HOW GREED POISONED PRU-BACHE
SERPENT ON THE ROCK
By Kurt Eichenwald
HarperBusiness 480pp $27.50
It's funny what you remember from moments of intense work pressure. It was a Wednesday evening in mid-February, 1991, and my colleagues and I were putting the finishing touches on an investigative BUSINESS WEEK cover story, "The Mess at Pru-Bache." The piece, written by Chuck Hawkins, then the magazine's Atlanta bureau chief, would blow the lid off the massive limited-partnership scandal at the troubled firm. As we strained to meet the magazine's closing deadline, we received a news flash: Prudential-Bache Securities Inc. was changing its name to Prudential Securities Inc. It seemed as if the Wall Street giant was abruptly altering its identity just as it was about to be hit by scandal.
Chuck's article proved to be a bombshell that had an enormous impact not only at Pru but also with regulators, investors, plaintiffs' attorneys, and other reporters. One who subsequently began following the story was Kurt Eichenwald of The New York Times. Now Eichenwald has published a book-length account of the affair, Serpent on the Rock. At 480 pages and rich in detail and insight, it is sure to be the definitive book on the scandal. Indeed, it should be required reading for investors, brokers, and brokerage-firm managers. As Eichenwald says in his prologue: "This is a cautionary tale about an abuse of the investor faith that is an essential building block of the American economy....By taking advantage of that faith, Prudential-Bache cracked the foundation of the marketplace."
That may sound hyperbolic, but by the time you finish reading this book, you will probably decide that Eichenwald is not exaggerating. From 1980 to 1990, Prudential sold $8 billion in limited partnerships. Many of those turned out to be worth far less than the prices they fetched, resulting in hundreds of millions in losses to investors. But the sales were so lucrative for the brokers and the firm that ethical and legal considerations were apparently tossed aside. Meanwhile, across the U.S., small investors, many of them elderly, saw their life savings and hopes for comfortable retirement vanish.
How could Pru have behaved so recklessly? Eichenwald portrays a money-hungry bureaucracy where no one took responsibility for the firm's products. Product development was left to the limited-partnership department, headed by James J. Darr, whose only interest seemed to be in enriching himself. In addition to legally skimming payments off the LPs, Eichenwald says, Darr took money under the table from energy and real estate developers who then became partners for new Pru LPs. One of Eichenwald's most shocking revelations is that Darr is still collecting payments from the LPs.
Darr's boss, George L. Ball, was one of the worst chief executives the securities industry has ever seen. Ball, who had the dubious distinction of pushing a multimillion-dollar check-kiting scheme during his tenure as president of E.F. Hutton, cared little about the quality of Pru's products. His primary concern was for short-term profits that would help stem Prudential Insurance Co.'s losses--profits that the LP sales delivered. After Pru's legal staff reported Darr was on the take, it took Ball nine months to remove him, during which time $500 million more in LPs were sold.
And, as Eichenwald demonstrates, Pru's LP department was a joke: Its products were dogs, and there was virtually no due diligence to ensure that investment ideas were legitimate. Darr intimidated employees into rubber-stamping harebrained projects, such as a fund to buy discounted bank loans secured by oil reserves--loans that never existed. Then department personnel would win over brokers with tales of high rates of return and handsome commissions. Brokers who questioned the LPs' performance were fired. Those who went along got trips to conferences in such places as Hawaii and Scotland.
Despite such systemic abuses, some Pru employees and others behaved heroically. Early in Darr's career at Pru, five limited-partnership professionals met secretly to figure out how to stop Darr. They alerted Pru's legal department, claiming that at his previous job Darr took payoffs from developers. Management ignored the warnings, and Darr soon fired the whistle-blowers. So much for doing the right thing. Federal Judge Marcel Livaudais comes across as equally praiseworthy. Pru tried to get him to approve a class-action settlement that would get the firm off the hook, leave unscrupulous lawyers who helped arrange the deal rich, and pay investors pennies on the dollar. Tipped off by securities regulators from a number of states, Livaudais stopped the settlement.
For investors, the biggest heroes are these state regulators, who took investor complaints seriously and pushed for a $371 million downpayment on an open-ended federal settlement. This tale makes a compelling argument for keeping the system of state securities regulators, which, given the federal Securities & Exchange Commission, is periodically attacked by the brokerage industry as redundant. It ain't.
Serpent on the Rock can be faulted for providing too many details. But the wealth of anecdotes and vignettes provides an important postmortem for a shameful chapter in the history of Wall Street. BUSINESS WEEK broke the story, but Eichenwald's powerful book will ensure that it is not forgotten.BY LEAH NATHANS SPIRO