Serpent on the Rock

by Kurt Eichenwald

  “All right, Virg, thank you for telling me.”

  After Sherrill left, Ball sat at his desk, pondering his next move. He didn’t have the time to waste playing Twenty Questions. Prudential-Bache had ended up being a much bigger disaster area than he had ever anticipated. The firm had its share of incompetents, but Ball was shocked at the huge trove of sleazy executives who had roosted over the years in middle and senior management. The bumblers were easy to spot and boot out, but no one walked the halls with name tags saying “Sleazebag.” Ball had too much else on his plate to hunt them all down. Very little at the firm seemed to be managed well. About the only departments Ball did not worry about was the Direct Investment Group. It was one of the few that ran on all cylinders. Left to its own devices, the department brought in as much as $40 million in annual profits. Ball thought Darr deserved the lion’s share of the credit. Although Darr struck him as a shameless self-promoter with lousy people skills, there was no arguing that he knew how to sell partnerships.

  Still, if people as disparate as the patrician Sherrill and the street-smart Hogan thought there was a problem, Ball could not ignore it. He picked up the telephone and called Schechter’s law department. He had decided to have Darr secretly investigated. For what, Ball wasn’t sure. But he felt confident that once someone looked into Darr’s activities, the man would either be cleared or be sent packing.

  How could anybody run up an $1,800 hotel bill in just one weekend? Bill Petty was so stunned by the bill on his desk from Dallas’s elite Mansion Hotel that he reviewed it again and again. He could not decide what was more outrageous: that Jim Darr and his wife ran up a bill that high in just two days or that Darr expected the Watson & Taylor partnership to pay it for him. Why was it partnership business to host a Prudential-Bache executive and his wife to a lavish weekend on the town?

  Petty first heard about the bill from Paul Proscia, the senior product manager with the Direct Investment Group, who told him that Darr’s bill was on its way to Watson & Taylor.

  “Why?” Petty asked, astonished.

  “Because Darr and his wife had dinner with George and his wife,” Proscia said. “And this is the way Jim wanted to handle it.”

  Petty was not going to stand for it. There was no way the retail investors in the public Watson & Taylor partnership should pick up the tab for Darr’s extravagance. Petty picked up his telephone and called down to Watson’s office. He wanted him to hear what Darr was pulling.

  “George, I’ve got this $1,800 bill here for Darr and his wife, and Paul Proscia wants us to pay it,” Petty said.

  “Yeah, OK,” Watson said. “Go ahead and pay it.”

  Petty sat back in his chair, stunned. “You’ve got to be kidding. George, this is $1,800 for one weekend.”

  “That’s OK,” Watson said. “Pay it.”

  Petty hung up. He could not believe how cavalier Watson was about throwing the money away. Particularly since it was money that belonged to his investors.

  Loren Schechter read Darr’s contract several times on a day in early 1984. He had never seen anything like it. As far as Schechter was concerned, Darr’s deal with Prudential-Bache had to be one of the most amazing in the history of Wall Street.

  The contract showed that Darr was getting a huge share of the cash flow going through the subsidiary corporations that were serving as co–general partners. Other executives in the Direct Investment Group had similar contracts, but none anywhere as lucrative as Darr’s. Essentially, without having to put a penny into the deals, Darr was the largest single recipient in the world of partnership cash distributions. Even if a single partnership distributed only a few thousand dollars, that had to be multiplied by scores and scores of others sold by the firm. Darr’s bank account was like an ocean fed by endless little raindrops of cash.

  Some of the other terms of the contract were even more unbelievable. The way the contract read, Darr could well keep being paid even if he left Prudential-Bache to work for a competitor. Schechter had never seen an agreement that more thoroughly divorced the interests of an executive from the interests of the firm. But there was nothing he could do about it. The contract had been signed and delivered long before he started handling the firm’s legal work.

  Besides, even if Schechter wanted to change the contract, he would probably meet stiff resistance. Darr was bringing in huge amounts of cash to the firm. And cash was Ball’s bottom line. So Darr could operate his department as his own personal fiefdom and demand most anything he wanted. Unless Schechter caught him doing something heinous, Darr was probably untouchable.

  The prospectus for Prudential-Bache/Watson & Taylor Ltd. 2 arrived at the Securities and Exchange Commission on March 16, 1984. A clerk in the commission’s Office of Applications and Report Services picked up the document, stamped it “Received,” and placed it in a box for filing by a coworker. There was nothing unusual about the four-inch prospectus, nothing that made it stand out from the other records stacked around the office.

  In fact, the document was immensely important, mostly for what it did not disclose. The prospectus was the first to be filed since George Watson started giving Darr the opportunity to invest in the private land deals, investments that had reaped Darr a return of more than 100 percent. But nothing about those side deals was disclosed to the 3,764 investors who poured $25.6 million into the second public deal for Watson & Taylor sold by Prudential-Bache. Even the section “Conflicts of Interest” was silent about Darr’s investments.

  Perhaps Darr’s investments in Trinity Mills and Lombardi had somehow slipped everyone’s mind. After all, it had been many months since those deals had closed. But it was not likely that his third and latest transaction with Watson & Taylor had been missed—Darr’s personal investment of $43,398 in a deal called Northwest Highway/California Crossing Joint Venture was negotiated even as the prospectus for the public partnership was being written. He was admitted to the joint venture on March 1, one day before the completion of the prospectus. Darr’s personal finances were on the table at literally the same time decisions were made about the new public partnership.

  When stockbrokers called up their clients to peddle the newest Watson & Taylor product, none of them would know about Darr’s conflicts of interest. Instead, they repeated the assurances from the marketing material provided by Darr’s Direct Investment Group that the partnership was safe. “These partnerships will exhibit our philosophy of risk aversion,” brokers throughout the country said, reading off the sales script. The investment had three objectives: income, growth, and perhaps most important, safety.

  It would not be until years later, after losing almost 70 percent of their money, that Prudential-Bache clients would find out about Darr’s conflicts. Only then could they ask whether the Direct Investment Group approved the deals because of their perceived quality or because of undisclosed investing opportunities offered to Darr by the general partner.

  It was a question that could have been raised in those years about a number of strange partnership offerings emerging with increased frequency from the Direct Investment Group. But no one at Prudential-Bache—not even Darr’s superiors whom he soon started inviting to join in his side deals—thought to ask.

  Back in New York in late 1983, Joe Quinn, the new head of real estate due diligence for the Direct Investment Group, focused on a growing problem: Could he keep Clifton Harrison’s deals, and perhaps Harrison himself, from going bankrupt? And could it be done without investors finding out?

  The lack of care in the department’s due diligence for the Harrison deals became evident over the summer, as their financial problems mushroomed. Both the Barbizon and the Archives partnerships, two of the first big Harrison deals sold through Prudential-Bache, were on the verge of going belly-up. All of the flaws that had been overlooked when the deals were first sold—from the missing construction budgets to the inadequate bank financing—had come home to roost. The Direct Investment Group faced potential catastrophe. If the Harrison d
eals went under so soon after being sold, Pru-Bache brokers would never trust the department again. Darr dropped the problem into Quinn’s lap, while shutting Harrison out of bringing in any more partnerships until the troubled deals were fixed.

  For weeks, Quinn thrashed over the problems with Harrison in Prudential-Bache’s offices. At times other members of the due diligence department were called in to explain facets of the deals. Quinn, whose stiff, fastidious demeanor showed up in his penchant for frequently combing his hair, stood like a high school teacher at an easel in his office, writing down each element of the deals while his staff explained them. Some due diligence team members looked on Quinn’s easel as a form of torture, as he forced them to explain the same concepts over and over again. But for Quinn, the easel was a crutch that helped him to understand. Unlike some of the dive-bombers of Wall Street, who would rush in with a solution without understanding the problem, Quinn always wanted to be sure he was fully prepared.

  Quinn did not like the answers the easel gave him about the Barbizon. It needed a cash infusion of about $1.5 million. Without that money, re-development of the hotel would soon stop, and the banks could well foreclose. That would be a disaster for investors—under federal law, a foreclosure could result in the government recapturing all of the tax deductions they had taken so far. Worse for Darr and the department, a number of Pru-Bache executives, including Darr himself, had been so persuaded by the sales pitch that they purchased their own interests in the Barbizon partnership. Failure of the deal would not only burn the department with the brokers, it would cost Darr and his bosses money.

  Quinn had to think of someplace to find a loan. Apparently, going to the bank was out of the question—even though Prudential-Bache investors were assured of Harrison’s financial stability, the banks might balk at his creditworthiness. The firm itself could not give the loan without assuming huge new liabilities for the partnership. So Quinn came up with an idea: He would hit up one of the department’s growing stable of general partners for a loan to Harrison. Then Harrison could lend the money to the Barbizon and salvage the deal.

  After discussing the idea with Harrison, Quinn decided that Barry Breeman, a tough-talking, chain-smoking New Yorker, would be the perfect general partner to ask. Breeman had been Quinn’s last employer and was instrumental in helping him get his job at the Direct Investment Group. When John D’Elisa resigned, Breeman recommended Quinn to Clifton Harrison, who was well known for having the inside track in the department. Harrison carried the recommendation on to Darr, who hired Quinn almost immediately.

  Breeman, a high school graduate with one year of college, ran a real estate syndication company called Carnegie Realty Capital that he formed in 1983 with three partners: Anthony Viglietta, Fred Manko, and Jon Edelman. As Quinn knew, Carnegie would have strong reasons to keep Harrison out of bankruptcy court. Before Harrison was restricted from doing new deals, he was brought in to help Carnegie market a partnership called 680 Fifth Avenue Associates to Prudential-Bache brokers. Carnegie would be as eager as anyone to make sure that Harrison kept his good name with the sales force.

  In November, Quinn telephoned Breeman and quickly got to the point. “Clifton Harrison needs $1.5 million to put into the Barbizon,” he said. “Could Carnegie lend him the money?”

  “I have to speak to my partners,” Breeman said. If they agreed to the loan, then Harrison would get the money. He told Quinn he would call back soon with their answer.

  That day, at Carnegie’s offices at One Exchange Plaza, Breeman told his partners about Prudential-Bache’s request. Without much discussion, the partners agreed to lend Harrison the money. But Jon Edelman insisted that they extract as much as possible from Harrison for security on the loan. Edelman disliked Harrison from their dealings on the 680 Fifth Avenue deal; at one point, he walked away from a conversation convinced that Harrison had insulted him. Now, with Harrison in desperate shape so soon afterward, Edelman saw an opportunity for a payback. To assuage Edelman, the partners agreed to impose the strict terms he wanted.

  Soon Breeman called Quinn with their answer. “All right, Joe,” he said. “We’re willing to provide Clifton with the loan. But we’re going to need some significant collateral.”

  “That’s understandable,” Quinn said. “Did you have anything in mind?”

  “Yeah,” Breeman said. “Everything he owns.”

  It was no joke. For Harrison to get his money, he had to put every one of his belongings in hock. His home. His general partnership interests. His cars. Even his Cartier watch. If Harrison defaulted, Carnegie would take it all.

  When told of the demands, Harrison swallowed hard but accepted. He had little choice. In November 1983, when he signed the agreement, his finances could scarcely be more precarious. He was effectively insolvent. No one would be willing to buy a partnership sponsored by someone in such sorry financial shape. And no one could argue it was immaterial—a general partner’s financial health was among the most important of disclosure items. If he didn’t find a way to bail himself out, Harrison would never sell another partnership. But apparently for Darr, Harrison’s dilemma seemed like a remarkable opportunity to make money. In a few weeks, he would convert the Carnegie loan into a centerpiece not only of his own personal finances but those of other Prudential-Bache executives as well.

  On February 27, 1984, Darr thumbed through the fourteen-page brochure for a new $1.67 million real estate partnership offering that Clifton Harrison wanted to sell. Clearly, Harrison hoped that the money from this deal would get him out from under the Carnegie loan. But Darr did not like what he saw. He thought Harrison was trying to charge investors in the new partnership too much. He decided to tell Harrison that the asking price had to be lowered. It was a rare instance where Darr demanded a decrease in the amount of money partnership investors had to pay. Then again, in this deal, all of the investors would be Prudential-Bache executives, including Darr himself.

  Darr sat down at his desk and wrote a brusque letter to Michael Walters, the head of marketing for Harrison Freedman Associates. “Dear Mike,” he began. “We intend to pay no more than $1.2 million total for this offering, if it is to be purchased by Prudential-Bache executives.” He added sharply, “I would suggest you restructure your numbers or sell it elsewhere.”

  Harrison had little choice but to lower his asking price. Selling the partnership, which held his interest in the Barbizon and a neighboring brown-stone, was the fastest way to pay off the Carnegie loan. And the partnership could scarcely be sold through Pru-Bache brokers. If it was, all of them would see his financial troubles and probably would never sell one of his deals. He needed to get back into the partnership business desperately, so that he could start charging some new fees. Despite his tight finances, he still spent money with abandon. In the weeks after he obtained the Carnegie loan, Harrison purchased a roomful of nineteenth-century English antique furniture, including a satinwood table for $3,800 and a George IV mahogany clock for $5,500. In one month alone, Harrison rang up $12,000 in bills on his credit cards and, on top of that, purchased an $11,000 stereo system.

  Darr held all the cards. To keep up his wild spending, Harrison needed to get out from under his Carnegie debt quickly. So Darr negotiated the most lucrative investment possible: None of the Pru-Bache executives would have to put up a dime to buy the partnership. Instead, they would simply assume a piece of Harrison’s debt to Carnegie, which they would then pay off over the years. That made the deal a no-brainer. Though they would have no money at risk, the Pru-Bache executives would be able to obtain immediate tax credits. Even better, they stood a good chance of making a significant profit on the deal, as Darr was virtually dictating the price and refusing to allow Harrison to charge any fees for managing the partnership. In essence, Darr was not allowing Harrison to do to Prudential-Bache executives what he routinely did to hundreds of Prudential-Bache clients.

  Within a few weeks, Harrison and Darr agreed to set the value of the deal at $1.25 mill
ion. Darr contacted senior executives throughout Prudential-Bache, including George Ball, and told them about the great investment opportunity he had created for them. Apparently, no one questioned the propriety of Darr striking personal deals with the same people whose partnerships were being sold by his department.

  Ball declined to participate in the deal, but three other executives outside the department—Virgil Sherrill, the vice-chairman; Bob Sherman, the head of retail; and Richard Sichenzio, a senior vice-president in the retail group—agreed to invest. In the Direct Investment Group, only Paul Proscia, Bill Pittman, and Joe Quinn were offered the opportunity. Quinn opted out; Darr, Pittman, and Proscia invested. All of the executives assumed $125,000 of Harrison’s debt to Carnegie, except for Darr and Sherrill, who each assumed $375,000.

  The Carnegie partners were delighted with the outcome. Not only had the risk of the loan been spread among many more people, but Harrison still owed Carnegie for the debt that the Prudential-Bache executives left on the table. And until the executives’ partnership closed, Carnegie continued to retain all of Harrison’s belongings as collateral.

  The inequity of the deal was obvious to Harrison’s staff. Mike Walters of Harrison Freedman wrote a letter on March 26 to Howard Feinsand, a lawyer for Harrison, describing the terms for the deal that had been forced down Harrison’s throat. “Enclosed please find the final edition of Barbizon ’84,” he wrote. “This deal has been carefully structured for the investing pleasure of Jim Darr and his merry men.”

  But the deal achieved Harrison and Darr’s original purpose: Harrison’s financial statements had been prettied up, to the monetary benefit of Pru-Bache executives. The Direct Investment Group lifted its ban on Harrison deals. Although no investors would ever be told, the side deal also gave Harrison enough appearance of financial strength that he would soon be used to salvage an important private placement. By the completion of that deal, called Madison Plaza, Darr’s own interests and those of Carnegie, Harrison, Watson & Taylor, and First South would converge. This time, they would be in deep conflict with the interests not only of investors but also of banking regulators.