For Prudential Securities Inc., the settlement was great news. For years, the brokerage subsidiary of Prudential Insurance Co. of America has been plagued with class actions by angry investors who alleged the firm had committed fraud in selling interests in limited partnerships throughout the 1980s. On Nov. 16, Prudential Securities and Graham Resources Inc., a Covington (La.) energy company, reached a deal with plaintiffs in one of the largest and potentially most damaging suits. They agreed to pay $37 million to 120,000 investors who had bought $1.46 billion worth of interests in 35 separate Pru-Bache Energy Income funds, just 1.9 per dollar of their original investment. "We got a good settlement," insists lead plaintiff counsel Edward A. Grossmann. "There are no guarantees we would have won at a trial years down the road." Plaintiffs' attorneys are asking for a 25% cut.
But the proposed settlement may not be the end of the matter. Internal Graham documents, which BUSINESS WEEK recently received from anonymous sources, contain evidence of potentially serious wrongdoing by Graham that goes beyond allegations in existing lawsuits. They suggest that Graham executives may have inflated reported returns to investors--and siphoned off investors' profits to themselves. Investors who don't want to accept the settlement must opt out by Jan. 22 and can initiate independent actions. The documents also could be of interest to U.S. District Court Judge Marcel Livaudais Jr., who will rule on Feb. 9 whether the settlement should be approved.
Pru Securities spokesman William J. Ahearn says any comment on the documents should come from Graham. "We only first saw them several weeks ago," says Ahearn. Graham Resources Chairman John J. Graham declined to comment on them. And attorney Grossmann didn't view the documents as an impediment to settling.
TRICK RETURNS. The current settlement also seems beneficial to Graham, which is 4.9% owned by Prudential Insurance. Under its terms, all 35 partnerships will be "rolled up" into a new firm, Graham Energy Resources Inc. Graham executives will maintain day-to-day control. A new board of directors, including three Graham executives, will have the power to sell the company's assets or operate it independently. John Graham will receive $375,000 a year as chief executive.
The new documents could jeopardize these arrangements. In one, dated Jan. 9, 1985 (illustration), Graham's chief administrative officer, Mark W. Files, outlined a plan to artificially maintain a 15% payout rate on the first three energy funds. Returns had fallen below 15%, and Files suggested that Graham resort to bank loans to finance the difference. A good track record from the first energy funds was crucial in attracting investors to later funds. Files was not available for comment.
Such a strategy, if implemented, may raise questions about whether it was adequately disclosed to investors. Files's memo indicates that an effort might be made to "camouflage" the source of the payouts from executives at Prudential-Bache Securities. The memo said Graham should "ask 'forgiveness rather than permission' if Pru-Bache sees through the borrowing plan."
Files's memo suggested the payouts could be bolstered by what he referred to as "unexpended capital," presumably money collected from investors. In effect, he would be giving investors back their own money disguised as a superior payout rate. Says a former Pru Securities broker who read the memo: "It was a Ponzi scheme right from the start."
A July 19, 1985, letter to Graham executive Anton H. Rice III, obtained by BUSINESS WEEK, suggests that both Prudential Insurance and Pru Securities were aware that distribution rates were being inflated. Written by Matthew J. Chanin, a Prudential managing director, with a copy to a Pru-Bache executive, the letter agreed with a plan for Graham to advance its own cash to maintain a 15% payout rate in three of the funds. A Prudential spokesman says Chanin's letter was intended to authorize "anticipated payout levels based on the then current oil and gas price levels."
In another Graham memo, dated Dec. 11, 1987, to Graham and Rice, Files said he had "squirreled away" $2.6 million in excess cash and wanted to know what to do with it. It listed three options: return the money to investors; keep it for bonuses; or transfer it to the "rabbi trust," a retirement plan for Graham executives. Asked about the memo, John Graham declined to say where the squirreled funds came from or ended up. "To talk about any one of the documents out of context would not be fair," he says. Rice could not be reached for comment.
Graham has recently encountered troubles with regulators. In October, the National Association of Securities Dealers (NASD) fined Graham's securities unit $250,000 for several securities violations and expelled it from the NASD. Graham didn't admit or deny the charges.
So far, Pru Securities has avoided regulatory problems. But due to Prudential Insurance's 4.9% stake in Graham, the actions of Prudential and Graham executives may figure in ongoing NASD and Securities & Exchange Commission probes into Pru Securities' limited-partnership sales practices.
Investors are now deciding whether to accept the settlement or pursue independent litigation. Houston attorney George M. Fleming will recommend that his 1,300 clients opt out of the settlement. "I'm not impressed," he says. Others will argue at the Feb. 9 settlement hearing that it is unfair. But unless Judge Livaudais knocks it down, that's what most investors will have to live with.