Serpent on the Rock

by Kurt Eichenwald

  It seemed like almost nobody wanted to buy the Madison Plaza partnership. The $52 million offering in 1984 was the most important real estate partnership Pru-Bache ever sold. As the largest private placement in the history of the firm, it would pay at minimum more than $7 million in fees and expenses. The partnership also involved some high-profile property: a full square block in the heart of midtown Manhattan, near Grand Central Station on Madison Avenue. But the deal, sponsored by Carnegie, was inordinately complex, involving multiple mortgages and two partnerships, one that owned the buildings and another that owned the land.

  The deal’s complexity scared off brokers. Few were willing to sell their customers a deal they could not explain. That made Madison Plaza enormously frustrating for Darr—unlike some other deals, the partnership was an “all-or-nothing” deal. If the full $52 million was not raised by May 31, 1984, the deal would be canceled and Prudential-Bache would not be paid. In turn, all of the investors who had already signed up to purchase it would receive their money back. It was a requirement designed to make early investors comfortable that, if the marketplace rejected the partnership, they would not be left holding the bag. Such market discipline was rarely applied in the Direct Investment Group, and it was chafing Darr badly.

  With so much at stake, Darr launched a direct, personal effort to sell the deal. He reviewed a marketing video for brokers called Miracle on Madison Avenue and ordered a series of editing changes to snazz it up. Still, sales did not improve. He ordered Proscia and other executives to shelve competing deals so everyone could focus their selling effort exclusively on Madison Plaza. That didn’t work. So on February 29, Darr dictated a series of intimidating wires to his regional sales staff to pressure them into pushing Madison Plaza out the door.

  “I fully expect you to take the lead in this transaction nationally,” Darr dictated in one typical internal memorandum to Ed Devereaux, a marketer for the New York region. “I also expect you to have sold $10,000,000 by the end of the production month in March.”

  Darr then added, “Whatever it takes, do it.”

  Even that failed to improve the sales. In early May, with the deadline for closing fast approaching, slightly more than half of the Madison Plaza deal had been sold. The market had decisively rejected the deal. Under the terms of the offering memorandum, Madison Plaza should have been canceled and investors’ money returned. But the prospect of losing the huge fees and having to return the clients’ money was too embarrassing. So, contrary to the terms of the partnership and without the approval of investors, the Direct Investment Group extended the deadline. As Darr had encouraged, the department did whatever it took. They turned to Clifton Harrison.

  In May, Harrison called Carnegie, sounding confident and flush. He had just finished negotiating the deal with Prudential-Bache executives that would help bail him out of his Carnegie loan. And he recently had found new partners with access to millions of dollars.

  “I know you’re having trouble selling the Madison units,” Harrison said. “I have some money, and some partners, and we should get together to see if we can work out a solution to close this transaction.” But Harrison imposed conditions: He would have to be named a co–general partner on the deal, and Carnegie had to release its claim to the collateral he had put up for his loan.

  Harrison’s newfound negotiating power came from the business relationship he had just struck up with John Roberts Jr., the president and sole shareholder of Summit Savings Association, a high-flying savings and loan in Plainview, Texas. Harrison and Roberts met weeks earlier, as they were separately looking at a Florida hotel called the Brazilian Court that both considered a spectacular property for a partnership. As they chatted about real estate, they decided that they would make a fabulous team. Roberts thought Harrison, with his Prudential-Bache connections, was a premier real estate investor.

  Meanwhile, Harrison knew that his new friend had huge sums of cash from Summit at his disposal. Roberts, whose only banking experience had been as a borrower before he purchased Summit in 1983, reveled in his sudden ability to invest millions of dollars in big-time transactions. After taking control of Summit, he started throwing money around while sniffing out huge deals. He attracted a lot of attention: He lived a high-flying lifestyle, jetting on private planes between New York, Palm Beach, and Plainview. He insisted on expensive dinners, top-rate caviar, the best champagnes, and first-class hotels. While his wife remained at home, Roberts would fly with his girlfriends around the country on a regular basis. To a large degree, Roberts and Harrison were soul mates—they both lived to spend money.

  “I don’t need a salary,” Roberts told a colleague at Summit. “Just pay my expenses.”

  At times, Roberts paid for his expensive tastes by illegally helping himself to Summit’s money. When he decided that he wanted a new Gulfstream II jet aircraft, he arranged for a fraudulent $4.5 million loan to a borrower who was simply a front for Roberts himself. The borrowed money was then illegally used to buy Roberts his plane.

  With Roberts’s easy-money ways, his small S&L quickly gained the reputation among financiers as a ready source of cash. Roberts began rubbing elbows with the likes of Adnan Kashoggi, who would later gain fame in the Iran-contra affair for his help in financing weapons deliveries to Iran. But Harrison seemed most likely to be able to catapult Roberts into the big leagues. First, Harrison introduced him to senior Pru-Bache executives. Then Roberts met other members of the firm’s stable of general partners, including John Holmes, the headhunter who helped Darr get his job. The message from all the feting was clear: Roberts could be a player at Prudential-Bache as long as he came to the table with his thrift’s money. If he helped on the Madison Plaza deal, he would win the gratitude of some powerful people.

  The proposal to use Harrison and Roberts was as complex as Madison Plaza itself. About $15 million worth of the deal still had to be sold for it to close. So, rather than wait for Pru-Bache brokers to track down retail investors, Summit would lend the $15 million to the deal. Carnegie would then transfer that money to a Cayman Islands bank account and use it to purchase the unsold units for the benefit of the ACP/CRC trust, a company managed by Harrison and Roberts. Then, as Prudential-Bache continued to sell interests in Madison Plaza, the money raised from retail investors would be transferred back to Summit to pay the loan. The proposal sidestepped the “all-or-nothing” requirement and ensured that Pru-Bache would be paid its hefty fees.

  That proposal was finalized on May 25, 1984. Without even asking for a loan application, Roberts agreed to lend the $15 million. The only strict term of the loan was that Summit had to be repaid before any general partners’ fees went to either Harrison or Carnegie.

  Darr was delighted. He wanted to meet Roberts, the man who had rescued the deal and saved his department from an embarrassing failure. So on June 1, while on a trip to New York with James Holbrook, a lawyer for Summit, Roberts made a pilgrimage to the Direct Investment Group accompanied by John Holmes, Darr’s old friend.

  They met on that warm and sunny Friday afternoon in Darr’s new office. Weeks earlier, Prudential-Bache had moved to a shiny thirty-two-story office building off the East River called One Seaport Plaza. The meeting was amiable, and Darr was positively gracious to Roberts.

  “I’m really pleased that you’re doing the Madison project,” Darr said. “I want you to know, I will personally make phone calls to Prudential-Bache brokers and see to it that the project is sold out quickly.”

  Roberts thanked Darr, feeling dazzled. Here he was, a former real estate broker, being told that the awesome retail network of Prudential-Bache Securities was about to be set in motion for his benefit. Roberts started laying out the details of the next acquisition he wanted to pursue. He had been examining First American Financial, a title insurance company he wanted to buy out of the American Century Corporation, another company he controlled. Darr’s eyes seemed to light up as the details of the possible inside deal were described.

 
“That sounds like an incredible deal,” Darr said. “If Prudential-Bache doesn’t get involved in the deal, I’d like to invest in that personally.”

  Holmes then took the floor, telling Darr and Roberts about an oil and gas venture he and a partner were pursuing called American Completion. Darr beamed. That sounded like another great deal, he said. Turning to Roberts, Darr suggested that he should not let Holmes’s deal pass him by.

  “I think you ought to give John Holmes a million dollars or so,” Darr said.

  Roberts nodded in agreement. He would lend Holmes the money once he returned to Texas. Roberts was rapidly becoming another Darr disciple.

  Days later, after a week of marathon negotiations, Roberts returned to Texas. Holbrook, the Summit lawyer, met one last time with Harrison and Steven Davis, a senior vice-president for acquisitions at Harrison Freedman, at La Guardia Airport in the American Airlines Admiral’s Club. They relaxed over drinks while munching on free pretzels and crackers. At one point, Harrison excused himself, leaving Holbrook and Davis alone. Davis seemed to feel a little boozy, and the conversation became fairly loose.

  “You know, Clifton needed this Madison Plaza deal,” Davis said. “He’s really overextended.”

  “Really?”

  “Yeah, Clifton lives from deal to deal,” Davis said. “He needs the next deal to pay for the expenses he didn’t pay in the last deal. So every deal becomes very critical. He lives from hand to mouth on a daily basis.”

  Holbrook sat back in his chair. What he was hearing sounded awfully dangerous. At some point, Harrison would be unable to sell the next deal; then the whole house of cards would come tumbling down. When that happened, it would burn Harrison’s investors, including the newest ones in the huge Madison Plaza deal. But worrying about the investors was Prudential-Bache’s job, not his. As long as Summit was paid back its $15 million, Holbrook didn’t much care what happened to retail investors.

  John Roberts picked up the telephone in his office at Summit Savings Association and dialed Darr’s direct number at Pru-Bache. It was Roberts’s second call on the morning of Thursday, August 30, and he was excited. He had just finished speaking with Clifton Harrison, who offered some positive news about several deals they were working on together. While they spoke, Darr had called and left a message.

  Roberts’s call was put right through, and the two men chatted about various deal ideas of Darr’s. The merger business was starting to boom, and Darr was dropping the names of companies he thought could be ripe for takeover, such as the Weyerhaeuser Company, the Seattle timber concern. Later, Roberts mentioned a deal involving some Aspen real estate that he hoped to sell through Prudential-Bache.

  “Well, if you bring it here, you should hire Clifton Harrison as a consultant to put the book together,” Darr said, again trying to insert Harrison into someone else’s deal. “He knows how to do it and knows his way around the firm.”

  At the end of the conversation, Darr brought up another matter. He said that Watson & Taylor, one of Pru-Bache’s general partners, had some loans with an Arkansas thrift called First South. Would Summit be willing to swap some of its own loans for $50 million worth of First South’s loans to Watson & Taylor? Roberts said he would be happy to look into it.

  Roberts could not have known, but at that moment, First South was desperately trying to get one step ahead of banking regulators. Two weeks earlier, on the same day that Darr purchased his new $1.8 million house with money supplied by the Arkansas S&L, First South’s independent auditors from Deloitte, Haskins & Sells finished a devastating report. The auditors said that First South had loaned $55 million more to Watson & Taylor than was legally permitted to go to a single borrower. As required, they sent a copy of the audit report to the Federal Home Loan Bank Board, then the chief regulator for the savings and loan industry.

  The report petrified Howard Wiechern, First South’s chairman. He fretted that federal regulators would soon be breathing down his neck about his relationship with Watson & Taylor. That could present a major problem. Just months earlier, First South and Watson & Taylor launched a criminal conspiracy to hide the true nature of their financial relationship from the thrift’s auditors. A company called Watson & Taylor Management, which had a total worth of $25 million, had borrowed $40 million from First South. When the auditors objected, Watson signed guarantees for the loan. But in a secret scheme, Wiechern agreed in writing that the guarantees would never be enforced. In effect, nothing about the problem loans would change except that a few fraudulent documents would be stuffed into the files at First South. If the government figured out what had happened, somebody was going to go to jail.

  Wiechern had to eliminate the government’s interest in the loans to Watson & Taylor by getting them off the books. That required finding another S&L willing to trade loans so First South could hide the magnitude of its problems from regulators. Apparently, either directly or through Watson & Taylor, First South turned for help to its largest mortgage borrower, Darr, who in turn spoke to Roberts at Summit.7

  For months after their August conversation, Darr heard no developments on the loan-swap proposal from Roberts, and apparently he assumed everything had been handled. But, in fact, Roberts was severely distracted by his own growing troubles. Regulators had begun to question him about the propriety of his management at Summit. Both First South and Summit were getting caught up in the first wave of the savings and loan scandal that would unfold across the Southwest for much of the rest of the decade. Eventually, Texas state regulators swooped down on Summit and demanded that, because of his wild spending, Roberts remove himself from the S&L. That same day, federal regulators contacted Wiechern in Arkansas to say that they would be arriving soon to start a complete audit of First South. All of the problem loans to Watson & Taylor were still on First South’s books.

  Soon Darr was phoning Summit again, demanding to speak with Roberts. He reached Holbrook, the S&L’s lawyer. Holbrook was surprised to hear from Darr—over several months, he had left messages for Darr at the Direct Investment Group, saying that he wanted to know why Summit had not been repaid its $15 million from the Madison Plaza deal. Darr never called him back. At first, Holbrook assumed that was the purpose of the call, but he quickly realized that Darr had other matters to discuss.

  “Listen, I’ve had some conversations with John Roberts, and he made a commitment to have Summit buy some loans from First South,” Darr said. “Why isn’t that being done? I want it taken care of quickly.”

  Holbrook could not believe what he was hearing. Darr’s tone put him on edge. He’s talking to me like he’s the president of a bank and I’m some loan officer, Holbrook thought.

  “I have no knowledge of any of this,” Holbrook said. “Roberts is no longer involved with the savings and loan and can’t make these commitments. We certainly aren’t going to be making these commitments.”

  Darr sounded nearly apoplectic. “But John promised me. So I think you need to do this.” Suddenly his tone of voice became more menacing. “And if not, I have done a lot of things for John and Summit and you in New York,” he said cryptically. “We’ve done things that were supposed to be paid back, and this is one of the things you were supposed to do for me.”

  Holbrook had no idea what favors Darr was talking about and did not want to know. And he did not take well to being threatened.

  “I’m sorry,” he said. “John is no longer involved here, nor can he make a commitment. And, I apologize, but to this extent, I am not going to help you.”

  Then he hung up the phone.

  Holbrook did not know it, but at that instant, he helped to set in motion a series of events that would damage First South, Watson & Taylor, and eventually Darr himself. But it would be years before anyone at Prudential-Bache knew anything about it.

  George Ball felt a little virtuous. He had not allowed himself to be unduly swayed by the rumors about Jim Darr’s ethics. And now, in late 1984, months after Ball ordered the investigation of Darr,
lawyers for Prudential-Bache reported that they had found no evidence of impropriety. The lawyers chased down every rumor they heard and repeatedly hit dead ends. Although there were widespread stories that Darr was dirty, none of the people they interviewed had any details. To a degree, the investigation had been hampered by Ball’s instructions: He wanted it conducted as quietly as possible, to avoid feeding the Darr rumors. The investigators did not even question Darr himself. From all the lawyers could tell, Darr might not be the most pleasant fellow in the world, but they found nothing to prove that he was dishonest.

  What was most telling about the second investigation of Jim Darr is what the lawyers left out in their oral report to Ball: They did not mention that Darr had already been investigated by the firm once before, or that the five men who reported specific allegations of wrongdoing against him had been fired or eased out. The lawyers did not find out about Darr’s demands for an apartment from VMS for Sherman or about Darr’s private investment deals with Watson & Taylor. They also missed his $1.8 million sweetheart mortgage loan from First South and his efforts to coordinate loan swaps out of that troubled S&L for the benefit of Watson & Taylor. In short, the investigators learned nothing about what was actually going on in one of the firm’s biggest departments.

  Once the lawyers finished their report, Ball felt pleased. He had prevented an innocent man from being maligned by jealous tongues, he thought. Better still, he could now take comfort in Darr’s honesty. After all, Darr had just been investigated. Regardless of whatever bad rumors he heard about Darr in the future, Ball felt confident that he would not have to take them seriously.