Serpent on the Rock

by Kurt Eichenwald

  But the case had its benefits. Page earned the reputation among Prudential-Bache brokers and managers as a man willing to take on the firm. His office became a drop-off point for Pru-Bache employees who thought they were being mistreated. Over the years, Page heard numerous horror stories about the way employees were abused and clients’ accounts ransacked. Still, with everything he had heard, he was not disposed to believe the stories that his most recent visitor from the firm had to tell about massive fraud and deception of clients.

  Until a few weeks later. True to his word, Blass returned with his files in tow. Page met with him in a conference room just off the law firm’s entryway. For more than an hour, he reviewed the information. There was no mistake. The marketing material he sifted through clearly made the Risers out to be safe and secure investments.

  Finally, after reading an array of papers, Page looked at Blass with a smile.

  “Well, sir, congratulations,” he said. “We’ve got ourselves a case.”

  Loren Schechter walked briskly into the boardroom at Prudential-Bache, where the firm’s executive committee was meeting in 1989. He was there to make one of his most dire presentations ever. The firm had already been sued over VMS. It was a small lawsuit, one that normally could be swatted away with a quick settlement. But Schechter believed that the firm’s exposure was enormous. Hundreds of millions of dollars’ worth of the VMS investments appeared to have been sold to elderly, risk-averse investors. Its value was dropping like a rock. The case would be trouble.

  Ball glanced up and saw Schechter walking into the room. He had just finished reporting on some of the events of the day.

  “Loren, perhaps you ought to let everybody know about this lawsuit,” Ball said.

  Schechter made a quick presentation, describing the claims of the lawsuit. Then he opened the floor up to questions.

  Ted Fowler, the firm’s investment banking chief, was the first to speak up. “Well, Loren, is this just some nut that lost some money, or is this something prevalent?”

  “This is serious,” Schechter said. “This is going to be a huge problem. Huge.”

  The top sellers of the Graham energy partnerships arrived in June 1989 for their seven-day sales trip to Costa del Sol, Spain, just a short distance from the real Rock of Gibraltar. All of the best-known brokers at Prudential-Bache qualified for the trip. And by now, almost every one of them was angry.

  As always, Graham Resources and the Direct Investment Group planned an awards ceremony, where the top brokers would be honored for their sales. But unlike most years, the awards carried a bitter tinge. By that point, everyone on the trip knew that the brokers who sold the most Graham partnerships in 1988 probably had the most customer complaints in 1989.

  The ceremony was going to be led by Joe DeFur from the Direct Investment Group and Al Dempsey from Graham Resources. As DeFur was preparing, he saw Bill Webb, a broker in Pru-Bache’s branch in Fort Myers, Florida, heading toward him. Few brokers carried more credibility with the sales force than Webb. He was one of the best-known and most-respected sellers of the Graham products. In years past, Graham Resources had even featured interviews with Webb in the newsletters that the energy company distributed around Prudential-Bache. Webb’s opinion carried a lot of weight with his colleagues.

  “Hey, Joe,” Webb said as he walked over. DeFur returned the greeting.

  “Listen, I don’t want to sandbag you here,” Webb said, “so I want you to know I’m going to stand up during the ceremony and make a few points about the problems with the energy growth fund. The marketing really misrepresented everything. The investments the fund made were nothing like what we were told they were going to be. I really need to say something about it.”

  DeFur looked Webb in the eyes for a moment. “Good for you,” he stated.

  As the ceremony began, there was little jovial backslapping or frivolity. This meeting was all business. Eventually Webb stood up.

  “Al, Joe, I’ve got a few things I want to say,” Webb said. “I think we all know that there were some serious problems with the energy growth program. We’ve seen some dismal results. What we were told about the investments the fund was going to make never occurred. This program was clearly misrepresented, both to us and to our customers. So now I want to know what you’re going to do about it. What’s the answer to this problem?”

  The crowd seemed to adopt Webb’s statements as the universal opinion. As a group, they turned toward DeFur and Dempsey. The room was silent in expectation.

  “We understand, Bill,” DeFur said. “We’ll just have to get back to you on that.”

  Webb sat down, feeling proud for speaking up. Even so, he knew that he would never hear back from anyone in the Direct Investment Group.

  Bob Jackson, the regional marketer in Florida for Graham Resources, looked at the screen of his personal computer and took a deep breath. Jackson was a family man and was not the kind of person to act irresponsibly. So he had considered his actions carefully before sitting down to write his bosses a letter on the warm afternoon of August 23, 1989. He was sure that once the letter arrived at Graham Resources, he would be fired. After all, it wasn’t all that often that an employee accused his superiors of fraud.

  Jackson had been struggling for a year with the obvious signs that Graham had deceived everyone in its marketing of the growth fund. Until the prior summer, Jackson could rationalize what was happening. But after the executives in New Orleans decided to let the marketers know some of the truth about the investments that were made by the partnership, Jackson had been unable to stomach it. It was all he could talk about.

  Just the week before, Jackson had been speaking with Bill Webb from the Fort Myers branch. Webb was still clearly angry about the growth fund situation. It was obvious to him that the prospectus had been written with enough caveats to provide a cover to Graham Resources and Prudential-Bache but that customers had been told a pack of lies.

  “The prospectus may protect Pru-Bache and Graham from any legal liability,” Webb had said, “but there is very definitely a moral liability.”

  For Jackson, that summed up the whole situation. He and all the other marketers had been used in a cynical deception, and he knew it. Regardless of what it meant for his future, he could no longer keep silent about what had happened.

  Jackson addressed his letter to Pete Theo, the president of Graham Resources’ marketing subsidiary, Graham Securities. He started by saying that, in the past, whenever the marketers had questions about performance, Graham executives became defensive or tried to gloss over the issues with lots of figures and charts. That had always happened with questions about the first Energy Growth Fund, which Jackson called EGF-1. The time had come, he implied, for someone to start talking straight.

  “It is still impossible for me to look at the investments in EGF-1 and understand why anyone would have agreed to purchase them,” he typed. “We all know only too well that the program ultimately turned out to be totally different from what we were told it was going to be prior to, during and throughout the marketing of the initial growth fund.”

  There were no heavily discounted, heavily collateralized loans, he wrote. “I do not personally believe that the dismal results we have witnessed in this program would have occurred at all had the investments been made as they were represented.”

  Without using any names, Jackson recounted his conversation the previous week with Bill Webb and said that he agreed with the broker’s sentiments.

  “It has been inferred that Jim Darr was the reason that the changes that were taking place in the investment were not communicated to the brokers in the Pru-Bache system,” he wrote. “But whether or not he advocated such a policy, it would seem that it would take the cooperation on the part of certain individuals at the senior management level of Graham Resources for our wholesalers not to have been made aware.”

  This problem, Jackson wrote, had been eating away at him for a year and undercutting his ability to do the job.
Making the situation worse was the fact that all of the other partnerships seemed not to be performing anywhere close to how they had been advertised.

  “It appears that only a few of the thirty-five Pru-Bache programs formed to date would have the potential to equal the investment results of a CD if they were liquidated today, in spite of the fact that the price of oil is higher,” he wrote. After studying the data, “I am considerably more alarmed at the lack of increase in the distributions even if the price goes up.”

  Jackson wrote that Graham Resources desperately needed to address those concerns, which were shared by his colleagues. If it could not, he wrote, then there was only one option. “I would like to go on record as being in favor of then considering rolling up or consolidating the Pru-Bache energy partnerships in an effort to maximize returns to investors,” he typed, “and then withdrawing from the retail marketplace.”

  Jackson typed his name at the bottom. As he reread the letter, he was frightened. It wasn’t every day an employee suggested that his company get out of its most profitable business.

  The lunchtime crowd at Houston’s restaurant in Fort Lauderdale was large and noisy. Jackson walked through the crowd, looking for Jim Parker, the Florida regional marketer for the Direct Investment Group. Usually the two men met in Parker’s office at Prudential-Bache. This time, soon after Jackson wrote his letter to Graham, he had asked for Parker to meet him at Houston’s.

  Jackson saw Parker at a table and headed over. Parker was smiling, and the two men broke into the easy conversation of good friends. Within a few seconds, Parker could tell that something was wrong. Jackson seemed nervous, almost frightened. He was always a relaxed kind of guy with a level head. Parker didn’t want to push, so he waited to hear what the problem was.

  Jackson cleared his throat. “I really need to talk to you, Jimmy,” he said soberly.

  “I can tell. What’s wrong?”

  “It’s about something I’m about to put into the mail.”

  “What is it?”

  Jackson paused. “Jimmy, do you remember when the growth fund first came out? And I told you it was either going to make everybody a lot of money or cause everybody a lot of grief?”

  Parker nodded. He’d found the comment amusing when he first heard it.

  “Well, it looks like both predictions have come to pass,” Jackson said. “It made a lot of money—for the brokers, and Graham and Pru-Bache. But now it’s going to cause a lot of grief for everybody who invested in it.”

  Parker didn’t understand. He knew that the growth fund was having troubles but knew none of the details. “Bob, what were you saying about the mail?”

  Jackson then told him about his letter. He described how it all but accused the senior management of Graham Resources of conspiring to defraud investors. He said that he ended the letter by suggesting that Graham get out of the retail partnership business.

  Parker listened quietly and injected only a few comments. Whatever the truth was about what was happening, he knew it was agonizing for Jackson. His friend made a very good living as a marketer for Graham Resources. For him to risk losing all that, the problems had to be serious.

  “So I just want you to know in advance what I’m doing,” Jackson said.

  “Until this gets resolved, one way or the other, I’m not going into the Prudential-Bache branches anymore. I’m not going to represent these products anymore. Not when I don’t have any faith in them. And I just hope that you’ll support me in this, as a friend.”

  Parker nodded. “Bob, of course I will. Look, based on what you said, I’ve already got my own serious doubts. But listen, I don’t want to put my job on the line. I’m not going to go to New York and resign. I’m just going to quit selling the Graham products and support your efforts in however you want to go forward from here.”

  Jackson took a deep breath. “Thanks, Jimmy.”

  Parker and Jackson discussed what they should do next. Parker suggested that they go up to Gainesville to speak with Ernie Higbee, the biggest seller of the growth funds in all of Florida. Higbee had been so won over with the idea of the growth fund that he had handled some seminars on it. He even sang the praises of the fund at a regional meeting in Virginia. There he had told the brokers to “chuck” the prospectus after they read it.

  When Parker and Jackson arrived in Gainesville, Higbee was off at his club, playing tennis. They drove there and wandered around the courts. Finally they spotted Higbee, playing a set with his wife. They waited off court until the game ended. Higbee walked over, mopping his brow with a towel. The three men sat down at a table next to the tennis court.

  “Ernie, we’re here because we have something we think you deserve to know,” Jackson said. “Something has gone terribly wrong with the growth fund.”

  Higbee listened as Jackson described his concerns and how executives from Graham Resources were unable to answer his questions. He and Parker both said they were going to stop marketing the Graham products. They didn’t want any more clients hurt.

  Higbee picked up a glass and sipped a cool drink. Then he set it down. “Thank you both for coming forward on this,” he said. “I really appreciate it.”

  “No problem, Ernie,” Parker said.

  Higbee took another sip. He let out a sigh. “You know, I put all my best customers into the growth fund. Every one of them I could persuade. Every one.” He rubbed his fingers across his brow.

  “Now it looks like I’m going to lose them all,” he said. “Then they’ll all probably sue me, too.”

  Higbee slowly shook his head and took another sip. “This just isn’t right,” he muttered. “Where was everybody?”

  The surviving senior officers of the Direct Investment Group gathered somberly in the thirty-third-floor conference room. Once it had been the place where their victories were mapped out. Now it was the command center where they planned how to handle the sprawling disaster.

  Proscia had taken charge after Darr’s departure, but there was little he could do as the partnership empire crumbled. Among the other executives in the room were Frank Giordano, a lawyer who had worked for the department for years, and Mark Harper, the regional marketer for the Southwest.

  The executives looked at a loss. It seemed as if each week another handful of the almost seven hundred partnerships sold by Prudential-Bache ran into serious problems. Nothing worked anymore. Damage control was the only remaining topic of concern. On this day in 1989, they were running through the latest of the emerging problems.

  Harper rubbed his eyes, then looked at the group. “Guys, what we’re trying to do here isn’t working.” He leaned in eagerly.

  “Listen, perceived sins are forgiven if the perceived sinner admits fault and vows to do better. We need to think of that.”

  The others stared back blankly.

  “Hey, this whole thing wasn’t fraudulent, but there were some serious mistakes made that need to be rectified,” Harper insisted.

  Specifically, Harper said, it was clear that things had gone terribly wrong with all of the Graham partnerships and VMS, as well. There was no avoiding that liability.

  “If we make restitution now, we could save hundreds of millions of dollars down the road,” Harper continued. “We need to ask Prudential Insurance to step up to the table with a billion dollars and give the investors their money back with a rate of return. Just the amount of goodwill that would be saved would make it a bargain.”

  Harper stopped talking. For an instant, no one responded.

  “You must be out of your mind,” Giordano finally said. “You want us to go ask Prudential for a billion dollars? Just like that?” He snorted a laugh. “Let’s get back to work and get serious.”

  Harper’s suggestion was waved away. The senior officers never considered it again.

  John Hutchison peeked over his shoulder before he started typing codes into the computer. He had all the necessary passwords to look into brokerage accounts, and today he had decided to satisfy his c
uriosity once and for all. He was going to call up Darr’s account. He didn’t care what was already in it. He wanted to know what had just been deposited.

  Hutchison knew all about the payments from the partnerships that Darr had arranged for senior executives in the department. They were called “residuals.” Every quarter, the checks were distributed. They weren’t salary or bonus. Instead, the money was a share of the cash flow from all of the co–general partners, such as Prudential-Bache Energy Production. Money coming out of the partnerships was going straight into the pockets of the people who put together the deals and sold them. At the same time, the customers who invested their savings in the partnerships saw nothing but losses.

  The group that received the money was well known. Proscia and Pittman, of course. A number of marketers, as well. But what left Hutchison agog was the rumor that Darr had made these payments contractual and continued to receive them even though he had left the firm.

  The checks had recently gone out, and Darr’s would have been deposited in his brokerage account.

  Hutchison finally found the account and typed the necessary codes. He watched the screen as the numbers scrolled past.

  And then his mouth fell open.

  $381,000.

  Hutchison sat back, staring at the number flickering on his screen. In one quarter, Darr had received more than a quarter of a million dollars from partnerships he didn’t invest a penny in.

  The voices of all the screaming brokers ran through Hutchison’s mind. So many people were going through anguish for having invested in Darr’s partnerships.

  And he’s getting $381,000.

  Hutchison signed off the computer and sat for a moment, staring at it.

  If those payments weren’t some sort of crime, then he felt sure that somebody needed to write a law.

  “New York does the due diligence,” Richard Sichenzio said to the crowd of brokers. “New York picks the products. And your job is to sell them. You’re not supposed to examine them or ask questions about them. Just sell them.”