The symbolic importance of the indictment was lost on no one. Simmons’s effort to rebuild the Direct Investment Group died.
That same summer, a young state prosecutor in Tucson, Arizona, was beginning to see the broad outlines of a criminal case in the partnership scandal. John Evans, an assistant attorney general for Arizona, first heard about troubles at Prudential Securities from a plaintiff’s lawyer in Tucson. At first, it seemed only to involve fraudulent partnership sales by a Prudential broker in Arizona named Jay Jablonski. Evans started to pursue the case with the same mentality the Dallas prosecutors had toward Schiller: This was a fraud caused by a bad broker.
As Evans called around to other local lawyers, he learned that Jablonski’s major defense was that he, too, had been deceived by the brokerage firm’s partnership department. Arizona securities regulators had received dozens of complaints about the firm’s partnership sales, most of them involving the energy deals with Graham. The regulators told Evans that they were conducting an investigation into the firm’s partnership sales. Many of the complaints referred them to the Bristow, Hackerman firm. Already the regulators had obtained a large number of internal marketing materials from the Houston lawyers.
Intrigued by what he heard, Evans obtained copies of the Bristow, Hackerman records for himself. By the time he finished reviewing them, he had no doubt that he had enough information to justify a criminal investigation. But Evans also knew that a state attorney general’s office would need help taking on a firm like Prudential Securities. His department had only three investigators, and alone they could never crack the case. So, in August 1992, Evans picked up the telephone in his office and dialed a number in the Tucson federal building. The telephone rang just a few times before it was answered.
“FBI,” a receptionist said.
The first criminal investigation of the partnership scandal had begun.
A group of almost a dozen executives and lawyers with Prudential Securities gathered at the firm’s headquarters in the summer of 1992 to debate a single question: Could Prudential Securities finally fire Fred Storaska?
Michael McClain, who had been installed as manager of the Dallas office in late 1990, was demanding the right to get rid of the big-producing broker. As always, the firm was raising hurdles. Storaska already had more than $20 million in claims filed against him by clients. With so much on the line, McClain’s regional director, Peter Archbold, was not willing to fire the man without consulting the top executives in retail, as well as Schechter and other lawyers for the firm. Archbold organized the meeting in New York.
Every executive who had contact with Storaska was there, including three men who had worked as his branch managers. Also in the room from the retail group were George Murray, the head of retail, and Joseph Haick, Murray’s second in command. Schechter was there with a number of lawyers who worked for him, including Noah Sorkin and James Tricarico.
McClain was given the floor. He said that Storaska refused to allow himself to be supervised. In one case, McClain had ordered Storaska not to do certain business, but the broker just ignored the instructions.
The biggest problem in McClain’s mind was something he had found and already shut down. In 1988, Storaska had reached a secret pact with a Prudential Insurance agent named Don Gustovich. Under the agreement, Gustovich would be the agent who would sell Storaska’s wealthy clients their multimillion-dollar life insurance policies. But the sales would not be processed through Prudential, which normally would claim half of the commissions. Instead, the sale would go through a shell company called Ambryshell, headed by Storaska’s wife, Betty Lou. She was not licensed to sell insurance. Through the scheme, money that should have gone to Prudential went into Storaska’s pocket instead.
“I want to fire him,” McClain concluded.
“So what’s the problem?” Joe Haick blurted out. “Fire the son of a bitch.”
The lawyers disagreed. “We’re not going to fire him,” Schechter said. “We’ve got millions of dollars in lawsuits from his clients. We need him as a friendly witness.”21
Some of the retail executives shrank back. It seemed as if the only way to avoid getting fired at this firm was by angering lots of clients.
“I could force him out, get him to resign,” McClain said.
“How could you do that?” Schechter asked.
“You’ve got to understand this guy,” McClain said. “He’s an egomaniac. Right now, he’s working in his office a floor below the branch. I’ll tell him we can’t afford the space anymore. We’re moving him upstairs to a nice little office next to mine. That we’re going to cut his staff in half. Fred’ll never stand for it. He’ll resign as soon as he can.”
Schechter thought about it for a moment. “If you think it will work, give it a try.”
The plan was in place. Prudential Securities would force Storaska, a man his bosses believed to be violating any number of securities laws, to resign without a mark on his record. Of course, some other firm would hire him, and he would start doing his business elsewhere. And the problems that led to $20 million worth of lawsuits could start all over again somewhere else.
But nobody at the meeting mentioned that fact. After all, whoever those other clients might be, Prudential Securities wasn’t going to be liable for their damages.
The ruse worked. Within days of being told in August of his new restrictions, Storaska resigned to take a job with Bear Stearns & Company. When Bear Stearns asked about Storaska, executives from Prudential Securities gave him a clean bill of health.
Months later, Marvin Coble, the assistant branch manager in Dallas, realized that before leaving, Storaska had opened a series of accounts that charged up-front fees. Storaska had received about $26,000 in those fees before he walked out the door. Afterward, the accounts were canceled and the customers were reimbursed all of their money.
Coble spoke with Peter von Maur, one of the firm’s lawyers in New York. He explained what had happened and said that, at this point, the $26,000 repaid to customers was coming out of the branch’s profits.
“I want to see if we can go after Fred on this and get him to repay the firm that money,” Coble said.
A short time later, von Maur called back and said that the decision had been made to leave things as they were.
“We’ve decided to let him keep the money,” von Maur said. “That will help make sure that we keep Storaska as a friendly witness in all these upcoming arbitrations we have with his former clients.”
Coble hung up the telephone, chilled. He couldn’t believe that Prudential Securities was willing to walk away from that much money just to make sure it got the testimony it wanted. He was no lawyer, but he knew right from wrong. And this was damned wrong.
Jim Burns, an investigator with the Idaho Securities Bureau, sorted through the latest pile of questionnaires on his desk. Klein had assigned Burns the job of reviewing the answers to the questionnaires that the bureau had recently sent to investors in the Prudential-Bache partnerships. Slightly more than half of the 290 investors who were contacted had responded. For Burns, the questionnaires had started to seem repetitive after the first few weeks, all telling the same story: Safety-conscious investors, including a number of elderly people, were sold the partnerships as conservative and secure investments. Few of the investors ever received a prospectus before they agreed to purchase.
After a while, the responses had stopped coming in, and Burns figured that everyone who wanted to respond had done so. Then something strange had happened. All new batches of filled-out questionnaires had started arriving at the securities bureau. And the story in these new ones was the exact opposite from the earlier responses. Everyone said they knew all about the risks of partnerships before investing in them, had been provided with a prospectus right away, and had been told only truthful statements by their brokers. Burns kept mentioning the differences to Klein. In some ways, the upbeat stories raised some doubts in the regulators’ minds.
T
oday’s batch was the same. None of these investors had any complaints. Then Burns noticed something about the answers that bothered him. He was still reading through the new batch when Klein walked in and asked how it was going. All the late arrivals were still telling a story of proper sales, Burns said.
“But, Wayne, there’s something about these questionnaires that bothers me,” Burns said. “The wording in each one is amazingly similar. It’s very suspicious.”
Klein looked puzzled. He asked Burns what he was driving at.
“I think some of these positive ones were filled out by the brokers.”
On November 5, 1992, Prudential Securities reached a tentative settlement of the largest class-action suit stemming from the partnership debacle. The suit involving the energy income partnerships had been filed by a number of class-action lawyers the year before, immediately after the article in Business Week pointed out the problems with the Graham deals.
The latest settlement made all the other class-action sellouts look fabulous. For just $37 million in cash, Prudential Securities wiped out $1.4 billion in potential liability from its eight years of the energy income partnerships. The investors would receive less than two cents for every dollar they put into the partnerships.
The settlement was loaded down with a number of other features, purportedly designed to increase its value to investors. But, in truth, the biggest beneficiaries were Graham and Prudential Securities. Graham made vague assurances that it would reimburse investors for future administrative expenses of the partnerships. That term of the agreement contained the condition that, if any Graham principals stopped acting as managers, the reimbursement was off.
On top of that, Graham would be placed in charge of a publicly traded company that would take over the assets of the partnerships. The investors’ partnership units would be exchanged for shares in that new company, called Graham Energy Resources. The limited partners would lose control of the energy assets and turn them over to Graham. And they would cover $13 million of expenses associated with the roll-up.
Analysts were outraged at the deal. The American Association of Limited Partners branded the deal a “scam.”
Another partnership publication, called The Perspective, was harsher.
“Yes, the champagne will soon be flowing in Covington,” an unsigned article in the newsletter said. “And with John J. Graham receiving $375,000 a year as chief executive of this new company, you can bet it won’t be the screw-top brands. For Graham, it doesn’t get any better than this. As for the 128,000 investors? They lost out the day their partnerships were formed.”
Few of the investors would likely figure out how bad the deal really was. For those who did, the chance that they would know to opt out of the settlement was small. The deal was described in a three-hundred-page proxy. The opt-out procedure was spelled out on one page. Investors who didn’t follow the tortuous and unusual procedure of writing three separate opt-out letters to three different groups of lawyers would end up in the settlement. In all likelihood, hardly anyone would be able to figure it all out. All Prudential Securities needed was the approval of a federal court in New Orleans, and the deal would be done.
Throughout Prudential Securities, the proposed settlement was treated as a blessing. After the terms were disclosed, Richard Haughey, the manager of the firm’s Rancho Bernardo, California, office, called a meeting of some of his top brokers. The branch had been consistently one of the biggest sellers of the energy income partnerships, and it looked like the settlement would bail it out of a lot of potential claims.
As he briefed some of his brokers on the settlement in early January 1993, Haughey smiled. “We’re not supposed to give legal advice to clients,” he said. “But if your clients go into the energy income class-action settlement, they cannot sue Prudential, and they cannot sue you.”
Then Haughey winked at the assembled group of brokers.
James Barrett, one of the branch’s biggest sellers of the energy income partnership, stood up and walked out of the meeting. He was incensed. For years after the problems with the partnerships became apparent, he had demanded to know what the firm was going to do for the defrauded clients. Now he knew. It was going to cheat them again.
Barrett headed into his office where his fiancée was waiting for him. As he was describing what had just happened in the meeting, Haughey knocked on his door.
“Jim, I don’t like to see you looking so upset,” Haughey said. “What’s the matter?”
Barrett spun around. “This settlement sounds like a damn screwing, and you know it.”
Haughey closed the door. “You know what happens in class-action lawsuits, don’t you, Jim?” he asked.
“You tell me.”
“The only ones who make out in a settlement are the attorneys and the defendants,” Haughey said.
Barrett felt so angry his hands trembled. “Well, what about my clients?”
“The clients always get screwed in a class action, Jim,” Haughey said. “They always get screwed.”
After a few minutes, Haughey left. The broker sat down at his desk and stewed. He picked up the telephone, dialed the Direct Investment Group in New York, and asked for Jim Kelso, the head of the department. Once Kelso got on the line, Barrett started complaining about the horrible class-action settlement.
“Jim, it’s out of our hands,” Kelso said. “You need to talk to the law department.”
Later that day, Barrett called Carlos Ricca in the law department. He mentioned several concerns he had about partnerships and then got to the settlement.
“What’s going on with this settlement for $37 million?” Barrett asked. “Brokers in my office are saying that’s like two cents on the dollar. How in the hell can we do this to our clients? I mean, I’ve got my brother in this crap, I’ve got my ex-wife in it, I’ve got myself in it. All my good clients who are my friends are in there. How can we do this to them?”
“It’s all being done in New Orleans,” Ricca responded calmly. “It’s out of our hands, you know.”
Barrett was sick of everybody saying it was out of their hands. His anger finally got the better of him.
“Fine, it’s out of your hands, it’s out of Kelso’s hands, nobody is responsible for this bullshit,” Barrett said. “What would you do if I called 60 Minutes or Business Week and told them what the hell was going on? Would that be in your hands?”
Ricca’s voice stiffened. “I wouldn’t do that if I were you.”
“Well, I guess you’re not me, are you?” Barrett said.
Barrett was angry for the rest of the day. By January 6, two days later, he had calmed down. His statement about going to the media had been an idle threat. Instead, he just went back to work. He began his morning by preparing a mailing of two thousand invitations to an investment seminar. As Barrett was getting them ready, Haughey’s secretary dropped by. Haughey wanted to see him.
Barrett walked into his manager’s office and babbled for a few seconds about the mailing. Haughey looked on stone-faced.
“Jim, I can’t have you do that mailing,” Haughey said finally. “I have to terminate you.”
Barrett gasped. “Why?”
“This has nothing to do with me,” Haughey said, holding up his hands. “I’m just following orders. This comes straight from the law department. Carlos Ricca called and said that we had to fire you. He said that you have an overconcentration of direct investments in your accounts.”
“Wait a minute,” Barrett said. “I haven’t sold one of those things in a long time. Are you telling me they just noticed that I sold a lot of them?”
“Jim, I’m just doing what I was told. I have to terminate you for having an overconcentration of direct investments.”
Bullshit, Barrett thought. You have to fire me because Ricca thought I was going to blow the whistle.
At that moment, Barrett realized that, even if he bothered to tell any reporters what he knew, Prudential Securities would just dismiss it as t
he ravings of a disgruntled former employee. He stood up and walked out. It was his last day at the firm. Barrett left convinced that his clients would be tricked into joining the energy income settlement. But he didn’t think there was anything he could do. If Prudential Securities fired him for making a hollow threat, Barrett felt sure that the firm would crush anyone it saw as a danger to the settlement. He feared that no one would be able to stop it.
Barrett had no way of knowing that a little-known securities regulator from Idaho was just getting ready to try.
CHAPTER 18
SCORES OF CASUALLY DRESSED state securities regulators milled about the Hibiscus Room at the Brazilian Court Hotel as they hunted for their seats. The meeting about trends in securities law enforcement was scheduled to begin any minute. It was the morning of January 11, 1993, the third day of the winter enforcement conference at the hotel in Palm Beach, Florida.
The group began to quiet down as William McDonald, a regulator from California and the chairman of that day’s session, stepped up to the podium. He asked everyone to come to order quickly because they had a packed agenda. The first topic was Prudential Securities. The firm’s partnership troubles had first been mentioned at last year’s meeting. The number of state investigators had since grown rapidly.
“A number of states have approached me about complaints they have received regarding Prudential in the limited partnership area,” McDonald said. “Some states have already progressed far along in their own investigations.”
McDonald nodded toward Klein, who was leaning against a wall at the side of the room. “Wayne Klein from Idaho has been looking into this matter for some time. So, Wayne, could you give everyone a sense of what it is that you’re finding, and where the investigation might be going?”
Klein spoke for a few minutes about his department’s findings. He had expected that McDonald would ask him for a presentation. The previous day, Klein and Joseph Goldstein, a lawyer from the SEC enforcement division who was attending the conference, had spoken with McDonald about setting up a system to coordinate the different state investigations. That would help the SEC, which was receiving dozens of requests for information from regulators across the country, and could give the states more leverage in dealing with Prudential Securities. McDonald had agreed to get it done before the end of the conference.
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