Emanuel Pearlman admits he has an ax to grind with his former company, Chicago-based Bally Total Fitness Holding Co. and its chief executive, Paul Toback.

“We do not think the CEO is up to the task,” said Pearlman, who runs a Los Angeles-based hedge fund, Liberation Investments LLC. “The capital markets hate him, the bondholders don’t like him, and there’s a credibility issue with the management team.”

Toback, also Bally’s chairman, is a former staff member in the Clinton White House. He also worked for Chicago Mayor Richard Daley and has been with Bally since 1997.

It’s been a rough ride.

The fitness company is saddled with $757 million in debt and has not filed a quarterly report since early 2004, when it reported a loss of $13.8 million (though that was down from a loss of $635.2 million in the first quarter a year earlier.)

The delays in filing its financial statements have been prompted by a three-year audit and Securities and Exchange Commission investigation. The company now plans to hold its annual meeting in 2006 and will file its restated financials by Nov. 30.

Just last month, Bally barely staved off default on $275 million in junk bonds by negotiating with its largest bondholders: Tennenbaum Capital Partners LLC, in Santa Monica, Grandview Capital Management in Manhattan Beach and Deephaven Capital Management in Minnetonka, Minn.

In the past year, Pearlman has amassed a 12 percent stake in Bally and demanded that the company’s board replace Toback. The dispute with Bally reached an apex last week, when Liberation filed suit in Delaware to compel Bally to hold its annual meeting no later than Oct. 28, and to elect four new board members.

Toback, through Bally spokesman Matt Messinger, declined to comment.

Pearlman’s interest in Bally appears to go much deeper than just making money off its depressed shares assuming that the company can eventually stage a turnaround.

He spent 10 years as a prot & #233;g & #233; of Arthur Goldberg, the corporate raider who took over Bally Manufacturing Co. in 1990, and then spun off its health club business.

Pearlman then became a consultant to former chief executive Lee Hillman, who resigned from the company in 2002 and has since been accused of contributing to Bally’s accounting troubles.

Pearlman claims that Toback conspired to get Hillman ousted before launching an internal investigation in an effort to shift blame for the financial problems to his predecessor. In March, an internal audit committee accused Hillman of making “multiple accounting errors” and creating a culture that encouraged “aggressive accounting.”

Jerold Solovy, Hillman’s lawyer and chairman of Chicago law firm Jenner & Block, called the allegations “ridiculous.”

Hillman received a $1.3 million lump sum as part of a severance package three years ago, and monthly payments of $110,000 for two years.

Bally has not filed a lawsuit against him or three other executives who left the company and were later accused of causing its accounting problems. But it identified deficiencies in internal controls that constituted a material weakness in its financial reporting.

Moreover, the Securities and Exchange Commission has an ongoing investigation into Bally’s finances covering the six-year period of Hillman’s tenure, from 1996 to 2002. And the U.S. Attorney’s Office launched a criminal probe last year, as the company also fends off nine class-action lawsuits.

All that sounds like the making of a disaster, but Bally still has some prized assets. It operates 420 health clubs that are highly valued for their real estate and membership lists.

The company also expects to avoid filing bankruptcy, and several bondholders are rumored to be working on a sale. Before he left the company, Hillman held merger talks with HealthSouth former chief executive Richard Scrushy, in an effort to combine a health maintenance organization with a health club. The deal ultimately fell through.

*Staff reporter Kate Berry can be reached at (323) 549-5225, ext. 228, or at

[email protected]

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