Pru Securities Isn't Secure YetChuck Hawkins
"It's all behind us now" says Hardwick Simmons, president and chief executive of Prudential Securities Inc. For the past several years, the brokerage subsidiary of the Prudential Insurance Co. of America has been plagued by lawsuits from angry investors who lost hundreds of millions of dollars in limited partnerships sold by Pru Securities brokers (BW--Mar. 4, 1991). The firm set aside $150 million in 1991 to cover litigation, restructuring, and other costs.
Yet to Simmons, who was hired to turn the firm around after former CEO George L. Ball's departure in 1991, Pru Securities is back to business as usual. It had record earnings in 1991. In the first half of 1992, it made $127.5 million before taxes, up from $98.7 million in 1991's first half. "Performance has improved dramatically," says a Prudential Securities spokesman. The firm has also launched an aggressive ad campaign. And most tellingly, it announced in July that it might resume selling some form of limited partnerships.
HARD-HITTING. Pru Securities' limited-partnership woes, though, appear to be anything but history. BUSINESS WEEK has learned that, in recent weeks, the Securities & Exchange Commission and the National Association of Securities Dealers (NASD) have expanded and intensified their yearlong investigations of Pru Securities. As a matter of policy, neither SEC Enforcement Chief William McLucas nor NASD Vice-President Douglas Henderson would confirm or deny the existence of any investigations.
Securities regulators in at least six states are pursuing their own inquiries into the sales practices of Pru Securities' limited partnerships. The result could be fines and additional payments to investors. In a written response to questions by BUSINESS WEEK, Pru Securities' spokesman, William J. Ahearn, said the firm does not discuss any "inquiries involving regulatory agencies" or "matters in litigation."
Although Pru Securities has settled many of the private lawsuits and arbitration cases, resolution of the remaining litigation seems far away. Several potentially damaging class actions remain outstanding. And Pru Securities' strategy of keeping secret any potentially harmful information produced by the litigation may be unraveling. All of this could significantly increase the firm's legal damages.
The cause of all of these troubles is some $6 billion worth of limited partnerships sold in the 1980s to more than 100,000 investors by what was then called Prudential-Bache Securities Inc. The partnership interests are now valued at only a fraction of their original selling price. The drop is due, in part, to hefty up-front fees, plummeting real estate and oil markets, and tax-code changes. In its earlier story, BUSINESS WEEK said that serious questions existed as to whether Pru Securities and Prudential Insurance properly disclosed potential conflicts of interest between James J. Darr, head of Pru Securities' direct-investment department from 1979 to 1988, and general partners of some firms that raised money through Pru Securities' brokerage network.
Darr, according to BUSINESS WEEK's investigation, had business dealings with some of the partnerships' sponsors. At issue is whether Darr's alleged conflicts compromised his responsibility to find the best partnerships to sell to Pru Securities customers. Darr's lawyer, Stuart Perlmutter of New York, says that Darr has cooperated fully with the SEC and that he does not believe his client is a target. "No regulator has accused him of doing anything wrong," says Perlmutter.
The SEC probe is probably the gravest new problem Pru Securities faces. Lawyers interviewed by SEC attorneys say they have been told that a formal order of investigation has been authorized by the commission. In recent weeks, SEC enforcement lawyers from Washington, New York, and Atlanta have been taking depositions from current and former Pru Securities employees, representatives of firms that sponsored limited partnerships, and lawyers retained by individual investors.
The SEC is said to be interested in whether Pru Securities violated the terms of an SEC settlement in 1986 of the so-called Captain Crab case. It concerned the manager of a Pru Securities branch in Atlanta who overrode directives from the firm's compliance department. He let two Atlanta brokers sell stock in a seafood-restaurant chain controlled by the father of one of the brokers. The SEC determined that top Pru Securities executives failed to supervise the branch manager. The former Pru branch manager declined comment.
Pru Securities agreed to be censured and to beef up its compliance department by following the recommendations of an independent outside consultant. The settlement required Pru Securities' compliance department to notify the firm's general counsel anytime that anyone in a branch or regional office failed or refused to adhere to compliance-department directives.
These rules were intended to apply to all operations, including units selling limited partnerships. As one plaintiff's lawyer, who recently gave a statement to SEC investigators, puts it: "What it boils down to is this: Did they make a mockery of the 1986 consent decree?"
ALL SETTLED? Probes into limited partnerships by state securities regulators are expanding. Formal complaints have been filed in Kansas and Florida. Kansas Securities Commissioner James W. Parrish says an agreement in principle has been reached, under which Pru Securities will accept a public censure. It will also pay restitution of nearly $700,000 to more than 40 Kansas limited-partnership investors. Many of the probes in other states now include a broad examination of Pru Securities' limited-partnership sales practices, including whether the firm's brokers sold customers unsuitable investments. Pru says it is working with Florida and Kansas to resolve their complaints "satisfactorily, and we expect that will be achieved."
A criminal investigation in Texas raises more troubling issues. A grand jury convened by the Dallas County district attorney's office is looking into dealings between Pru Securities and Graham Resources Inc. of Covington, La., which sponsored several energy partnerships. The first indictment in the case was handed down on July 15. It alleged that Jeffrey A. Schiller, a former Pru Securities broker, had fraudulently misrepresented to a customer the supposed low risk and high potential return of the Prudential-Bache Energy Growth Fund No. 3 limited partnership, which was sponsored by Graham and Pru Securities. Graham Resources could not be reached for comment.
Schiller, say former colleagues, is expected to contend that he relied on sales material developed by Pru Securities' direct-investment department to make those promises. That raises questions about whether the grand jury will focus next on higher-ups at the brokerage firm. Theodore P. Steinke Jr., chief of the Dallas district attorney's specialized crime division, comments: "All I can say is that there are a number of individuals we are interested in." Schiller will enter a not-guilty plea and expects to be vindicated, his lawyer says. Pru says it has "fully cooperated" with the investigation. "There has been no suggestion that any action is contemplated against Prudential Securities."
TEXTBOOK DEFENSE. Whatever its problems with government investigations, Pru Securities has been very successful to date in handling the flood of litigation brought by private investors. The firm has pursued a textbook defense strategy to minimize payments to investors. It has routinely pushed for out-of-court settlements with litigants' class-action lawyers, which almost always require confidentiality agreements. This has kept any potentially damaging information about its partnership problems out of the public eye, thus avoiding negative publicity. And it has allowed Pru Securities to settle many class actions for mere pennies on the dollar. Critics contend that with class-action lawyers eager to reach quick settlements and reap big contingency fees, it's little wonder that no Pru Securities class action has gone to trial. Complains one critic, Stuart C. Goldberg, a lawyer in Austin, Tex., who represents investors suing Prudential: "Class actions are for the benefit of lawyers and Prudential. The whitewashes I've seen are worse in the class actions than the original fraud."
Prominent New York class action attorney Stuart Wechsler denies that class-action settlements are inadequate or inappropriate. "People have the right to opt out," he says. Pru, for its part, says: "We are always willing to talk with investors and, where appropriate, reach settlements." It says that confidentiality provisions are "absolutely typical within the industry."
One key settlement involved VMS Realty Inc. A Chicago real estate syndicator, VMS raised $500 million by selling eight funds through Pru Securities brokers. In 1989, it ran into financial difficulties. Most of the funds, which were sold to investors at $10 a share, now trade at less than 50 . Investor lawsuits have accused VMS, Pru Securities, and other defendants of fraud.
In April, 1991, the parties agreed to a $66 million settlement: Pru Securities contributed $10.5 million, and VMS and other defendants put up the rest. The 35 law firms representing plaintiffs were paid $23 million in contingency fees. Plaintiffs' lawyers agreed to a broad secrecy order barring disclosure of such details as evidence of fraudulent activity they might have uncovered.
Pru Securities' tactics in winning unpublicized settlements are illustrated by the experience of Dr. William M. Bethea Jr., a Norfolk (Va.) internal-medicine specialist, whose case was mentioned in the earlier BUSINESS WEEK story.
Last November, an obviously agitated Bethea called BUSINESS WEEK. He was in the midst of an arbitration hearing seeking treble damages on his claim of $750,000 in losses. Bethea said he had rejected a $200,000 settlement offer a week before the hearing was to start. An attorney representing Prudential, he said, told his lawyer that if Bethea didn't agree to a $350,000 settlement, "something they found out about my past would be brought out at the hearing. . . . There was absolutely nothing there. It was a gangster ploy. And probably hundreds of people have been abused in the same way they've made life hell for three years for me and my wife."
But when BUSINESS WEEK called Bethea several days later, his wife said Bethea would never be able to speak to the press again "because we settled." Asked if the amount was satisfactory, she replied: "That's something we've agreed to never talk about." Bethea declines comment, as does Pru.
Now, Prudential's carefully crafted legal strategy is showing strain. For the first time, one of the general partners in two limited partnerships sold by Pru Securities has turned against the firm. In lawsuits filed early this year in New York and California, Edward M. Strasser alleges that he and the partnerships' some 650 investors, whose money was invested in two Manhattan buildings, were defrauded. He's seeking more than $180 million in damages for his firm. "In all my discussions with them," he says, "no one ever asked me what was the right thing to do for the investors."
`FALLACIOUS.' His lawsuits charge that during the 1980s the partnerships' former general partner, Clifton S. Harrison, made payments to senior Pru Securities executives through secret accounts in the name of Bache-Harrison Associates at two Texas banks. "The business interests of certain Prudential executives, in their individual capacities, and Harrison were intimately connected," says one of the suits. The suit also claims that Darr, who oversaw Pru Securities' limited-partnership program, and other executives at the firm "proceeded to divert and misuse investment funds" without disclosing this to investors.
Harrison denies the charges. "Mr. Strasser's statement is incorrect, and I am sure that in future weeks this will be proven," he says. Darr's lawyer calls the allegations "fallacious." Pru comments: "We believe Mr. Strasser's claims are totally unfounded."
Pru Securities' secrecy shield has been cracking. In late June, the firm and a Louisiana oil company it partly owns agreed to pay $35 million to settle a series of Texas lawsuits involving more than 5,000 investors in Prudential-Bache Energy Growth Funds No. 1 and No. 2. Pru Securities had insisted on a confidentiality agreement. According to the deal, investors in Fund No. 1 will receive 50 on the dollar, and those in Fund No. 2 will get 35 . After a 40% contingency fee to plaintiff lawyers, that works out to 30 and 21 , respectively.
But in an unusual turn of events, Pru Securities on July 1 disclosed details of the settlement to its 6,000 brokers on its internal message system. As a result, say brokers, the firm is letting brokers offer the same deal to some 12,000 other investors in the funds who hadn't sued and who weren't part of the settlement. If all investors in Growth Funds No. 1 and No. 2 who weren't part of the action come forward, BUSINESS WEEK estimates, the additional cost to Pru Securities' could be as much as $33 million. Pru says it told its brokers about the settlement "to keep financial advisers aware of relevant information." It says "further settlements" will depend on "the circumstances of any case."
NEVER AGAIN. Meanwhile, perhaps the largest of the private actions remains unresolved. It involves nearly 100,000 individuals who invested some $1.3 billion in a series of oil-and-gas partnerships known as Prudential-Bache Energy Income Funds. One plaintiff's attorney believes that the case will be settled for $100 million. Such talk is "premature," says Edward Grossman, the lead plaintiffs' lawyer seeking a consolidated class action. But Grossman confirms that negotiations with Pru Securities are under way.
Whatever the eventual damages, Pru Securities appears to be striving to make sure that such an embarrassing debacle never happens again. On June 29, the firm's general counsel, Loren Schecter, sent a memo to all employees reminding them of the firm's ethical code of conduct. It also established an ethics hotline for employees to pass along confidential tips about violations.
However laudable, the policy is too late for the thousands of Pru Securities investors who have received back only a fraction of their limited-partnership investments and for the thousands more whose claims are still unsettled. These individuals are not likely to forget their experience. Take Andrea Konig, a 28-year-old widow who lost most of her husband's insurance proceeds. On the advice of a Pru broker who attended her husband's funeral as a guest of a friend, she invested $200,000 in Pru Securities limited partnerships in 1988. When she tried to negotiate a settlement with Pru Securities' lawyers on the grounds that the Pru broker had sold her unsuitable investments, she was met with what she contends were bullying legal tactics. Afd now, she has an $8 million suit against the firm, which Pru contends is "baseless." Says Konig: "They're not going to get away with this. The rock they're hiding behind is crumbling."
That's probably an overstatement. But the rock is likely to show some serious cracks for a long time to come.