Serpent on the Rock

by Kurt Eichenwald

  “Oh, my God, Mike,” Tillman said. “The people I put into these deals are some of my best friends in the world. What the hell do I tell them? What do I say?”

  Tillman swallowed hard. He might not know what to tell his clients, but he knew what he would tell his colleagues. He was ready to make enough commotion that by the time he was done, brokers throughout Prudential-Bache—including all of the biggest sellers of Harrison’s deals—would know the truth. The same questions would start to be asked again and again. How could something like this have been kept secret? And where were the people who were supposed to be watching the Direct Investment Group?

  Kristi Mandt, a broker with Prudential-Bache’s Seattle office, woke gradually on the morning of July 9, 1986. Her head pounded a bit, and her mouth felt dry. Before she opened her eyes, Mandt knew she had drunk too much the night before. That was bad. Mandt had been struggling with alcoholism since 1983. She knew if she kept drinking, her job was on the line.

  Mandt slowly opened her eyes. She was in a hotel room. She looked over to the side of the bed and felt a rush of shock. Lying next to her was Bob Sherman, the head of retail for Prudential-Bache. She looked under the sheets. Both of them were naked. She could tell that Sherman had had sex with her.

  Mandt stood up, looking for her clothes scattered around the room. She needed to dress and get out. Slowly it all started to come back to her. She was in Denver, Colorado, at a sales conference. A few weeks earlier, Carrington Clark, the Prudential-Bache regional administrator in charge of her office, had told Mandt that her drinking had put her job in jeopardy. Clark said he had kept her from being fired. Now, he said, she was in debt to him. He could fire her at will. The speech frightened her. She needed her job.

  Then Clark told Mandt that he wanted her to fly to Denver for the sales conference, where she would meet up with him and Sherman. Mandt did as she was told. On arriving the night before, Sherman and Clark took her to a bar. There they all drank heavily. They did nothing related to business. Mandt remembered very little else. She felt ashamed. Sherman, and maybe even Clark, had sex with her while she was drunk, she thought.12

  As Mandt gathered her things, she noticed her airline ticket and scooped it up. She needed to keep it for later. When Clark told her to travel to Denver, he said all expenses would be paid; all she had to do was send him her ticket receipt for reimbursement. As she packed to leave, she remembered precisely what Clark had said about the bill.

  “We’ll just charge it to a limited partnership promoted by Prudential-Bache.”

  Garnett Keith, a vice-chairman of the Prudential Insurance Company, dabbed a linen napkin to his mouth as he ate his lunch. He was eating alone with Jim Darr for the first time. In recent years, Darr’s Direct Investment Group made up such a huge portion of Prudential-Bache’s revenues—and was one of the few departments in the whole firm that showed a profit—that the senior officers of Prudential Insurance could not help but notice. George Ball himself had nothing but praise for Darr, and often singled out the Direct Investment Group in his presentations to the board of directors of Prudential Insurance. With Darr’s unquestionable success, he might be someone on the way up in the Prudential organization. So Keith, a bone-thin man with graying hair, was more than happy to host Darr for lunch in the fall of 1986.

  Things went poorly almost from the start. Even though Keith had a Wall Street background, he was used to dealing with insurance executives and sophisticated investment bankers. Darr was nothing but a pure salesman, and one who was far too ham-fisted in his self-promotion.

  As Keith listened, Darr expounded on the huge volume his department was doing in partnerships and the great success he saw for the future. Darr’s naked ambition was too close to the surface. His crude attempts to portray himself as the person who should run Prudential-Bache’s retail division, or perhaps even take over for Ball someday, left Keith uneasy. This was Darr’s big opportunity with Prudential Insurance, but he was taking a wrecking ball to his own reputation. By the time the lunch came to an end, Keith felt a strong distaste for the executive so responsible for bringing in revenues to the firm.

  “Well, Jim,” Keith said as he stood up. “That was a most enjoyable lunch. We’ll have to do it again sometime.”

  Smiling, Keith headed toward the exit with Darr. Despite his attempt to project enthusiasm, he was glad the lunch was over. Darr unsettled him. But Keith never shared his concerns about Darr with George Ball, the man most responsible for the business of Prudential-Bache.

  In Frankfurt, West Germany, Guenter Hoffstaedterr, an executive with the Bache office there, prepared a cable for transmission to Clifton Harrison. Hoffstaedterr had developed a relatively close relationship with Harrison over the years, although most of their conversations were by cable and telephone. Hoffstaedterr had believed in Harrison, particularly given the strong backing that the Texan received from the New York headquarters. That was why Hoffstaedterr had so strongly pushed the Bessemer–Key West deal among German citizens.

  But the customers had grown angry about their investment in recent years. First, they stopped receiving distributions. Hoffstaedterr begged Harrison to figure out a way to make them, but to no avail. He didn’t know that Harrison had kept all the money that could have been distributed as a fee. Now almost all the customers were demanding their money back, plus 50 percent. They came in waving some piece of paper Harrison had signed committing himself to make the huge payoff. Hoffstaedterr knew that Harrison didn’t have the money on hand to buy back the interests. Worse, he knew that Harrison had told no one in New York what was happening. With each new demand from a customer, Hoffstaedterr’s concerns grew. He had to reveal to his bosses in America what was happening.

  At 6:15 P.M., Frankfurt time, Hoffstaedterr sent off his cable over the RCA Global Communications network. In it, he told Harrison about a few new customers who wanted their money back and added up the new total debt for him. Near the end, he delicately told Harrison that as far as New York went, the jig was finally up.

  “Clifton, please remember that whatever happens in respect to your repurchase obligations, I have to report to my senior officers in New York,” he wrote. “I hope that this is understood and doesn’t upset you.”

  The news would greatly upset the executives at Prudential-Bache in New York.

  “Tough shit. It’s Harrison’s problem. We’re not paying it.”

  The lawyer from the New York legal department could not have been more vehement when talking to the firm’s executives in Frankfurt. Almost as soon as Hoffstaedterr informed his bosses in New York, the matter had been turned over to the firm’s lawyers. After just a little research, they were well aware that Harrison did not have the means to shell out almost $2 million to his investors. He already was swimming in personal debt— finding a bank to take care of this problem would be almost impossible.

  But the lawyers took a hard line. In their conversations with the Frankfurt executives, they repeatedly stressed that Prudential-Bache would not shell out a penny to any of the German investors. Harrison had been the one who signed the commitment letter; Bache had just been the selling agent. It was not responsible.

  That aggressive position did not last for long. Some of the German investors became angry with the repeated refusals from Harrison and the firm to honor the commitment. By Harrison’s agreement, they were supposed to have been paid their money by September 30, and yet by October, they were still waiting with no end in sight. Some of them contacted German regulators. Within a matter of days, officials from the West German government called Pru-Bache in New York, demanding to know why it was not honoring the commitment.

  When the lawyers argued that the commitment had been Harrison’s and not theirs, the German officials were not impressed. After all, the letterhead Harrison had used was for a company called “Bache-Harrison Associates.” That, the officials said, was enough to put Prudential-Bache on the hook. The Germans did not know, nor would they likely have cared, that Bache-Ha
rrison had simply been a contrivance intended to be nothing more than a means of gathering fees.

  After some back-and-forth, the officials implied heavily that if Prudential-Bache chose not to live up to its commitments, the firm would be facing trouble. It might even lose its right to sell securities in West Germany.

  That changed the lawyers’ minds. They realized this was a problem that the firm would have to help resolve. Prudential-Bache would have to bail Harrison out of trouble again.

  At precisely forty-five seconds after eleven o’clock on the morning of October 22, 1986, the Marine Corps band assembled on the south lawn of the White House struck up “Hail to the Chief.” President Ronald Reagan, wearing a lightweight brown suit, strode briskly from the White House toward a specially erected platform. It was a glorious, Indian-summer day. Behind Reagan, the Truman Balcony of the White House was decorated with rows of yellow chrysanthemums. Reagan bounded up to the platform and smiled out to a crowd of more than fifteen hundred people. It was the largest audience ever gathered during the Reagan administration for the signing of legislation. But it wasn’t every day that the federal tax code was revised from top to bottom.

  As the crowd applauded, Reagan passed by a desk and walked to a podium that held the presidential seal.

  “Well, thank you, and welcome to the White House,” Reagan said. “In a moment, I’ll be sitting at that desk, taking up a pen, and signing the most sweeping overhaul of the tax code in our nation’s history. To all of you here today who’ve worked so long and hard to see this day come, my thanks and the thanks of the nation go out to you.”

  It had been an incredible journey to this day, beginning in 1982 when Senator Bill Bradley and Representative Richard Gephardt proposed the Democratic version of tax reform. In 1984, Don Regan, the secretary of the Treasury, had unveiled his own version, and in 1985, Reagan had adopted tax reform as the central piece of domestic legislation in his second term.

  The legislation was shockingly simple. It replaced more than a dozen tax brackets, ranging from 11 percent to 50 percent, with two basic brackets. The top bracket was just 28 percent. In exchange, the legislation wiped away hundreds of deductions that taxpayers had used over the years to cut their tax bills. The new legislation would almost completely gut the tax shelter business, which had been fueled by the rules in Reagan’s first tax bill.

  “I feel like we just played the World Series of tax reform,” Reagan said to the laughter of the crowd. “And the American people won.”

  “Tax reform should be a wash,” Darr told the executive committee of Prudential-Bache. “It shouldn’t affect our partnership sales at all.”

  Ball listened impassively as Darr made his presentation. For months, Pru-Bache’s senior executives had watched anxiously as the tax reform legislation moved slowly through Congress. Some had felt elated each time the legislation seemed to be teetering on the precipice of failure; they had felt dismayed when, time after time, the bill survived, only to move the next step toward becoming law. By the summer of 1986, when tax reform had begun to seem much more of a real possibility, Ball had begun asking Darr about whether the Direct Investment Group could survive. Darr had assured him repeatedly that it not only would survive, it would flourish. So, now that the bill had become law, Darr was presenting his upbeat viewpoint to the executive committee of the firm.

  To a large degree, the department’s survival was a testament to the planning of Ball and Darr. By redirecting their energies in 1982 away from just tax-driven deals, focusing their attention instead on economic deals like the energy income partnerships, they had created a special niche in the industry. They believed that business could survive whatever tax changes Washington wanted to put in place.

  Of course, the potential tax deductions of an asset such as real estate make up a portion of the price any buyer would be willing to pay. A property without tax deductions would be worth less than a similar property that offered such benefits. But Darr told the committee that Washington’s removal of that tax value was meaningless for the future of the department.

  “If we’re looking at a building worth $20 million last month, it should be worth $12 million today,” Darr said. “The price adjustment should be instantaneous. This is a sophisticated market. We just buy at the lower price and ride the profits up from there.”

  The argument was sheer lunacy—every lobbyist for the Realtors, syndicators, and builders had argued all through the drafting of tax reform that it would send real estate into a prolonged recession. An apartment building was not like a stock—it didn’t have an instantaneous quote adjustment on the floor of some exchange. Instead, because real estate was illiquid, prices would have to drop slowly, over many years, as sellers and buyers struggled to find the true value of the assets. It was a process no one in the real estate industry had ever been through before.

  But Ball felt soothed and delighted by Darr’s breezy assurances. Partnership departments around Wall Street were shutting down, but Ball just shrugged that off as bad planning on their part. He felt sure that he had the best people in the partnership business. Ball could trust their judgment. Prudential-Bache’s advertising didn’t just describe the firm as “market wise” for nothing. The Direct Investment Group could keep growing strong. With so many firms dropping out of the business, now was the time to try to step up Prudential-Bache’s sales and start profiting from their experience.

  “All right, Jim,” Ball said with a smile. “Go get ’em.”

  Clifton Harrison stood in his home in Dallas, holding the telephone slightly away from his ear. On the other end of the line, Joel Davidson, a lawyer from Prudential-Bache, was screaming at him.

  “Sir, I honestly don’t believe this is my obligation,” Harrison said. “Perhaps Mr. Hoffstaedterr said some things to the German investors that I didn’t understand. I don’t speak German.”

  Davidson was apoplectic. The commitment to the German investors was written in English. It was signed by Harrison. This was Harrison’s obligation. He had to make good on it. The stakes were too high.

  Finally, after days of negotiation, Harrison agreed to Prudential-Bache’s demands: He would accept the responsibility for repaying the Bessemer– Key West investors their money but would use loans from the firm to do so.

  By early November 1986, Davidson was writing up the outlines of a deal between Harrison and Prudential-Bache. Under their agreement, Pru-Bache would loan Harrison about $1.9 million in exchange for two promissory notes from him. Interest payments on the notes would be due quarterly. As security, Harrison would take out a second mortgage on the Bessemer Shopping Center in Alabama, granted in favor of Prudential-Bache. Harrison would not be permitted to sell the Bessemer property, and all of the cash flow from it would be applied to paying the new mortgage interest.

  Harrison accepted the terms. Under the highly restrictive agreement, he waived all his rights to the Bessemer property until he paid Prudential-Bache back the $1.9 million. The property effectively belonged to Pru-Bache.

  The lawyers for Prudential-Bache felt comfortable that they had protected the firm’s interests. But there was one big problem: Whenever a mortgage is created, it must be recorded for public files. If Pru-Bache did that, a public record would be created, one that would be accessible to every investor in the Harrison partnerships—as well as their lawyers. Recording the mortgage would be direct proof of Harrison’s financial problems. It also could lead to the disclosure of the huge commitment Harrison made in 1980 to the Bessemer–Key West investors. More than $250 million in Harrison partnerships had been sold by the firm since then, and not one of the disclosure documents revealed the commitment to the Germans. Any investor who found out about it could sue.

  Prudential-Bache sidestepped the problem, and the mortgage was never recorded. No public document was created. Investors would never be told of this financial crisis.

  Prudential-Bache, as a firm, was now effectively a secret investor with Clifton Harrison. It would soon
learn the grim reality of that position: Despite the written assurances, Harrison would soon renege on every term of the agreement. Within a few months, he skipped the first quarterly payment he owed on the loan. Soon he was declared in default.

  Prudential-Bache lawyers threatened to take legal action against Harrison but never did so. They had outsmarted themselves and handed Harrison a weapon: If they sued, the firm would create a public document showing all of the information it had failed to disclose to investors. Harrison had them over a barrel.

  Harrison’s control of the situation was so complete that, later, when he sold the Bessemer property and pocketed the proceeds, Prudential-Bache didn’t raise a single objection. Years later, when asked why Harrison had been allowed to walk away with millions of dollars of the firm’s money, Loren Schechter offered an incredible explanation.

  “It was an administrative oversight.”

  “Mr. Harrison, would you raise your right hand and repeat after me, please.”

  Harrison, seated at a conference table in his lawyer’s office on East Fifty-second Street in Manhattan, raised his hand and swore to tell the truth. It was ten o’clock in the morning on March 23, 1987. The lawsuit brought by John McNulty, the angry investor in the Archives deal, had finally reached Harrison’s doorstep. Charles Cox, McNulty’s amiable but aggressive Minneapolis lawyer, was ready to start the deposition. It would be the first time that any investor with Harrison would be able to ask him questions under oath.

  The stakes were enormous. Almost without fail, every deposition begins with a short questioning about the witness’s background. Depending on the questions Cox asked, Harrison might be compelled to reveal the secret of his criminal background that he and Prudential-Bache had tried so long to keep hidden.

  Cox reviewed some notes. After asking Harrison to state his name and place of residence, Cox started with an open-ended, catch-all question.