, they’re cleared with a method called batch swiping. A TSO swabs a cart full of checked bags in a few places and tests for explosive residues. The day after McHugh sent the e-mail, his counterpart at Boston’s Logan Airport forwarded it to several colleagues with a note attached: “McHugh says it like it is and never receives a response from [TSA] HQ other than to chide him for being too progressive.” Soon after the e-mail went public, McHugh, a former international security director for Philip Morris, resigned.

4. Training for TSA Screeners Is Getting Worse
Inadequate training is a common complaint among the more than a dozen TSOs interviewed at JFK and other airports. In the first years under the TSA, screeners say they were given between 40 and 100 hours of training, some of it on the job and the remainder through interactive training modules on a computer. But TSOs aren’t paid for time spent studying, and the materials are considered SSI (security sensitive information) and can’t leave a secure area in the airport, so screeners have to travel to the airport on their own time, at their own expense, in order to study. They seldom do. Meanwhile, new TSOs receive less training than experienced ones do, and most of it occurs on the job, where overwhelmed veterans now have to worry about training rookies while looking for weapons and explosives. “We have people running around the terminal who are not being trained and not being monitored, and nobody seems to care,” says one TSO supervisor at JFK.

“You teach people all this security sensitive information, give them security clearance, and then three weeks later, they quit,” adds Sara, another TSO at Terminal 4 who didn’t want her real name used. “I have to fly somewhere next week, and I’m scared to get on a plane.”

5. Sensitive Areas Are Not Secure
At JFK, a TSO colleague of Wendy’s and Sara’s, whom we’ll call Mark, demonstrates for us a handful of security concerns in public areas of the airport. At several JFK terminals, for example, screened bags have to be wheeled manually on a cart outside the secure checked-baggage area to reach the airplane, where they are accessible to people who haven’t undergone security screening. It’s an issue that’s common at many of the nation’s older airports, which don’t have in-line baggage systems. Mark also points out that no one is guarding the door to the ramp adjacent to the baggage-return carousels. Directly on the other side of this door, dozens of aircraft are waiting to refuel and load before departing for their next destinations. The ramp door is clearly visible from the street and is accessible to anyone walking into the arrivals area. As Mark, Wendy, and Sara look on, an airport employee swipes his card, opens the door, and holds it as one, two, three, four other employees walk through. “That’s called piggybacking,” says Mark. “It’s supposed to be a $10,000 fine for every offense, but no one is watching the ramp doors.” He explains that all the TSOs are needed upstairs at the checkpoint; there aren’t enough to station any downstairs. “Look, they are holding the door for that guy with the big box,”says Wendy. “That thing could be full of explosives. No one is even checking.” It turns out that while the TSA has taken over responsibility for checkpoint security and baggage screening, security throughout the rest of the facility remains in the hands of the airlines and the airport owners—just as it did prior to 9/11.

Up until this point, the majority of problems reported here are things that are right out in the open, things that all travelers, airline executives, and politicians can see but have somehow collectively chosen to ignore. This enrages Steve Elson, a 63-year-old retired FAA special agent and former leader of the FAA’s Red Team, the small, elite, clandestine unit that was responsible for discovering and correcting security weaknesses before 9/11. It was once his job to smuggle through airport security the bombs and weapons we hear about in those GAO reports. He exposed the vulnerability of U.S. aviation security by successfully sneaking past screeners with potentially deadly items (e.g., bombs, knives, and guns) 90 to 100 percent of the time, but his findings received little attention from Congress or the airlines. Elson became so fed up with the lack of attention paid to security issues that, in 1999, he quit the agency. Two years later, on the morning of September 11, he was dismayed to discover his predictions had come true. “There is no goddamn way in hell those in Congress don’t know the abysmal and inexcusable state of affairs in TSA and AVSEC [aviation security],” says Elson. “But when something happens, they will be up there in front of the media feigning ignorance, demanding accountability, and wanting more hearings and investigations.” The only difference is that today, the danger is obvious, and the American public is complicit in the self-deception—to a point. The remaining items on this list are problems even the most attentive traveler may not realize.

6. No After-Hours Security
“We’re so off the mark as far as real security,” says a high-level TSA official in her fifties who is responsible for making sure the TSOs and the airlines follow all the agency’s security guidelines at one the busiest airports in the Northeast. “We are much more vulnerable than we were before 9/11. I am an inspector. I am there every day.” She mentions, for example, the susceptibility of aircraft parked on the ramp. “I was doing a test to see how easy it would be to get on an aircraft after hours,” she says. “I found ramp doors open, aircraft doors open. A lot of the time, the airlines didn’t even close the doors to the aircraft overnight. If I could easily get something onto an aircraft, so could a terrorist.” This official also discovered another security lapse: The FAA requires that all aircraft be searched during off-duty hours for planted items that can later be used in a terrorist attack. Several airlines at her airport employ the low-wage janitors who clean the aircraft every night to inspect the planes. “A low-paid employee from some cleaning company can get up in the middle of the night, swipe his card, and go into any area of the airport he wants,” she says. In November of last year, 23 illegal immigrants were arrested at Chicago’s O’Hare International Airport for using fake security badges.

7. No Accountability
Security infractions such as those listed above are punishable by fines and other penalties—but they are rarely enforced. “All the carriers are given a rule book,” says the high-level TSA official, “but TSA headquarters won’t enforce it. If you go against anything, raise questions, not only are you not encouraged or just ignored, but you are also blacklisted.” Apparently, the problem is endemic. In the course of this investigation, Best Life repeatedly reached out to Democratic Texas Congresswoman Sheila Jackson Lee, chairwoman of the Subcommittee on Transportation Security and Infrastructure Protection, who is responsible for TSA oversight. Her press secretary first said she’d be available for comment, but after we sent the findings of this investigation, she retracted her offer.

8. Institutional TSA Cover-ups
Last fall, an investigation by the Department of Homeland Security uncovered evidence that the TSA gave its screeners advanced warning that undercover inspectors would be coming through checkpoints to test the effectiveness of security procedures. On April 28, 2006, the TSA sent a message on its system-wide communication system, NETHUB, to alert 650 airport-security officials of a “possible security test.” The chairman of the House Homeland Security Committee, Democratic Mississippi Congressman Bennie G. Thompson, requested a Department of Homeland Security inquiry after TSA denials. “Our government cannot play on our fears of an attack and then try to cheat its way through its midterm exams,” said Thompson at the hearing to discuss the attempted cover-up.

9. Endemic Obfuscation
When TSA chief Kip Hawley was asked to explain the allegations of a cover-up, he proclaimed his support for covert testing and said he believed it was working. When pressed about the high failure rates of TSA screeners, Hawley explained that even if screeners fail to detect bomb components or weapons, there are still “multiple layers” of security in place to apprehend terrorists. It is a mantra the TSA repeats whenever its security flaws are exposed publicly. “Every failure has been greeted by the TSA with the comment, ‘We’re proud of what we’re doing,” says Michael Boyd, president of the Boyd Group, consultants to the aviation industry. “Doctoring tests by warning screeners before the tests are implemented…that’s corruption. But not one TSA official has been fired. Not one.” The real problem, says Boyd, is that Congress doesn’t hold the TSA accountable. “While C-SPAN cameras were rolling, boy, that was tough questioning,” he says, referring to Thompson’s hearing. “But the minute the camera went off, they were slapping each other on the back.”

10. The Airline Lobby Exerts Enormous Control Over the TSA and FAA
“Right from the start, it was apparent that the TSA was going to be even worse than the FAA had been,” says Bob Monetti, who was on the TSA’s Aviation Security Advisory Committee when the agency was established. Monetti has a long history with the U.S. aviation-security apparatus. After losing his son in the 1988 bombing of Pan Am Flight 103, he became a vocal advocate for improving aviation security measures, eventually becoming a consultant for the FAA. After 9/11, he testified before the House Transportation Committee that the government had known for years about significant weaknesses in aviation security. “September 11 wasn’t a surprise,” says Monetti. “I didn’t have much security clearance, I didn’t have access to the information they did, and I could see it coming.” He adds that any real reforms the TSA—and before them, the FAA—attempted to implement were thwarted by the airlines. “To solve these issues will cost airlines money, and the occasional plane won’t be able to take off on time. That’s unacceptable to airlines. They ran the FAA, and now they run the TSA.”

A look at campaign contributions from the airlines to key individuals in Congress supports Monetti’s assessment. In 2002, when many airlines had declared bankruptcy, the industry contributed large sums of money to congressional candidates. These contributions seemingly paid off as Congress continued passing laws that relieved airlines of liability from future acts of terrorism. “When Congress passed the bill making the airlines not responsible, and the security companies too, for their horrible lack of behavior and their lack of security, we lost any chance of accountability,” says Mary Schiavo, a former inspector general for the Department of Transportation. “We are in a very dangerous situation now because if nobody is responsible, the job won’t get done.”

During testimony last fall before a House Homeland Security subcommittee, Hawley acknowledged that the top security threat faced today by U.S. aviation is from terrorists bringing onto an aircraft a bomb made from components readily available in a grocery or hardware store. Hawley’s justification for the high failure rates was that the investigators had “moved from testing of completely assembled bombs… to the small component parts.” The real issue, he explained, was not with TSA security, which was doing the best it could do, but with the tests being too difficult. Screeners were looking for the bombs they had seen in the script. Now they were supposed to improvise.

More than seven years after the September 11 attacks, it’s time for America to get serious about a response. And while it will take time, effort, and creativity to rebuild Ground Zero and capture bin Laden, our first national priority isn’t repairing the damage from the nation’s most devastating attack. It’s ensuring that the same thing doesn’t happen again.

But while other fallen chieftains spend their final days of freedom gorging themselves on the vestiges of ill–gotten gains before the feds move in—picture the bloated, alcohol–tinged countenance of ex–Enron honcho Jeffrey Skilling—Black remains characteristically sanguine, ever the battle–tested general counting his casualties and awaiting reinforcements before launching his next attack. “It has been a four–year battle, and after the opening assault that I had pillaged the company for hundreds of millions of dollars, and the prolonged effort to impoverish me and imprison me for life, I feel I have steadily gained ground, and have an excellent basis for appeal,” Black wrote to me in his first interview since a Chicago jury found him guilty of three counts of mail fraud and one count of obstruction of justice. “Being a historian, I am fairly familiar with the ups and downs of people’s careers and may be able to assimilate a cataract of horrors better than some people.” I had e–mailed him a long list of questions in August (on his lawyers’ advice, he consented only to a written exchange, with his responses vetted by his legal team) about his thoughts on his criminal trial, his state of mind as he prepares for a lengthy prison sentence, and his feelings about his fallen media empire. Three days later, I received a 1,400–word response that was candid, thoughtful, and wholly unapologetic. Written in the bombastic, abstruse style for which he is famous, Black’s statement displayed the fierce intellect responsible for his extraordinary rise—but also suggested the qualities responsible for his sudden, devastating fall.

Black’s conviction ended a long saga at the company he cofounded in 1969 with the purchase of a small Quebec paper and transformed into the third–largest newspaper empire on the planet, with more than 500 papers including The Telegraphof London, the Chicago Sun–Times, and Canada’s National Post. It all began more than four years ago, when a special committee appointed by Hollinger International’s board of directors—headed by former SEC chairman Richard Breeden—accused Black and several of his associates of running a “corporate kleptocracy” that siphoned $400 million from shareholders. It continued when a grand jury corralled by U.S. Attorney Patrick Fitzgerald—the überprosecutor who scored a conviction against Lewis “Scooter” Libby—indicted Black on 14 counts of criminal fraud: racketeering, obstruction of justice, money–laundering, and mail and wire fraud. And it culminated on July 13 when the jury found him guilty on four of those counts.

From the moment he was accused, Black has couched his predicament in militaristic terms. A history buff since childhood who can recite from memory, say, the main armament of a World War II battleship or the daily casualty reports during Hitler’s siege of Stalingrad, Black portrays himself as the victim of a malicious witch hunt; at one point during the trial he even called the prosecution Nazis. It’s clear that his conviction has not tempered his views. “We have the…pursuit of prominent, well–off people who get into the crosshairs of the system essentially as a substitute for a wealth–redistribution policy, and we have a certain revulsion against extreme proliferations of wealth,” he wrote to me. “Property is seized without compensation, due process has eroded, and the grand jury is no protection at all against capricious prosecutions. It is a difficult time to be a corporate defendant.”

Indeed, Black’s was the last in a series of prominent corporate trials—Enron, Tyco, WorldCom—that defined an era of unprecedented shareholder activism in American business. Like Dennis Kozlowski at Tyco and the Rigas family of Adelphia, Black was convicted of running the publicly traded Hollinger like his own private smoke shop, helping himself to the till—and the pockets of shareholders—whenever he needed spare change. But like Martha Stewart, Black’s renown transcended the boardroom. In Britain, where he holds a seat in the House of Lords, he is Lord Black of Crossharbour, the former proprietor of the most popular conservative broadsheet in the country. And in Canada, where he was born and where he began his meteoric rise, he is, as the director of the documentary Citizen Black put it, “our own Charles Foster Kane.”

Black’s trademark blend of glamour, erudition, and audacity are best captured in a photograph of him, taken at Kensington Palace in the summer of 2000, dressed in the crimson vestments and matching four–cornered hat of Cardinal de Richelieu, the 17th–century French prelate and Chief Minister to King Louis XIII. A self–described Francophile who reveres Napoleon and de Gaulle, Black is also a convert from Anglicanism to Catholicism (at age 41) who famously built a private chapel—consecrated by two cardinals—on the grounds of his home in Toronto, where he grew up a member of the city’s moneyed elite. He no doubt identified with Richelieu’s reputation as one of history’s true Renaissance men: a nobleman, clergyman, statesman, author, and patron of the arts. Standing by Black’s side, his wife, Barbara Amiel, makes a fetching modern–day Marie Antoinette, her bounteous décolletage heaving beneath demure white lace.

As Black awaits his sentencing in Palm Beach—the judge forced him to surrender his passport and remain there or in Chicago—he says his faith provides some comfort. “It has been helpful…in reading apposite passages from ecclesiastical authors, especially Cardinal Newman, and in conversation with several very knowledgeable clergymen.” Every evening, if the weather permits, he sits on his terrace and enjoys a glass or two of good French wine. “It is a terrible thing to be wrongly accused, and assaulted and defamed,” he wrote me. “And it is even more terrible to be unjustly convicted…[But] my health is good and I will survive it all.”

The trial of United States v. Conrad Black et al. began on March 19, 2007. But for Black’s defense team, the true showdown came nearly two months later—the day Hollinger International’s former president David Radler took the stand to testify against his friend and business partner of 35 years. “The government has based its case against Conrad on David Radler,” Black’s attorney Eddie Greenspan—a heavyset 63–year–old with a full head of well–coiffed white hair and a reputation as the Canuck Johnnie Cochran—would say during his closing argument. “The government, at the very beginning of the trial, admitted its star witness is a liar. But [the prosecution] told you that David Radler’s testimony would be supported by other witnesses and by documents. Well, they were at least right about one thing: David Radler is a liar.”

On the morning of May 8, Radler—a trim sexagenarian with a receding hairline and large glasses perched on his prominent nose—shuffled self–consciously into Courtroom 1241 of the Everett McKinley Dirksen building. To reach the witness box at the back of the room, he had to walk through eight rows of church pew-style wooden benches, packed with reporters who had traveled from across the U.S., Canada, and Britain to cover what the Canadian newsmagazine Maclean’s billed as “The White–Collar Trial of the Century.” In front of Radler, two large rectangular tables had been arranged to accommodate Black, his co–defendants (Mark Kipnis, John Boultbee, and Peter Atkinson), and their respective teams of attorneys and laptops, giving the room the appearance of a trading floor at a brokerage house rather than the setup familiar to viewers of Law & Order. The four principal members of Fitzgerald’s prosecution team huddled around a third table, which was so close to the jury box that prosecutors could smell who had eaten garlic on their lunch break. During nearly two weeks inside the witness box, Radler had to pass within a foot of his ex–friend and colleague. But Black steadfastly avoided his gaze.

In fact, the longtime associates were a study in contrasts. Radler slouched forward when he walked, his head darting furtively from side to side, while Black had a stiff, almost regal bearing. Radler sported bright pink or orange ties with his white shirts and dark suits, whereas Black wore the subdued blues and grays of a London banker. Radler’s face was deeply tanned, as though he had just returned from a trip to Tahiti; Black, we learned during testimony about a Hollinger–financed jaunt to Bora–Bora, was not a fan of the tropics, and his chalky gray complexion betrayed years spent writing and pontificating into the early hours of the morning (he once e–mailed me at 4:22 A.M.).

In order to fully grasp the case against Black it is important to understand the convoluted corporate structure through which he controlled Hollinger International—a series of interconnected private companies that resembled a set of nested Russian matryoshka dolls. In the center was Ravelston, a private Toronto holding company owned by Black and Radler, which owned another privately held Toronto holding company, Hollinger Inc., which in turn controlled a majority of the publicly listed Hollinger International. In an ingenious arrangement, Ravelston collected “management fees” from Hollinger International, essentially an outsourcing fee for the use of Ravelston’s executives. The same team already collected generous compensation from Hollinger International, meaning Black and the others got paid twice for the same job: a salary from International and a management fee through Ravelston. Although Black and his co–defendants weren’t charged criminally for it, the double–dipping formed the basis for the investigation by the Special Committee—and ultimately led to Black’s indictment.

Lead prosecutor Eric Sussman—a lithe, 38–year–old marathon runner with boundless energy who presented a marked contrast to Black’s ponderous, aging defense team—began by taking Radler through his long history with Black in order to portray them as inseparable colleagues and friends. How the two men—Radler, the son of a restaurateur, and Black, the son of a wealthy brewery executive—had met in Montreal in 1969 and together made an $18,000 investment in a community newspaper, the Sherbrooke Record. How they drastically cut costs and increased profitability, selling the paper in 1977 for a whopping $865,000, and plowed the profits into another paper, and then another. Sussman then outlined a central charge of the government’s case: That during a sell–off of most of Hollinger International’s newspapers between 1999 and 2001, Black and his co–defendants schemed to divert more than $60 million that rightfully should have gone to the public shareholders of Hollinger International.

The details are mind–numbing, but basically they involve a standard business tool in the newspaper world: the noncompete agreements guaranteeing a paper’s seller that the buyer will not simply start up a new rag, poach the best staff, and reenter the marketplace. The prosecution charged that Black, Radler, and the others inserted themselves and Hollinger Inc. as beneficiaries in several of the noncompete agreements, personally claiming a large chunk of the proceeds of these sales and thus defrauding the shareholders of Hollinger International. (There is nothing criminal per se about an executive at a public company signing an individual noncompetition agreement as long as 1. the company’s board of directors and auditors approve it and 2. it is disclosed to shareholders—the latter of which, in the jury’s mind, Black failed to do.) “The payments were approved as management fees and again as noncompetes,” Black insisted to me. “I do not think they were illegal. I don’t think any serious doubt about my business acumen was raised in this case.”

On the stand, Radler blamed it all on Black: “He suggested that we insert ourselves in the noncompete process and I agreed.” While Radler’s story may have been straightforward, his delivery was anything but. Nicknamed “Ratler” by the media for his willingness to testify against his former partner, the government’s star witness often seemed to have a frog in his throat. Under cross–examination, Radler at first appeared shaken by Greenspan’s aggressiveness:
Greenspan: Was it easy for you to lie? Did you stutter before you lied? Was there a long pause before you lied? Did you avert your eyes?
Radler: Sir, I told lies.
Greenspan: I take it we could be talking to you right now and you might be lying, true?
Radler: False.
Greenspan: False? I have your word on it?
Radler: Yes, you have my word.

But Radler recovered as the cross–examination continued, parrying Greenspan’s barely controlled fury with dry wit. In one memorable exchange, Greenspan asked him about the time—shortly after they acquired the Sherbrooke Record—the U.S. Congressional Record selected an article Black had written about LBJ.
Greenspan: That was a very big deal in Sherbrooke?
Radler: I don’t remember that.
Greenspan: Having an article from Sherbrooke, Quebec, read into the Congressional Record wasn’t a big deal?
Radler: It was certainly a big deal for Conrad.

As the details of his life and alleged criminal acts emerged in open court, Black looked on with an expression of studied disinterest. When something caught his attention, he would lean over to whisper in Greenspan’s ear. Occasionally, his eyes would wander over to the press—many of whom had worked for him directly or indirectly—or settle on the jury of nine women and three men who would decide his fate. Juror Jean Kelly, a 51–year–old mail carrier from the suburb of Crest Hill, was unnerved by Black’s gaze. “He had a tendency to look down at us, like he couldn’t believe people so beneath him were responsible for his freedom,” she told me recently. “He didn’t portray any warmth, any emotions at all. It looked like he thought the whole trial was a big waste of his time.”

During breaks in the action, Black often huddled with his wife and grown children from his first marriage, who were seated in the front pew just behind the defense team. (Staunchly supportive of her husband, Amiel had her own run–ins with journalists during the trial, calling some of them “sluts” and “vermin.”) Black’s sons, James and Jonathan, made occasional cameos, and his daughter, Alana—a tall, striking 25–year–old who looked like she had just stepped out of the pages of a fashion magazine—was a daily fixture. But for a noted raconteur used to commanding every room he enters, Black’s forced silence as witness after witness attacked him seemed to drain his magnetism, leaving him vulnerable at the end of each day to the throng of reporters and TV cameras outside the courthouse. When I asked him whether he would have liked to take the stand in his own defense, Black wrote, “My testifying would have opened the trial up to a much wider range of questions, which I could have dealt with, but it would have made the trial longer and more complicated.”

In their unrelenting focus on destroying Radler, the defense made a fatal error: They failed to convince the jury that Black and the other co–defendants were legally entitled to the millions of dollars in noncompete money that flowed to them directly—or indirectly, through Black’s private holding company, Hollinger Inc.—from the newspaper sell–offs. Early in the trial, several buyers testified that they had not requested noncompetition agreements from anyone other than the publicly held Hollinger International—leading the jury to conclude that Black and his cohorts did not deserve the additional proceeds from these sales. “We did not consider these people to be potential competitors in these small towns,” Michael Reed of Community Newspaper Holdings Inc. of Birmingham, Alabama, testified in a particularly damning moment. The buyers also established a pattern of dubious behavior at Hollinger—including a $5.5 million noncompete fee paid to Hollinger Inc. from one of Hollinger’s own subsidiaries, American Publishing. Black’s defense team claimed the deal was meant to ensure that Black and the others wouldn’t compete with American Publishing should they leave the company. But at the time of the deal, American Publishing owned just one small paper in Mammoth Lakes, California.

Allegedly turning a blind eye was Hollinger’s star–studded audit committee—responsible for approving all executive compensation—composed of Marie–Josée Kravis, a noted conservative economist, president of MoMA, and spouse of private equity titan Henry Kravis; James Thompson, a former U.S. attorney and four–term governor of Illinois; and Richard Burt, a former U.S. ambassador to Germany. The committee contributed some of the trial’s more far–fetched moments, repeatedly insisting on the witness stand that they had missed every single reference to the noncompetes when approving Hollinger’s financial statements. In his closing statement, Greenspan argued: “These three individuals, knowing full well their responsibilities as members of the audit committee, want you to believe that they missed this disclosure…a collective total of 33 times?” The prominence of Hollinger’s directors—other board members had included Henry Kissinger and Richard Perle—has always been a source of pride for Black, and even now, he tries to put a positive spin on their betrayal. “The jury clearly determined that all of the former Hollinger directors who testified lied under oath, and they did,” he wrote to me. “None of them would have wished to lie, but all appeared with an official rod on their backs, immunity or a plea bargain.”

Whether or not this is true, the defense also failed to counter the only real smoking gun—surveillance videotape that showed Black personally removing boxes from Hollinger Inc.’s Toronto offices in apparent violation of an SEC order, which resulted in his conviction for obstruction of justice. For effect, the prosecution subpoenaed the 13 boxes—containing Black’s files and personal belongings—from Canada and had them brought into the courtroom, where they stayed in view of the jury for several days. When Greenspan called Black’s secretary, Joan Maida, to testify about the incident, she proved to be the worst witness of the entire trial, transforming what could have been a simple explanation—that Black had to remove his personal effects after being dismissed as chairman—into a dubious one by repeatedly changing her story about how many boxes she packed. “I knew nothing of any official interest in the famous 13 boxes, had nothing to do with selecting their contents,” Black wrote to me. “I did not alter or even examine the boxes when they were in my house. Doubtless, this could have been better explained.”

Indeed, Black’s vaunted legal team drew mixed reviews for their performance. Greenspan was trying his first case ever in the U.S., which resulted early on in a series of embarrassing gaffes. And his vicious treatment of Radler alienated the jury, undermining his effectiveness in other areas of the case. “I was offended by Greenspan,” Kelly says. “When Radler was on the stand, he was screaming at us, telling us what we were supposed to think. We walked out of there every day with stomachaches.” And cocounsel Eddie Genson, a famed Chicago trial lawyer who suffers from a neuromuscular condition that relegates him to a motorized scooter or crutches, often seemed lost. “I felt sorry for him,” says Kelly. “I heard he used to be a great attorney, but he should have been put out to pasture a long time ago.”

Throughout, the prosecution put Black’s lifestyle on trial, including perks like his $5 million corporate apartment in New York, Amiel’s sixtieth birthday party at four–star Manhattan restaurant La Grenouille—a $62,000 extravaganza largely paid for by Hollinger International—and the company jet, which shuttled him between luxurious homes in London, Toronto, and Palm Beach. This strategy had backfired in the case of Dennis Kozlowski and his infamous $6,000 shower curtain, and the prosecution was mindful of not distracting the jury from the core charges. “They made a conscious effort not to overplay the perks,” says a source close to the prosecution. “But they would do it again in a heartbeat because it gave the jury insight into how Black treated his company’s money.”

The Blacks were certainly an easy target. Black’s exalted position as the proprietor of The Telegraph attracted a social set that included Margaret Thatcher and Lord Carrington, the former secretary–general of NATO who in 2001 secured Black the seat in the House of Lords that he had openly coveted for years. (After a public spat with then Canadian prime minister Jean Chrétien, Black was forced to give up his Canadian citizenship to accept the honor.) Black’s defense team was obviously concerned that their client’s wealth would turn off the jury, and tried to draw a distinction between fortune and fraud. “Ladies and gentlemen, Conrad is different…from you and me. He is a rich man,” Greenspan said during his persuasive closing argument. “But in America, you do not convict people for being rich. Ask yourself: Why are the prosecutors focusing on this? Because they hope you will judge Conrad Black not on the facts of this case, but on his wealth, his lifestyle, and his vocabulary.”

Although the jury acquitted Black on all the so–called lifestyle counts, evidently they never believed that a man who spent his life being chauffeured around in limousines and waited on by servants would lug his own boxes—unless he had something to hide. And when the two–week deliberations began, nine of the twelve jurors wanted to convict Black on all counts. “A lot of people may have been swayed with the talk about his $4,000 towel–warming bars, and they were angry about what he had done to the shareholders,” Kelly told me. “They said, ‘He’s arrogant, we have to nail him on something.’” But the three holdouts pushed them to examine the counts one by one and convict based on evidence rather than emotion. “I don’t think anyone realizes just how close Black came to being found guilty on everything,” Kelly says.

On November 30, Conrad Black will finally have to face the enormity of his fate. He could spend the rest of his life in a federal prison, although experts predict that Judge Amy St. Eve will probably give him between seven and fifteen years. The company he built into a media behemoth, Hollinger International, has changed its name to the Sun–Times Media Group and is now run by Cyrus Freidheim, a turnaround specialist who previously took the helm at Chiquita Brands following its bankruptcy. Meanwhile, Black faces a mountain of civil suits—from the SEC, the Ontario Securities Commission, and Sun–Times Media, which is suing him and other former executives for $542 million—that could bankrupt him and keep him in court for the rest of his days. Most of his personal wealth, once reported at $400 million, came from Hollinger shares and stock options—neither of which are much good to him now. The majority of his remaining assets are in real estate, but those properties have been seized or diminished in value by large mortgages, tax liens, or bail bonds. He is also currently waging a battle to keep his $35 million Palm Beach house, which he used as collateral to secure his $21 million bail, though the government has argued in court that it should be seized as “forfeiture”—the spoils of his criminal acts. While it’s impossible to say exactly how much of his fortune remains, it is likely not enough for a man who once famously claimed that “greed has been severely underestimated and denigrated.”

Although old friends like author George Jonas and Canadian news broadcaster Brian Stewart have stuck by his side, Black’s dance card is lonelier these days. “This experience tends to reduce social activity, not so much because of fewer invitations, though there is some of that, but because it has been such an ordeal, anyone would naturally be less sociable,” he wrote me. “And the subject of these travails becomes an 800–pound gorilla nobody mentions. We and other polite people don’t want to talk about it, but it is hard to ignore, and some awkwardness results.”

Characteristically, Black prefers to focus on his appeal rather than dwell on thoughts of detention. “I still hope for a complete acquittal,” he wrote, “and on a worst case, not a severe sentence.” He has hired noted appeals specialist Andrew Frey, who helped investment banker Frank Quattrone overturn his obstruction of justice and witness tampering convictions. Legal experts say Black’s chances of exoneration are slim, but some point to the government’s narrow margin of victory as cause for cautious optimism. “Fitzgerald did a masterful job in his press conference, spinning this like it was a complete and total no–hit shutout,” says Hugh Totten, a trial attorney at Perkins Coie in Chicago who regularly attended the trial as a legal analyst. “At the end of the day, Black was convicted of defrauding the company of $3.2 million, much less than [the] $60 million he was accused of—and a far cry from the ‘kleptocracy’ Breeden found in his report. That’s what I call winning a case just barely.”

So far the only real winner appears to be David Radler, who is likely to get less than 29 months in prison. As a Canadian citizen, he may end up spending less than six months in a country club for pleading guilty to the same crimes for which Black now faces up to 35 years in the U.S. Ironically, Black would have been eligible to serve time in Canada—where sentences for nonviolent crimes are much less severe—had he not given up that right for a seat in the House of Lords. “I do regret giving up my Canadian citizenship,” he acknowledged, “but I always said I would take it back.”

Meanwhile, Black remains focused on the larger war—the one for his place in history: “I am hopeful that I will win, sooner or later, the battle for my reputation. The other matters are secondary.” It is a reputation Black’s friends say is badly misunderstood. “There is a Stephen Colbert quality to Conrad,” says David Frum, a conservative author who grew up in Toronto and has known Black for many years. “He has a style of talking that is larger than life. But he is not bombastic. A lot of the comedy of knowing him is that he has created this persona and is playing it for laughs.”

History is littered with stories like Black’s—men who lost everything they had trying to reach for what they didn’t need. And given his obsession with history, it seems a sad cliché that he was destined to repeat it. He has even been compared to the subject of his latest biography, Richard Nixon—a man of great talent undone by even greater flaws—though he sees few parallels. “He was a president and a historic figure; I was just a somewhat prominent publisher,” Black wrote me. “There is a stronger case for charges of illegalities against Nixon than against me. Where there may be some comparison is in the virtues of fighting these crises through and never giving up.”

In the eyes of Black’s former school chum John Fraser, a prominent Canadian journalist who worked for him as the editor of Saturday Night, Black’s obsession with American presidents (he also wrote a well–received biography of FDR) is reflective of a larger obsession with America. “Throughout his life, Conrad so admired the United States—there was no country he was more desperate to be successful in,” says Fraser. “But he was terribly naive to think he could behave the same way in the U.S. as he did in Canada.” In Canada, Black was the ultimate insider who ended up an outsider—the Establishment Man who abandoned the Establishment for a peerage. Now he can only look out at the waters of the Atlantic toward Britain—the country he adopted to become a lord—wishing perhaps that he had remained at home.

Like most intimate confabs at the conference, the dinner wasn’t expected to generate much controversy, or to compete for press coverage with just about anything uttered by Angelina Jolie, who was on hand in Davos as a United Nations goodwill ambassador. Toward the end of the evening, however, the collegial vibe took a turn: During an informal question-and-answer session, hedge fund manager Daniel Loeb—seated in the audience—began to criticize private equity firms for hoarding profits that rightly belong to public shareholders. While some attendees may have agreed privately with Loeb, those dinner guests well accustomed to the sanguine navel-gazing of business conferences were taken aback. In the pantheon of audacious acts, Loeb’s behavior was akin to wearing an NRA T-shirt to a peace rally.

Of course, nobody who has followed Loeb’s career was too surprised. As the founder and chief executive of the $3.6 billion New York-based hedge fund Third Point LLC, Loeb has developed a reputation as one of America’s most outspoken and controversial investors. A self-styled successor to activists such as Carl Icahn and T. Boone Pickens, the 44-year-old California native takes large stakes in companies and then agitates for change through public, often hostile negotiations with management. He is known as Wall Street’s poison pen—an epistolary assassin who employs words as ammunition against the top brass of corporations in which his fund invests. Witty in comparison with the mind-numbing style of most securities filings, Loeb’s bons mots have attracted a cult following among analysts and money managers, who forward them like off-color jokes and post them on investing blogs.

Loeb’s activist MO has been lucrative for Third Point, raking in an average annual return of nearly 23 percent since 2002, according to a former employee, well above the 7.7 percent average of HedgeFund Intelligence’s Absolute Return Composite index, a leading benchmark. As one of the 100 largest hedge funds in the country, Third Point earned Loeb $150 million in 2005—landing him twentieth on the list of America’s highest-paid managers in Alpha magazine, the bible of the kill-or-be-killed industry.

Increasingly, however, Loeb’s brash style has put him at odds with some Alpha associates—and the saber-rattling that fueled his fortune now threatens to undermine him. The hedge fund community is under siege after operating in relative obscurity for decades. High-profile funds have been accused of crossing the legal line; the federal government is pushing for more oversight; and the media, once content with an occasional peek behind the curtain, is clamoring to tear it down. The glare has motivated some of Loeb’s peers to adopt a level of secrecy not seen since the early days of the Cosa Nostra, and it’s not necessarily paranoia: In 2003, hedge fund billionaire Edward Lampert was kidnapped at gunpoint while leaving his Greenwich office and held for nearly two days.

Loeb appears to recognize the need to restrain himself in order to succeed in this new climate. He talks to the media less, and declined repeated requests to be interviewed for this story. But his antics in Davos—one of a series of recent incidents in which he has turned his patented vitriol on his own colleagues—suggest his activist investing may not be just a calculated strategy. “When Dan walks in a room, he makes everybody nervous,” says a Davos dinner attendee. “He will sit quietly for a while and then suddenly have an outburst. People don’t really know how to handle that.”

To be sure, the saga of Daniel Loeb offers a revealing glimpse into the hush-hush world of hedge funds—whose influence on Wall Street has grown in equal measure with their swelling coffers. Since 2003, cumulative hedge fund assets have skyrocketed from an estimated $600 billion to $1.2 trillion, consolidating wealth in fewer hands and transforming what was once the Wild West of investing into an increasingly institutional place—and leaving little room for the cowboys who once roamed free.

When Alfred Winslow Jones launched what is widely regarded as the first hedge fund in 1949—coining the phrase to describe his approach to guarding against the risk of the stock market—the notion that a fund manager could earn anywhere near as much as his wealthy clients was heresy. Charging a management fee as well as a share of his fund’s profits, Jones reconfigured the economics of the manager-investor relationship and paved the way for today’s celestial earnings. In 2005, the top 10 hedge fund managers each cleared more than $275 million—nearly $162 million more than the combined compensation of the CEOs at Morgan Stanley and Goldman Sachs.

Flush with wealth and power, today’s hedge fund managers have become the It Boys of American capitalism, following in the footsteps of the Gordon Gekko?style buyout barons of the eighties and the dot-com wunderkinds of the nineties. Newly minted MBAs who once flocked to JP Morgan now crowd the early-morning trains from Grand Central to the constellation of hedge fund offices in Greenwich, Stamford, and other moneyed Connecticut towns—lured by the promise of earning more in a single week than they could otherwise earn in a year. Commercial rent in downtown Greenwich has climbed to more than $80 a foot—on par with prime office space in Midtown Manhattan—while Fairfield County’s manicured suburbs have become a giant construction zone, with each mega-McMansion more garish than the last. SAC Capital head Steven Cohen, who took home a $550 million paycheck in 2005, has a 32,000-square-foot estate with an ice-skating rink and an indoor basketball court—and scattered throughout are pieces from his estimated $700 million art collection, which includes a Van Gogh, a Pollock, and Damien Hirst’s formaldehyde-preserved tiger shark.

The “2 and 20″ fees often associated with hedge funds—2 percent management fee on all assets and a 20 percent share of the fund’s trading profits—haven’t deterred investors: In the past three years, the number of U.S. hedge funds has jumped from 6,000 to nearly 9,000. As funds have multiplied, they have branched out into increasingly varied investment strategies, placing them in the same orbit as the other behemoth of the investing world—private equity—and blurring the distinctions that once separated them. Similarly, private equity firms now invest like hedge funds, taking large stakes in public companies. “The concept of public and private equity is defunct,” says Anand Sunderji, a vice president of the $2.5 billion Swiss firm Adveq Management. “It’s all just equity.”

Most of the new money flowing into the industry comes from giant institutional investors—such as pension funds and university endowments—which attract a higher degree of scrutiny from both the media and regulatory bodies. In recent years, prominent hedge funds have been accused of insider trading (Pequot Capital Management) and naked short-selling (Rocker Partners)—to say nothing of Bayou Management, which swindled $450 million from its investors before its founder and CFO were both charged with fraud. (Pequot was subsequently cleared of the charges; members of Bayou’s management pled guilty and await sentencing; and Rocker Partners, whose lawsuit is ongoing, maintain there is nothing illegal about their short-selling practices.) The recent implosion of Amaranth Advisors, which lost $6 billion in capital almost overnight, has only intensified the pressure. In a victory for the libertarian-minded, the U.S. Court of Appeals for the District of Columbia ruled last summer that the SEC no longer has the authority to impose rules on hedge funds beyond those that govern all investors—but given that hedge funds account for roughly half of all daily trading on the New York Stock Exchange, Congress will no doubt continue to push for government regulation.

Institutional investors have also fostered a more conservative outlook. Many are turned off by what they call “headline” risk—the idea that an irascible, heat-seeking manager like Loeb could bring them negative attention or embarrassment. “We initially looked at Third Point because of its extremely attractive performance history,” says one portfolio manager at a multi-billion-dollar fund who invests solely in hedge funds. “But we decided not to put our money with him for reputational reasons.”

Armed with a B.A. from Columbia, several years of Wall Street experience, and $3 million from friends and family, Loeb started Third Point LLC in 1995. An avid surfer, he named his fund after the choicest break at Malibu’s Surf-rider Beach near his boyhood home in suburban Los Angeles. It didn’t take long for him to make headlines. In 1999, he was sued for libel by public relations executive John Liviakis for allegedly “repeatedly and maliciously publish[ing]” anonymous postings on Yahoo! Finance, Silicon Investor, and other Web sites under the pseudonyms “John_Crimiakis_StockSwindler” and “Mr. Pink” (after a character in Reservoir Dogs). Liviakis’s complaint quoted one posting: “I have registered 1.7 million shares to sell and these will soon flood the market. Hopefully I will sell these before the company loses its Nasdaq listing…Then I will laugh at you fools for buying my shares and I will celebrate with a bottle of grappa, some fresh feta, and a nice young boy—just like in the old country.”

The lawsuit was eventually settled, and Loeb has never acknowledged a connection to either pseudonym. In August 2005, three days after Bloomberg Markets published a flattering piece about Loeb, the article appeared on Mr. Pink’s Silicon Investor message board with the caption “Oh Lord He is Wise!”

In 2000, Loeb honed the strategy that would come to define him, already introduced by his L.A. hedge fund pal Robert Chapman. After penning a scathing letter to the CEO of an investment trust, Chapman attached it to a Schedule 13D form, which the SEC requires major stockholders to file when they take an action that will influence the company’s business. Typically the form alerts shareholders that an investor has acquired a significant stake in a public company, but Chapman had a more cunning calculus: It ensured that his letter would be widely seen.

Emboldened by Chapman’s approach, Loeb stepped out from behind the curtain. His first target was William Stiritz, the chairman of two companies, one of which, Ralcorp Holdings, had made an offer to acquire the other, Agribrands International. Third Point had a substantial stake in Agribrands, and Loeb’s 13D letter argued that the offer was too low. In the first of many vindications for Loeb, a competitor topped Ralcorp’s bid by 28 percent, netting Third Point $20 million. In the years since, Loeb seems to have grown more charmed with his own voice and more personal with his attacks, emphasizing the pay, perks, and lifestyle of a CEO in addition to the issues afflicting his company. Their result is often to humiliate an executive so badly that he resigns, is fired, or acquiesces to Loeb’s demands. “Dan refers to it as ’social pressure,’” says a former Third Point employee. “He believes that if you embarrass a CEO in front of his friends at the club, make him feel like people are talking about him, you can exert change on his company.”

A 2005 letter to Irik Sevin, then CEO of Star Gas Partners, called him “one of the most dangerous and incompetent executives in America.” Another missive to the board of directors of Salton Inc. criticized CEO Leonhard Dreimann’s decision to advertise at the U.S. Open tennis final. Loeb’s tones seemed to show arrogance, not just in the skewering of his target but in the self-aggrandizing possibilities of the cannonball communiqué: “You can only imagine my consternation when I…saw the Salton name emblazoned all around the interior of the stadium walls next to such robust companies as IBM, JP Morgan, and Mass Mutual….My bewilderment quickly turned to anger when I saw…the private box that seemed to be occupied by Mr. Dreimann and others who were enjoying the match and summer sun while hobnobbing, snacking on shrimp cocktails, and sipping chilled Gewürztraminer.”

Loeb’s belligerence is unusual even when compared with other hedge fund managers, who tend to flex their muscle behind the scenes. “Our first approach is to talk to management on a friendly basis,” says Charlie Penner, general counsel at the $5.5 billion activist fund Jana Partners. “We don’t see any point in taking a tone or approach that is personal or bitter. Our goal is never to get in the headlines.” Wilbur Ross—the legendary investor who runs a $200 million hedge fund and several private equity funds totaling $4 billion—has a similar philosophy. “Most of these young shareholder activists have no management experience,” says Ross. “[I]t would be societally more responsible if they said, ‘I don’t like that company, but I’m not just going to terrorize them. I’m actually going to take control, put out the management, put in new people, and fix it.’ I don’t see them doing that. It’s all wham, bam, thank you ma’am.”

Meanwhile, Loeb has also called attention to himself with his own conspicuous appetite, which seems to have turned him into the greed-is-good cliché that he targets. Last fall he reportedly agreed to purchase the most expensive apartment ever sold in New York, a $45 million penthouse in a building now under construction on the site of the old Mayflower Hotel. Plans for the 10,000-square-foot space overlooking Central Park are said to include 8 bedrooms, 10 bathrooms, and 800 square feet of terrace space. He also owns a modernist oceanfront house in the Hamptons designed by Rafael Viñoly, and a burgeoning art collection with works by such artists as Andy Warhol, Cindy Sherman, and Martin Kippenberger. But, like other hedge fund managers, he’s more parvenu than patron of the arts. After New York gallery owner Barbara Gladstone reportedly cancelled the sale of a Matthew Barney photograph to Loeb, he was irate. “Dan doesn’t understand that just because you have the money doesn’t mean you will get what you want,” says a prominent art consultant. “It’s not a world you can buy into so easily.”

Loeb’s aggressive persona has spilled over into his personal life as well. Before his 2004 marriage to former yoga instructor Margaret Munzer—with whom he recently had a child—he was a fixture on the social circuit in Manhattan and the Hamptons. “He was out all the time,” says an acquaintance who ran in Loeb’s circle. “There were a lot of girlfriends.” His extracurricular life was on display in a 2001 New York article about yoga, which included a character referred to only as “Mr. Hedge Fund.” I was told that it was actually Loeb, hidden behind an alias. A longtime devotee of Ashtanga yoga, Loeb practices every morning at 5:30 and often travels to Mysore, India, in search of higher learning. But evidently, Loeb has managed to weaponize the peaceful spiritual practice: “Companies are short, management’s trying to defraud us, and I’m like Rambo in the office, headset on, three computers in front of me, mowing them all down,” he told the magazine. “Yoga is all about focus and perfect aim.” Confronted with these points, a spokesman for Loeb retorts, “These allegations do not dignify a response.”

In September 2005, another Loeb letter flooded in-boxes. But this time the recipient, Citadel Investment Group’s Kenneth Griffin, was not a bungling CEO but a respected hedge fund manager. Prompted by the allegation that Griffin had hired an employee away from a fund run by Loeb’s crony David Einhorn, Loeb sent Griffin an abusive e-mail in which he referred to Citadel as a “gulag” and its employees as “indentured servants.” “I understand your need to hire employees from other firms,” wrote Loeb, “something that Third Point has not had to do based on the fact that, unlike yourself, I actually enjoy and have talent in investing and am able to nurture others within my organization….Let me be clear that under no circumstances are you to approach any Third Point employees…should you attempt to hire people from [my friends], I will consider it a similar act of war.”

Loeb’s attack on Griffin was one of several episodes, culminating with his behavior in Davos, in which he has cannibalized his colleagues. Other targets include Wilbur Ross, whom Loeb accused of unfairly profiteering from the reorganization of a coal company in which both had invested, and London-based hedge fund managing director Alan Lewis, who approached Loeb for a job, only to have his e-mail exchange broadcast across the Internet. “We find most Brits are a bit set in their ways and prefer to knock back a pint at the pub and go shooting on weekends rather than work hard,” wrote Loeb.

But Loeb’s own record as an employer may leave something to be desired. “Third Point should really be called ‘Daniel Loeb Inc.,’” says an investor. “The big question on the street is how someone who puts up such good returns can have so much trouble retaining people.” In the last year alone, according to an insider, two of six partners, two analysts (of roughly a dozen), and the CFO all left Third Point either to join other hedge funds or to start their own. Of those who remain, only two were at the firm prior to 2003.

For the most part, Loeb’s former employees prefer to keep their thoughts about him private. And of more than two dozen friends, acquaintances, and ex-employees contacted for this article, most declined to speak about him. Their reluctance may be motivated by Loeb’s treatment of the last employee to challenge him, Youlia Miteva. In 2003, Miteva sued Loeb for “erratic and sometimes abusive behavior,” claiming that he had promised bonuses he later reneged on in a “scheme…to deprive [Miteva] of approximately $1 million in wages and other employment benefits.” The suit also charged that after Miteva left Third Point, Loeb deliberately sabotaged her attempt to get a position at Cohen’s SAC Capital. Loeb denied these allegations.

Possibly embarrassing to Loeb was the discovery of e-mails he sent to fellow 13D devotee Robert Chapman expressing disdain for Third Point analysts. In one e-mail quoted in the court’s findings, he wrote, “[I] hate them intensely.” In another, he joked, “I need to conduct a pogrom around here.” When Loeb fired Miteva—just four days before her $650,000 performance bonus was due—he wrote to Chapman that “the nuclear submarine launch sequence” had been “initiated” and was “headed for [E]astern [E]urope,” an apparent reference to Miteva’s Bulgarian nationality. The lawsuit was later settled.

One evening last June, the nonprofit Prep for Prep held its annual Lilac Ball fund-raiser at Manhattan’s Waldorf-Astoria. Like many New York causes célèbres, Prep for Prep counts among its trustees a roster of Wall Street heavyweights, including Loeb. Hoping to gain an audience with him, I gate-crashed the dinner. Around 7:00 p.m., I spotted Loeb holding court near one of the bars that dotted the reception area. He looked about 5′9″, his slight, yoga-toned build tucked into a black suit. Despite the gray slowly colonizing his full head of brown hair, he appeared much younger than his 44 years. I approached cautiously. “Mr. Loeb,” I said, reaching out my hand.

“Hi,” he replied blankly, betraying his lack of rec-ognition.

“We’ve exchanged e-mails,” I said. “But we haven’t met.”

“I didn’t think I knew you,” he replied, smiling, “but I always pretend I do. What were the e-mails about?”

“I’m the writer from Men’s Vogue. Since we haven’t managed to connect, I was hoping to ask you a few questions.”

His face, which had registered a pleasant calm, suddenly expressed concern. “I can’t talk to you,” he said, starting to back away. “I’m not allowed to talk to you.”

Not allowed? The gun-shy response speaks volumes about Loeb’s commitment to rehabbing his reputation. Similarly, several recent articles about Third Point have downplayed Loeb’s activism, emphasizing that the fund devotes less than 10 percent of its assets to activist investments. One former Third Point employee suggested that Loeb is using the media to improve his standing among deep-pocketed, risk-averse institutional investors—without whom Third Point will be unable to maintain its place among the T. Rexes.

Another reason for Loeb’s restraint is that 2006 may prove to be an underwhelming year for Third Point. Through the first half of the year, the fund was on course to register only a single-digit gain—which may not be enough, especially in the increasingly crowded and competitive activist-fund niche. When the $1.7 billion activist fund Pirate Capital stumbled to a 3 percent return for the first three quarters of 2006, the fund lost half its investment team, and its investors may follow. Ultimately, Loeb’s fate will also hinge on his ability to anticipate the next market cycle. “Dan is very good at figuring out where the opportunities are,” says the former Third Point employee. “He always seems to know where the hot money is going.”

If a hedge fund manager with as many sharp edges as Loeb is trying to soften his image, could the era of the hedge fund cowboy be over? Are hedge funds destined to become more like the somber investment vehicles against which they once defined themselves—mutual funds? Recent history suggests they are already there. In November, Morgan Stanley acquired $5.5 billion hedge fund Frontpoint Partners, becoming the latest in a line of giant institutions to bring once-independent funds into the fold. And the largest U.S. hedge fund is no longer run by a maverick in Greenwich. It belongs to Goldman Sachs. But if hedge fund managers become employees of large public corporations, do they really have the right to demand such enormous fees? It is a question Daniel Loeb might ask.

It was not unusual for Klebnikov to work late. He had moved to Moscow six months earlier to launch a Russian edition of Forbes, leaving his wife and three young children in New York, and the 41-year-old’s life revolved around the office.

Klebnikov’s magazine had intrigued the nation’s new elites. “It wasn’t just about business coverage,” says James Michaels, the legendary former editor of Forbes, “but also about lifestyle—wine, clothes, travel. He wanted to use the magazine to raise the standards of taste, as well as ethics.” A list of Russia ’s 100 richest people appeared in the second issue and was much discussed in the media—as were the angry responses from several newly minted billionaires who wanted knowledge of their extreme wealth kept private. At that moment, the man on top of the list, Yukos chief executive Mikhail Khodorkovsky, was facing criminal prosecution, and other business leaders were anxious. One occupant of the list anonymously told the Russian business paper Vedomosti that inclusion was an invitation for a government investigation. Forbes Russia’ s growing notoriety raised its editor’s profile, and Klebnikov was becoming a frequent commentator on Russian television.

As a reporter for Forbes in the 1990s, during the former Soviet Union’s tempestuous transition to a free market, Klebnikov was among the first Western journalists to expose the dubious manner in which a handful of men—the self-proclaimed “oligarchs”—came to dominate Russian business and politics. His feature on oil-and-media magnate Boris Berezovsky, later expanded into the book “Godfather of the Kremlin,” so incensed Berezovsky that he sued Forbes for libel.

But Russia was more than a great story for Klebnikov; it was a lifelong cause. As the scion of Russian emigrés, Klebnikov had been immersed since early childhood in the country’s language, history, and culture. “There was an attachment to the place that was very powerful,” says his wife, Musa, the daughter of Wall Street financier John Train, whose family had socialized with the Klebnikovs since childhood. “I remember Paul walking up a snow-covered road in upstate New York, reciting Pushkin, or singing loud Russian military marches with the kids. It was a source of joy for him.”

Klebnikov’s strict Russian Orthodox family instilled in him a vision of Russia as a glorious republic deformed by years of Soviet rule, a perception Klebnikov embraced more fully after completing a Ph.D. in Russian economics and political science at the London School of Economics. As a result, he saw the country through the impassioned eyes of a patriot, not the objective lens of a journalist. He became an apostle for economic reform and transparency in Russia, and believed his magazine could be an ideal instrument to help return the country to greatness. His reporting not only would expose the corrupt elements that threatened Russia’s development but would also celebrate the companies and individuals who advanced it. “He was so devoted to the idea of helping Russia,” says Musa. “He wanted to show them a better way, to introduce the best of American civic values.”

Increasingly, Klebnikov was encouraged by Russia’s progress. Before leaving his office that night, he called his brother Peter, his sister, Anna, and Musa. He was thrilled about the prospects for the magazine—and for Russia—and wanted to share his excitement. When Musa had expressed concern for his safety in Moscow, Klebnikov reassured her. “He told me Russian businessmen now settled their disagreements with lawsuits instead of with guns.”

Outside the offices of Forbes Russia, the driver of the Zhiguli closed in on the tall, lean figure in front of him, knowing already where Klebnikov was headed. The driver had monitored the journalist’s movements virtually every night for the past two weeks. As Klebnikov neared the Metro station, the car raced forward and cut him off. Klebnikov caught a glimpse of the driver, a dark-haired Russian in his early 30s. Then the driver raised his 9mm Makarhov pistol and fired, repeatedly, through the open window. Nine of the bullets hit Klebnikov, ripping through his stomach, leg, and chest. He staggered back toward his office, where he begged a passerby for help. “My name is Paul Klebnikov,” he said. “I’m with Forbes . I write about business.”

The next day, the Russian media reported that Klebnikov had died in an ambulance en route to the hospital. But Klebnikov’s life had actually ended inside a hospital elevator that stalled on its way to the operating room. By the time the doors were pried open, he was dead.

Murder for hire remains disturbingly common in Russia. Klebnikov was the fifteenth journalist assassinated since Vladimir Putin assumed the presidency in 2000—and there have been many more murders among business figures. But Klebnikov is only the second American—and the first American journalist—assassinated in Russia since the demise of the Soviet Union. His murder occurred just as the West was becoming increasingly wary of the Putin regime. Western governments and media outlets have expressed concern over Putin’s oppressive and authoritarian clampdown on the independent media in Russia, particularly journalists covering the brutal war with Chechnya. And last year’s trial and conviction of Khodorkovsky, perceived by some as a witch-hunt, has raised fears about the security of Western investments in Russia.

Consequently, the Russian government, which has largely failed to solve contract murders and seldom puts much effort into investigating them, has devoted significant resources to the Klebnikov case. The U.S. government has raised the case in diplomatic meetings between the two countries, with both presidents discussing the incident face-to-face. Additionally, several leading investigative reporters and news organizations were inspired last summer to launch Project Klebnikov, a collective devoted to shedding light on the murder.

Last June, two weeks before the first anniversary of the murder, Russian prosecutors claimed they had cracked the case. They fingered four members of a Chechen gang, allegedly hired by fugitive Chechen warlord and former mafia boss Khozh-Ahmed Noukhaev. Klebnikov had published a book about Noukhaev, “Conversations with a Barbarian,” in 2003, and prosecutors argued the Chechen had been so insulted by the book that he ordered the killing. The jury trial of two of the men, including the alleged triggerman, began in late December and has sparked controversy because in his dying moments Klebnikov described his murderer as Russian, not Chechen. But Noukhaev, who has not been seen in two years, and two other suspects remain at large.

Given the lowly reputation of Russian jurisprudence, sources familiar with the evidence say the major surprise so far is that the case against the two Chechens on trial appears to stack up. But no one has seen any evidence against Noukhaev, not even Klebnikov’s own attorneys. And despite protests from the U.S. State Department and the Klebnikov family, the trial has been closed to the public, leaving many expert observers—including the Klebnikovs—skeptical about Noukhaev’s role in the murder.

From the beginning, suspicion about the identity of Klebnikov’s killer has centered on the journalist’s work: that he was targeted as payback for something he had published or was about to publish. But Klebnikov was digging in so many deep, dark places, any one of them could have doomed him. Compounding the mystery is the nature of Russia itself, a place where every truth is relative and must be weighed against a web of constantly shifting interests and alliances. However, nearly two years after Klebnikov’s murder, new details have emerged that suggest a diverse and powerful pool of individuals who may have wanted Klebnikov dead.

“If you want to understand Paul Klebnikov, you have to read “Escape to Adventure,”” says Michaels, who encouraged his protégé’s aggressive reporting in Russia. “Escape to Adventure,” which Klebnikov read and revered, is a first-person account of author Fitzroy Maclean’s extraordinary experiences while serving as a British diplomat in Stalin’s Soviet Union and, later, during World War II, as the brigadier general sent behind enemy lines to aid Yugoslavia’s fight against the Germans. Maclean, described by the New York Times as “an extraordinary man if ever there was one, a scholar, a diplomat, a linguist, a soldier, and an adventurer,” was rumored to be a model for James Bond. “Most journalists think of themselves as observers,” says Michaels. “But Paul thought of himself as an actor. Like Maclean [who went on to become a Conservative MP in Britain], Klebnikov wasn’t only interested in recording what he saw. He really believed he could play a part in public affairs.”

Klebnikov’s grandparents all fled Russia in 1917 after the Bolshevik Revolution, as part of the exodus of the so-called White Russian ruling class under the czars. As a young boy, he heard stories about his maternal great-great-great-grandfather Ivan Pouschine, a political prisoner in Siberia after the 1825 Decembrist uprising and friend to Pushkin. His father descended from a long line of military officers, including his great-grandfather Arcadi Nebolsine, a navy admiral murdered by his own mutineering sailors during the Bolshevik Revolution.

To Klebnikov, such men were not obscure names on a family tree but forces in the rich Russian reservoir that coursed through the family’s Upper East Side apartment and through his grandparents’ weekend home in Sagaponack, New York. Klebnikov’s grandfather Ross Nebolsine, an MIT-educated civil engineer, was a leading figure in New York’s White Russian emigré community; his grandmother Catherine Nebolsine oversaw the Russian Children’s Welfare Society. “My grandparents were anti-Communist, but they all loved Russia,” recalls Klebnikov’s sister, Anna. “They thought it was a wonderful country gone astray.”

Paul and his three siblings learned Russian as their first language and recited Russian songs and poetry from memory. In the evenings, Klebnikov’s mother read passages from the great Russian novels out loud. “There was a sense we had a responsibility to carry on these ideals and values,” says Klebnikov’s brother, “to be good examples of our heritage.”

Klebnikov’s father, George, was a master linguist who had pioneered the art of simultaneous translation while working at the Nuremburg tribunals and later headed the interpretation department at the United Nations. He often quizzed his children at the dinner table, asking them to translate words from English to Russian to French. Even around three quick-witted older siblings, Paul was not easily intimidated. Anna recalls that when her younger brother was about nine, he had a heated argument about Napoleon’s strategy in the War of 1812 with a well-known historian who was attending a dinner party at the Klebnikov home. “To the astonishment of all the guests,” she says, “the discussion went on for a full hour.”

Klebnikov attended the private St. Bernard’s School in Manhattan and later Phillips Exeter Academy, where he was voted student-body president. At boarding school, Klebnikov arranged student demonstrations, including one against the Seabrook nuclear-power plant. “Paul object[ed] to the arbitrary imposition of unfair, oppressive, or dangerous decisions by powerful people,” says his former classmate Ashok Chandrasekhar, who remained a close friend.

After Exeter, Klebnikov graduated from Berkeley and attended the London School of Economics, where he conducted his Ph.D. on Piotr Stolypin—the man who would have the greatest impact on Klebnikov’s views about Russia. As prime minister under Czar Nicholas II, Stolypin initiated a land-reform policy that created more than a million private farms and made Russia the world’s largest agricultural exporter. Klebnikov was convinced that if the Bolshevik Revolution hadn’t happened, Stolypin’s privatization reforms would have put the country on a path toward capitalism. (Stolypin’s methods were not without controversy: He had so many dissenters executed that Russians began to refer to the hangman’s noose as the “Stolypin necktie.”)

In 1989 Forbes hired the 26-year-old Klebnikov just as the prospects for capitalism in Russia were brightening after seven decades of Soviet rule. “Here we are on the brink of what would become one of the biggest business stories of the century,” says Michaels. “And into my lap drops a guy who is fluent in Russian and has a Ph.D. in Russian economic history.”

Moscow in the 1990s was like the American Wild West—or the “Wild East,” as Klebnikov described it in early articles about the Soviet Union. “Change the accents, change the costumes, change the scenery,” he wrote in November 1990, “and Moscow today is Dodge City . . . the biggest piece of virgin territory open to capitalism this century.” After decades of state control, it was as though a giant For Sale sign suddenly had been erected over the entire country. Thousands of government-owned businesses, including some of the world’s richest petroleum, natural-gas, and aluminum deposits, were freed from their Soviet overseers and put on the auction block. To raise public support for privatization, the government of President Boris Yeltsin issued vouchers to every Russian citizen—148 million in all—that could be used to buy shares in newly privatized businesses or mutual funds. With ownership no longer against the law, the gold rush was on. But the media at large were so focused on the end of the evil Soviet empire they largely ignored the story of how Russia’s considerable spoils were being divided by oligarchs with private armies. As Klebnikov witnessed and reported on Russia’s transformation, he began to experience one of his own. The objective reporter became an impassioned crusader out to expose corruption and fraud.

Scrutinizing the way the state’s vast natural resources and business holdings fell into private hands, Klebnikov realized that Russia’s rapid and chaotic transformation to a free market had been a shell game. With the Yeltsin government’s active cooperation, the state was simply being replaced by a small number of unscrupulous opportunists who profited wildly at the nation’s expense. In 1996, there was not a single Russian billionaire on Forbes’ s annual list of the world’s richest people. By 2004 there were 36—more than in every other country except the United States. “When Paul got up close,” says Musa, “he became outraged and horrified by the way the country was being depleted and abused.”

In 1996 Klebnikov met Boris Berezovsky, the oligarch who personified for him much that was wrong with Russia—and who would occupy him for much of the next four years. During the Soviet era, Berezovsky had been an academic, a math Ph.D. who headed a research institute devoted to developing practical applications for decision theory. By 1997 he had become Russia’s richest man, with stakes in the country’s largest car dealership and its most-watched television network.

Klebnikov documented Berezovsky’s improbable rise in a 1996 profile that appears to portray the Russian tycoon as a powerful gangland boss and a key suspect in Russia’s most famous murder investigation. The murder in question was that of Vladislav Listiev, a popular Russian television-talk-show host and the former head of Berezovsky’s network. In the article, titled “Godfather of the Kremlin?,” Klebnikov intimated that Berezovsky may have been involved in the death of Listiev in a dispute over control of the network’s advertising revenue. “The Berezovsky article made his name,” says Andrew Meier, a former Moscow correspondent for Time. “It was a landmark and was widely picked up in the Russian press.”

It also provoked a lawsuit. Berezovsky sued Forbes in the London courts, whose libel laws are significantly favorable to plaintiffs. In 2003, following a six-year legal battle, the two sides settled. Forbes read a statement in open court making it clear that they accepted there was no evidence that Berezovsky was responsible for Listiev’s murder and that it would be wrong to characterize him as a mafia boss. In return Berezovsky agreed to withdraw his suit—though he later took out full-page ads in the New York Times and two London papers denying any illegal conduct and proclaiming his victory. When Klebnikov released a book with the same title in 2000, however, the question mark at the end of “Godfather of the Kremlin” had been removed, but this time Berezovsky did not sue.

During his research for the Berezovsky book, Klebnikov interviewed Khozh-Ahmed Noukhaev, the man the Russian government has accused of ordering his murder. At the time, Noukhaev was in exile in Baku, Azerbaijan, ducking an arrest warrant. His discussion with Klebnikov so disturbed the journalist that he decided to make it the subject of his second book, “Conversations with a Barbarian.”

Noukhaev was a legendary Chechen figure who entered Moscow’s criminal underworld in the 1980s and became a leader of the Chechen mafia. He spent time in prison in Russia but somehow managed to escape. When war broke out in Chechnya, Noukhaev helped lead the resistance. Though still wanted in Russia, Noukhaev became an international ambassador for the Chechen cause, flying to meetings with world leaders and entertaining British lords in grand style in Chechnya and Azerbaijan.

By the time Klebnikov interviewed Noukhaev, however, the Chechen had become decidedly undiplomatic. “For us, Russia is an enemy, but an even bigger enemy is the West,” Klebnikov quoted Noukhaev as saying. “America has no need to wage war. It has another weapon: a virus called civilization.”

During interviews, Klebnikov’s missionary zeal toward Russia often rubbed his subjects the wrong way. Passages from the Noukhaev book have been interpreted as strongly anti-Islamic or anti-immigrant and even wholly racist. But a Russian journalist who knew Klebnikov well says the book simply related what he believed was a struggle for the survival of his worldview. “He believed liberal tendencies to excuse other cultures have gradually deteriorated European Christian civilizations,” says the journalist, who spoke on condition of anonymity.

After nearly a decade of frustration, Klebnikov once again grew optimistic, following the 2000 presidential election of Vladimir Putin. The new president launched investigations of some of the oligarchs and their empires. Media mogul Vladimir Gusinsky fled Russia for Israel, and Berezovsky found asylum in London. (He left Russia after being charged with embezzling funds from state airline Aeroflot; Berezovsky insists the charges were politically motivated, and the London courts rebuffed efforts by Russia to extradict him.) Yukos chief Khodorkovsky, of course, suffered a harsher fate: Last year he was sentenced to eight years in prison. “While not exactly civilized yet, the Russian marketplace is benefiting from the stability brought by . . . Putin,” wrote Klebnikov in March 2003. “Gone is the gangster free-for-all of the Yeltsin era. Putin has chosen a more measured pace of market liberalization, as well as more predictable rules.” These were the rules that Klebnikov had hoped to enforce, but in the end, they couldn’t protect him.

In a world of gray, criminal trials often provide a reassuring sense of black and white. But Russians have been so conditioned to view the judicial process as a tool of the state, the actual guilt or innocence of a defendant often seems irrelevant. Paul Klebnikov’s accused murderers, Kazbek Dukuzov and Musa Vahaev, are Chechens from the town of Urus-Martan. When the doors of the Moscow City courtroom swung open, it was possible to catch a glimpse of them—enclosed in a bulletproof-glass cage. Yet little else about the trial can be known, except for the vague outline of the state’s case.

Dmitry Shokhin, the federal prosecutor renowned for securing the conviction last year of Khodorkovsky, alleged that Dukuzov shot Klebnikov, and that Vahaev, together with two associates who are still at large—Dukuzov’s brother Magomed and Magomed Edilsultanov—assisted with the planning of the murder. The prosecutor further charged that the men were hired by Noukhaev, who allegedly was so enraged by Klebnikov’s book that he ordered the murder as revenge.

Despite the characteristically low standards of Russian jurisprudence, sources familiar with the evidence in the Klebnikov case say that while it is entirely circumstantial, it is seemingly quite convincing. Most compelling are records that allegedly put Dukuzov’s gang’s cell phones in the vicinity of Klebnikov’s office nearly every evening for a two-week period before and including the night of the murder—but never prior, never after, and never during the day. The Zhiguli allegedly driven by Dukuzov was discovered near the crime scene; Vahaev’s fingerprints were found on the car, as were clothing fibers traced to Dukuzov. Cell-phone records placed both men at the murder location around the time of the murder, and the prosecutor alleged Dukuzov had called to arrange a pickup after shooting Klebnikov. In addition, witnesses testified that the defendants showed signs of having come into a significant sum of money soon after Klebnikov’s death.

The government is not required by law to release its evidence against Noukhaev until he is apprehended, so the strength of the evidence against him is not yet known. Few doubt that he is capable of such an act; while describing the feudal culture of Chechnya to Klebnikov, Noukhaev explained that if someone kills or even insults a member of your clan, “he will be hunted for the rest of his life.” But the prosecutor’s hard-to-prove theory hinges on whether Noukhaev was ever insulted by Klebnikov’s book. Several journalists who have spent time with Noukhaev say he is a publicity hound, likely to have been flattered by the ministrations of a famous American scribe. “Given that Noukhaev has been plausibly accused of a great many murders, the thought that he would have ordered this is entirely plausible,” says journalist Anatol Lieven, author of “Chechnya : Tombstone of Russian Power.” “It is just as plausible that he had absolutely nothing to do with it.”

For years a visible leader of the Chechen cause, Noukhaev disappeared from view near the beginning of 2004, roughly half a year before Klebnikov’s murder. Several Chechen newspapers have reported him dead, and E-mail sent to an address on his Web site went unanswered. While the Russians have been unable to locate Noukhaev, they were suspected of setting off the car bomb that killed his close friend Zelimkhan Yandarbiyev, Chechnya’s former separatist leader, in Qatar in 2004.

Since Klebnikov’s murder, and even after charges were filed against Noukhaev and his cohorts, the Russian media have reveled in proposing their own theories about who might have had Klebnikov killed. Unsubstantiated allegations have been made against a number of powerful men whom Klebnikov appeared to be investigating before his death. Michael Klebnikov says that a cursory reading of his late brother’s computer files revealed “no smoking gun,” but showed that he “had his hands in many pots.”

Various political names have cropped up during Klebnikov’s murder investigation. A senior telecom executive in Russia, for example, has told investigators that less than a month before the murder he gave Klebnikov secret documents that suggested that Leonid Reiman, the Russian telecommunications minister, may have been involved in the embezzlement of shares and assets at Russia’s state-owned telecom company Svyazinvest. A multi-billion-dollar scandal involving Reiman was first reported last summer in the Wall Street Journal, but it turns out Klebnikov had already been investigating Reiman several years earlier. No charges have been brought against Reiman in connection with the telecom scandal and the minister denies any wrongdoing. There is no evidence to link the murder of Klebnikov with the scandal, and, indeed, the government has expressed confidence that they have the right man in Noukhaev. During a trip to New York last fall, President Putin himself met with some of Klebnikov’s family and assured them of Noukhaev’s guilt—but not his capture. Yet many of those closest to Klebnikov have been struck by the number of well-known figures whose names have been bandied about in association with the murder investigation, even though there’s no evidence of their involvement. “We are grateful to the Russian government for their efforts,” says Peter Klebnikov, “but we would have liked a more thorough investigation of other potential suspects before the case was closed.”

In Russia there remains scant belief in the concept of independent media. The country’s older generation was raised with the idea that the media were indistinguishable from propaganda, while the younger generation was exposed to what the Russians call kompromat, the notion that the media can be used as a tool to disseminate negative stories about one’s enemies. Of course, the state of the Russian media is emblematic of the country as a whole. Today the country’s political, economic, and judicial systems are manipulated by those in power, like pieces on a chessboard, to strip their rivals of wealth and status. Twenty years into its experiment with democracy, Russia still bears more resemblance to a corrupt Central American dictatorship than to its counterparts in the G8.

In the midst of this place, one American family has lost its youngest, brightest son. And neither Klebnikov’s wife, his family, nor his government have been able to play a meaningful role in the search for justice. The Klebnikovs are optimistic about the case against the Dukuzov gang, but they are withholding judgment about Noukhaev until they see evidence of his involvement. They also have expressed disappointment that the Russians refused help from American and other Western authorities in the hunt for Noukhaev.

Musa Klebnikov has sought to continue her husband’s legacy with the Paul Klebnikov Fund, a foundation dedicated to promoting an independent press in Russia and contributing to all the causes—the strengthening of small community churches, the preservation of Russian architecture—that her husband believed were the foundation for a civil society in Russia. “The idea of helping Russia was his greatest motivator,” says Musa. “He felt that was his duty. And a lot of Russians found it remarkable that an American would be so determined, and so effective.” Unfortunately for Klebnikov’s family and for Russia, these were precisely the qualities that cost him his life.

Now Morningstar’s own reputation for integrity is on the line. The company is the subject of two government investigations–one by the Securities and Exchange Commission and the other by New York attorney general Eliot Spitzer. According to Morningstar, the SEC inquiry, which began in the spring of 2004, deals with erroneous fund-performance data that the company posted on its website and failed to correct for nearly two weeks after being alerted to the problem. Morningstar says Spitzer’s subpoena, which it received in mid-December, concerns retirement-plan services it provides on behalf of large institutions. But FORTUNE has uncovered new details that suggest both investigations may be broader than previously reported.

For Morningstar, the scrutiny could not come at a worse time. Surprisingly small, with just 830 employees and $139 million in revenue, the firm has lost nearly $80 million over the past five years. In May, Morningstar filed for an initial public offering, which it hopes will raise at least $100 million to fund new initiatives. Now, with the specter of civil and criminal charges looming, the IPO appears to be in jeopardy.

Although distinct, the two government investigations both touch on a potentially troubling aspect of Morningstar’s business: the company’s burgeoning financial relationships with the same mutual funds it rates. Morningstar wields tremendous influence over America’s $7.4 trillion mutual fund industry. Academic studies have demonstrated a direct correlation between the company’s easy-to-grasp star ratings and mutual fund flows. In 2003, for example, funds that received Morningstar’s coveted four- and five-star grades (those with the best medium- and long-term performance records) attracted $215 billion in new investment, while funds that received three stars or fewer saw $50 billion go out the door.

Morningstar, meanwhile, has become increasingly reliant on the income it gets for selling its data, research, and expertise to large institutions, including mutual funds. In 2003 institutional sales accounted for 43% of the company’s revenues, compared with just 25% from consumer ratings and research.

Morningstar declined all interviews with FORTUNE for this article except to specifically address the government investigations, citing quiet-period restrictions that precede an IPO. But dozens of conversations with former employees, industry experts, and mutual fund executives reveal a picture of a firm that has never fully made the jump from great idea to great company, and has struggled to find a way to capitalize on its valuable brand. The firm’s leadership, particularly founder and chief executive Joe Mansueto, has clung to the same make-it-up-as-we-go-along spirit that fostered creativity when the company was a scrappy startup. And that lack of definition and discipline in its business plan has contributed to its current troubles.

In 1984, Mansueto launched Morningstar with a revolutionary idea: to provide small investors research and analysis about the neglected area of mutual funds. The 27-year-old entrepreneur’s goal was to cover funds the way newspapers did sports, with statistics, rankings, and interviews with the participants–in this case the fund managers. It was a winning formula, and the timing couldn’t have been better. In 1984 there was just $371 billion invested in roughly 1,200 U.S. mutual funds. By 2000 that amount had swelled to nearly $7 trillion in more than 8,100 funds.

Mansueto surrounded himself with bright young employees who shared his passion. Most were liberal arts graduates from the University of Chicago, who Mansueto believed were better equipped than business school grads to pursue Morningstar’s journalistic approach to investment research. “People really thought they were adding value to society,” says a former Morningstar fund analyst. “It wasn’t just a bunch of greedy Wall Street people.” One of his first hires was Don Phillips, who had been working on a Ph.D. in English. Articulate and charismatic, Phillips became one of the most frequently quoted figures in the business press (including FORTUNE).

Morningstar quickly outpaced more established competitors, such as Lipper Analytical Services and Value Line, for the affections of the investing public, and its star ratings became the benchmark for both investors and fund managers. “They came out of nowhere in an industry where the research had been very shabby, and created a new standard,” says a prominent fund manager, who spoke on condition of anonymity. “All the other companies were forced get better.”

Citing fatigue, Mansueto stepped down as CEO in 1996 and chose Phillips as his replacement. At the time, the Internet was raising the small firm’s profile to a much higher level. The very creation of a website, of course, made its analysis easily available to a wide audience. And spurred by the fear that a high-tech upstart or an established Internet player like AOL could extinguish its business overnight, Morningstar began to transform its operations radically. The firm invested millions in a spate of new initiatives, many aimed at large institutions such as mutual fund companies, brokerage firms, and insurers. Morningstar sold subscriptions to its databases and launched institutional consulting and retirement-planning businesses. It also introduced Advisor Workstation, an advanced, web-based version of Principia, the successful software package of stock and fund data it had sold to financial planners since 1991. The new product was geared toward advisors at large brokerage houses. From October 1999 to October 2000, the staff grew from 520 to 830.

One seemingly obvious move Morningstar did not make was to cash in by going public in the booming IPO market. Mansueto has said he preferred to avoid the distractions, particularly in such an overheated environment. Whatever the reason, in 1999 Morningstar instead accepted a $91 million investment from Japanese venture capital firm Softbank, which already knew Morningstar from a joint venture with its Japanese subsidiary. (Softbank received a 20% stake in the firm, and Mansueto kept the rest, except for a small portion dedicated to employee stock options.)

To manage the rapid growth, Phillips broke with the firm’s long-held practice of hiring from within and brought in a team of experienced managers, many from the fund industry, such as Tim Armour of Stein Roe and Jim Wironen from Fidelity. The new executives quickly observed what the company’s income statement had shown for some time: Morningstar’s prospects rested on its ability to develop large institutional customers, not the small investors that had defined its original mission. Wironen, in particular, worked on developing new products for big fund companies and investment banks.

But the new team didn’t get the chance to carry out its vision. Former executives say a power struggle developed between the new management and the old guard–longtime executives such as retail head Catherine Odelbo and CTO Tao Huang–who were unaccustomed to taking orders from outsiders. “It became the old Morningstar vs. the new,” says one former executive, “and the organism rejected the implants.”

In October 2000, Mansueto demoted Phillips and Armour, fired the rest of the executive team, and reinstalled himself as CEO. At the time, the explanation was that Morningstar’s spending had grown out of control, a rationale that certainly had some truth to it. In the 14 months before Mansueto’s return, Morningstar burned through $40 million of the Softbank investment, much of it on technology upgrades and consumer marketing for the website. But several former executives wonder if Mansueto simply blanched at the pace with which his creation was changing.

In Phillips’s place, Mansueto promoted Huang, who assumed the title of COO. A classic American immigrant success story, Huang arrived in New York from China in 1987 at the age of 25 and began his career as a bicycle delivery man for a Chinese restaurant. After getting a master’s in computer science, Huang went to work for Morningstar in the late 1980s.

Several former employees describe Huang as a run-and-gun programmer, someone who didn’t stop to document his work because it slowed down the process. “There was a fear that the thing was a real Krakatua,” says one former executive, referring to the company’s database. “The database had been bad for a long time,” says another former executive, who left Morningstar in 2001. “Parts of it were antiquated, overloaded. It’s inexplicable that a company whose whole revenue stream depended on the quality of its data wasn’t more rigorous.” The executive questions whether Huang’s control over technology contributed to Morningstar’s current data problems. Morningstar would not make Huang available for comment.

The incident the SEC is investigating surfaced in February, when Jonathan Ferrell, the portfolio manager of the Rock Canyon Top Growth Fund, noticed that Morningstar had mistakenly recorded the 25% dividend he paid out to shareholders as a loss. But when his transfer agent reported the problem to Morningstar, the company misunderstood the problem and exacerbated it, adding 25% to Rock Canyon’s annual return and pushing it to the top of its category. Despite several attempts to persuade Morningstar to correct the problem, the erroneous data remained on the site for 12 days.

Although the Rock Canyon error appears to be inadvertent, it is not isolated. Within the industry, the company has a history of data problems. Since July 2003, the Wall Street Journal and the New York Times have printed three corrections they attributed to mistakes in Morningstar data. And an article published last summer in the Journal of Portfolio Manage-ment reported significant problems with Morningstar’s historical data–”The moral is: Do not attempt a study of this sort without data that is better than Morningstar’s.” Since it publicized the SEC inquiry in September, Morningstar has taken steps to shore up its data. The company now has a corrections page on its website, which averages about one or two entries a day.

But there are indications that the SEC may be investigating more than data errors. A Morningstar spokesperson acknowledged to FORTUNE that the agency is conducting a “routine examination” of two of the company’s business units–Morningstar Associates, which recommends funds for 401(k) plans and advises investors on how to allocate their assets, and Morningstar Investment Services, a registered broker. The SEC didn’t respond to requests for comment, but sources tell FORTUNE the examination is part of a larger investigation of the role of middlemen in the retirement and annuities business.

According to sources with knowledge of Spitzer’s subpoena, the attorney general’s interest in Morningstar arose as a result of an inquiry into a retirement product sold by two large insurance companies, which are clients of Morningstar Associates. Spitzer is looking into Morningstar Associates’ role in what a source calls an “unsavory product,” including whether fund companies may have paid Morningstar to recommend their funds over those of other firms. The investigation is still in its early stages, but a source says, “This is the kind of problematic structure we’ve seen issues with in the past.”

Mansueto is adamant that his firm is above reproach. “Our only fee comes from the plan provider,” he says. “We are not getting anything from the funds we include in our [recommended] lineups.” Morningstar has been criticized for potential conflicts of interest before–in 2002 it accepted an undisclosed fee from Fidelity to provide research to the fund giant’s customers. But even former executives critical of Morningstar doubt the firm would jeopardize its reputation–and its entire business–with the sort of behavior being investigated by Spitzer’s office. “The kind of people working there would never do such a thing,” says Lillian Goldthwaite, a mutual fund consultant employed by the firm until 2002. “But when you set out to be a white knight, you’re asking for people to inspect your whiteness.”

Ironically, Morningstar’s latest growth plan, a push into stock research, was created after an earlier investigation by the New York attorney general. In the “Spitzer settlement” of 2003, ten of the world’s largest investment banks agreed to pay $432.5 million over five years to fund independent equity research to settle a lawsuit charging them with improperly shaping their analysis to favor their investment-banking clients. Morningstar was selected to provide research to five of the banks, including Merrill Lynch and Goldman Sachs. The firm has invested heavily in the effort and now employs nearly three times as many stock researchers as fund analysts. But industry experts don’t expect the contract to be more than marginally profitable and say it won’t solve the company’s long-term problems.

Morningstar’s future almost certainly depends on expanding its institutional services business. And if it can manage to pull off an IPO, the cash infusion may give the company the flexibility to get there. But without an overhaul of its basic model, Morningstar will have to continue straddling the line between its original mission of serving individual investors and serving its own self-interest. In the past when times got tough, the company always had one thing to fall back on: its unimpeachable reputation. In the days ahead, that may not be so easy.