Serpent on the Rock (63 page)

Maybe this long ordeal is finally over
, he thought.

Klein telephoned the other task force members, telling each one to get to Atlanta the next day. On September 23, they gathered in a conference room at the downtown Hilton. They were soon joined by a large team from Prudential Securities, including Schechter, Finley, Mathews, Dan Bell, and Nathalie Maio, the executive who would be in charge of the proposed settlement fund.

The meeting began with Schechter raising all the issues that divided the two sides. After some time, the states agreed to drop the condition that would prevent Prudential Securities from going into the partnership business again. Schechter said that the firm's new management saw that as an unfair criticism of them, since they were not at the firm when the partnership problems occurred.

Both sides were tense, but they gradually made progress. Finally Schechter raised the last issue: Prudential Securities needed a clean slate. The firm wanted the settlement to include every violation from its past. Essentially, the states were being asked to waive their ability to pursue Prudential Securities for any improper activities that they had not yet discovered.

“We don't want to do this settlement and then have you come back and hammer us again on something else that might be hanging out there,” Schechter explained.

Some of the regulators wondered if Schechter knew of some other problems at the firm that they hadn't found yet. But others just assumed that Prudential Securities didn't trust the motives of anybody on the other side of the negotiating table.

“We can't possibly sign away our statutory responsibilities like that,” one regulator said. “No one gets a walk on everything just for settling one case.”

“Well, what other issues are out there that the task force is investigating?” Schechter asked. “What else might be coming down the road?”

“It's not appropriate to get into anything like that,” Klein said. “That has nothing to do with this settlement.”

“Well, how do we know this isn't just some plan to take one piece out of us and then come back again?” Schechter responded. “We need a general release. Otherwise, we could sit back with a final settlement and then get additional sanctions right after that.”

“I'm sorry, but that's ridiculous,” Smith said. “That was never on the table in these negotiations. I would have to go back and do an extensive investigation of Prudential Securities for about a year before I could possibly sign off on a general release.”

Schechter looked at Smith with fury in his eyes. “You're being disingenuous,” he snapped.

“Loren, what are you talking about?” she asked.

“You know!” he exclaimed. “You have an investigation going. You've audited a branch. And now you're just waiting to spring something on us when the settlement is signed.”

Smith stared back at him, floored. Her office had conducted an audit of a New Mexico branch of Prudential Securities many months before. But that was just standard regulatory oversight. Nothing had been found, and there was no investigation.

“Loren, I don't know what you're talking about,” Smith said. “But I find your comments to be very offensive.”

Without warning, Schechter suddenly leaped up from his seat. He went red in the face and began screaming at Smith and the other regulators.

“You're being disingenuous!” he yelled. “You're dealing in bad faith!”

Smith crossed her arms. “So basically, you're saying that I'm lying.”

“Well, you know you have this investigation going,” Schechter yelled. “You just don't want to include it. Then, after we sign this settlement, you're going to spring it on us and go after our license for this other thing.”

Smith tried to control herself. Never before had her honesty been attacked like this. She couldn't believe that Schechter was behaving in such an unprofessional manner. It was almost as if the pressure finally caused him to blow.

“I find your remarks incredibly offensive,” she said tersely. “You're questioning my integrity, and you're questioning my good faith. And I won't stand for that.”

Don Saxon of Florida broke in. “I don't much like what you're saying either,” he said. “I've worked with Nancy a lot, and I have the highest respect for her ethics and integrity. And I'm appalled that you would try and call that into question.”

A long, uncomfortable silence followed.

“Maybe this is a good time for a break,” Mathews said finally.

The Prudential Securities team stood up and walked out of the room silently. After they were gone, the regulators fumed.

“How dare he talk to us like that!”

“The pressure's getting to him.”

“We're too close to agreement, and he wants to push it over the end zone. It was just an eruption of frustration.”

But, the regulators agreed, it was another in the firm's long string of tactical errors. Now the Prudential Securities side had to overcome the embarrassment of Schechter's blowup. There would be no more concessions, they decided. They were going to get everything they wanted. That was that.

Within a few minutes, the lawyers and executives from Prudential Securities returned. Schechter looked tired. He sat down in his chair and said, “Nancy, I apologize for getting so agitated. It was inappropriate.”

Schechter took a deep breath.

“OK, it's time to bring this to an end,” he said. “We'll accept your terms. Let's go through them.”

Prudential Securities had finally blinked. For the next half an hour, the regulators laid out the specifics of the settlement. Schechter said he wanted everything in writing. The whole group headed two blocks from the Hilton to Prudential Securities' Atlanta law firm. A secretary had stayed late to type drafts of the agreement.

For more than two hours, drafts were written and reviewed. Finally, at 7:30, the agreement in principle was laid out on the conference room table, ready for signing.

Klein leaned over the table, reading the draft one last time. He picked up a pen and looked up at his fellow regulators.

“Speak now or forever hold your peace,” he said.

The other members of the task force nodded. They were in agreement.

Klein looked back down at the document and signed it. Copies were passed around the room. Everyone finally relaxed. Klein took Schechter aside as they shook hands. They walked toward a large window in the conference room. Outside, dusk was changing into night. Workers were walking along the sidewalks, heading home. Cars on the highway were cutting a white ribbon of light past the downtown office buildings. The calm September evening seemed in stark contrast to the tension of the day.

“Loren, I want you to know that now we're moving from opposite sides of the table to the same side of the table,” Klein said. “We all now have the same interest in making sure that Prudential Securities operates properly and that this money gets back to investors as quickly and fairly as possible. Now we're here to help you.”

Schechter nodded. “I understand. And congratulations. You've negotiated a very good settlement. You've gotten a lot more than the firm ever thought it would give. Investors are going to be a lot better off because of how well you've handled this.”

Afterward, Klein and the other regulators headed down to the lobby and out into the Atlanta evening air. Outside, they slapped high fives. Their victory was intoxicating. They walked down the street in search of a restaurant. They hadn't eaten in hours, and all of them were starving. After a few blocks, they found a restaurant called Dailey's and slipped in for dinner.

Until that meal, the regulators had always been frugal at restaurants. The state regulators' association restricted them to spending no more than $35 a day on food or personal items. But now, as part of the settlement, Prudential Securities had agreed to pick up the task force expenses. The regulators unanimously decided that this was the night to ignore the $35 restriction. They'd earned a good dinner, particularly since Prudential Securities was paying for it.

Winding down, they ordered several rounds of drinks. Klein, who didn't drink alcohol, ordered rounds of 7-Ups.

The celebration went long into the night as the regulators laughed and recounted stories from their long battle. They offered numerous toasts. The first was to the task force. The second was to the SEC.

Then Klein rose from the table, 7-Up in hand.

“Now let's have a toast to the people for whom we did this,” he said. “The investors.”

Without a word, the five state regulators raised their glasses.

 

 

1
Trupin's empire eventually fell apart. The Internal Revenue Service placed tax liens against him, and he moved out of the United States, owing millions to various banks and insurance companies.

2
Darr denies ever having asked any of his employees for part of a bonus.

3
Through his lawyers, Darr denied ever demanding money from Gosule's client.

4
Harrison admitted that he gave Darr expensive gifts, including a $9,000 painting— a charge Darr denied. Both men denied that Darr ever received improper cash payments. Also, although Darr told the government that he had an interest in an account at Swiss Canto Bank as part of another investment, he said he did not control a Swiss account. See Notes and Sources.

5
Sherman's lawyer acknowledged that his client obtained an apartment in a VMS building, and, although VMS did renovate the apartment, he said his client received no special breaks and no special benefits.

6
Petty described this conversation in secret sworn testimony to government investigators. In an interview, Watson denied it ever occurred and denied that the Lombardi deal had been presold. See Notes and Sources.

7
Darr denies having discussed loan swaps between Summit and First South. See Notes and Sources.

8
Sherman denied asking anyone to procure women for him while he was in Cancún.

9
Clark and Sherman were later accused by a Prudential-Bache broker of sexual harassment in a suit against Prudential Securities before the National Association of Securities Dealers (NASD). See Notes and Sources.

10
Storaska's industry records do not show any action ever being taken as a result of the Options Exchange investigation.

11
Graham has denied making some of these comments. In addition, former Graham executives contend that no borrowings were ever used to inflate distributions. Money was borrowed only for other purposes. See Notes and Sources.

12
Sherman denied ever sexually harassing Mandt or doing anything improper with her. Clark refused to comment on the record. These events are described by Mandt in an NASD arbitration she filed in 1992 against Prudential Securities.

13
Through his lawyer, Storaska has denied doing anything improper at Prudential-Bache. See Notes and Sources.

14
Petty was mistaken about the size of the mortgage. The first mortgage, covering 100 percent of the purchase price, was for $1.8 million. The second mortgage was for $345,000.

15
Darr and other executives purchased a horse from an Almahurst Bloodstock partnership. They named it Sherman Almahurst. Darr said that the purchase was made at auction, as required by the partnership prospectus.

16
Ricca denies making this statement. See Notes and Sources.

17
Prudential Securities denies that it ever attempted to herd investors into class-action suits and denies that Eisle ever suggested that be done. See Notes and Sources.

18
Schechter was referring to the Locke Purnell report. Although the report found nothing improper about the mortgages, it also barely touched on them. It did not mention First South by name and went no further in discussing the mortgages than describing what was said in the anonymous telephone calls engineered by Curtis Henry.

19
Fiske would rise to national fame in early 1994 as the first independent counsel investigating the Whitewater affair.

20
Months later, the indictment would be dropped after the prosecutors finally realized that Schiller had only been repeating the lies he heard from Prudential-Bache.

21
Schechter denies using these words. Instead he said he rejected the recommendation to fire Storaska for another reason: He wanted to avoid creating the impression among other brokers that Storaska was being fired because his customers had filed complaints. See Notes and Sources.

EPILOGUE

THE NEXT MORNING, the task force members boarded a plane bound for Orlando, Florida. They were scheduled to brief other state regulators on their negotiations at the fall conference beginning that evening at the Hilton Hotel at Walt Disney World. Now they had some news to tell.

Klein felt restless on the short flight. Ever since returning to his hotel the night before, he had been keyed up. Unable to sleep, he had wandered about the city of Atlanta, haunted by a question: Would the other states accept the settlement? If they didn't, Klein had no doubt that Prudential Securities would walk away from the deal. The next few days would determine whether all the effort had paid off.

The task force made its presentation on September 27, in a meeting room just off the Hilton's grand ballroom. Klein paced nervously in the front as the other regulators found their seats. Security was tight—the room had been searched for recording devices, and everyone was checked at the door to make sure they belonged in the meeting. Klein was terrified of leaks. The last thing the task force needed was outside criticism of the settlement based on sketchy news reports.

Klein began his presentation promptly at 3:15 P.M.

“In coordination with the SEC, we've reached an agreement in principle with Prudential,” Klein said, still pacing. “What we want to do now is explain to you the terms of the agreement and get indications whether you think this is acceptable. We'd like to get as many indications as possible right on the spot, at the meeting.”

Klein ticked off the terms: the open-ended compensation fund, including the $330 million down payment. The firm's agreement to waive the statute of limitations on claims to the fund. A requirement for stepped-up monitoring of the firm's business by regulators. Another that made the firm responsible for paying the claims administrator selected by the SEC.

There were some downsides to the deal. Investors who had accepted class-action settlements could not file a claim. Since those cases had been resolved by a court, the regulators had no power to reopen them. In essence, Prudential Securities had succeeded in walking away from some of its most egregious frauds for a token amount of money.

After half an hour, Klein was finishing up. He had saved the best news for the end.

“And for the last item,” he said, “Prudential has agreed to a fine of $500,000 for each state.”

There was an audible gasp. No firm, not even Drexel, had ever paid a fraction of that amount to every state. Some in the audience figured they must have misunderstood.

“Did we hear that right, Wayne?” one regulator called out. “Was that $50,000?”

The members of the task force chuckled.

“No, you heard it wrong,” Klein said. “It's $500,000.”

For the next half hour, the task force members took questions. A number of regulators stepped forward to congratulate them on a job well done. Even before the questions were finished, Klein could tell that there was enough support in the room to keep the settlement alive. The task force had succeeded.

At 5:00 P.M., Klein checked his watch. He excused himself and turned the floor over to Don Saxon, a fellow task force member. Klein had to leave. His wife and children were scheduled to arrive on a 5:16 flight at the Orlando airport.

After almost two years of nonstop investigation of Prudential Securities, Klein couldn't wait to see his family. He had been working too hard and been out of town too much. Now, with the end of the negotiations and the opening of the fall conference, he could start to make it up to them.

He was taking them to Disney World.

It took three more weeks for the SEC to distill the settlement into a final agreement. By then, forty-nine states, plus the District of Columbia and Puerto Rico, agreed in principle to accept the terms. Only Texas, which was still investigating Fred Storaska's activities, held off.

On the morning of October 21, lawyers for the SEC went to the federal district court for the District of Columbia. They filed a civil complaint against Prudential Securities and the firm's agreement to settle the charges. Afterward, more than a dozen federal and state securities regulators gathered for a press conference in a basement meeting room at the SEC's Washington headquarters. There they listened attentively as Arthur Levitt, the SEC chairman, described the charges against Prudential Securities and the terms of the settlement.

In total, the firm would pay the $330 million down payment plus $41 million in fines, including $5 million for the NASD. It was the largest monetary settlement ever paid by a retail brokerage firm. And, Levitt said, the SEC was continuing to investigate the people responsible for the scandal.

The next morning, an advertisement from Prudential Securities appeared in newspapers across the country. It was an open letter from Hardwick Simmons, explaining the settlements and the firm's commitment to do better. It was a classic example of the doublespeak of Prudential Securities. At no point did Simmons apologize for the firm's centralized fraud that had destroyed the lives of so many trusting clients. Only one grammatically tortured sentence came close to acknowledging the massive wrongdoing: “Certain limited partnerships were sold by our firm to some clients that lacked adequate information or were not suitable for their investment needs,” the letter said. “That was wrong.”

What Simmons omitted spoke volumes. He mentioned nothing of the fraudulent sales literature pumped out to the branch offices by the Direct Investment Group in New York. He left out that the firm itself had misled clients for years by issuing monthly account statements that showed the plunging partnership values as holding steady. In fact, he disclosed virtually nothing about the widespread fraud that emanated from the firm's New York offices. The words of his statement seemed directed only to failure on the part of certain brokers.

The reasons for that were simple: Despite the mountains of evidence that so many government officials found overwhelming, Simmons still refused to accept that there was a widespread, coordinated effort at the firm to defraud its clients. While trying to portray the firm as reformed, Simmons simultaneously refused to face what it had done. Months later, he summed up that blindness with a single statement:

“I still don't believe that there was a systemic problem.”

In Newark, the settlement hit Prudential Insurance hard. After 118 years of seeing its name associated with words like
trustworthy
and
reliable
, Prudential Insurance was being linked to far uglier terms, such as
scandal
and
fraud
. Morale at the company was collapsing. Executives who had once proudly boasted to their friends about the firm now avoided mentioning its name.

On November 23, 1993, the company called a special meeting for employees at Dryden Hall, its auditorium in Newark. Hundreds attended. Thousands of others around the country saw the meeting broadcast live over Prudential television, a closed satellite network. Robert Winters, the chairman, looked somberly out to the crowd as he attempted to soothe their concerns.

Winters implicitly slammed Ball, saying that the management at Prudential-Bache had not lived up to the insurance company's standards. He acknowledged his own failures for not moving quickly enough when the problems started to emerge. Finally he asked Simmons to join him on-stage. Together, Winters said, they would answer written questions that had been submitted from employees anonymously.

Although some questions blamed the press for the company's troubles, most tore away at Prudential Insurance and its management, expressing a deep sense of betrayal:

“Faith has been broken with our employees, with our customers, and with the regulators. Who is accountable?”

“What will it take before the Prudential aggressively disciplines executives and others whose illegal or unethical behavior threatens the company's good name?”

“Since our record on policing ourselves is dubious at best, shouldn't we invite some respected third parties to audit all of our business practices?”

“I think the company is underestimating the damage that has been done to the good name and goodwill that the Prudential once had. Have we considered making a public apology? If not, why not? There are many people who feel an apology is overdue.”

“Why should employees want to stay here?”

Winters and Simmons assured the employees that the company had changed. Prudential Insurance would survive, they said. It would rebuild its reputation.

“My job, your job, everyone's job is to safeguard the Prudential's name with more vigilance than ever before,” Winters said. “It's not just a question of making sure we follow the letter and spirit of the law. We have to ask ourselves the question: Will this do right by our customers?”

But it was not to be. Instead, over the coming months, Prudential Securities executives pursued a strategy that seemed aimed at a single goal: to pay as little as possible to the investors defrauded by the firm.

Dozens of lawyers sat before Judge Livaudais in his New Orleans courtroom in late January 1994. Many were gathered at tables before the bar. Others, including a federal prosecutor, were sitting in the audience. All were there to hear evidence about the new proposed settlement of the energy income class-action lawsuit.

It had been almost a year since Livaudais had refused to approve the first settlement in the case. Since then, the investors had been paid nearly half a billion dollars for selling their stakes to Parker & Parsley. Now Prudential Securities was offering investors another $120 million in cash in a new class-action settlement. All it needed was Livaudais's approval. The money involved was much more than the $25 million in the first offer. But still, it translated to less than seven cents for each dollar invested.

By this point, the class-action settlement made little sense for anyone except those who had
not
been defrauded. Any of the investors could fill out a form and submit it to the regulatory compensation fund without bothering to hire a lawyer. The fund was required to give them full and fair compensation, not just some penny-ante amount. Based on that alone, some state regulators had asked Livaudais to again postpone approval of any class-action settlement. The only ones who stood to benefit from it were the class-action lawyers, who would receive millions in fees, and Prudential Securities, which would eliminate a huge portion of its liability for a fraction of what it might otherwise cost.

But Livaudais felt the case had to proceed. The states had finished their investigation. Investors who did not want to participate could opt out. The judge had given them two chances to do so. It was time to say “enough” and bring the case to an end.

Livaudais had scheduled hearings for late January, when he would hear arguments about the fairness of the new class-action settlement. After three days of hearing evidence, closing arguments began.

As he had a year before with the first proposed settlement, Edward Grossmann, the lead class-action lawyer, argued that the settlement was the best one possible. Scott Muller, representing Prudential Securities, said that the firm would contest the case if it went forward and believed it could win. It was willing to settle, he said, only out of a desire to put the partnership problem behind it.

The last of the closing arguments was presented by Stuart Goldberg, a lawyer from Austin, Texas. In recent years, Goldberg had turned energy income fraud claims into a virtual cottage industry. He won arbitrations on the partnership for large numbers of investors. To teach other lawyers how to bring those cases, he put together a book and video entitled
Prudential-Bache's $1.3 Billion Energy Income Limited Partnership Oil Scam
. He often bragged that no one had ever bothered to sue him for libel over the title because it was true.

“How many more multibillion-dollar frauds can this country stand?” Goldberg asked. “At what point does our economy get weaker and weaker and weaker? At what point is the message sent to the multibillion-dollar con artists that you can't get away with it? When is it that a court says that a class action isn't going to give you a pass?”

Goldberg finished his plea and thanked the judge. In an instant, Livaudais proceeded with his ruling.

“I'd like to respond to Mr. Muller's statement that Prudential wants to get this behind them by saying, ‘Well, Mr. Muller, I will let you get this behind you if you double your offer,' ” Livaudais said, sounding torn. “But I can't. My role here is to rule on the fairness of
this
settlement. Take it or leave it.”

Livaudais said that many investors had not opted out, despite the chances. All he could assume, he said, was that there were investors out there who, like Prudential Securities, simply wanted this problem behind them.

“I don't think I should stand in the way,” he said with a tone of resignation.

Livaudais approved the settlement.

The largest piece of Prudential Securities' liability was gone. Months later, investors would receive less than seven cents for every dollar they invested in the energy income fund. Grossmann and the other class-action lawyers received more than $22 million in fees.

News of Prudential Securities' coup in the class action crackled through law firms and regulators' offices throughout the country. The firm's effort to limit the amount of money it repaid investors seemed back on track. Its executives started getting cocky again.

By early 1994, some state regulators were angry. The firm had been all sackcloth and ashes when it needed them to agree to the regulatory settlement. But now some regulators were wondering whether Prudential Securities had ever meant to do right by its defrauded clients. California regulators in particular wondered whether the firm had tricked them into settling.

Before the state signed on to the agreements, Schechter had sent a letter to Gary Mendoza, California's top securities regulator. It promised that the state's defrauded investors would receive full compensation for their losses. But since the settlement had been announced, the firm had backed away from that commitment.