Serpent on the Rock (38 page)

It wasn't. By Dempsey's calculations, the partnerships were still $500,000 short, despite the $1.5 million that Chanin had allowed them to advance to the partnerships. Dempsey was concerned. If they didn't make the 15 percent distribution, he felt sure that sales would fall.

Dempsey had to let his bosses know. He sat down at a typewriter. “STRICTLY CONFIDENTIAL,” he typed at the top of the memo addressed to Rice and Files. He then told them about his findings about the $500,000 deficit.

“If we were dealing with anyone but Matt, I would not feel uncomfortable finessing the $0.5 million shortfall,” he typed. “What do you think?”

Dempsey hit the return key twice and typed a final sentence.

“Please destroy this memorandum after reading,” it said.

“$uperbroker” arrived on the desks of Prudential-Bache brokers in July 1985. He was the main character in a poorly drawn, cheesy comic book. The superhero himself appeared to be bursting through the cover. He was unlikely to win fans: $uperbroker looked like a self-absorbed yuppie with a dollar sign emblazoned on his chest.

The comic book was being used to advertise two upcoming sales trips sponsored by Graham. The first was to Oktoberfest in Munich, West Germany, and the second was to a Caribbean island. On the back cover, the mild-mannered version of $uperbroker explained that brokers only had to sell between $250,000 and $600,000 worth of the energy income partnerships to qualify for various versions of the trips. The more the brokers sold, the better the trip.

The first page of the comic book featured Clark Barr, a stockbroker who made a good business selling stocks and bonds. In the first panel, he wisely instructs an elderly client named Mrs. Grimsley to invest $5,000 in relatively safe municipal bonds. But the next day, he reads about the energy income funds and their sales contest for the trip to Munich. Images of large-breasted women offering steins of German beer pop into his head. From then on, every time the broker hears the word “contest,” he becomes $uperbroker, selling the energy income fund to all his clients. By the last panel, $uperbroker is—foolishly—telling the elderly Mrs. Grimsley to forget about those municipal bonds and advising her to put the money into the much riskier energy income fund instead.

The comic book was just the first part of a concerted effort to encourage more sales with the two free trips. At the same time, Graham also sponsored a “limerick contest” with brokers, with beer steins as a prize. Throughout Prudential-Bache, dozens of brokers turned away from their stock quote machines to start writing limericks. Alan Myers, a broker from Philadelphia who was one of the contest winners, wrote a limerick that celebrated the Munich trip and reflected the deeply held but false beliefs about the partnerships' tax advantages. He wrote:

Income that's sheltered from “Sam,”
Is the product of Pru-Bache and Graham,
If you sell enough
(And that's not too tough)
You'll travel to Munich and “jam.”

Not all the brokers enjoyed the fun and games. A number of Pru-Bache's female brokers were particularly offended by the $uperbroker comic book, with its sexist portrayal of women. The whole thing seemed horribly unprofessional. In late July, a copy of the $uperbroker comic book, complete with a short note of complaint, arrived on George Ball's desk from Barbara Gutherie, a broker from Paramus, New Jersey.

“Mr. Ball,” Gutherie wrote, “if we wish to lose our image as a ‘schlock house,' we should stop acting like one.”

As far as Matt Chanin was concerned, the energy income partnerships were just not viable in the long term. He had looked at the numbers over and over again, and they just weren't working. By October 17, 1985, he was ready to take a drastic step.

“If Graham doesn't make some significant changes,” Chanin told a group of executives in a conference room at Prudential-Bache headquarters, “I'm going to have to consider whether I should keep investing Pru's money in this.”

The words hit the room like an atomic bomb. The investment of Prudential Insurance in the energy income partnerships had been the big selling point. How would they explain it to the brokers if the Rock decided that it had to drop out?

The first step needed for renewed support from Prudential Insurance, Chanin said, was for the high expenses at the partnerships to be cut. Despite the terms Chanin had put in place months earlier, Graham's bloated expenditures still ate into profits.

“This issue has to be addressed and resolved before I agree to participate in another offering,” he said. For the first time, the future of the energy income partnerships was in question. The expenses had to come down if Prudential was going to stay on as an investor.

Darr watched the thick group of bare trees pass by as he rode in Tony Rice's car through the winding roads in Stamford, Connecticut. They were on their way to a shoot at a nearby range. Their shared interest in hunting and guns had become a passion. Already, by late 1985, they had hunted prairie dogs in Wyoming, wild boars in south Texas, and, of course, quail at Longleaf. Now Rice was planning a real treat for Darr in the next few months: a bear hunt in Alaska. The cost of the hunts was tens of thousands of dollars, all paid by the partnerships. With all the expenses the partnerships had, Rice figured that a $20,000 or $30,000 bill for a hunting trip was just a drop in the bucket. Keeping Darr happy was a necessary cost of business.

But by constantly paying for Darr, Rice had created expectations that sometimes proved embarrassing. When he invited Darr to hunt prairie dogs, Rice said that he would need a .22 Winchester magnum. The rifle could be ordered at any gun shop, but Darr apparently did not want to be bothered. He called Rice and asked him to take care of getting the gun for him. So Rice ordered the gun, had the sights adjusted, and put on a scope. In total, it cost about $900. A few days after it was ready, Rice took the gun with him to a party at Darr's house. After arriving, he set the gun in a closet and later told Darr it was there. When Darr asked how much he owed, Rice just shook his head. After the hunt, he said, he would just take it back. Using partnership money, Graham Resources was just entering into a hunting lease with a ranch in west Texas. Rice said he would use the Winchester down there.

But after the hunt, Darr kept the rifle, and Rice avoided the embarrassment of asking for it back. It must have been, Rice assumed, just an honest misunderstanding.

Rice headed toward Interstate 95. As they often did, he and Darr discussed their personal finances. Darr mentioned that he had borrowed $1.8 million from First South.

Rice seemed a bit taken aback. “That sounds like a big mortgage to me,” he said.

It also didn't sound particularly wise. Rice knew from earlier conversations that First South was largely controlled by George Watson and Tracy Taylor, the principals of Watson & Taylor. Owing that much money to a savings and loan might give those men an inordinate amount of power over Darr.

“Jim, considering you have a mortgage with people you've got another business relationship with, you might want to have a larger cushion,” Rice said. Perhaps, he was suggesting, Darr should have more equity in his house.

The conversation rambled on, until Darr returned to the topic of First South. Rice didn't know it, but Darr himself was now a huge shareholder in the financial institution. Federal regulators had recently finished examining First South and were preparing a report on the loans to its biggest shareholders, Watson & Taylor. In that environment, First South executives had contacted Darr and told him they had a huge block of more than eight thousand shares in the S&L for sale. They did not tell him who the seller was. Darr agreed to buy, but on the condition that First South lend him another $345,000 for the purchase, through a second mortgage on his house. The deal was quickly struck, and Darr bought the block of stock. By now the loans on his house exceeded the price he had paid for it a little more than a year before.

Darr had been so persuaded by the pitch on First South that he thought Rice might be interested in buying some of the stock himself. It was a fabulous investment, Darr said. “Would you be interested in buying some First South shares?”

Rice shook his head. The ties among Darr, First South, and Watson & Taylor already struck him as strange. He didn't want to bet his savings on it.

Mark Files tapped a few numbers into his calculator as he looked at some records on his desk at Graham Resources. The results were horrible. Just a few months before, Al Dempsey had estimated that the partnerships' profits, plus maximum borrowings, would leave them short $500,000 for the last two quarters of 1985. To deal with that problem, Graham Resources agreed to advance the money, even though Files didn't think the energy company had the financial wherewithal to do it.

Now, in the first week of January 1986, the final numbers for the year were coming in. And they were far worse than anyone ever imagined. The partnerships were short another $800,000 in the fourth quarter alone. Graham had to figure out how to bring the bad news to Prudential Insurance and Prudential-Bache. Maybe they could help out.

After all, Graham Resources had a lot of financial demands coming up. The company was planning to move in a few months from suburban New Orleans to Covington, Louisiana, on the north shore of Lake Pontchartrain. There would be no more of the modest office space in Metairie. Instead, they wanted to lease a tony, $11 million building. Their new office was a virtual palace, looking out on acres of man-made ponds, waterfalls, and streams, complete with a row of fountains marking the entrance. And all of it had been designed to the strict specifications of John Graham's wife, Suzy.

At that point, poor distributions would be a disaster. If sales fell off now, they couldn't pay for their new, regal digs.

On Monday, January 23, 1986, the oil market cracked. Almost thirteen years after the Arab oil embargo, the oil ministers for the Organization of Petroleum Exporting Companies were split. They were unable to curb the production of oil by their members. Oil prices dropped below $20 a barrel for the first time in years. Everyone, from New York commodities brokers to Texas oil barons, was stunned. In Washington, the White House celebrated the price drop, saying that the lower prices were good for consumers. The slide would continue relentlessly for months—eventually, for a fleeting moment, pushing oil prices below $10 a barrel.

The possibility that a rising oil market would cover up the mismanagement of the Prudential-Bache Energy Income partnerships was obliterated.

That same day, Matt Chanin called Jim Sweeney at the Direct Investment Group and lowered the boom: Prudential Insurance wanted out of the energy income partnerships.

“With the recent developments in the oil markets, it's time for all of the partners to reassess their positions,” Chanin said. “There's no stability in the market now.”

Prices could go in any direction, he said. Any assumptions he made to help him decide what to do would be only so much guesswork.

“In view of this,” Chanin said, “I can't at this time recommend to the Prudential board that they authorize participation in Energy Income Fund III.”

Sweeney took a breath. The new series was slated for marketing in a matter of months. The department was still selling some partnerships out of Series II. Chanin's decision could change everything.

“Well, in light of this, do you think that sales of the current income fund should be halted?” Sweeney asked.

“I never try to tell marketing people what to do, Jim,” Chanin replied. “But I think it's in everyone's best interest to take a step back and reassess the situation.”

Resigned, Sweeney told Chanin that he would arrange a meeting between him and other executives in the department to discuss future plans. In all likelihood, that would be the death knell for the energy income partnerships.

Al Dempsey hung up from his conference call with executives from the Direct Investment Group. He was feeling pretty good. Just a few days before, Matt Chanin's decision about pulling out seemed to threaten the future sales of the energy income partnerships. But now, after hearing the word come back from the Direct Investment Group's quarterly meeting, Dempsey knew everything was under control.

Earlier that day, he had spoken with Darr, Pittman, and Sweeney about the ramifications of Chanin's decision. The executives had been debating whether it would be better for Prudential Insurance simply to cut its investment substantially or to withdraw from the program. They spoke with all their top marketers during the conference, and the opinion was relatively uniform: It would be hard to explain why Prudential Insurance was cutting its investment. But if the company withdrew completely, the executives would be able to find the right marketing spin to persuade the firm's brokers to keep selling. Given all the regulations on insurance company investments, the executives agreed that Prudential Insurance's disappearance could be made more “believable” than its cutback.

Within months, the announcement of Prudential Insurance's decision went out on the internal communication system at Prudential-Bache branches around the country. It stressed that California regulations limited insurance companies to 10 percent of their assets in a single investment and that the Pru was bumping up against that limit. Apparently, nobody realized that the assets of Prudential Insurance grew massively each year, meaning that it could always invest more and still be below 10 percent.

As the announcement came across the internal computer, executives throughout the firm immediately smelled something fishy.

In Florida, Jim Parker, who had been the regional marketer there for partnerships since shortly after Darr arrived, looked at the announcement with disbelief. He picked up the telephone and called Bob Jackson, a slender, sandy-haired man who worked as the Florida regional marketer for Graham Resources.

“Hey, Bob,” Parker said. “What's this about Prudential backing out of putting money into this deal because of some California regulation?”