“All right,” Levine said, and he got up to leave.
To a degree, Levine had seen it coming for months. Ever since he successfully killed Harrison's deal in Chicago, Levine had allowed himself to become increasingly vocal in his objections to the low-quality deals that were flying through the department. He threw up roadblocks every time he saw a problem and refused to back down. In doing his job, he knew he was putting his career in jeopardy.
Levine tried handling the esoteric deals. Keith Fell, the due diligence executive who had been reviewing partnerships such as horse-breeding deals, was moved over to cover real estate.
In October, Levine went to the office of Peter Fass, an outside lawyer who worked with the partnership division, to review a horse-breeding deal that was being readied for sale. Levine was told to help draft the prospectus on the partnership.
After a few minutes, Levine excused himself and went to call Fell, who was back at Prudential-Bache. Maybe Fell could explain the horse deal to him. But a quick conversation with Fell reinforced how little he knew. When Fell started talking about mares, Levine had no idea that was the word for a female horse.
As Fell finished his explanation, Levine felt frustrated with how little he knew. “What the hell am I doing here?” he asked.
Levine knew the answer to his question even as he asked it. When he had been hired to handle due diligence for the department, he knew very little, and so had been considered harmless. Back then, he couldn't slow down Darr's aspirations for huge sales by objecting to bad deals. But once he understood his job, he was simply in the way. By having Levine and Fell switch jobs, Pittman had successfully put them all back to square one. Neither of them knew enough now to consistently sift the bad deals from the good.
Freddie Kotek and David Levine had never seen someone looking so anguished. Dick Anastasio, an appraiser for the Direct Investment Group, had come to speak with his two colleagues a few minutes earlier on this day in October 1984. His face looked ashen.
“What the hell am I supposed to do?” Anastasio asked. “This deal is terrible. I'm really being pressured by Pittman to change my numbers. I just don't think I can do it.”
Anastasio had been a respected member of the due diligence team since he started working for the department a few years before. His job was to examine the real estate properties that sponsors wanted their limited partnerships to purchase. The job was incredibly important: When the proposed partnerships came into the Direct Investment Group, the general partners already knew what price they would have to pay for the property they wanted. If the property appraisal came back lower than the purchase price, the deal had a significant problem. Clients who put money in the deal would be overpaying and would be virtually guaranteed that much of their investment would be lost. Anastasio was known as an appraiser who was thorough, reliable, and totally independent.
His latest appraisal had been for a partnership sponsored by the Related Companies, a New York real estate group. Anastasio's values for the property had come back far below what Related had proposed to pay. A few weeks earlier, when real estate due diligence was handled by Joe Quinn, that would have killed the deal.
But now Bill Pittman was in charge. He sent Anastasio's appraisal back and asked him to try again. Perhaps, he suggested, he could increase his numbers. Appraisals are flexible; there are often honest disagreements about values. Anastasio took another look and raised the value slightly, but the values still were nowhere near the purchase price. Pittman was not pleased. He sent the appraisal back again.
That was a few days before Anastasio came to speak with Levine and Kotek. “Pittman keeps sending the numbers back to me, again and again. He keeps asking me to push it up higher. I can't raise it much more.”
Both Levine and Kotek looked uncomfortably at Anastasio. They both felt bad for him. They knew he was under enormous pressure. He had a family, a mortgage, and could not afford to lose his job. But he also could not bring himself to give Pittman the appraisal he wanted. There would have been no rational justification for it, other than self-preservation.
“Dick,” Levine finally said. “Do whatever you feel you have to do.”
The agony that Levine and Kotek saw in Anastasio's face angered them both. They hated Bill Pittman. Hated his willingness to cut corners. Hated his willingness to get deals sold at almost any cost.
A few days later, Kotek and Anastasio were speaking with Pittman when the topic of Anastasio's latest appraisal on the Related deal came up. Still millions less than the sale price, it was the best he could do within the parameters of an honest appraisal.
“Well, look,” Pittman said. “Now we're within ten percent of the price. That's fine. We can write ten percent off as the margin of error.” He smiled. “We're going to do the deal.”
Anastasio blanched. Kotek looked at Pittman with disgust.
Levine kept in close contact with Fell over the next few weeks. He explained all of the problems he had with the real estate deals that were in the pipeline and let him know all of the dirty secrets about the Harrison partnerships. And he continued being vocal in his objections to the low-quality deals coming out of real estate.
But he never had the opportunity to do much more work on the horse-breeding deals. About thirty days after Levine was told of the job switch, Pittman's secretary showed up at his office door. Pittman again wanted to speak with him. Levine headed over to Pittman's office right away.
“David,” Pittman said as Levine sat down. “It's very obvious to us that you're not happy here. We think you should resign today.”
In his heart, Levine knew it had been coming. Still, Pittman's statement hit him hard. He sat in front of Pittman's desk, momentarily unable to speak.
“Either you can resign,” Pittman said, “or you're fired, as of now.”
Levine halfheartedly mumbled a few objections. He was too discouraged to put up much of an argument. That day, he typed up his letter of resignation and handed it to Pittman. Fifteen minutes later, he headed out the front door of Prudential-Bache's office by the East River, feeling depressed and defeated. His two-year career in the Direct Investment Group was over.
“Bruce, we've got to find another deal,” Pittman said. “Have you got another deal?”
Bruce Manley, the national sales manager from Franklin Realty, listened with amusement in late 1984 as Pittman begged him to come up with another partnership to sell. Franklin, a real estate company, had never been a big partnership sponsor at Prudential-Bache. For years, the company had sold only small private deals through the firm. But Manley had enough exposure to know that the firm's due diligence operation was deteriorating. When D'Elisa ran things, there had been tough questions. Although Quinn asked a lot of questions, he did not have D'Elisa's real estate savvy.
Manley's opinion of the due diligence operation had hit an all-time low a few months earlier. Franklin had presented a deal to the firm for consideration, sending a copy of a proposed prospectus. Weeks later, Manley heard that he would be receiving a telephone call from Direct Investment Group's due diligence team. He assembled all the necessary paperwork and waited by the telephone.
About ten minutes later, the call arrived. A woman from due diligence got on the line. She asked one question: Where were the commissions for the firm listed in the prospectus? After Manley told her the page number, she thanked him, then hung up.
From that point on, Manley had lost his respect for the due diligence at Prudential-Bache. Now, on this day, he had Pittman on the phone, practically pleading for Franklin to come up with an offering. Franklin had just offered a deal through the Pru-Bache system, and it had sold out in about five days. Pittman wanted desperately to pull off a repeat performance as fast as possible.
Manley thought for a moment. The only deal that the company had ready was one that had been shown to Prudential-Bache a few weeks earlier. The due diligence team had rejected the deal, saying that the real estate market in the area looked weak and that it appeared Franklin was overpaying for the property.
“The only one I can think of that's available was the one you guys rejected a short time back,” Manley said.
“Well, that's fine,” Pittman said excitedly. “We need to have another deal. So why don't we take a look at that one again. Maybe we can futz with it and make it a little more acceptable and revive it.”
Manley agreed and spoke with some of Pittman's team about changes that could be made. After reviewing the numbers for a few weeks, Pittman came back and said that the deal had been made acceptable. It was scheduled for marketing through the Prudential-Bache system.
That day, Manley sat in the chair at his desk, making a final review of the prospectus. It was almost identical to the original deal that had been sent to Pru-Bache, the one that had been rejected for being too risky for investors. The price of the apartment building was the same. The projections for performance were the same. The market conditions in California were the same. In fact, only one change was made in the entire prospectus that made the deal acceptable to Pittman:
Prudential-Bache's fees were increased.
The deal sold out in about ninety days. Investors eventually lost most of their money.
George Ball laughed at the large, ugly statue of a mother suckling her child. It was being presented to him as a joke at the November 1984 retirement party of David Sherwood, the outgoing president of Prudential Insurance. Traditionally, the statue was given to the worst-performing company in the Prudential family, symbolizing the struggling company's need to feed on mother Pru. For losing a bundle of money, Prudential-Bache was the statue's new home.
After two years of running the firm, Ball was beginning to feel some heat for its lousy performance. The firm had been hemorrhaging cashâ for the first nine months of 1984 alone, it lost about $105 million. Prudential Insurance had been compelled to invest another $100 million into Pru-Bache on October 22 to help keep the firm going. The high hopes that followed Ball's arrival had all been dashed.
Ball desperately wanted to turn things around. Somehow, he needed most of the firm to start generating huge profits. Only a few departments seemed able to make any money at all, with the Direct Investment Group being one of the standouts. If every department could run as efficiently as that one, Ball felt sure that Prudential-Bache could start making some consistent profits.
So Ball decided to use the presentation of the statue as an opportunity to urge his troops to start bringing in the profits. On November 26, he wrote up a Ballgram, describing how the firm had been given the statue and what it symbolized. It was something that no member of the Prudential family wanted.
“I also want to unload the statue as soon as possibleâto pass it, flowing on a sea of profits, to another Prudential company,” he wrote. “Accomplishing that, quickly and loudly, is one of our primary goals.”
At the end of the memo, Ball included a new rallying cry for the firm: “Shed the statue. Losses suck.”
To make sure no one would miss the point, Ball sent out thousands of buttons that featured a picture of the statue. Surrounding the picture, in bright red lettering, were the words “Losses Suck.”
Within six months of Bill Pittman taking over real estate due diligence, the group's makeup was almost totally changed. Levine had been asked to leave. Freddie Kotek, Lauren McNenney, and Jeff Talbert had all found other jobs. It was the same thing that had happened a year earlier when Darr gave Pittman the responsibility for energy due diligence: Everyone who had done their jobs and raised questions that slowed down the limited partnership money machine had been driven out of the firm.
By late 1984, the transformation of the Direct Investment Group was complete. It was run by Darr, a former broker. Due diligence was handled by Pittman, a former broker. It reported to Sherman, a former broker. And the firm was controlled by Ball, a former broker. Everyone in an important supervisory position for the department came from a background based purely on sales. For them, the proof of success was the dollar volume of the partnerships that could be stuffed into accounts of Prudential-Bache clients.
Only one person with supervisory authority over the Direct Investment Group was not a broker. But by then, that executive, Loren Schechter, had a number of other issues on his plate. Even as the general counsel, he could not pay much attention to what was happening in the firm's partnership division.
In that year, Schechter was too busy negotiating with the Securities and Exchange Commission on behalf of Prudential-Bache. He was desperately trying to stop the regulatory agency from filing one of the largest complaints in its history against a national brokerage firm.
CHAPTER 10
WARM AIR FILLED THE conference room at the SEC's Atlanta regional office. Someone had turned the thermostat up too high. Even though it was just 9:45 on the frosty morning of February 21, 1985, the heat made all five people in the room shift in their seats from discomfort. But Richard Saccullo, head of Prudential-Bache's largest branch in Atlanta, was probably the most uncomfortable of all.
It was the beginning of Saccullo's second day of interrogation by two SEC lawyers from Washington, D.C. With each pointed question, it grew more evident that the investigators doubted the professed zeal of Saccullo and Prudential-Bache for enforcing securities rules on brokers.
The SEC lawyers, Jared Kopel and Karen Shapiro, sat across a conference table from Saccullo and Patrick Finley, an associate general counsel for Prudential-Bache. A court reporter sat nearby. Kopel, the senior SEC lawyer on the case, watched Saccullo closely as he answered questions. Saccullo, a heavyset, jovial-looking man with thinning brown hair, was a star in the Pru-Bache system. Even though he had already been cited once by the commission for failing in his supervisory duties, Saccullo remained one of Sherman's favorites. He projected the image of a man who knew he was untouchable at the firm.
But Saccullo would have trouble emerging from this new investigation unscathed. By following a trail of documents, Kopel had uncovered a web of connections between Saccullo's branch and Joseph Lugo, a shady penny-stock trader from Florida. From all appearances, the Prudential-Bache Atlanta branch had been involved in a complex scheme with Lugo to illegally manipulate the price of a penny stock.
The stock was in a Florida restaurant chain called Capt. Crab's Take-Away. By studying trading records, Kopel had discovered large purchases of the stock coming from the Atlanta branch in the summer of 1983. That heavy buying drove up the price of Capt. Crab shares. At the same time, insiders at Capt. Crab, along with a handful of stockbrokers associated with Lugo, had been selling shares. The purchases by the Pru-Bache Atlanta branch looked like the classic manipulation, designed to temporarily increase the share price so that the sellers could make huge profits. Making it all the more suspicious were the identities of the two young brokers whose clients were the biggest buyers of the shares: Robert Scarmazzo and his close friend David Scharps, the son of Capt. Crab's president.
Somehow, Prudential-Bache had become tied up in a sleazy scheme. Now, with the deposition of Saccullo, Kopel thought he had the best chance to find out why that happened. Saccullo had been the manager of the Atlanta branch during the manipulation. At the time, the firm's compliance officers found the trading in Capt. Crab suspicious. They ordered Saccullo to restrict the purchases by only accepting unsolicited orders, meaning trades requested by customers without being suggested by the brokers. Saccullo disregarded those instructions for some time. Later he ignored orders from compliance to stop trading in Capt. Crab shares altogether.
SEC lawyer Shapiro paused for an instant as she studied a document in preparation for her next question. It was one of the wires from compliance that had been sent to Saccullo. It said that six clients of the young broker named Scarmazzo had purchased 14,200 shares in Capt. Crab on one day. All of the order tickets described the sales as unsolicited. Because the compliance department had trouble believing that so many customers decided to buy the same obscure stock on the same day, the wire asked Saccullo to investigate.
Shapiro held the Scarmazzo wire in her hand as she read it to Saccullo. “Do you recall receiving this wire?”
“In general terms, yes,” Saccullo said.
“What, if anything, did you do to ascertain whether the shares were, in fact, unsolicited?”
Saccullo almost shrugged. “I spoke with Scarmazzo and was told by Scarmazzo that the shares were, in fact, unsolicited.”
Kopel kept staring at Saccullo, unflinching.
My broker told me he didn't
break the rules, so I believed him
. The basic point of the compliance department's concern was that they feared Scarmazzo was
lying
.
“Did he give an explanation as to why so many accounts decided to make purchases on the same day?” Kopel asked.
“I called the man and we had a conversation,” Saccullo replied. “He assured me the trades were unsolicited, and I had no reason to think he was telling me anything but the truth.”
It was like a game of cat and mouse. No matter how the SEC investigators asked the questions, Saccullo fell back on the same answer. But by this point, it didn't much matter what Saccullo had to say in his defense. Already the SEC investigators believed that he had not done his job as a manager. That was enough for a regulatory sanction.
Still, the SEC needed to know more about Joseph Lugo, the Florida penny-stock trader involved in the manipulation. After asking about David Scharps, the son of Capt. Crab's president, the investigators brought up Lugo's firm, Rooney Pace.
“Did you have any discussions with Mr. Scharps about Rooney Pace's activity in the stock?” Shapiro asked.
“Mr. Scharps periodically had conversations with someone by the name of Joe Lugo,” Saccullo replied.
“How frequently did you hear Mr. Scharps having conversations with Mr. Lugo?” Shapiro asked.
“Probably half a dozen times.”
“Prior to your hearing any conversations between Mr. Scharps and Mr. Lugo,” Shapiro asked, “had you otherwise heard of Mr. Lugo in any other context?”
“No,” Saccullo said. “Mr. Lugo at some point in time opened up an account in my office to buy a tax shelter.” The deal, Saccullo said, was an airplane leasing deal with a company called Polaris.
“Who did he open that account with?”
“With David Scharps.”
No one in the room realized the significance of what Saccullo had just said. Some of the money Lugo earned on the Capt. Crab manipulation had been sucked into the partnership fraud. The Polaris deal that Lugo had purchased had been sold by the Prudential-Bache system as safe and secure. Within ten years, it would lose 90 percent of its value. But Pru-Bache and its brokers would receive large fees and commissions.
Prudential-Bache had defrauded one of its accomplices in a major stock scam.
The crowd in the courtroom of Florida state judge Nelson Harris stared silently at the dark-haired man sitting at the defendant's table. Many in the audience knew the man and had once been his clients. He was Sam Kalil Jr., the former assistant manager in Prudential-Bache's Jacksonville branch. And he was in the courtroom on this day in February 1985 to find out how much jail time he would have to serve for looting his customers' accounts at the firm.
Just two years earlier, Kalil had been among the elite at Pru-Bache. He had been a member of the Chairman's Council, the organization for the top ninety brokers at the firm. Even George Ball had thought that Kalil was the kind of salesman everyone else should emulate. Kalil had projected an image of a convincing, energetic, and engaging broker.
“Sam is a model of what I want this firm to be,” Ball had told an associate after watching Kalil at a meeting.
A few months later, in December 1983, Kalil was arrested on charges of grand theft, forgery, and securities fraud. The broker's success had been founded on crime. He created huge commissions by buying and selling securities without customer approval and by pushing his unsophisticated clients into complex, unsuitable investments. They lost millions of dollars. To hide his crimes, Kalil stole close to $2 million out of profitable customer accounts and transferred the money into the accounts with losses. Kalil had contested the charges until January 1985, when he agreed to plead guilty to felony charges.
Judge Harris asked Kalil if he had any statement before he passed sentence.
“I'm so sorry for what happened,” Kalil said. “I'm deeply ashamed for what I've done.”
But Judge Harris was not moved. He sentenced Kalil to serve twenty-six months in prison, four months in a halfway house, and ten years' probation.
The sentence did not bring an end to the Kalil matter for the SEC. The agency had launched an investigation of Prudential-Bache's Jacksonville branch at the time of Kalil's arrest. By the sentencing, the SEC investigation had raised troubling concerns about the firm's management: A branch executive had notarized a signature that Kalil had forged. And Kalil's suspicious cash transfers all were approved unquestioningly by his manager.
The Kalil and Capt. Crab investigations moved simultaneously up the pipes in the SECâby 1985, a consensus emerged at the commission to consolidate the investigations into a single case. The violations in Atlanta and Jacksonville signaled systemic problems at Prudential-Bache. Since 1976, the firm had been sanctioned for problems in its branches four timesâmore than any other major firm. Nothing made the firm straighten out. Somehow it had wandered off the path of investor protection.
This time would be different. The SEC lawyers wanted to set an example with Prudential-Bache. The punishments meted out would have to be severe. That way, the lawyers felt sure that the firm would not be able to simply ignore the SEC again.
In the spring of 1985, a group of lawyers sat in a narrow conference room on the fourth floor of the SEC's Washington headquarters. Several had lined yellow legal notepads in front of them, ready for use. On one side of the table sat Loren Schechter, the Prudential-Bache general counsel, looking confident and calm. With him was Arthur Mathews, a wiry, red-bearded partner from the prestigious law firm of Wilmer, Cutler & Pickering. Mathews, a former deputy associate director of enforcement for the SEC, was widely regarded as one of the country's top experts on securities laws.
Across from the two men sat a small group of staff lawyers from the SEC enforcement division. They were there to listen to the Pru-Bache lawyers argue why the commission should not take any action against the firm in the Kalil and Capt. Crab matters.
“A lot of this goes back to the spring and summer of 1983,” Schechter said. “We were just taking over from the old guard at Bache. We've solved the problems since then. We've beefed up compliance. Everything you're talking about is just ancient history.”
The SEC lawyers seemed unimpressed. Over the years, they had heard various executives from Bache protesting the same thing every time regulators caught the firm violating securities laws. This time, the regulators felt compelled to take serious action.
“Look, I'm in charge now,” Schechter said. “The compliance department has direct access to me. I will enforce their directives. I'm there to make sure that this firm follows the letter of the law.”
Again, Schechter's sentiments were met with shrugs. The enforcement division had heard this all before, one of the lawyers said.
“But that was different,” Schechter said. “You don't need to worry about us. We know how to clean up the messes from the Bache bunch. We're the real professionals from E. F. Hutton.”
Reporters and television cameras packed the Justice Department briefing room on May 2, 1985. They were there for a rare event: Edwin Meese, the attorney general of the United States, was personally going to announce a development in a major criminal case. At 2:00 P.M. sharp, Meese stepped up to a podium, scowling slightly from the bright lights. He began to read a prepared statement.
“The Department of Justice today filed a criminal information charging E. F. Hutton & Company, one of the nation's largest securities dealers, with two thousand counts of mail and wire fraud,” Meese said. “The essence of the charges was that Hutton obtained the interest-free use of millions of dollars by intentionally writing checks in excess of the funds it had on deposit.”
Hutton was pleading guilty to the charges, Meese said, and would pay the maximum criminal fines allowable of $2 million.
The four-year investigation of Hutton's elaborate bank fraud by prosecutors in Pennsylvania had finally hit its target. With the charge led by Al Murray, the assistant U.S. attorney in Scranton, the government had unwound the complex scheme that between July 1, 1980, and February 28, 1982, had defrauded some four hundred banks of up to $8 million. As part of the settlement, the department agreed to grant immunity to as many as fifty Hutton executives. No one from the firm would ever go to jail for the crimes.
The meetings between the SEC and the Prudential-Bache lawyers continued throughout the summer of 1985. By the fall, serious negotiations for a settlement began.
The talks were tense, and Schechter took a hard-line position. But after Hutton's guilty plea, he never again spoke of how the regulators could rest comfortably knowing that compliance at Pru-Bache was in the hands of the team from Hutton.
“Mr. Ball, you have the right to have counsel assist you in the course of this morning's proceedings,” said Congressman William Hughes. “Are you accompanied by counsel?”
It was 10:25 on the morning of October 31. Hughes, a New Jersey Democrat, had just struck his gavel to its base, silencing the crowd in room 2237 of the Sam Rayburn House Office Building. The ten-member House Judiciary Subcommittee on Crime was ready to hear from Ball in its investigation of the crimes of E. F. Hutton.
Ball introduced his lawyer, Lloyd Cutler, the former White House counsel in the Carter administration.
“Thank you,” Hughes said. “Mr. Ball, I am going to place you under oath at this time. Will you please raise your right hand?”
A few minutes later, Ball began his testimony. He said he knew that Hutton had a cash management system in place to minimize the loss of interest on the float to banks. But that was as far as his knowledge went.
“I was not aware of the procedures or specific methods used,” Ball said. “I was certainly not aware that some regions and branches were abusing the system in order to generate additional interest income by excessive overdrafting.”