Serpent on the Rock (47 page)

But Trice wasn't about to push brokers to sell investments they couldn't explain.

“Look, Rich,” he replied. “A lot of brokers and managers don't understand this product. It's very complicated. They don't feel comfortable with it, so they don't understand it.”

“Well, that's your job,” Sichenzio barked. “Make them understand it so they can sell it.”

“Richie, let me tell you,
I
don't understand it in some ways. On top of that, I don't like the way this is being shoved down people's throats.”

Trice also mentioned that, even though this product was being sold as safe and secure, the Prudential-Bache analyst who examined Risers had already suggested over the in-house communications system that their outlook was not good. Why on earth would the firm start selling another one, this one called RAC Mortgage, when the analyst seemed so doubtful?

“The analyst didn't know what he was talking about,” Sichenzio said. The analyst had already made a revised presentation on the firm's communications system to correct any misimpression.

“So your job is to get behind the effort to sell more of these,” Sichenzio said.

The conversation came to an end. Trice said he would see what he could do.

Trice was right to be worried. That same month, Merrill Lynch, which also offered Riser products, distributed a research report to its brokers. It covered the latest Riser being sold by Merrill and Prudential-Bache. But the analysis would only be seen by Merrill brokers. The word “safety” was nowhere to be seen in the report.

Instead, under the bold heading “Merrill Lynch Research Suitability Comment,” the report contained this warning: “Research considers the common stock to be suitable only for SPECULATIVE accounts.”

At Merrill, only the customers most willing to gamble would be sold the newest Riser product. At Prudential-Bache, the sales focused instead on the elderly and the retired. Merrill was right.

Paul Tessler, an executive in the Direct Investment Group, dropped the financial statements for one of the Harrison partnerships on his desk and reached for the telephone. Something in the numbers for the partnership, called Stamford Hotel, didn't make sense. As an asset manager, his job was to review the performance of the partnerships that had already been sold and make sure everything was running correctly. Normally, that involved looking at the numbers, running them through a few times, and signing off. But this time, in the fall of 1988, Tessler couldn't figure out the statements for the Stamford partnership. If he didn't know better, he would have bet that several hundred thousand dollars of the partnership's money was missing.

Still, Tessler wasn't worried. He was sure there was some routine explanation for the apparent discrepancy. He dialed Harrison Freedman Associates and asked for Gayle Gordon, one of the company's accountants. He told her about the document he was examining.

“I'm having a little trouble finding this number,” he said. “Could you help me out here?”

Slowly Gordon took him through the numbers, and Tessler followed along. By the time she finished, he was no better off than when she started. He still came up several hundred thousand dollars short. It was too large a discrepancy to shrug off.

“I still don't get it, Gayle,” Tessler said. “Could you send me some of the backup on this?”

Gordon said she would send him the supporting documents soon.

About a week later, Tessler was feeling anxious. He still had not heard from Gordon, so he called her again.

“Hi, Gayle,” he said. “I still need some help here. Can you send me what I need? I don't understand what these numbers are. I just really need to check.”

Again Gordon said she would send the materials soon, and the call ended.

The next morning, Tessler's boss, Joe Quinn, the head of asset management, asked him to come to his office immediately. Tessler walked in and shut the door.

“We've got a real problem, Paul,” Quinn said. “Gayle Gordon resigned. Apparently it had something to do with you questioning the numbers on the Stamford partnership.”

Tessler was flabbergasted. Until that moment, the questions he had asked had seemed nothing but routine. He had simply been making the workaday demands of his job. But any time an accountant resigns from a company, antennae go up on Wall Street. Gordon must have found something she couldn't tolerate. Before Tessler had another moment to think about it, Quinn answered all his questions.

“Apparently she found out that there's some money missing,” Quinn said, his voice completely calm. “We have to move very quickly on this.”

Within a few minutes, Tessler and Quinn had Harrison on the line. Slowly, they began to browbeat the man about where the money had gone.

“This is not a problem,” Harrison said. “I've just been borrowing some money against future fees.”

“Well, how much money are we talking about?” Tessler asked.

“About $200,000.”

That amount sounded enormous. Under the terms of the Stamford deal, Harrison had no right to advance himself fees. It wouldn't take too clever a plaintiff's lawyer to argue that he had been embezzling partnership money. Quinn and Tessler told Harrison they would be over to see him immediately.

At ten o'clock in the morning on October 11, 1988, Quinn and Tessler arrived at Harrison's office. When he saw Harrison, Tessler could not believe his eyes. The gregarious, upbeat fellow he knew from the past was gone. In his place was a shaking, downtrodden, highly emotional man. Both he and Quinn had known about Harrison's enormous cash flow problems. Only now did they realize the emotional toll those financial troubles were wreaking on him.

The interrogation made things worse.

“So,” Quinn asked, “the full amount you took out was $200,000? We're not going to look at the numbers and find any other surprises?”

Harrison took a deep breath and sighed. “No,” he said, shaking his head. “It wasn't just $200,000. It was more.”

Over the next few minutes, Harrison admitted that the amount was in fact closer to $500,000. He had been taking the money, a small bit at a time, for much of the year.

Harrison's eyes filled with tears as he said he had always intended to pay the money back once he received his next set of fees.

Quinn stood up. “If you will excuse me, I have to go call the firm's lawyers,” he said.

He walked into the other room and dialed the Prudential-Bache law department, telling the lawyers that he had just found out that one of the firm's biggest general partners had been improperly pocketing partnership money. He needed to know what to do.

The changes came quickly. Harrison lost the power to write any more checks out of the partnerships on his own. Control of the partnerships was out of his hands.

It was the last time Clifton Harrison had any major involvement with the partnerships he sold through the Direct Investment Group. Instead, the responsibility for them was largely left with one of his consultants. Harrison simply walked away from the deals. His relationship with Prudential-Bache was essentially over.

In a matter of weeks, the same would be true for Jim Darr.

“Jim, come on in,” Ball said as he saw Darr at his doorway. “Let's talk.”

Darr stepped slowly into the room, his face a mask of anxiety. He was holding himself together well, particularly for a man who had just been told he was losing his job.

Ball came around his desk and patted Darr's shoulder as they walked toward the couch and chairs on the other side of his office.

It was November 25, 1988, and it had been a day of wild extremes for Darr. It was the first day of the Direct Investment Group's latest quarterly meeting. Darr had opened the meeting with an upbeat speech about the future of direct investments and the new directions he thought the department should take. By the afternoon, he had been told to see Lee Paton, the man who had originally hired him. It was Paton who delivered the bad news. Shortly beforehand, Bob Sherman was also told that he was being let go. Ball wanted to meet with each man after they had heard what was happening and handle any mop-up that was necessary. Ball had met with Sherman first, and the session was short and simple. Then he had waited for Darr to arrive.

The changes had taken a long time to put in place. Ball had finally settled on Richard Sichenzio as the man who should replace Sherman. Even though Sichenzio had never been a broker, Ball thought he had done a fabulous job in a lot of areas, particularly in his recent push to get the Riser products sold. Replacing Darr was much easier. Paul Proscia had been at Darr's side for years. Ball liked Proscia and was fully confident that he could pick up where his old boss left off.

Ball settled into a chair and Darr took the couch. He sat on the very edge, a bundle of nerves.

“I'm terribly sorry about all this, Jim,” Ball said. “I know you wanted Sherman's job. You've been lobbying for it very hard. But I decided to give the job to Richie Sichenzio. In view of that, I really think it's better that you leave the firm rather than being a bitter person who potentially might snipe or try to undermine Richie.”

The reality of what was happening seemed to be going over Darr's head. Right in the middle of being fired, he launched into a promotion pitch.

“Look, George, I'd be the right person for the retail job,” he said. “I know the people here. I know I could run things. I'd be the right guy.”

Ball shook his head. “No, Jim,” he said. “It's not going to happen.”

“Then let me just continue to run the direct investment department.”

For the most fleeting of instants, Ball considered bringing up the disquieting Locke Purnell report. But he wanted to keep the conversation strictly on a business level.

“Consciously or unconsciously, you're going to be a critic of Richie,” Ball said. “Having somebody who sought a senior position and failed remaining with the company is an invitation to disaster. It's time for you to move on, Jim.”

Darr nodded as the reality of what was happening appeared to start crashing down. His career at Prudential-Bache was coming to an end.

About an hour later, a few select executives from the Direct Investment Group gathered for a private meeting in the department's boardroom. Darr had spread the word through Barron Clancy, one of his trusted executives, that he wanted to meet with his top aides. Many of the veterans who worked in New York were there, including Pittman, Proscia, and Quinn. Other longtime marketers in the field were also invited. The men sat around the table quietly, wondering what was happening. They anticipated a big announcement.

Darr stepped into the room and sat down. He was noticeably and un-characteristically quiet. He stared at the table for a good minute, saying nothing. The gathered executives looked at him and then exchanged confused looks.

What in the world is he going to say?

Finally Darr looked up. “I've been asked to resign from the organization. I just want to tell you how much I appreciate and have enjoyed my association with you.”

At that moment, Darr choked up. Tears began to well up in his eyes and stream down his cheeks. He shook his head slightly and regained his composure, saying, “I'm leaving on good terms with the firm. This is just something they thought needed to be done.”

For the next eight minutes or so, Darr relived his happy memories from his days building the department. He told stories about several executives in the room. He mentioned things he considered to be the department's successes.

“We've been able to get a lot done as a team,” he concluded. “I will never forget you and what we have been able to accomplish.”

With that, Darr stood up, and a number of the executives came around the conference table to shake his hand and thank him for what he had done for them. They talked for another few minutes before slowly filing out of the room.

The next day, Curtis Henry was speeding down Interstate 10, heading from Pensacola, Florida, to Mobile, Alabama. He was scouting out new locations for his video stores. He was in one of those places that seemed like the end of the earth, with no one in sight and nothing ahead but miles of empty road.

Suddenly his car telephone rang. It was a former manager from Prudential-Bache, asking him if he had seen the
Wall Street Journal
that day. When Henry said no, the former manager read him the story about Darr and Sherman leaving Prudential-Bache. It quoted Darr saying that he had resigned. “It was my decision,” Darr told the newspaper.

The article went on to say that Darr planned to start his own limited partnership operation. Ball said that Prudential-Bache expected to be Darr's biggest customer.

Henry laughed. “Boy, that's a great cover.”

Within thirty seconds of hanging up, the car phone rang again. It was Roy Akers, another former Pru-Bache branch manager.

“Curtis, did you hear about Darr?” he asked. “I know you must have had something to do with this. Congratulations. You finally got him.”

This time, Henry shook his head. “I didn't get him,” he said. “I didn't have anything to do with it.”

Akers chuckled. “I'm sure,” he said sarcastically.

No, Henry said. He was serious.

“He didn't need me,” he said. “Darr got himself.”

CHAPTER 15

FEDERAL JUDGE BRUCE VAN SICKLE handed down the decision in Mc
Nulty
v.
Prudential-Bache
on February 3, 1989, in Minneapolis. It was an all-out win for McNulty and his lawyer, Charles Cox. The secrets of the Harrison partnerships were finally exposed.

Van Sickle ruled that Pru-Bache had failed to tell investors material information about Harrison's 1982 Archives partnership. Some of it involved the Archives' financial condition. But the judge also criticized the firm for not disclosing Harrison's criminal record, a failure that occurred in every partnership he sponsored.

“It seems clear,” Van Sickle wrote, “that a reasonable investor would consider information about such a conviction important in making an investment decision.”

Van Sickle also dismissed out of hand Prudential-Bache's argument that the pardon Harrison had received from President Ford made his conviction a nonevent.

“The pardon releases Harrison from the effects of his conviction, but it does not have the Orwellian effect of re-writing history to make the fact of the conviction non-existent,” he wrote. “The fact stands and the failure to mention it in the offering memorandum constitutes a material omission.”

The decision was devastating for Pru-Bache. The ruling was now the precedent. As long as that decision was on the books, the firm could never again argue in court that Harrison's background did not have to be revealed. The judge's finding itself was material and would have to be disclosed to every investor in the Harrison partnerships. Worse for the firm, the finding would be available to every lawyer and in every law library with access to computerized databases. Prudential-Bache would soon be facing hundreds of millions of dollars in lawsuits, with little ability to defend itself.

So the lawyers at Prudential-Bache plotted a strategy. They would make Van Sickle's decision disappear.

Within a few days of the ruling, the firm's lawyers contacted Cox with a proposal. Pru-Bache would not appeal the decision but instead would settle. Even though McNulty won everything back—his entire investment, plus interest, plus legal fees—the firm was willing to pay more. But there was a condition: McNulty had to join Prudential-Bache in a motion to vacate the judgment.

A vacated decision essentially never existed. It does not establish any precedent. It never appears in any legal databases. And it is kept out of the federal records of court decisions. The only way to know it was issued would be to dig through the files at the Minneapolis court, where the only copy of the decision would remain.

Investors and their lawyers would be hard-pressed to figure that out. As a second term of the settlement, McNulty was required to sign a confidentiality agreement. No one would be told about the secret information hidden in Minneapolis. Even though Van Sickle made it clear that Harrison's background was material, Prudential-Bache still would not tell investors. It would not even disclose that Harrison and the firm had just been successfully sued for selling faulty deals.

Deception alone would no longer contain the damage that had grown within the Direct Investment Group for more than ten years. So now Pru-Bache was resorting to the brute force of its law department. With the backing of the giant Prudential Insurance, the firm prepared to use its financial firepower to keep the emerging scandal under wraps.

But soon the problems started popping up faster than the Prudential-Bache lawyers could conceal them.

Brokers throughout Prudential-Bache punched up the results from the first day of trading in the VMS Mortgage Investment Fund on their stock quote machines. After being sold for almost a year, in April 1989 its shares were finally opening on the American Stock Exchange. Shock ripped through the firm on the opening bell. The fund, which had been sold as a safe, guaranteed investment, collapsed in value on the very first trade. Investors had purchased their shares at $10 each. The first share traded at close to $7.50.

Bill Creedon, a broker in Prudential-Bache's Los Angeles office who had sold the fund to his most conservative clients, stared at the Quotron machine on his desk with a rising sense of concern. The fund had a few halfhearted rallies during the day, but it never did—and indeed, never would—recover its original value.

Creedon didn't like what he saw, but he wasn't ready to give up. He still felt safe as long as those guarantees were in place. Whether the shares went up or down, he felt confident that his clients would still get their 12 percent return as well as all of their principal back. But he knew a number of them would be mad when their account statement arrived the next month. The drop in value would bring down the net worth calculation on the front page of their statement. Already, he prepared himself to handle a flood of angry phone calls.

In the middle of the trading day, John Eisle, the Los Angeles branch manager, came out to assure the troops that everything was all right with the mortgage fund.

“Don't worry about VMS,” he said. “I've spoken with the people in New York. This is just market action. It'll recover.”

Managers around the country made similar assurances to their nervous brokers. Still, a degree of panic was setting in. When the fund price sank below $7.40 a share, one broker decided to bail his clients out. Later the broker told Eisle that he had sold their holdings in VMS. Since they wanted safety, the broker said, he used those proceeds to purchase one of the new energy income partnerships.

Eisle nodded. “That sounds like a viable alternative.”

The telephone rang on John Hutchison's desk almost as soon as he hung up from his last call. It was a broker, screaming about his customers' losses in VMS and the falling distributions in the Graham partnerships. The broker wanted to know what the Direct Investment Group was going to do. Hutchison, who marketed both VMS and Graham products for the Direct Investment Group, gave the standard excuses that had been told to him by his superiors. Soon he hung up and rested his head in his hands. The complaints were coming in too fast, at a rate of about 100 a week. And the brokers were angrier than ever.

Everything that the Direct Investment Group had ever touched seemed to be collapsing. Airplane deals with a company called Polaris were unraveling, as were real estate deals with Fogelman Properties. Problems were turning up in the Harrison deals, the Lorimar deals, the Almahurst deals. Hutchison heard brokers complain about another Prudential-Bache deal called Risers that had lost about 80 percent of its value. The list was endless. Nobody could understand what was happening.

Hutchison stood up and headed down the hallway to visit Kathy Eastwick, a friend and fellow product manager. Eastwick had been at the department forever, first as a compliance administrator working for Pittman and then, for the last few years, as a marketer. She was both a straight shooter and Hutchison's best buddy in the department. The two of them viewed each other as kindred souls, strapped to the center mast as the storm blew in around them.

Eastwick was on the telephone when Hutchison walked in. She was speaking to a broker who was complaining about the performance of one of the products she marketed. Hutchison slumped into a chair and listened quietly. Finally Eastwick hung up and looked at Hutchison, exhaustion clouding her face.

“Kathy, this is just awful,” Hutchison finally blurted out. “I don't know how much longer I can take this. Everything's erupting at the same time.”

Eastwick threw a pen on her desk. “I know.” She sighed. “I don't take any phone calls to help place orders anymore. I just listen to brokers all day yelling and screaming. Everybody just keeps asking me what's happening and why aren't we doing anything about it.”

The two sat for a moment in silence. Then Eastwick's telephone rang again.

“I wish I knew the answer to that myself,” Hutchison said.

Across the country, the answers were slowly starting to emerge.

J. Boyd Page, an Atlanta securities lawyer, sat back in the overstuffed chair in his office and tried to hide his disbelief.

“All right,” Page said in a southern drawl. “Walk me through this one more time.”

In front of him sat Rick Blass, a Prudential-Bache broker with its Atlanta branch. Blass had asked for this meeting in the spring of 1989 to see about retaining Page. Already Blass had gone through his story once, but he did as Page asked.

“My clients and I have invested in a deal that was sponsored by Prudential-Bache,” he said. “The firm told me it was like a CD and that it was safe, secure, and virtually no risk. But everything they said was false. I lost my money, and my clients have all been blown out. I want you to represent all of us against the firm and help us get our money back.”

Page leaned toward his desk and picked up a cigarette. “Mind?” he asked. Blass shook his head.

Page took a drag of his cigarette. He had known this broker a long time. Almost ten years before, he had represented him in another case. Still, he had trouble believing him.

“OK, prove it,” Page said. “You know, I heard what you're saying, but if I walk into an arbitration and say that, people are going to look at you and laugh. It's a little too convenient for the guy who sold this stuff to blame his firm.”

“But it's not just these things,” Blass said. “It's not just the Risers. It's everything they push us to sell. They keep telling us that every big product they put together is safe and secure and there's no risk to it. But it's just not happening. Not with any of them.”

Page took another puff of his cigarette. “Look, I watch television sometimes on Saturday and Sunday afternoons,” he said. “I've seen ‘the Rock.' I've seen all these advertisements about the reliability of Prudential. I'm just not too easily inclined to believe that something quite as massive as you're describing has happened at a place like that.”

Blass sighed. He said he would go back to his office and look through some of his files for the marketing material that proved he was telling the truth. The meeting came to an end, and the two men shook hands.

Page didn't hold out much hope that the broker was going to persuade him. A native of east Tennessee, Page was the kind of person who needed a lot of evidence to accept the incredible. But the broker had made the right choice by coming to Page. In 1989, Page probably knew more about the internal workings of Prudential-Bache than any lawyer in the country.

His law firm, Page & Bacek, started handling big cases involving Pru-Bache in 1986. The first one that came in the door had helped make his reputation. In that case, Page represented Bill Kane, a former executive with the firm's Atlanta branch. Kane had been fired from his job as an administrative manager. The dismissal came after the firm found out that a broker at the branch had done some improper trades over more than a year. Kane, who had been there just a few weeks, was the only executive punished. From what Page could tell, it looked like Kane had been nothing more than a scapegoat.

The case opened an enormous window for Page on the inner workings of Prudential-Bache. He learned about the sloppy compliance procedures that led to the Capt. Crab settlement. He heard about the heavy pressure exerted on brokers to sell Pru-Bache products. He won the Kane case, but it was not a big economic victory. Kane walked away with about $40,000.

But the case had its benefits. Page earned the reputation among Prudential-Bache brokers and managers as a man willing to take on the firm. His office became a drop-off point for Pru-Bache employees who thought they were being mistreated. Over the years, Page heard numerous horror stories about the way employees were abused and clients' accounts ransacked. Still, with everything he had heard, he was not disposed to believe the stories that his most recent visitor from the firm had to tell about massive fraud and deception of clients.

Until a few weeks later. True to his word, Blass returned with his files in tow. Page met with him in a conference room just off the law firm's entryway. For more than an hour, he reviewed the information. There was no mistake. The marketing material he sifted through clearly made the Risers out to be safe and secure investments.

Finally, after reading an array of papers, Page looked at Blass with a smile.

“Well, sir, congratulations,” he said. “We've got ourselves a case.”

Loren Schechter walked briskly into the boardroom at Prudential-Bache, where the firm's executive committee was meeting in 1989. He was there to make one of his most dire presentations ever. The firm had already been sued over VMS. It was a small lawsuit, one that normally could be swatted away with a quick settlement. But Schechter believed that the firm's exposure was enormous. Hundreds of millions of dollars' worth of the VMS investments appeared to have been sold to elderly, risk-averse investors. Its value was dropping like a rock. The case would be trouble.

Ball glanced up and saw Schechter walking into the room. He had just finished reporting on some of the events of the day.

“Loren, perhaps you ought to let everybody know about this lawsuit,” Ball said.

Schechter made a quick presentation, describing the claims of the lawsuit. Then he opened the floor up to questions.

Ted Fowler, the firm's investment banking chief, was the first to speak up. “Well, Loren, is this just some nut that lost some money, or is this something prevalent?”

“This is serious,” Schechter said. “This is going to be a huge problem. Huge.”

The top sellers of the Graham energy partnerships arrived in June 1989 for their seven-day sales trip to Costa del Sol, Spain, just a short distance from the real Rock of Gibraltar. All of the best-known brokers at Prudential-Bache qualified for the trip. And by now, almost every one of them was angry.

As always, Graham Resources and the Direct Investment Group planned an awards ceremony, where the top brokers would be honored for their sales. But unlike most years, the awards carried a bitter tinge. By that point, everyone on the trip knew that the brokers who sold the most Graham partnerships in 1988 probably had the most customer complaints in 1989.