Serpent on the Rock (64 page)

In particular, Mendoza was incensed to learn that the firm planned to make certain deductions out of every cash award to defrauded investors equal to some appraised value for the partnership stakes still owned by the investors. Never mind that the partnerships could rarely—if ever—be sold. Prudential Securities would simply pretend that the appraised value was the same thing as cash in the investor's pocket. With the partnerships still having some $3 billion in value, Mendoza thought he understood why the firm had been so sure that $330 million would cover its liability. It was planning to use some accounting trick to avoid paying investors the money they were owed.

Mendoza arranged a meeting with executives from the firm to discuss the problem. In early March, several of the firm's lawyers and executives gathered at Mendoza's office in Los Angeles. The chief negotiator was Woody Knight, the man who had so badly mishandled talks with the state task force.

Mendoza offered several suggestions about how to deal with the remaining values of the partnerships. Perhaps, he said, if Prudential was so certain of the appraised values, it should purchase the partnerships back at those prices. Knight waved the idea away, saying it would be too costly and had not been part of the settlement.

Mendoza tried another tack, suggesting that the firm deduct a certain amount from the appraisal values to account for the difficulty in selling the partnerships. These so-called liquidity discounts would be a much better representation of reality, he said.

“Asked and answered,” Knight snapped, looking irritated. “That's not part of the deal.”

“Fine,” Mendoza said as he stood up. “I guess we have nothing more to talk about. I hope you have a pleasant trip back to New York.”

With a smirk on his face, Knight shook Mendoza's hand. He and the other representatives from Prudential Securities walked out of the room, apparently confident that they had successfully steamrolled the California regulator.

They had no idea that they had just made another horrible blunder. It was one that would finally humble Prudential Securities.

Two days later, on March 3, a Prudential Securities lawyer telephoned William McDonald, the assistant director of enforcement for California's securities division. The lawyer asked how close California was to signing a final settlement agreement.

“Well,” McDonald said, “in fifteen minutes we're going to announce that we intend to suspend you.”

The firm's executives had botched it again. Mendoza would not accept their out-of-hand rejections. If Prudential Securities refused to fully compensate the victims of its fraud, then Mendoza would put them out of business in California.

A series of rapid negotiations ensued. The SEC pressed California and Prudential Securities to resolve the problem. Within a week, all the parties met in Washington, D.C., at the office of SEC chairman Arthur Levitt. By the meeting's end, the firm accepted the liquidity discounts. It was going to have to pay far more to investors than it had planned.

With that capitulation, Mendoza agreed to finalize the settlement. He told reporters that the liquidity discounts could as much as double the firm's settlement costs. When told of the statement by a reporter, Knight scoffed, saying that the discounts would cost no more than $25 million. And besides, he added, Prudential Securities had always planned to include them. Mendoza was shocked when he was told of Knight's statement. He could not believe that a senior executive would lie so readily.

Over the next few weeks, scandal after scandal involving multiple divisions of Prudential Insurance emerged in news reports. It was as if the full disclosure of the partnership fraud had ripped aside the company's facade, exposing its dirty secrets.

New York State officials were reported to be investigating Prudential Insurance for illegally selling financial products that had been turned down by insurance regulators. Under pressure from a lawsuit by a whistle-blower, the company also admitted that it had improperly inflated the values of properties in some institutional real estate funds, making it appear that the funds were performing better than they actually were.

The articles were also devastating to Prudential Securities. They disclosed that federal prosecutors were examining the role of the firm's law department in the partnership sales. The government was also reported to be investigating whether the firm had offered misleading legal advice about class actions to its partnership investors. A drug ring was exposed in an Arizona branch, which had been using overnight delivery services to ship illegal narcotics. The firm was forced to repurchase $70 million in recently sold mortgage securities because their true risk had been misrepresented to investors.

Even the firm's advertising led to embarrassment. Prudential Securities launched a new $22 million campaign just after the settlement in 1993, using Simmons and some Prudential Securities brokers in television commercials that boasted of the firm's “straight talk.” But the talk proved anything but straight.

In one commercial, a broker named Jeff Daggett told of his desire to ensure the safety of his clients' investments. Within days of its first appearing on television, the advertisement had to be pulled. An eighty-one-year-old Roman Catholic priest filed a lawsuit against Daggett, charging that the broker had sold him inappropriate partnerships, then misled him into joining a class-action settlement.

The most humiliating moment came in July. The senior management of the firm finally admitted that, despite their months of arrogant assurances, they had been wrong. The cost of settling valid claims to the compensation fund would be far more than the $330 million down payment. The firm had to add another $305 million to its cash reserves to pay the claims. The liquidity discounts and interest on the claims had pushed up the total cost. All told, the price of the partnership mess to the firm was projected to exceed $1.1 billion. But even that estimate proved optimistic. The firm's projections for the cost of cleaning up the partnership debacle would later rise to more than $1.5 billion. It was the costliest fraud scandal for any investment house in the history of Wall Street.

In the wake of the July announcement, the cocksure air of the firm's executives melted away. They were left struggling to explain how they could have been so wrong.

“I wasn't lying” by promising that $330 million would be enough, Simmons later said. “I may have been stupid.”

Four months later, the final, crushing blow landed. After three years of denying that it had broken any law, Prudential Securities was compelled to admit in public that it committed crimes in its partnership sales.

Federal prosecutors in Manhattan had completed their investigation of the firm. They had found the mountain of incriminating documents as persuasive as the regulators had.

On October 27, 1993, the prosecutors filed a criminal complaint against Prudential Securities charging that the energy income partnership sales had been laced with fraud. But, in part out of fear that an indictment would lead to the firm's collapse, they deferred prosecution for three years. If the firm did not violate the law during that time, the charges would be dropped. In essence, Prudential Securities was on probation.

In exchange for the deferred prosecution, the firm agreed to pay $330 million more into the compensation fund for investors. In a sign that the prosecutors did not trust executives to police the firm, Prudential Securities was compelled to appoint an independent ombudsman to review future allegations of misconduct. But, most important, lawyers for the firm conceded in a written statement that fraudulent sales literature had been knowingly distributed to brokers by the Direct Investment Group.

That afternoon, Mary Jo White, the U.S. attorney in Manhattan, promised that the criminal investigation of the executives involved in the partnership debacle was continuing. The SEC inquiry of individuals was also still on track.

Long before any of those investigations ended, some of the firm's executives would pay a heavy price.

Jack Graner, the former regional director in the Pacific South, tapped out lines of heroin on the bathroom counter. He was in room 214 at the TraveLodge Hotel in Burbank, California, about a mile up the road from the gates of Warner Brothers studios. It was one o'clock on the morning of January 27, 1994. In the bed a few feet from Graner, a young woman was asleep. The two had met just days before at a hotel in Hollywood. They had been together ever since, smoking crack, snorting heroin, and drinking ethanol.

Graner's life had fallen apart. With the departure of Bob Sherman and George Ball, he had lost his protectors. As the man who had been the regional director in Atlanta during the Capt. Crab fiasco, Graner was marked. His longtime drug problem grew worse. He was forced to leave the firm.

With his finances in shambles, Graner had been trying to get himself back together and kick his drug habit. He had formed a consulting business where, for a fee, he would testify as an expert in investor arbitrations. He specialized in cases involving Prudential Securities, and he always testified against the firm. By late 1993, he was scheduled for at least two arbitrations against the firm. One case involved a former Storaska client. The other was a wrongful termination case brought by Bill Webb, the Florida broker who was fired for helping his clients find lawyers.

Then one day, Graner had called Webb to say he was dropping out of the case. He had just been notified that the SEC planned to file a complaint against him alleging that he had failed to properly supervise his brokers. The charges would destroy him as an expert witness. In a matter of days, Graner had vanished, bouncing from hotel to hotel in a depressed drug spree. After several weeks, he landed at the TraveLodge in Burbank.

Graner leaned over the countertop and snorted several lines of heroin, then stumbled out of the bathroom. Three and a half lines were left on the counter, but Graner had taken enough to accomplish his goal. He staggered past the suicide note he had placed on a bag and fell onto the bed. The woman beside him barely stirred.

Graner closed his eyes and drifted away. He would never wake up.

The death of Jack Graner hit some brokers and executives from Prudential Securities like a bucket of cold water. Suddenly the implications of the multiple government investigations of the firm's current and former employees was all too real; the costs of the scandal in human terms became far more tangible.

About the same time Graner heard from the government, more than a dozen other executives and brokers were informed that the SEC enforcement staff planned to recommend charges against them stemming from trading violations at the firm's branches, particularly in Atlanta. By the spring of 1995, no charges had yet been filed against any individual as the cases wound their way through the administrative process.

The first onetime senior executive to hear that he faced charges was Richard Sichenzio, who had succeeded Sherman as head of retail at Prudential-Bache. He was informed in a letter that the SEC planned to charge him with failing to properly supervise the firm's brokers. Sichenzio had just finished two years of working as a consultant for Prudential Securities for a fee of $1.2 million. He had since taken a job as president of Spencer Trask Securities, a brokerage firm. Within weeks of hearing from the SEC, Sichenzio left Spencer Trask. He now works as an industry consultant.

No matter what decision the SEC makes about Bob Sherman, it will have little effect on his life. After being pushed out of Prudential-Bache, he invested in Nathan's Famous, a hot dog chain, and became its president. In little more than a year, he was out of that job. Sherman now sells heavy equipment in New Jersey. Family members believe that he never intends to join another brokerage firm.

After a decade on Wall Street of dodging the responsibility for scandal, George Ball finally had his Teflon scratched. At the time the regulatory settlement was announced, Ball had been working as a senior executive at Smith Barney, Harris Upham & Co. for a year. But the scandal gave heavy ammunition to his enemies there, who considered Ball an embarrassment and wanted him out of the firm. Within a matter of weeks, he was gone. Afterward, he worked as chairman of Sanders Morris Mundy, a Houston firm run by Don Sanders, one of Ball's top brokers at Hutton.

In December 1994, Ball was notified that the enforcement staff intended to recommend bringing a civil complaint against him for failing to properly supervise Fred Storaska, who in turn also faces charges. Ball said he will contest the case.

Shortly after the regulatory settlement, Loren Schechter was forced out as general counsel of Prudential Securities. Hardwick Simmons asked him to leave following news reports that Schechter had hired a criminal lawyer. Although Schechter was not known to be a target of any criminal investigation, the disclosure made him appear too scarred by the scandals to continue in his job. He remains as a lawyer and adviser to the firm.

By the spring of 1995, the government was finishing the final interviews in its investigation of individuals involved in the partnership scandal. While no action had yet been taken against those men, their lives already seemed to have changed irrevocably.

Graham Resources was purchased by Prudential Securities and was essentially shut down. John Graham decided to largely abandon the energy industry and instead commit his time to raising money for inventions in the medical field. To do that, he opened Graham Partners, a business he started with his old colleague, Mark Files. Tony Rice was also persuaded to participate in some of the new company's ventures. Despite the findings in the criminal case, all three men continue to insist that nothing improper ever occurred in the sale or management of the energy income or energy growth partnerships.

As the partnership scandal unfolded, Clifton Harrison left Dallas for Moscow, the newest and wildest frontier of capitalism. There he linked up with several partners and pursued Russian real estate and film deals. But doing business in Moscow carries risks: One of his partners was killed in what authorities believe was a contract hit by the Russian mob. Still, Harrison has seen success there. “People here know Harrison for what he is,” one American in Moscow said. “But it doesn't matter. This is the land of the second chance.”