Hardwick Simmons hardly looked like someone facing what could be a hit of hundreds of millions of dollars. In a rare interview, the chief executive officer of Prudential Securities Inc. seemed surprisingly relaxed and optimistic about the continuing fallout from the firm's sale of $6 billion in limited-partnership interests during the early and mid-1980s. Many of those investments went sour, setting off an avalanche of customer lawsuits. Following a BUSINESS WEEK cover story on Mar. 4, 1991, the Securities & Exchange Commission, the National Association of Securities Dealers, and several state securities regulators began probes of allegations ranging from misleading sales practices to outright fraud.
Simmons, who replaced George L. Ball as CEO in May, 1991, acknowledges that the impact on the firm has been significant and that recruiting new brokers has been tougher in recent months. But he maintains that Pru Securities, which has consistently denied any wrongdoing, is close to putting the limited-partnership episode behind it. "What you're seeing is a very solid company performing very well in the markets," says Simmons. Before taxes and reserves, "we're doing as well as anyone in the securities business," with a return on equity of 20% even after litigation reserves, he says.
Simmons uses the same "rotten apple" defense that Salomon Inc. did during the Treasury-bond market scandal and brushes aside any notion that Pru Securities' problems are systemic. "Ninety-nine percent of Pru Securities' employees did their jobs exactly as they should have," he says, "but there was always that 1% back then that created a problem."
The firm, Simmons continues, is within "several months" of reaching a settlement with the SEC and state regulators involving a payment of what he says is about $200 million. "It's all a fluid situation," he adds. That could come on top of $400 million that Pru Securities has already put aside as reserves against investor-litigation settlements and legal fees. It may also have to pay additional amounts to settle hundreds of millions of dollars of remaining investor claims. The reserves have taken a huge bite out of the firm's profits (chart, page 87).
But Simmons' optimism apparently is not shared by some regulators. A regulatory source familiar with the negotiations says a $200 million settlement offer from Pru Securities was rejected by SEC enforcement chief William R. McLucas at a meeting in Washington on June 18. It's not clear how much more the SEC is seeking, but the source says state regulators are pressing for a much larger settlement--perhaps, claims the source, in the range of the record $650 million fine paid by Drexel Burnham Lambert Inc. in 1988, when it pled guilty to felony charges. McLucas refused to discuss Pru Securities, saying he is barred by law from even confirming the existence of an investigation.
Representing the brokerage firm at the SEC meeting were General Counsel Loren Schechter; Deputy General Counsel Patrick Finley; and two of the firm's outside lawyers. Schechter and Finley were the firm's top legal officers during George Ball's tenure, and their presence during the current negotiations raised some regulators' eyebrows. "One has to wonder why those two are still involved," says one regulator.
Simmons defends Schechter and Finley's role. "I don't feel [they] have been compromised in any way," he says, indicating that Schechter has the full backing of Pru Securities' parent, Prudential Insurance Co. of America. Schechter reports to James R. Gillen, the general counsel of Prudential Insurance, as well as to Simmons. Schechter and Finley declined comment.
Meanwhile, Pru Securities has been trying to settle its biggest outstanding class action, involving $1.4 billion worth of Prudential-Bache Energy Income funds. As an interim step, the firm has reached an agreement to sell most of the oil and gas assets of those funds to Parker & Parsley Petroleum Co. for about $508 million in cash, with $491 million to be distributed to limited-partnership owners.
But not enough of the limited partners have tendered their partnership interests to Parker & Parsley to complete the deal. So the tender offer cutoff date has been extended to July 2. In the meantime, Pru Securities has not yet settled the underlying class-action involving the energy funds. A federal judge in New Orleans rejected Pru's $37 million offer in February.
The firm also faces a criminal investigation launched in the past month by the U.S. Attorney's office for the Southern District of New York. This inquiry comes in the wake of a May 25 New York Times story that attributed the unsavory sales practices to J. Frederic Storaska, a Dallas Pru Securities stockbroker. "My client certainly has not done anything inappropriate," says Storaska's attorney.
Simmons confirms that the U.S. Attorney's office is looking into allegations of wrongdoing at Pru Securities' Dallas office. But he brushes off concerns that the new investigation could sink an early settlement with the SEC and state regulators. No one at Pru Securities has been subpoenaed, he says. And he maintains that the U.S. Attorney's office will not come up with anything that the SEC hasn't already uncovered. "What they're looking at is the subject of previous SEC inquiries," says Simmons.
LONG MEMORIES. Some Wall Street analysts say the episode has had a debilitating impact on Pru Securities' reputation despite the firm's strong profits. "It's the same as when Hutton was caught for mail fraud. You don't live it down," says Perrin Long, research director at First of Michigan Corp. "A customer never forgets a brokerage firm that causes him grief."
But that has been offset by the high turnover of brokers and customers at Pru Securities. The firm has basically replaced the customers it sold the limited partnerships to with new ones. In the 1980s, some 40% of the firm's clients owned limited partnerships. That number fell to 12% by 1991, says Simmons, mainly because of the flight of disgruntled customers and the high turnover of brokers, who traditionally take their customers with them.
At the same time, the firm has increased its customer accounts from 1.5 million five years ago to 2.5 million today. Simmons says his army of 5,700 brokers is opening about 30,000 new accounts a month. "If the bad news had a silver lining, it was that there were fewer disappointed limited-partnership holders remaining with us," he says.
That's little solace to the thousands of investors who by some estimates lost hundreds of millions of dollars in the partnership fiasco. Simmons insists that he's "building a squeaky-clean firm that has one primary motive, which is to serve its clients." But it could cost considerably more than he expects to wrap up the mess.