(FORTUNE Magazine) – The next time you consider sailing your small investor dinghy into the tempting but turbulent waters of an emerging market, keep the following exchange in mind: When FORTUNE asked swashbuckling financier Michael D. Dingman--a fellow who says he considers pirates merely misunderstood entrepreneurs--whether he traded on inside knowledge during his recent business adventures in the Czech Republic, he cheerfully replied, "That's probably true." Other investors, he went on to volunteer, "are saying, 'We can't get enough information, so we're going to sell, we're going to go home to bitch and complain.' That's the kind of meat I like to eat."

Remember Dingman? He was the Al Dunlap of the 1980s, a swaggering, make-no-apologies, take-no-prisoners turnaround artist who dazzled Wall Street by rescuing a series of companies like Wheelabrator and Signal. A daredevil whose hobby was high-speed auto racing, Dingman later led a then-record $1.2 billion IPO of AlliedSignal's castoffs into the Henley Group, a feat that ultimately made him a multimillionaire but also left a trail of angry shareholders who claim he enriched himself at their expense.

Last fall Dingman, who a few years ago gave up his U.S. citizenship for a passport from the tax-free Bahamas, resurfaced in investing's Wild East. Allied with a controversial young Czech investor (and fellow exile), Viktor Kozeny, he announced a bold scheme to take over and transform a rusty bucket of Czech industrial companies--all without ever leaving his tropical base. Though some in Prague greeted this incursion by Caribbean buccaneers with skepticism, much of the foreign press hailed Dingman--who claimed he was pouring $140 million of his own money into the investments--as a hero, a man who would teach the locals much needed lessons in free-market capitalism and Western management skills. an island breeze blows in prague was Business Week's headline, while London's Financial Times called him a "breath of fresh air."

Instead, as it turned out, this breeze proved an extremely ill wind. After failing to deliver on his promises to import American management and accounting know-how, Dingman recently declared that he was tired of the "hassles" and was bowing out of day-to-day management of his Czech investments. Meanwhile, despite a strong continued rise in the overall Czech stock market over the past 12 months, the value of most of the public companies and mutual funds associated with Kozeny and Dingman has plummeted. Hundreds of investors, ranging from Czech retirees to sophisticated international fund managers, are furious, not to mention considerably poorer.

"Dingman wasn't investing in the Czech Republic," says Harvey Schuster, chairman of the Czech-California Investment company in Prague. "He was ripping off in the Czech Republic." That may be too strong. Dingman himself hasn't been charged with breaking any laws. And as a man who's used to suffering slings and arrows in pursuit of outrageous fortunes, he characteristically dismisses any such criticism as sour grapes.

But FORTUNE has learned that last summer the Czech Finance Ministry quietly fined Kozeny's fund management company for a long laundry list of financial offenses at one of the two dozen mutual funds he ran. Some $30 million of the fund's $100 million in assets was frittered away in inflated fees and illegal transactions, according to a copy of the unpublicized ministry ruling obtained by FORTUNE. (Kozeny paid the fine and agreed to pay $6.8 million in restitution.) At the very least, it seems, Dingman, who sits on the board of Ford Motor Co. and formerly was on the board at Time Inc., FORTUNE's publisher, could be accused of keeping some questionable company in his alliance with Kozeny.

Indeed, few have prospered more from exploiting the lax regulatory standards of Eastern Europe's still-emerging financial markets than Viktor Kozeny. After emigrating to the U.S. as a teenager, he was virtually penniless when he returned to Prague in 1990 at the age of 27. Yet in just four years, armed with only an economics degree from Harvard and a short stint working at the London fund manager Robert Fleming, Kozeny transformed himself into one of his country's most celebrated fund managers, with a personal fortune estimated at $200 million.

His main chance: a massive privatization program, launched by the government, that centered on offering to every adult citizen vouchers that would later become shares in publicly traded companies. After a generation of Communist rule, few Czechs had much interest in these pieces of paper--or any idea of what to do with them--until Kozeny's company, Harvard Capital & Consulting, named after his alma mater, stepped in.

Drawing on his experience in the U.S., Kozeny used hard-sell television commercials, a print campaign, and even girls in short shorts to sell his countrymen on two things: the value of creating closed-end mutual funds, whose prices trade on the stock market, and--more important--the value of handing their initial bundle of vouchers over to Harvard. The lure was an outrageous promise. Kozeny pledged that every person who entrusted him with vouchers would, within a year and a day, earn back at least ten times that initial investment. Over a few months in 1992, more than 800,000 people flocked to Kozeny's offices and received, in exchange for a coupon book initially valued at about $37, 20 shares of one of Harvard's funds.

If the market had turned down, of course, Kozeny would have been utterly unable to deliver on his pledge--which is why such promises are illegal under U.S. securities law. And even in the frontier atmosphere of Prague, where no such ban was in effect, Kozeny's reckless opportunism raised official eyebrows. "I was afraid, his behavior was so nonstandard," recalls Tomas Jezek, now head of the Prague stock exchange but at the time the minister of privatization. "He promised something he did not possess."

Luckily for Kozeny, when the Prague stock market began trading in September 1993, share prices headed skyward--making the young stock tout an instant golden boy. Within days those $37 coupon books were worth some $675. Kozeny then proceeded to add to his personal fortune by charging his happy if clueless investors a hefty fee for setting up the funds and another fee for managing them. In the first year of stock market trading, calculates Pavel Travnicek, who was financial director of Harvard Capital until 1995, Kozeny collected $45 million in fees on funds with total assets of $1 billion. But who was counting? By then the Harvard "miracle" had made Kozeny a national celebrity, and his funds had started attracting investors from big Western European institutional investors, including Credit Suisse's Central European fund and at least two London fund managers, Regent Kingpin and Buchanan Partners.

Around this time, things took a weird twist as Kozeny became embroiled in a bizarre case involving an agent of the state secret police. The agent, Vaclav Wallis, was arrested in December 1992 for selling Kozeny secret government documents. Kozeny claimed he was being blackmailed but eventually found himself investigated for his own role in the spy scandal. Although Kozeny was never charged in the case and today claims he was trying to trap Wallis in a government sting operation, he took steps to distance himself from his native country. He sold control of Harvard Capital to a shelf company in the Netherlands Antilles owned by his mother. He obtained an Irish passport. Then in 1994 he moved with his spouse and their two children to Lyford Cay, a wealthy beachfront enclave in the Bahamas where his neighbors included the actor Sean Connery, fund maestro John Templeton--and Michael Dingman.

When FORTUNE first caught up with Dingman and Kozeny last May at the exclusive Lyford Cay Club, the two were still brimming with optimism about their plans. They had met a year earlier at a dinner party and, despite their age gap--Dingman is 65, and Kozeny's now 33--quickly formed a strong bond. "I see myself in Viktor,'' Dingman said proudly. As he entertained on his yacht, Dingman enthusiastically laid out a picture of the Czech Republic as ripe for the kind of restructuring no one knew better than he how to deliver. "It's like a country that has gone through bankruptcy,'' he said, "and all of a sudden there is a Monopoly game created.''

To play this potentially lucrative new game, as Dingman explained it, he and Kozeny had, after months of exploratory talks, begun cooperating in the summer of 1995. Marrying Kozeny's intimate knowledge of the Czech market with Dingman's capital and turnaround skills, they were working together to take joint positions in targeted companies with solid assets but weak managements and overstaffed payrolls. (They could buy control quietly and cheaply because there was no disclosure law at the time in the Czech Republic, nor were there any requirements for investors to launch a public tender offer when they reached a certain ownership threshold.) Kozeny would formally hand Dingman operational control of the firms, while Dingman promised Viktor a bonus of 10% of any profits he made.

Rising at 3 a.m. in the Bahamas to work the phones, Kozeny embarked on a frenzy of dealmaking under Dingman's direction. By October 1995, Kozeny's Harvard funds and Dingman's Cyprus-based Stratton Group jointly announced that they had secretly purchased large blocs of eight leading Czech industrial companies: a paper mill, a chemical firm, a brewery, a shipping line, a glass company, a pulp mill, an oil exploration company, and the utility that sells heat to Prague apartment dwellers.

Initially the Prague market was buoyed by Dingman's pledge to import top American management talent and by the prospect of a huge new capital injection for these companies. Riding this flush of enthusiasm, Dingman made a trip to Prague in November 1995. Apparently forgetting that he had traded in his citizenship for zero capital gains taxes and a Bahamian passport, he even asked U.S. ambassador Jennone Walker to host a reception for his new venture. "That guy sure has chutzpah,'' marvels one diplomat, who recalls that the ambassador turned Dingman down cold.

Lost in all the hoopla, though, was the unnerving fact that since he had begun concentrating his formerly broad holdings of 50 Czech blue chips into big bets on these eight firms, the prices of Kozeny's family of mutual funds had been falling, even though the overall Czech market had continued to rise. Why?

On the surface it may have appeared that this was simply another case of a once-hot fund manager making bad portfolio decisions. But as the Czech Finance Ministry judgment privately handed down against Harvard last July and obtained by FORTUNE reveals, the real reason was far more serious: To acquire operating control of the companies targeted with Dingman, Kozeny appeared to be treating his funds as a personal bank account.

The judgment found, for instance, that Kozeny sold six blue-chip stocks, including SPT Telecom, one of the cornerstones of the Prague stock market, in a forward-sale deal at a loss of $6.3 million. Bad news for shareholders, to be sure. But what really upset Finance Ministry officials is that when shares in those stocks began trading, the market price they sported should have produced a nearly $10 million gain for Kozeny. Also singled out for skepticism was a $1.5 million loss the fund recorded on the sale of shares in Czech Ocean Shipping, Sepap paper, and Sklo Union Teplice--three of the companies that Dingman and Kozeny later ended up controlling. The clear implication is that Kozeny was selling stock at knockdown prices and letting fund investors take the loss. Shares were shifting "from Viktor's right pocket to his left pocket" is how one executive familiar with the deals puts it.

In perhaps the most egregious violation cited in the Finance Ministry judgment, Kozeny's Harvard Guarantee & Multiple fund parked $11 million with a brokerage firm he owned as a "down payment" on the future purchase of shares. But the stocks were never delivered and the money was never returned, the judgment states. Finally, the government found illegal a fee for nearly $8 million that Kozeny charged his fund shareholders for running splashy advertisements in leading Western magazines (yes, FORTUNE was one of them). Instead, officials concluded, that money should have been covered by the hefty management fees Kozeny was levying.

As a result of these charges, which were never made public, Harvard was fined the maximum amount under Czech law--the equivalent of $37,000. Further, Kozeny agreed to settle the case by paying back to the funds $6.8 million that had been improperly spent for advertising and consulting fees. Kozeny insists Harvard was fined for purely "administrative reasons." As for the charges of trading below market prices, he insists that "we have never done it, and we will never do it.'' He maintains the trades occurred in an informal "gray market" before formal share trading began, so he couldn't know what the eventual market price would be.

In any event, five months after going public with his partnership with Dingman, Kozeny torpedoed his funds' already sinking share prices by announcing his intention to convert the Harvard mutual fund family into a new industrial holding company. The plan was announced and rammed through--even though Kozeny at the time lacked outright control of Harvard's shares--at a shareholders' meeting called hastily and held in an obscure village near the Austrian border, four hours' drive from Prague. (Asked by FORTUNE why that site had been picked, Kozeny offered the lame excuse that there had been a lack of meeting space in Prague.)

When word filtered back to the capital that the country's leading family of mutual funds was turning itself into an industrial holding company--imagine the reaction if, say, Fidelity one day suddenly announced it was cashing in its diversified investment holdings and turning itself into an industrial giant along the lines of General Electric--pandemonium erupted. Tomas Jezek, who had just taken over as head of the stock exchange, issued a public warning to "avoid these companies, cut them off and push them to the margin of society." Investors stampeded to the exits, and Harvard Dividend shares slumped 22% in a single week.

The shares might have fallen even lower but for the fact that there was at least one person buying them: Viktor Kozeny. "It was really funny because we made a lot of money off that," Kozeny recalled of the rout of Harvard's share price. He told FORTUNE in May that he acquired 51% of the funds' shares as the price fell.

That cleared the decks for Kozeny and Dingman's final maneuver last July. First, all the Harvard funds, which by then had been transformed into holding companies, were merged into a single entity called Harvard Industrial Holding. Then Harvard was merged with Sklo Union Teplice, a holding company that Dingman and Kozeny controlled. That company was then merged with portions of Dingman's investment vehicle, Stratton, to form yet another holding company, called Daventree Ltd., whose board's roster, in addition to Dingman and Kozeny, includes such luminaries as former White House chief of staff John Sununu and former U.S. astronaut Thomas P. Stafford. The investors in Kozeny's funds now became indirect holders of paper in this Cyprus-based company, which is beyond the scrutiny of Czech authorities and shareholders, and has not published any accounts. Daventree shares aren't publicly traded, although Kozeny has promised to seek a listing for them in London or New York.

If he does, it's highly unlikely that any of the Harvard funds' original investors will be clamoring to get a piece of the action. Since last December, Harvard's main fund, now a holding company, has lost 83% of its value. The other funds have taken similar falls. Frantisek Hapka, a 79-year-old invalid in the Moravian town of Loucka, saw his life savings shrivel from nearly $2,000 to just over $180 today. "If I could walk, I'd march on the Bahamas," he says. "I feel like I've been robbed."

As things now stand, however, there's little point in folks like Hapka marching even on Prague. Though the Czech government has taken some steps to tighten up the loopholes exploited by Kozeny, such as requiring disclosure of share stakes above 10% of a company's stock and requiring companies to make tender offers when they reach more than 50%, the Czech Republic still offers nothing like the kind of investor protection standard in most developed markets. When FORTUNE recently asked Vladimir Ezr, director of trading at the Prague stock exchange, who ensures that investors don't get cheated, he replied, "Nobody."

Daniel Arbess, a former White & Case lawyer who had become Dingman's right-hand man in Prague, resigned shortly after the July mergers took place. When asked by FORTUNE if he was upset by the flurry of dealing, he responded as follows: "I was not involved in nor did I have any knowledge of any financial engineering or financial transactions that were undertaken."

For his part, Dingman has told FORTUNE he is quite happy with the profits he has made amid all last spring's and summer's wheeling and dealing. Just how profitable is hard to say, given the veil of secrecy these private offshore firms now enjoy.

But consider the case of Sklo Union Teplice. At the time Dingman and Kozeny's Harvard acquired this Czech company, it was sitting atop a cash hoard worth $57 million, or $13 a share. That alone was at least $1 a share more than the value of the shares in Harvard that Sklo's minority shareholders received when the Bahamian duo took charge. Today those folks are stuck holding shares in Daventree, a private company of uncertain value. Meanwhile, in addition to their control of that pile of cash, Sklo's new owners have raked in another $35 million from the recent sale of a Sklo subsidiary to a Belgian glassmaker. Not that it's easy to track where that money has gone. Since September, Sklo's ownership has been transferred to two other offshore companies, Berio Holdings and Bruker Holdings. "Who knows where the cash is?" asks Vladimir Jaros, chief of research at Wood & Co., a leading Prague brokerage. "It looks like they are taking the assets out of the country. It may already be gone."

Questions also have been raised about whether Dingman really invested all his money when he said he did. He claimed, you will recall, that he was putting $140 million into the Czech economy in the fall of 1995. In fact, the Prague company registry shows that Stratton didn't actually buy many of its industrial holdings until May 30 of this year. Dingman now acknowledges that he used "forward purchase" agreements to buy several of his stakes, but says he still feels he bought the stocks when he signed the agreements, not when the deals were actually executed months later. It was through this device, though, that Kozeny was able to sidestep a Czech market rule prohibiting mutual fund companies from holding more than 20% of any company's stock.

When FORTUNE told Dingman that some investors in Prague accused him of asset stripping, he replied, "Baloney." Asked if he had an interest in any of the offshore companies that now control Sklo Union and its corporate siblings, he replied that he didn't know the answer. "That's the way you do business in that part of the world. It's not the New York Stock Exchange," he says.

No, indeed, as he knows well. On the New York Stock Exchange in the late 1980s, when Dingman made his initial fortune by engineering similarly complex deals, he had to endure pesky complaints over issues such as the $9 million his Henley Group, the spinoff from AlliedSignal, spent reimbursing him for a series of household moves. And on the New York Stock Exchange, unhappy shareholders could sue. When Dingman as CEO of Henley spun off its chemical subsidiaries and then tried to take the new company private the following year, he found himself hauled into court by shareholders who insisted that he had enriched himself at their expense. (He subsequently settled the suits out of court, after upping his offer to buy out the minority shareholders from $80 a share to $90--a price, by the way, that was more than four times what Dingman paid for his own shares in the company.)

Today, though, Dingman appears to have grown just as frustrated with Prague as he did with Wall Street. While various companies he controls still own shares in Daventree, he claims to have turned over all day-to-day control to Kozeny because the strain of regular management proved too taxing. Recalling the fierce opposition his takeovers provoked from entrenched Czech corporate executives, he says, "I just woke up one night and said, I don't want to be in the middle of all this stuff, I've earned my stripes. I've been down that road and it's never-ending."

With Dingman's departure it's now clear that last year's grand promises of importing American management know-how and capital to restructure Czech industry have been vastly overblown. "They haven't given us any support of a technical or financial nature," says Ivo Klimsa, the CEO of pulp producer Biocel, one of the companies still in Daventree's portfolio.

Instead, Dingman appears to be turning his attention to Russia, where he owns a quarter share of a paper mill and where he says he has invested in Renaissance Capital, the firm set up by Boris Jordan, the Russian financial whiz who established CS First Boston in Moscow. It hasn't been smooth sailing there, either.

Dingman has been accused of defaulting on a note to Alliance Cellulose, the Cyprus company that sold him the Russian paper mill. He says that Alliance Cellulose owes him money, and he is considering suing them. Dingman for a time reportedly refused to pay an agreed-on fee to Brunswick Brokerage, the Moscow firm that arranged the sale. "We worked for Dingman for a time and then we resigned,'' says an executive at Brunswick who asked not to be named. Dingman claims it was a dispute between lawyers that was eventually settled. So it goes in the brave new world of the Old World's emerging markets.

Unwinding a few months ago aboard his yacht, a 115-foot leviathan called the Teel, Dingman interrupted a question about shady dealings in Eastern Europe with a philosophical fugue on pirates, whom he sees as misunderstood entrepreneurs. "I carried the history of pirates up through today," Dingman says, "and found out that pirates were Joe Kennedy and Sam Bronfman. Even in my lifetime, these were considered pirates. I said, there is nothing wrong with that; these countries are changing. You just want to be on the right side of it." Financially, at least, Dingman and Kozeny have wound up on the right side. Just don't expect these particular buccaneers to leave any more of a legacy than that.

REPORTER ASSOCIATES Jan Stojaspal, Shafaili Puri, Therese Eiben