WARM AIR FILLED THE conference room at the SEC’s Atlanta regional office. Someone had turned the thermostat up too high. Even though it was just 9:45 on the frosty morning of February 21, 1985, the heat made all five people in the room shift in their seats from discomfort. But Richard Saccullo, head of Prudential-Bache’s largest branch in Atlanta, was probably the most uncomfortable of all.
It was the beginning of Saccullo’s second day of interrogation by two SEC lawyers from Washington, D.C. With each pointed question, it grew more evident that the investigators doubted the professed zeal of Saccullo and Prudential-Bache for enforcing securities rules on brokers.
The SEC lawyers, Jared Kopel and Karen Shapiro, sat across a conference table from Saccullo and Patrick Finley, an associate general counsel for Prudential-Bache. A court reporter sat nearby. Kopel, the senior SEC lawyer on the case, watched Saccullo closely as he answered questions. Saccullo, a heavyset, jovial-looking man with thinning brown hair, was a star in the Pru-Bache system. Even though he had already been cited once by the commission for failing in his supervisory duties, Saccullo remained one of Sherman’s favorites. He projected the image of a man who knew he was untouchable at the firm.
But Saccullo would have trouble emerging from this new investigation unscathed. By following a trail of documents, Kopel had uncovered a web of connections between Saccullo’s branch and Joseph Lugo, a shady penny-stock trader from Florida. From all appearances, the Prudential-Bache Atlanta branch had been involved in a complex scheme with Lugo to illegally manipulate the price of a penny stock.
The stock was in a Florida restaurant chain called Capt. Crab’s Take-Away. By studying trading records, Kopel had discovered large purchases of the stock coming from the Atlanta branch in the summer of 1983. That heavy buying drove up the price of Capt. Crab shares. At the same time, insiders at Capt. Crab, along with a handful of stockbrokers associated with Lugo, had been selling shares. The purchases by the Pru-Bache Atlanta branch looked like the classic manipulation, designed to temporarily increase the share price so that the sellers could make huge profits. Making it all the more suspicious were the identities of the two young brokers whose clients were the biggest buyers of the shares: Robert Scarmazzo and his close friend David Scharps, the son of Capt. Crab’s president.
Somehow, Prudential-Bache had become tied up in a sleazy scheme. Now, with the deposition of Saccullo, Kopel thought he had the best chance to find out why that happened. Saccullo had been the manager of the Atlanta branch during the manipulation. At the time, the firm’s compliance officers found the trading in Capt. Crab suspicious. They ordered Saccullo to restrict the purchases by only accepting unsolicited orders, meaning trades requested by customers without being suggested by the brokers. Saccullo disregarded those instructions for some time. Later he ignored orders from compliance to stop trading in Capt. Crab shares altogether.
SEC lawyer Shapiro paused for an instant as she studied a document in preparation for her next question. It was one of the wires from compliance that had been sent to Saccullo. It said that six clients of the young broker named Scarmazzo had purchased 14,200 shares in Capt. Crab on one day. All of the order tickets described the sales as unsolicited. Because the compliance department had trouble believing that so many customers decided to buy the same obscure stock on the same day, the wire asked Saccullo to investigate.
Shapiro held the Scarmazzo wire in her hand as she read it to Saccullo. “Do you recall receiving this wire?”
“In general terms, yes,” Saccullo said.
“What, if anything, did you do to ascertain whether the shares were, in fact, unsolicited?”
Saccullo almost shrugged. “I spoke with Scarmazzo and was told by Scarmazzo that the shares were, in fact, unsolicited.”
Kopel kept staring at Saccullo, unflinching. My broker told me he didn’t break the rules, so I believed him. The basic point of the compliance department’s concern was that they feared Scarmazzo was lying.
“Did he give an explanation as to why so many accounts decided to make purchases on the same day?” Kopel asked.
“I called the man and we had a conversation,” Saccullo replied. “He assured me the trades were unsolicited, and I had no reason to think he was telling me anything but the truth.”
It was like a game of cat and mouse. No matter how the SEC investigators asked the questions, Saccullo fell back on the same answer. But by this point, it didn’t much matter what Saccullo had to say in his defense. Already the SEC investigators believed that he had not done his job as a manager. That was enough for a regulatory sanction.
Still, the SEC needed to know more about Joseph Lugo, the Florida penny-stock trader involved in the manipulation. After asking about David Scharps, the son of Capt. Crab’s president, the investigators brought up Lugo’s firm, Rooney Pace.
“Did you have any discussions with Mr. Scharps about Rooney Pace’s activity in the stock?” Shapiro asked.
“Mr. Scharps periodically had conversations with someone by the name of Joe Lugo,” Saccullo replied.
“How frequently did you hear Mr. Scharps having conversations with Mr. Lugo?” Shapiro asked.
“Probably half a dozen times.”
“Prior to your hearing any conversations between Mr. Scharps and Mr. Lugo,” Shapiro asked, “had you otherwise heard of Mr. Lugo in any other context?”
“No,” Saccullo said. “Mr. Lugo at some point in time opened up an account in my office to buy a tax shelter.” The deal, Saccullo said, was an airplane leasing deal with a company called Polaris.
“Who did he open that account with?”
“With David Scharps.”
No one in the room realized the significance of what Saccullo had just said. Some of the money Lugo earned on the Capt. Crab manipulation had been sucked into the partnership fraud. The Polaris deal that Lugo had purchased had been sold by the Prudential-Bache system as safe and secure. Within ten years, it would lose 90 percent of its value. But Pru-Bache and its brokers would receive large fees and commissions.
Prudential-Bache had defrauded one of its accomplices in a major stock scam.
The crowd in the courtroom of Florida state judge Nelson Harris stared silently at the dark-haired man sitting at the defendant’s table. Many in the audience knew the man and had once been his clients. He was Sam Kalil Jr., the former assistant manager in Prudential-Bache’s Jacksonville branch. And he was in the courtroom on this day in February 1985 to find out how much jail time he would have to serve for looting his customers’ accounts at the firm.
Just two years earlier, Kalil had been among the elite at Pru-Bache. He had been a member of the Chairman’s Council, the organization for the top ninety brokers at the firm. Even George Ball had thought that Kalil was the kind of salesman everyone else should emulate. Kalil had projected an image of a convincing, energetic, and engaging broker.
“Sam is a model of what I want this firm to be,” Ball had told an associate after watching Kalil at a meeting.
A few months later, in December 1983, Kalil was arrested on charges of grand theft, forgery, and securities fraud. The broker’s success had been founded on crime. He created huge commissions by buying and selling securities without customer approval and by pushing his unsophisticated clients into complex, unsuitable investments. They lost millions of dollars. To hide his crimes, Kalil stole close to $2 million out of profitable customer accounts and transferred the money into the accounts with losses. Kalil had contested the charges until January 1985, when he agreed to plead guilty to felony charges.
Judge Harris asked Kalil if he had any statement before he passed sentence.
“I’m so sorry for what happened,” Kalil said. “I’m deeply ashamed for what I’ve done.”
But Judge Harris was not moved. He sentenced Kalil to serve twenty-six months in prison, four months in a halfway house, and ten years’ probation.
The sentence did not bring an end to the Kalil matter for the SEC. The agency had lau
nched an investigation of Prudential-Bache’s Jacksonville branch at the time of Kalil’s arrest. By the sentencing, the SEC investigation had raised troubling concerns about the firm’s management: A branch executive had notarized a signature that Kalil had forged. And Kalil’s suspicious cash transfers all were approved unquestioningly by his manager.
The Kalil and Capt. Crab investigations moved simultaneously up the pipes in the SEC—by 1985, a consensus emerged at the commission to consolidate the investigations into a single case. The violations in Atlanta and Jacksonville signaled systemic problems at Prudential-Bache. Since 1976, the firm had been sanctioned for problems in its branches four times—more than any other major firm. Nothing made the firm straighten out. Somehow it had wandered off the path of investor protection.
This time would be different. The SEC lawyers wanted to set an example with Prudential-Bache. The punishments meted out would have to be severe. That way, the lawyers felt sure that the firm would not be able to simply ignore the SEC again.
In the spring of 1985, a group of lawyers sat in a narrow conference room on the fourth floor of the SEC’s Washington headquarters. Several had lined yellow legal notepads in front of them, ready for use. On one side of the table sat Loren Schechter, the Prudential-Bache general counsel, looking confident and calm. With him was Arthur Mathews, a wiry, red-bearded partner from the prestigious law firm of Wilmer, Cutler & Pickering. Mathews, a former deputy associate director of enforcement for the SEC, was widely regarded as one of the country’s top experts on securities laws.
Across from the two men sat a small group of staff lawyers from the SEC enforcement division. They were there to listen to the Pru-Bache lawyers argue why the commission should not take any action against the firm in the Kalil and Capt. Crab matters.
“A lot of this goes back to the spring and summer of 1983,” Schechter said. “We were just taking over from the old guard at Bache. We’ve solved the problems since then. We’ve beefed up compliance. Everything you’re talking about is just ancient history.”
The SEC lawyers seemed unimpressed. Over the years, they had heard various executives from Bache protesting the same thing every time regulators caught the firm violating securities laws. This time, the regulators felt compelled to take serious action.
“Look, I’m in charge now,” Schechter said. “The compliance department has direct access to me. I will enforce their directives. I’m there to make sure that this firm follows the letter of the law.”
Again, Schechter’s sentiments were met with shrugs. The enforcement division had heard this all before, one of the lawyers said.
“But that was different,” Schechter said. “You don’t need to worry about us. We know how to clean up the messes from the Bache bunch. We’re the real professionals from E. F. Hutton.”
Reporters and television cameras packed the Justice Department briefing room on May 2, 1985. They were there for a rare event: Edwin Meese, the attorney general of the United States, was personally going to announce a development in a major criminal case. At 2:00 P.M. sharp, Meese stepped up to a podium, scowling slightly from the bright lights. He began to read a prepared statement.
“The Department of Justice today filed a criminal information charging E. F. Hutton & Company, one of the nation’s largest securities dealers, with two thousand counts of mail and wire fraud,” Meese said. “The essence of the charges was that Hutton obtained the interest-free use of millions of dollars by intentionally writing checks in excess of the funds it had on deposit.”
Hutton was pleading guilty to the charges, Meese said, and would pay the maximum criminal fines allowable of $2 million.
The four-year investigation of Hutton’s elaborate bank fraud by prosecutors in Pennsylvania had finally hit its target. With the charge led by Al Murray, the assistant U.S. attorney in Scranton, the government had unwound the complex scheme that between July 1, 1980, and February 28, 1982, had defrauded some four hundred banks of up to $8 million. As part of the settlement, the department agreed to grant immunity to as many as fifty Hutton executives. No one from the firm would ever go to jail for the crimes.
The meetings between the SEC and the Prudential-Bache lawyers continued throughout the summer of 1985. By the fall, serious negotiations for a settlement began.
The talks were tense, and Schechter took a hard-line position. But after Hutton’s guilty plea, he never again spoke of how the regulators could rest comfortably knowing that compliance at Pru-Bache was in the hands of the team from Hutton.
“Mr. Ball, you have the right to have counsel assist you in the course of this morning’s proceedings,” said Congressman William Hughes. “Are you accompanied by counsel?”
It was 10:25 on the morning of October 31. Hughes, a New Jersey Democrat, had just struck his gavel to its base, silencing the crowd in room 2237 of the Sam Rayburn House Office Building. The ten-member House Judiciary Subcommittee on Crime was ready to hear from Ball in its investigation of the crimes of E. F. Hutton.
Ball introduced his lawyer, Lloyd Cutler, the former White House counsel in the Carter administration.
“Thank you,” Hughes said. “Mr. Ball, I am going to place you under oath at this time. Will you please raise your right hand?”
A few minutes later, Ball began his testimony. He said he knew that Hutton had a cash management system in place to minimize the loss of interest on the float to banks. But that was as far as his knowledge went.
“I was not aware of the procedures or specific methods used,” Ball said. “I was certainly not aware that some regions and branches were abusing the system in order to generate additional interest income by excessive overdrafting.”
Subcommittee members produced Ball’s memos from his Hutton years urging the retail sales force to do more overdrafting. But Ball’s resolve was unshaken. He insisted that he knew nothing about any improper activities.
“One should not mistake a search for improvement as a willingness to cut corners,” Ball said. “Exhorting branches to increase their interest profits or their stock sales or cost-effectiveness was in no way a call for sharp practices.”
More important, Ball protested, he was not Hutton’s top executive. He had no responsibility for the cash management system. No one in that department reported to him. He could not, he said, be held accountable for actions taken in divisions of the firm for which he was not responsible.
“Just out of curiosity,” asked Congressman Romano Mazzoli, a Democrat from Kentucky, “at Prudential-Bache, do you do any of this sort of thing now?”
“No, we do not.”
“You do not do excessive overdrafting?”
Ball explained that Prudential-Bache maintained an agreement with the banks that specified the amount of money the institutions could make off the firm’s float each year. He added that he was not sure how much money that was.
“You don’t know what’s going on in your company now?” Mazzoli asked.
“No, what I’m saying—”
“Because you said you didn’t understand, apparently, what was going on over at E. F. Hutton.”
“I was not responsible for the practices at Hutton,” Ball protested. “At Pru-Bache, I’m chief executive officer. And number two, being somebody who is not totally stupid—”
Mazzoli smiled. “So,” he said, interrupting Ball. “You do know what’s going on now?”
Ball never answered the question.
Bob Sherman sat on the edge of a couch in George Ball’s office, staring intently across a coffee table into his boss’s blue eyes. “We just can’t fire Rick Saccullo,” Sherman implored. “He’s a good guy. We’ve got to let him stay with the firm.”
Ball nodded.
“Listen,” Sherman said, “Saccullo was duped in this Capt. Crab thing. He may have been negligent, but he’s effective. We can’t just cut him loose.”
By the fall of 1985, Ball had heard the same impassioned plea from Sherman several times. When Ball first heard about the Ca
pt. Crab investigation, he could not imagine it would go as far as it had. Based on what he had learned from Loren Schechter, the SEC case sounded to Ball like just a small-time problem at a local branch. That was why he had said nothing when Sherman promoted Saccullo to the all-important position of regional director for the Southeast even while the investigation was still going on.
But in the last few months, everything had changed. Schechter had told Ball that the SEC was consolidating the Capt. Crab case with the Kalil matter and looking at both incidents as a sign of a systemic breakdown in compliance at the firm. The agency clearly wanted to make a big splash with the case.
The SEC lawyers had entered into settlement negotiations with the firm but were demanding a heavy price. The enforcement staff wanted to appoint an outside expert to review Prudential-Bache’s compliance procedures and remake them from the ground up. For a major brokerage firm, it was a humiliating requirement.
But on top of that, there was the problem with Saccullo. For the regulators, Saccullo had come to personify the cowboy atmosphere at Pru-Bache. He was a manager who had already been nailed once by regulators for failing to supervise. In most cases, there would be no question. Saccullo would be fired. But Sherman was putting everything on the line for him.
Ball stood up. “All right, Bob,” he said. “I hear you. I understand what you’re saying. We’ll see what we can do.”
Sherman thanked Ball and got up to leave. Ball wasn’t quite sure what would be done with Saccullo. He figured that Saccullo could probably continue at the firm only as a broker. Once the SEC filed their complaint, he thought, there would be no way for Saccullo to continue in a management role at Prudential-Bache.
The day broke bitterly cold on January 2, 1986. The New Year’s festivities had just ended. After a day of rest, the nation’s stockbrokers and traders were coming back to life. It was a slow, easy day. Most businesses were not yet back up to full speed. In the nation’s newsrooms, the first working day of the New Year was widely known as one of the dullest.
But in the press room at the Securities and Exchange Commission, excitement was brewing. The commission was releasing a thick pile of documents in what officials promised would be a major securities case. By early afternoon, copies of release number 34-22755 were dropped off to the reporters. At the top of the document, the case citation read “In the Matter of Prudential-Bache Securities Inc.”
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