“There were no scales on your eyes last fall,” the caption announced on the cover. “Thanks to you, this is the one that didn’t get away.”
Inside, the first page featured a picture of brokers standing on a ship, holding huge fish in the air, along with a sign proclaiming “Growth Fund: 17% annual distributions.”
A huge portion of that distribution came from the secret $4 million shuffle of cash in the HRB Rig loan that had actually produced a $1.2 million loss. Nothing was said of that.
“Congratulations to all of you for helping to make the growth fund such an enormous success!” the newsletter said. It also added that the high returns meant brokers could sell even more of the next growth fund, called G-2.
“You’ll find it much easier netting new accounts for G-2,” it said. “Big and little fish alike will respond to the allure of high returns, and you’ll be hoisting your sales higher!”
The purported success of G-1 had its effect. After raising just $89 million from about six thousand Prudential-Bache investors for the first growth fund, the fictitious performance brought in many new investors. More than nine thousand people, mostly small investors including many in retirement, sank $118 million into G-2.
It, too, would prove to be a loser.
John Hutchison walked out of his office on the thirty-third floor at Prudential-Bache and headed down the hallway. Hutchison felt pretty good about the work he had been doing in marketing the growth fund. With this latest 17 percent return, the growth fund really seemed to be proving itself. Lingering doubts among the brokers about the deal had held down the sales of G-1 somewhat, but now the performance was proving the naysayers wrong. Hutchison was getting ready to make a new pitch for G-2 and wanted to check a few things out with Brian Martin, an executive in the due diligence department who had been assigned the job of reviewing the growth fund’s performance.
Hutchison reached Martin’s office and tapped on the door as he walked in.
“Hey, Brian,” Hutchison said in his thick North Carolina accent. “How’s the deal doing?”
The instant Hutchison saw Martin’s face, he knew something was terribly wrong. Martin was pale, looking almost panicked. He signaled for Hutchison to close the door.
“God, Hutch, you’re not going to believe this,” Martin said. “I’ve been reviewing the loan portfolio we purchased from First City.”
Martin paused, then swallowed. “Hutch,” he said, “there’s not a single investment inside that portfolio that’s anything close to what we’ve been saying.”
“What?” Hutchison spluttered.
“None,” Martin said, shaking his head. “Absolutely none.”
Hutchison felt the blood rush from his face. His head was spinning. At that instant, an odd thought flashed through his mind. This was one of those “Kennedy assassination” experiences. He would never forget where he was when he realized that the Direct Investment Group had engineered a multimillion-dollar fraud with the first growth fund.
“Linda, could you please tell me how many of Fred Storaska’s orders are real?”
Hutchison was on the telephone with Linda Harding, a regional marketer for the Southwest. It was June 1987.
“They’re all real, John,” Harding said, laughing.
“Right.” Hutchison snorted. “Tell me that when he calls back in to cancel half of them.”
Despite what Hutchison knew about the fraud in the first growth fund, it was still his job to help market the second one. To do that, he had to keep an eye on purchase orders submitted by Storaska, the director of Corporate Executive Services in Dallas.
In the time since he had been hired by George Ball, Storaska had increased his business each year. His CES department had been doing well in its focus on the investment needs of newly wealthy entrepreneurs. By 1987, Storaska had accounts that were the kind other brokers built entire careers on. Part of the Onassis family money was invested with Fred Storaska. Some of the wealthiest oilmen in Texas trusted their savings to him. The reach of CES had become so broad that almost every entrepreneur who became rich by selling a company eventually received a cold call from Storaska or a member of his staff.
On top of that, Storaska had rapidly become the most important Prudential-Bache broker for the Direct Investment Group. Once he discovered limited partnerships about a year before, it seemed he could not sell enough of them.
But to midlevel executives like Hutchison, Storaska’s big business was largely a joke. The huge orders frequently arrived all on one day. Sometimes it would be on the last day that was counted toward monthly commission payments. Other times it was the last day that a particular partnership was for sale. Invariably, after the huge orders were in and the commissions were paid, Storaska would cancel them. No one watching closely in the Direct Investment Group could believe that so many of his clients could order the partnerships on the same day and all change their minds a few weeks later. It appeared as if Storaska was doing nothing more than lending himself huge amounts of the firm’s money interest-free each month by abusing the commission system.13
On June 12, 1987, Storaska placed at least $1 million in orders for partnerships, including $500,000 worth of the second energy growth fund. All of it went into just five customer accounts. Every customer ordered the exact same thing: $100,000 worth of the growth fund and $100,000 worth of a partnership called Summit Insured Equity. The mass order, entered on the last day of the commission month, had attracted Hutchison’s attention. That was exactly the kind of order Storaska would later cancel. On seeing it, he had immediately called Harding to find out how much of the order was going to be canceled.
Despite Harding’s confidence that Storaska’s orders were real, in a few weeks they were all canceled. Grose, the Dallas branch manager, sent an angry memo to Storaska, the latest in a series he had written accusing his top broker of improprieties.
“It is unacceptable for you to place a trade in a customer’s account [if] you have not previously discussed the trade,” Grose wrote. “In addition, it is unacceptable to place a trade in a customer’s account with intentions to move the trade to the appropriate customer at a later date. These actions are a major breach of internal policies and regulatory rules.”
Grose ended his memo with a threat. “Under no circumstances should this ever be done in the future. Trades must be placed where they belong with the customer’s full and prior knowledge. Any deviation will force me to take serious action.”
The threat meant nothing to Storaska. Three days later, he did it again, purchasing $50,000 worth of the energy growth fund for one of his clients. The trade was later canceled, with the customer claiming he had never been consulted. The purchases of partnerships—both canceled and kept— continued throughout the year. As always, Grose took no action out of fear of alienating his superiors, including George Ball. Storaska’s abuses continued unabated, pushing up the total sales of partnerships. He became one of the biggest winners of sales trips in all of Prudential-Bache.
The helicopter sat silently at the Kahului Airport in Maui as the first evening stars came into view. The pilot had been waiting several hours, ready to transport Darr and his party to their hotel on the Hawaiian island. They were the only ones on the Graham Resources’ 1987 sales trip to Maui who had demanded a helicopter flight to the Kapalua Bay Hotel and Villas. Darr did not want to endure the forty-five-minute drive over rough terrain. Besides, the cost of the helicopter would just be billed to the energy partnerships.
But that night, Darr’s plane arrived late. It was too dark for the helicopter ride. He seemed angry after hearing that he would have to travel to the hotel by car, just like everyone else. Within minutes, the car was loaded, and Darr was on his way. The partnerships still paid for the helicopter time.
By 1987, the Graham partnerships had become the most important product sold out of the entire Prudential-Bache system. Series II of the energy income program had been completed, and Series III was well under way, with more than $200
million in sales. The growth fund, of course, had been selling at a rapid clip. For all of 1987, Graham was projecting that it would sell $450 million worth of both partnerships. This trip to Maui was the perfect capper, a celebration of another year of big sales.
John Hutchison, the Pru-Bache product manager who helped arrange the trip, arrived in Maui exhausted. He was the one who had been assigned to arrange Darr’s helicopter. Darr had also demanded that several cases of expensive wines be waiting for him in his room, and Hutchison had spent hours on the telephone in search of his boss’s favorites. It was such a common demand that Hutchison kept Darr’s usual choices—Jordan ’77 and ’78, and Château St. Jean ’83—scribbled in his Rolodex for easy access. After finding enough of the wines, Hutchison then had arranged to have them shipped from the mainland to Hawaii.
A day or so into the trip, Hutchison wandered by the swimming pool at the hotel when he noticed his wife, Robin, sitting next to a Houston broker named Joe Siff. Hutchison slumped into a neighboring lounge chair and ordered a drink from a passing waiter. Siff was delighted. He liked Hutchison and always knew he would be good for another amazing tale about Darr’s excesses.
“Hey, John,” Siff said. “What’s the latest story on Darr?”
Hutchison sighed deeply. “You’re not going to believe this one, Joe.”
For the next few minutes, Hutchison told his rapt audience about the helicopter Darr had demanded and the long search for cases of his favorite wines.
“But that’s not the worst of it,” Hutchison said. “He demanded about two or three times the amount of wine that he could conceivably consume, even with a party. I don’t know what he’s up to.”
A few weeks later, Hutchison was back in New York. He needed to settle a few final issues on the recently completed trip. He telephoned Valerie Lee, a vice-president of the Wernli Group, the travel agency for Graham. Before Hutchison could get two words out, Lee interrupted.
“So, John, you know what happened with all that wine shipped out to Darr’s hotel?”
At first, Hutchison wasn’t sure he wanted to know. “No, what happened?” he asked cautiously.
“He had it all boxed up and shipped back to his home in Connecticut.”
This sounded like too much, even for Darr. “You’re kidding me,” Hutchison said.
“No, really. We were originally going to ship it UPS, but somebody at the hotel told the UPS man it was alcohol, and they refused to ship it. So they had to box it up and send it Federal Express.”
Hutchison finished his conversation and hung up the telephone, disgusted. From what he heard, the partnerships appeared to be spending money to stock Darr’s wine cellar.
He stood up, wandered down the hallway, and walked into Joe DeFur’s office. Everything he heard made Hutchison so anxious that he felt compelled to tell someone else about it. So he described everything he knew about the helicopter and the wine.
DeFur looked on, seeming nonplussed. But Hutchison was looking for an answer.
“Joe,” he asked, “why does Darr do this?”
“Because he’s the chairman of the department,” DeFur replied casually. “That’s the prerogative of the chairman.”
That summer, Darr latched onto a whole new idea about how he could make himself some money off the energy partnerships: unload Prudential-Bache’s interest in the energy income partnerships.
Clients and brokers were already beginning to see the first signs that the income partnerships didn’t work. The oldest of those partnerships, P-1 through P-4, no longer had the inflated distributions that investors had received early on. Their distributions dropped to 3 percent or less, a far cry from the 15 to 20 percent investors were told to expect. Investors with passbook accounts were earning more.
Each quarter, brokers called the Direct Investment Group and Graham Resources to find out why the distributions were so low. Every time, they heard a new excuse: A well had caught fire. There had been a tornado. There was a lag time between pumping the oil and seeing the profits. For a while, those stories had seemed to satisfy the brokers, but sales of the partnerships were starting to suffer.
In that atmosphere, Darr approached Tony Rice with a whole new idea. He had been reviewing his personal contract, which provided him with a piece of the money from the Prudential-Bache subsidiaries that served as general partners. Bearing that in mind, Darr told Rice that he wanted Graham Resources to strike a new deal to buy Prudential-Bache’s interest in the income funds.
“If I could sell Pru-Bache’s interest in these partnerships, I could make a lot of money by virtue of my contract,” Darr said. “I want Graham to make a tender offer for the Pru-Bache interest.”
Rice agreed to look into the idea, but it did not go over well with Graham executives. Rice came back to Darr and told him the idea would not fly. Graham Resources could not get the financing to pay for the deal. Darr said nothing, but he looked angry. He clearly wanted to make that money.
Darr came back, again and again, with new ideas about how he could make money by changing the way the energy partnerships did business. On July 23, 1987, Darr was in California when he called in to the office. He heard that Pittman and DeFur were meeting with Al Dempsey from Graham. Darr was immediately patched into the meeting through a conference call. He had an idea he wanted to explore with Dempsey, he said.
“How much cash is available in the income and growth funds for investment?” Darr asked.
“Basically, we’ve got about $275 million of the energy income fund and about $275 million of the energy growth fund,” Dempsey replied.
Darr asked a few more questions, then explained why he was interested.
“Prudential-Bache is changing our compensation,” he said. More of it would be based on the dollar volume of transactions filed. “So it would be better for all of us in the Direct Investment Group if you guys registered and became effective with any proposed transactions before December 31.”
Dempsey and Darr talked about the terms for a few minutes. Finally Dempsey agreed that Graham would work to ensure that the next $500 million worth of energy growth funds and energy income partnerships would be put together quickly. They could be ready for sale as soon as November.
Huge decisions about the future of partnerships involving thousands of investors were being based on the financial interests of senior executives in the Direct Investment Group.
The management committee of Graham Resources met on October 27, 1987, in a conference room at the company’s new headquarters in Covington, Louisiana. They faced a serious problem: Just nine months after the sale of the first growth fund was finished, the partnership was in desperate financial trouble. One Graham executive said that the growth fund only had enough money to pay an 8 percent distribution, but the market was expecting a distribution of 15 percent to 17 percent, which had to be paid in about two months. Investors were already jittery because the stock market had crashed eight days before. If the growth funds failed to perform, sales for every one of the Graham products might collapse.
There was only one significant deal in the pipeline for the growth fund, involving a transaction with Maple Gulf Coast Properties, a company partially owned by a consultant to Prudential. That transaction had been recommended about two weeks before but would not provide cash returns quickly enough to boost the upcoming distribution.
Within a week of the management committee meeting, the deal with Maple was changed. The growth fund agreed to purchase $6 million worth of preferred stock from Maple, although the true cost to the investors was closer to $7 million. About $1 million of their investment had been taken off the top for fees to Pru-Bache and Graham. The remaining money was handed over to Maple in November.
Of course, for there to be a distribution, the growth fund had to transform its investments into cash. So a few weeks after it handed Maple the $6 million to buy the preferred stock, Maple handed the same cash—from the same bank account—right back. The money paid part of a loan Maple had rec
eived from the growth fund. Effectively, the investors in the growth fund had paid off the Maple loan themselves. Then another 15 percent was sliced off the $6 million for the back-end fees to Graham Resources and Prudential-Bache. The remaining $5.1 million was distributed to the growth fund investors.
The growth fund celebrated its 14 percent distribution as a sign of its strength. No investors were told that they had just suffered a $1.9 million loss.
David Wrubel, a bearded young executive with a long history in the partnership business, sat in an anteroom outside of Darr’s office. He had been scheduled to meet with Darr at 2:00 P.M. and had been waiting for almost half an hour. He was supposed to be interviewed by Darr as the last step in getting hired as a marketer in the Direct Investment Group. He didn’t like the idea, but he needed the job and tried to be philosophical about it. If his father could survive World War II, Wrubel figured, then he could survive Prudential-Bache.
In a wave of cutbacks following the stock market crash a few weeks before, Wrubel had just lost a job marketing partnerships for Drexel. The timing was dreadful. He and his wife were expecting their first child in a matter of weeks, and at that moment, throughout Wall Street, thousands of people like him were being shown the door.
He had heard from some friends at Prudential-Bache that there was an opening as a regional marketer in the Northeast. He feared it would be nothing like his last job. Despite all the investigations of Drexel’s junk-bond department, he thought the firm was a great place to work. Everyone there seemed concerned about turning out high-quality partnerships. But Prudential-Bache had the reputation of being a schlock house that attracted lightweights. During his years in the partnership business, he had heard too much about Darr’s ego and bizarre behavior to think that the Direct Investment Group might somehow be an exception.
He had already had a taste of the department’s peculiarities. The previous night, he had received a call at home from Barron Clancy, one of the senior executives in the Direct Investment Group. Clancy said he had terrible news: Darr didn’t like beards.
Serpent on the Rock Page 38