“Let's find out if there's anything to it,” he said. “Let's call Prudential-Bache in New York and get copies of all the sales literature they sent out to the Boise branch. And let's also have them ship along copies of the prospectuses. That'll straighten out who's telling the truth.”
Either way, Klein said, they had enough information to pursue a full-scale investigation. If they were going to attempt to prove that New York executives had failed to adequately supervise brokers in Boise, it would take a lot of resources. For a few minutes, Klein thought through his department's caseload, as well as the manpower that would be needed for a full-scale investigation. He appointed five members of the departmentâ Blessing, Hughes, Marilyn Scanlan, Patricia Highley, and Jelean Haleâas investigators in the case. Klein then had an investigative order prepared, which would allow each member of the team to issue subpoenas and administer oaths for sworn statements.
On January 30, 1991, Klein brought the investigative order to his boss, Belton Patty, the director of the Idaho Department of Finance. Patty read through the order and signed it.
The investigation, titled
The State of Idaho
v.
Louise Schneider and
Prudential-Bache
, had begun. The timing was perfect. Prudential-Bache was just about to drop its calm facade.
By February 1990, George Ball knew that the game was over. The patience of senior executives at Prudential Insurance had worn thin. Robert Winters, who had been named chairman in 1986, seemed particularly exasperated by the inability of Prudential-Bache to generate any income. In board meetings, Winters frequently commented caustically that he was tired of the brokerage firm consuming cash instead of generating it. Every chance he had, Garnett Keith, the Prudential executive most closely involved in the business of the brokerage, would sharply and publicly distance himself from the decisions made during Ball's tenure. It seemed that Keith rarely made public comments now unless it was to protest that he was not responsible for what had happened at Pru-Bache.
For about six months, Ball's power had been waning. Arthur Burton Jr., a Prudential executive, had been made vice-chairman of the brokerage at Ball's request. Executives could see that Burton was taking over an increasing number of management responsibilities. Ball seemed to be standing by, almost helpless, as the insurance company gradually wrested control away from him. Every few months, Winters would issue a statement in response to press inquiries saying that Ball still had his full support. But every senior executive at the brokerage firm knew that the statement was a lie.
Prudential was also just starting to come to grips with the magnitude of the disaster unfolding at the brokerage firm. To get a fix on the potential liability, it had hired lawyers and investigators to dig through the records of the Direct Investment Group. At that point, things looked ugly. And already, the partnership debacle was causing enormous troubles. An attempt to sell the firm the year before to the Primerica Corporation had flopped because Prudential Insurance refused to limit the liabilities that a buyer would face.
By August, Ball had lost control of his own strategy. Months before, he had been telling consultants to the firm that its merchant banking and arbitrage departments were core parts of the business. The past year had been difficult for both departments, but the future looked strong. Prudential Insurance would hear none of it. Under orders from Winters, Ball cut back the arbitrage department's capital. With only $25 million, the departmentâwhich during Ball's tenure had been one of the most profitable divisions in Prudential-Bacheâbegan bleeding. Without the money to run its strategies, the profits from arbitrage dried up. It was like telling a long-distance swimmer to use only one arm.
Finally, on December 20, 1990, with Pru-Bache facing an annual loss of $250 million, Ball sent out a memo describing a massive restructuring of the firm. The assets of the merchant banking department were transferred to Prudential Insurance, officially ending the brokerage firm's four-year effort in that business. The firm's Canadian operations were sold. The arbitrage department was shut down, and its director, Guy Wyser-Pratte, a Bache veteran of more than twenty years, was immediately locked out of his office.
The last change was in the Direct Investment Group. Even with all the cutbacks the department had already experienced, the new proposal would slim it down even more. It became nothing more than a monitoring division, existing only to find what little could be salvaged out of the wreckage of a decade. James Kelso, an executive who performed the due diligence on the VMS Mortgage Investment Fund, was deemed the best candidate to take charge of that effort.
Even with all the changes, Winters and Keith were too soured on Ball. In February, at his annual performance evaluation by Winters, Ball decided to broach the issue himself.
“Bob, I think this business has been going too badly for too long,” he said. “I think the people at the Prudential have lost confidence in me.”
Winters stared straight at Ball, looking stern. “George, you're right.”
That was that. The time had come for Ball's exit.
“Well, I'd love to stick it out here and see through all the changes that we've made,” Ball said, “but the pressure on me is just too intense. I'm not sure that I could still be effective. So perhaps it would be best for me to pursue other options.”
“I think that would be best,” Winters said. “It would be the most graceful thing for all of us.”
A week later, on February 13, 1991, Prudential Insurance announced that Ball was resigning as chairman and chief executive of Prudential-Bache. Robert Beck, the former chairman of the insurance business who spearheaded the merger ten years earlier, was named interim chief executive.
Ball sent his last Ballgram to the employees of Pru-Bache that day. In it, he hinted at the mistakes he had made and the problems they had caused.
“The hubris of what happened to the securities industry in the 80's, and as a result to the firm, led to some bad results in several areas,” Ball wrote. “The net of it is that someone who is unencumbered by the aftermath of those past results should lead the firm into the future.”
A week later, the brokerage firm announced another significant change. Prudential-Bache was being renamed Prudential Securities. The name change brought the firm closer into the Prudential Insurance fold and marked the death of a Wall Street name dating back to Jules Bache in the 1880s. It was a symbolic break with the firm's sordid history and an attempt to put a shine on the hopes for the brokerage's future.
But a name change couldn't rewrite the past. Within the week, some of the firm's darkest secrets would finally emerge.
Chuck Hawkins, the Atlanta bureau chief of
Business Week
, dialed a long-distance call to Connecticut. It was an afternoon in early 1991, and Hawkins was ready to question Jim Darr. Hawkins had been on the trail of Prudential-Bache ever since writing about its real estate problems almost a year before. The original article had brought in dozens of telephone calls from Pru-Bache brokers and clients, all of whom had tips for him. Hawkins followed up his own hunches, as well, poring through prospectus after prospectus for limited partnerships and digging through court filings for more information.
This time, Hawkins had unearthed the mother lode. He uncovered the criminal record of Clifton Harrison and some of the secret deals between Harrison and Prudential-Bache executives. He knew of the Locke Purnell report and its allegations about Darr's dealings with Watson & Taylor and First South. He had even found evidence that Prudential Insurance executives had questioned Darr's apparent lack of concern about the quality of the investments by the energy income partnerships. Hawkins planned to ask Darr about all of it.
Hawkins finished dialing Darr's number. After a few rings, someone answered the phone.
“Yes?” a man asked, almost as if he were expecting a call.
“Is this Jim Darr?” Hawkins asked.
“Yes.”
“This is Chuck Hawkins from
Business Week
.”
“Oh, no!” the man blurted out, then quickly composed himself. “Who did you ask for?”
“Jim Darr.”
“I'm afraid you have the wrong number.”
An instant later, all Hawkins heard was the dial tone.
The Hawkins article appeared as the cover story in the March 4, 1991, issue of
Business Week
. The headline, “The Mess at Pru-Bache,” appeared on the cover over a picture of George Ball. The first words of the article set the hard-hitting tone.
“George L. Ball's reign is over at Pru-Bacheâbut his legacy lives on.” The article went on to say that the firm and Prudential Insurance “face legal troubles that could drag down their financesâand imagesâfor years to come.”
Hawkins described everything he had found, from the information in the Locke Purnell report to the background of Clifton Harrison. It was a devastating piece of journalism, one that laid bare many of the secrets that Prudential-Bache had kept hidden for so many years.
The story was an earthshaker. After reading it, class-action lawyers throughout the country began filing new lawsuits against the firm. The largest suit, filed in federal court in New Orleans, involved the energy income partnerships.
The enforcement staff of the SEC launched an investigation into Darr, but the inquiry did not receive a particularly high priority. It was not handled by lawyers in the Washington office, as most high-profile cases are. Instead, the SEC investigation into the
Business Week
allegations was conducted by the agency's New York regional office.
The magazine arrived at the offices of the Idaho Department of Finance the week it was published. Belton Patty, the head of the department, read the article quickly and realized that it related to the same matters under investigation in the securities bureau. He walked to Klein's office with a copy of the magazine in his hand.
“Wayne, I think you ought to take a look at this,” he said.
Klein read through the article carefully. By then, his investigators had found similar patterns of sales abuses at a number of Pru-Bache branches. He already knew that the problem in Boise was far more widespread than just a few bad brokers.
As he read, Klein was surprised that the story involved many of the same partnerships his team was investigating, as well as many similar allegations. It also astonished him to realize that his bureau probably had one of the most fully developed inquiries into the matter under way.
Klein made a few copies of the article, then took one to Bill Blessing's office.
“Bill, take a look at this,” he said. “I think we have some more things we're going to have to look into.”
The two men discussed what new documents they would want from Prudential-Bache. In particular, they wanted to see the Locke Purnell report and find out more about this former executive named Jim Darr.
CHAPTER 17
THE LAWYER FROM PRUDENTIAL Securities sat comfortably in a conference room at the Idaho Securities Bureau. Like all of the people Wayne Klein had met from the firm's headquarters, the lawyer, Noah Sorkin, projected a confidence that had long ago crossed the line into arrogance.
“This was not a widespread problem,” Sorkin said. “The vast majority of these partnership sales were done right. We had a few renegade brokers, that's all.”
Klein stared at Sorkin, not bothering to hide his disbelief. With Klein were two of his investigators, Mary Hughes and James Burns, who had recently joined the inquiry. By the time of this meeting in the spring of 1991, the Idaho regulators had developed enough information to know that they were not dealing with a few bad brokers. The assurances about the safety of the limited partnerships had come straight out of the marketing material sent from New York. The regulators had made some inquiries and found that the same problems existed at a number of Prudential Securities branches in nearby states.
“I'm sorry, Noah, but I don't believe this was renegade brokers,” Klein said. “We've seen the sales literature coming out of New York. That's where the problems start.”
Sorkin disagreed, again stressing the firm's line that most of the partnership sales had been done properly.
Klein just shook his head. “Now, what makes this worse is, in some of these cases, this broker is making proposals to investors on how to invest their money with a letterhead that says she's a vice-president of Prudential-Bache. She's an officer of the company. Of course they're going to believe what she says.”
“Oh, no,” Sorkin said. “She's not an officer of the company.”
“Sure she is,” Klein said, pulling out a copy of the letterhead for Louise Schneider. “It says right here âvice-president.' ”
“But she's not an officer.”
Klein took a breath. He was zeroing in on one of the more pervasive deceptions on Wall Street, not only at Prudential Securities. Lowly stockbrokers are often given lofty titles for the purpose of impressing clients. When someone with an officer's title at a national brokerage firm offers advice, investors are more likely to take it. On Wall Street, it's just viewed as good marketing. But Klein saw it for what it was: another deception.
“Well, I'm sorry, I may have gone to the Kmart School of Law, but when I went to law school, a vice-president was an officer,” Klein said.
“No, it's just a title,” Sorkin said. “She's not an officer.”
“Noah, that's ridiculous. Titles have meanings. They certainly mean something to the people out here deciding how to invest their money.”
Sorkin smiled. “I'll bet you the coldest beer in Idaho that it wouldn't make any difference to clients whether or not she was just a registered representative or a vice-president.”
“I don't drink beer,” Klein said, “but I'll take the bet. I'll be happy to go find a hundred people on the street down here and ask them if they would rather buy stock from a vice-president of Prudential-Bache or a registered representative. And I'll take the wager that people are going to be more impressed with someone who has the title of vice-president and more willing to do business with her.”
Then it was Klein's turn to smile. “After all, that's why you gave her the title.”
The men talked for a bit more. Sorkin asked what would be necessary to resolve the investigation. As Klein understood it, the firm was broaching the idea of reaching a settlement. He quashed the idea immediately.
“We can't resolve anything now,” he said. “We need to know the magnitude of what we're dealing with before we settle the case.”
The discussion moved on to problems that the Idaho investigators had uncovered at the Boise branch involving the improper trading of options. Late in the afternoon, the meeting came to an end.
A few weeks later, the state of Idaho adopted its first new policy statement coming out of the partnership investigation. Any employee of a brokerage firm with a title that appeared to bestow official authority would be treated as an officer of the company. The marketing deception could continue, but at the cost of increasing a brokerage firm's potential liability for wrongdoing.
A secretary buzzed Bill Creedon's intercom and told him that a visitor was waiting in the reception area. Creedon stood up and headed out to the front. He was not looking forward to this meeting.
It was 2:30 on the afternoon of March 9, 1991. Creedon had resigned from his job as a broker at Prudential-Bache several months before because of his refusal to mislead his clients about their legal rights in bringing a suit caused by losses from the VMS Mortgage Investment Fund. Instead, he took a job with a smaller brokerage firm. Still, he could not seem to get Pru-Bache out of his life. Every time a customer filed a complaint, the firm made sure to place it on Creedon's permanent record.
His visitor was Michael Licosati, a lawyer from Keesal, Young & Logan, a California law firm that represented Prudential Securities and specialized in arbitrations. Licosati had set up an appointment with Creedon a few days earlier when he called to tell the broker about a claim that had been filed by one of his former customers.
Creedon greeted Licosati and escorted him to his office. He was a young lawyer and struck Creedon as a friendly type. Once they sat down, Licosati got right down to business.
The former client, Betty Jean Prosser, had filed for an arbitration against Prudential Securities. She had purchased a fair amount of the VMS fund and felt she had been misled.
“She
was
misled,” Creedon broke in. “She should get all her money back. All my clients should.”
“That's not going to happen,” Licosati said. “Your clients are not going to get all their money back.”
“Why not?” Creedon asked. “They were defrauded.”
“It's not that simple,” Licosati replied. “Bill, I want you to know that I'm personally concerned because if too much pressure is put on Prudential, they may declare bankruptcy. We want to settle with the people but we don't want to go too rough on Prudential.”
Licosati then explained that Prudential Securities wanted Keesal, Young to represent Creedon in the Prosser case. That way, the defense would be unified.
“It really is in your interest to be represented by Keesal,” he said. “If we represent you and we settle these cases, we won't go after you for the money. But if we're not representing you and we settle, we would have every right to go after you in court.”
I don't even work for that firm anymore
, Creedon thought,
and they're still
pressuring me
.
Creedon set down his pen. “Look, I personally don't want to be represented by Keesal on this matter,” he said. “Basically, I want to do a laydown and put on no defense. I told her that VMS was safe and guaranteed. And I want to testify that she is entitled to her money back.”
“Well, I hope you don't do that,” Licosati said.
Too bad
, Creedon thought.
You're not going to scare me into cooperating.
A few months later, in July 1991, Creedon felt reinforced in his decision not to help Prudential Securities. A federal judge approved the first settlement of a class action involving private partnerships sponsored by VMS. After all the assurances to customers that they should look for compensation from the class action, Prudential Securities had cheated them again. In a deal it negotiated with Beigel & Sandler, a small Chicago firm that specialized in class actions, Prudential Securities agreed to pay $25 million to compensate customers who had invested more than $1 billion in ninety-five different VMS partnerships. That worked out to 2.5 cents in compensationâbefore legal feesâfor every dollar that investors had lost.
No reasonable investor would have accepted such a paltry sum. For every $10,000 they invested, they would receive less than $200. But not everyone did so poorly: Beigel & Sandler received $6 million in fees, plus $350,000 in expenses, for minimal work. By all appearances, the law firm was simply selling its clients' legitimate claims to Prudential Securities for the fat fees.
But class actions were the perfect strategy for Prudential Securities. No investor had to accept the settlement. Instead, they received a multipage court notification that described in tiny type the $25 million settlement. It did not say how much investors would receive individually. Under the rules of class actions, only investors who wrote to the court and specifically asked not to participate in the settlement were excluded from it. Investors who did not understand the legalistic document were automatically swept up into the settlement. Even investors who changed addresses and never received the notification were included. Because the essence of the Prudential Securities partnership fraud was that the sales were made to unsophisticated clients, many of the investors did not understand what they were reading and did nothing. As a result, they unknowingly accepted the settlement and waived their rights ever to sue Prudential Securities again. In exchange, they received a payment that was less than they might have obtained for one week on public assistance.
In another few months, a second settlement was reached for the public partnerships. Included in that agreement was the VMS Mortgage Investment Fund, the partnership that had been sold as guaranteed to so many elderly investors. They did not do as badly as the investors in the first settlement.
They received four cents on the dollarâbefore legal fees.
The word had leaked out days before that Prudential Insurance had found George Ball's successor. Still, when the announcement came out on April 24, some executives in the firm were surprised. Ball was being replaced by Hardwick Simmons, who eleven months before had been eased out as head of retail at Shearson Lehman Hutton in the wake of huge losses there.
Within the firm, the appointment was greeted with mixed emotions. Some executives felt relieved that at least someone was in charge. But others were horrified that the only person Prudential Insurance could find to run the firm was a man who had lost a midlevel management position at a financially troubled competitor.
But Prudential was not giving Simmons as much rope as it had handed to Ball. He was only named president and chief executive. Winters, the insurance company chairman, named himself chairman of the brokerage, as well.
Simmons began making changes quickly, shunting some senior executives aside. He fired Richard Sichenzio, the man who had succeeded Bob Sherman as the head of retail. Instead, he hired George Murray, a senior vice-president at Shearson and the man who gave Simmons his first job as a management trainee on Wall Street. He also brought on board another friend named Howard “Woody” Knight to handle corporate strategy and business development.
Early on, Simmons became aware of the partnership debacle unfolding in the firm. He didn't think much of it. Shearson had sold a wide range of limited partnerships, and many of those were having trouble. Senior executives assured him that the partnerships matter was a problem that could be resolved for, at most, $50 million.
Still, given all the legal troubles the firm was experiencing, Simmons asked for a report on whether Loren Schechter himself should be held accountable in any way for what had occurred. By that time, Schechter was a favorite among the senior executives from Prudential Insurance.
A brief inquiry cleared Schechter of any responsibility for the mess. He had raised all of the appropriate red flags to Ball, Simmons was told. In particular, it was noted that Schechter had immediately informed Ball of the Locke Purnell report. But Ball had, for his own reasons, chosen to wait nine months before doing anything about it.
Simmons liked what he heard. Schechter would continue as the firm's chief legal strategist.
Daryl Bristow carried some files into a room at the Sheraton Hotel in Fort Myers, Florida. Across the room, he saw an elderly man in his late seven-ties, looking fragile and frightened. The man was Darrell Haney, a former client of Prudential Securities and an investor in the growth fund. Haney was a recent client of Bristow, having retained the lawyer for one of the huge growth fund lawsuits his firm had filed against Prudential Securities and Graham. Bristow had never met Haney personally, and they had only a short time to discuss the case before the lawyers for Prudential and Graham would start taking the elderly man's statement.
Bristow and his partners had already progressed far in their lawsuits over the growth funds. After winning the court order that forced Prudential-Bache to turn over the investor lists for the partnerships, the lawyers had solicited each potential client by mail. Bristow was not filing a class action, so he had to find each of his clients individually. The response was astounding: Thousands of investors, many of them elderly and middle class, sent back a signed contract retaining the lawyers. Bristow had so many clients that, following a disagreement, he was able to split off from his old firm and set up a new one that used the Prudential litigation as its business foundation. The new firm, called Bristow, Hackerman, Wilson & Peterson, opened its doors on May 1.
At about the same time, Bristow had brought another lawyer into the case. With thousands of clients, all of whom had to be kept updated individually, the growth fund litigation was a communications nightmare. Handling it properly would require computer sorting and cataloging of clients' names and sophisticated letter-writing programs. So Bristow contacted another law firm, James R. Moriarty & Associates. Moriarty was a computer whiz who had already used his skills to keep thousands of clients updated in other mass claims. He could easily do the same thing in the growth fund cases. Within weeks, Moriarty had a computer program running that allowed the lawyers to write individualized letters to every one of the growth fund clients. On top of that, the two law firms had put together a slick full-color newsletter called
GFL News
. Clients began receiving updates on the growth fund litigation in easy-to-read articles, complete with graphics and pictures.