After Klein finished his presentation, McDonald recognized Don Saxon, the Florida state securities regulator, and asked for details of his state’s investigation of the firm. Saxon’s presentation was followed by another from Matthew Neubert, a regulator from Arizona. All of the inquiries were treading on similar ground.
“All right,” McDonald said after several presentations. “As you can see, there are a number of states working on the Prudential matter that have expressed interest in getting information from the SEC. Now, the SEC has suggested that a coordinating group would be the best way to funnel information. Which states would be interested in participating?”
A flurry of hands went up. Saxon and Neubert, who had both obtained information from Bristow, Hackerman, were the first to be named. Then Nancy Smith from New Mexico joined up, followed by Lewis Brothers from Virginia.
The last hand was Klein’s. He had hesitated for a moment, worried about whether working with the other states might slow his own investigation. But he put aside his doubts in the hopes of gaining access to more information from the SEC. McDonald immediately named Klein chairman of the group.
At 12:15 that same day, the newly formed Prudential Multi-State Task Force met for a buffet lunch at a circular table in the hotel’s dining area. They were joined by several members of the SEC enforcement staff.
The regulators quickly established an agenda. They listed the questions Prudential Securities needed to answer and the documents they wanted the firm to turn over. They discussed how, if the partnership matter was going to be resolved, it should be as a global settlement involving both the states and the SEC. That would prevent Prudential Securities lawyers from playing the two sides off each other. The SEC lawyers agreed.
Klein was delighted. Apparently Richard Breeden, the commission’s chairman, was no longer an obstacle to cooperation. Then again, Breeden was an appointee of George Bush. Bill Clinton had just won the presidency, so Breeden would be chairman for only another few weeks. Klein felt sure that had at least something to do with the new willingness of the SEC enforcement staff to work with the states.
Near the end of the luncheon, Nancy Smith, the New Mexico securities regulator, raised concerns about the energy income class-action settlement. Smith, a former aide to Congressman Ed Markey of Massachusetts, had investigated the types of partnership roll-ups involved in the settlement for congressional hearings a few years earlier. In her mind, roll-ups were little more than scams that enriched general partners at the expense of their investors.
“This is an outrageous settlement,” Smith said. “It has such a small amount of money, then they throw in this roll-up. It’s nonsense.”
The regulators also knew that the settlement could cause problems for their investigation. There were 120,000 investors in the energy income partnerships. Once their claims were resolved—no matter how unfairly— those investors would be less likely to spend the time and energy to help the regulators build their case. Not only would the paltry settlement wipe out valid investor claims, but it would severely hamper any chance regulators had of getting money back for other investors.
“There’s a deadline coming up soon,” Smith said. “The judge is going to hold a fairness hearing on the settlement’s terms. And I think it’s urgent that we get a letter to him and try to stop it.”
The state regulators agreed to write the federal judge in the case, Marcel Livaudais, and asked if the SEC would do the same. Goldstein from the SEC replied that was not likely. The commission had a policy against getting involved in private litigation.
As the meeting was about to break up, Klein mentioned that he had recently learned an interesting fact: The Brazilian Court, the hotel where the task force was formed and where its first strategy session was held, was part of the Prudential-Bache partnership debacle. The hotel had been syndicated in a deal sponsored by one of the firm’s biggest general partners, Clifton Harrison. It was later seized by S&L regulators when it defaulted on a series of loans. Investors lost everything.
The birthplace of the task force was also the perfect symbol of its cause.
In late January, Pat Conti, a senior counsel with the SEC enforcement staff in Washington, read over Prudential Securities’ five-page response to his most recent subpoena. Conti was in charge of investigation number HO-2636, titled “In the Matter of Prudential Securities.” When he started work on the case months before, Conti read through the documents that had been collected by the New York regional office in its original, aborted inquiry into the Business Week allegations. The material was useful, but Conti still thought a lot of important documents were not in the file. In particular, he wanted a copy of the three-volume Locke Purnell report.
A few weeks before, he had subpoenaed Prudential Securities seeking that report and any other documents relating to investigations of Darr. He had felt somewhat secure that the firm would turn over the material. In a recent lawsuit, an Alabama court rejected Prudential Securities’ argument that the Locke Purnell report was a privileged communication from its lawyers. In essence, the court held that the firm had simply farmed out its legally required responsibilities to oversee its operations. Just because it hired a law firm to handle that job did not mean Prudential Securities could hide the information.
But in its letter responding to the subpoena, Prudential Securities was refusing to turn over the report to Conti. The letter came from Gary Lynch, the former head of enforcement for the SEC who had been in charge when the Capt. Crab case was brought. Lynch was now a lawyer at Davis, Polk and represented the firm.
The letter was blunt: Every document that Conti wanted was an attorney-client product and was exempt from disclosure. The judgment by the Alabama court had no bearing on the situation, Lynch wrote. After failing to reverse the ruling on appeal, Prudential Securities had settled the case on the condition that the former client support having the judgment vacated. The former client accepted, and the judgment was withdrawn. The report was never turned over. As a result, the Alabama decision no longer existed as a precedent. Just as in the McNulty case involving Clifton Harrison, the firm had paid to have an adverse ruling disappear.
Conti finished reading the letter and set it down. The firm was clearly going to fight this one hard. Conti still wanted the Locke Purnell report. But at that moment, he hadn’t the faintest idea how he was going to get it.
Klein sat at a desk in the Idaho State Supreme Court’s law library, looking for a legal precedent in volume 748 of the Federal Supplement. He had returned a few days before from the conference in Palm Beach and was spending every working day in the library, researching class actions. If he was going to write a letter asking Judge Livaudais not to accept the energy income settlement, he wanted his arguments as strong as a legal brief.
The letter to Livaudais had become something of an obsession for Klein from the moment Nancy Smith suggested it. To him, the stakes were enormous. The financial future of thousands of unsophisticated, frightened investors rode on what the judge decided. If nothing else, Klein wanted to be sure that Livaudais had as much information as possible.
For a week, Klein did his research in the law library. Then, at night, he crafted legal arguments on his laptop computer. During his usual family time with his wife and three children, Klein sat alone in a room at his home, perfecting his letter. Sometimes, when his children seemed to really miss him, he carried his laptop into the family room and typed while they played or watched television.
On January 22, the twelve-page bombshell was ready. The letter, which would be placed in the court’s public file, disclosed for the first time the existence of the state task force. In careful detail, it described the inadequacies of the class-action settlement. It said the notices of the settlement that had been sent to investors did not disclose all relevant information, including a number of the government investigations. Finally it argued that the settlement could impede the regulators’ ability to do anything about any violations they found.
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bsp; The letter ended with several recommendations, including that Livaudais refuse to approve the settlement or postpone approval until the regulators finished their investigation.
Klein sent the letter by overnight mail to New Orleans. He wasn’t confident it would have any effect. At best, he figured, the chances that it would were no better than one in four.
The telephone call from Loren Schechter reached Klein four days later. It was the first time Schechter had called the Idaho Securities Bureau during its two-year investigation.
“I hear you sent a letter about the settlement to Judge Livaudais,” Schechter said.
“If you don’t have a copy, I’d be happy to send you one,” Klein said.
Schechter thanked him, but said he could get a copy himself. “I’d be happy to get together with you and talk about it.”
“I’d been thinking about just that,” Klein replied. “Let me check with the other members of the task force and get back to you about possibly setting up a time.”
Klein hung up, delighted at the turn of events. For the first time, Prudential Securities was reacting swiftly to regulators and offering assistance. It boded well for the chances of cooperation in the task force investigation.
The receptionist told Klein that a judge was on the telephone. She took a swing at pronouncing the name, but it didn’t sound like anyone Klein had ever heard of before.
He picked up the telephone. “This is Wayne Klein,” he said.
“Mr. Klein, this is Judge Marcel Livaudais from New Orleans.”
For an instant, Klein was shocked. But he had no doubt that the deep bass voice with the lilting New Orleans accent belonged to Livaudais himself.
“Yes, Judge Livaudais.”
“I’ve been out of town and just got back today,” Livaudais said. “I’ve read your letter and wanted to thank you for writing it.”
“Well, Your Honor, I just wanted to get some information to you that you could have while considering your opinion,” Klein said. “I hope it will be helpful.”
The two men spoke for another few moments, then Livaudais thanked Klein again and said good-bye.
Klein felt almost a sense of awe as he looked out the window of his second-floor office, gazing at the church next door. For an instant, he closed his eyes. Maybe, he thought, there’s a chance this might work after all.
The Klein letter was the central topic at a meeting on February 1, 1993, between the task force and lawyers for Prudential Securities. The letter had been something of a watershed—now approval of the biggest partnership settlement suddenly did not seem assured. It upended the firm’s entire legal strategy. Schechter had told senior executives that the best way to handle the partnership problems was to settle all of the class actions first, then deal with the regulators. The fewer clients with claims against the firm, the easier it would be to settle with the states and the SEC. The firm desperately wanted Klein to take his letter back. The threat to Schechter’s strategy was getting bigger each day, as other regulators from around the country wrote Livaudais to support Klein’s conclusions.
The meeting between the firm and the task force was held at a hotel in Washington, D.C. All of the task force members were there. A number of lawyers attended representing Prudential, including Schechter; Scott Muller, a lawyer from Davis, Polk who was handling the Graham cases; and Dan Bell, a former North Carolina securities commissioner who had been hired to deal with the state regulators. Bell was given the role of discussing Klein’s letter.
“This lawsuit is a private action, involving the parties and Judge Livaudais,” Bell said. “State regulation has no role here. It’s not your place. You shouldn’t be involved in private litigation.”
Klein disagreed. He mentioned a class-action suit from years before involving the sale of securities in the bankrupt Baldwin-United Corp. A court held that the brokers who sold those securities were not liable to regulators for any more than was paid to settle the class action. If the state regulators didn’t act now, their investigations could be scuttled.
“We have no desire to preclude any enforcement actions,” Schechter interjected. Perhaps, the Prudential Securities lawyers suggested, the firm would send a letter to the judge assuring him that it would waive the standard from the Baldwin-United case. If that was done, perhaps Klein would withdraw his letter, Schechter said.
“I’m willing to discuss this,” Klein said. “But I meant what I said in that letter.”
Bell continued to press Klein to change his mind, without success. Then the floor was turned over to Schechter.
“I want everyone here to understand Prudential Securities,” Schechter said. “We want to put this matter behind us. We’re not a bad firm, we’re not a corrupt firm. We had some serious problems in the past with these partnerships. But it wasn’t a firmwide problem. It was a problem with certain brokers.”
The explanation got Schechter nowhere. All of the regulators had seen enough information, particularly involving the Graham deals, to know that the problems emanated from New York. Besides, one of the regulators said, the responsibility for what happened could not be sloughed off onto the sales force even if the brokers were responsible. The senior executives in New York were still in charge of supervising those brokers. One way or the other, New York obviously had a problem.
“The people who were responsible are no longer at the firm,” Schechter said.
Everyone in the room knew that Schechter was referring to Jim Darr and George Ball.
“Why did they leave?” one of the regulators asked.
“Because the decision was made to put this problem behind us.”
“Well, that’s fine, put it behind you,” said Saxon, the Florida commissioner. “But you’re going to have to make people whole to do that.”
The firm had been doing precisely that, Schechter said. All told, the settlements or proposed settlements from the firm exceeded $180 million. And the total cost of dealing with the partnership problem, when legal fees were included, reached $300 million.
The regulators listened silently. Several were uncomfortable with Schechter’s numbers. Some quick arithmetic told them that the highly criticized class-action settlements made up most of what had been paid to investors. Worse, the firm’s legal fees were almost as high as the cost of its settlements. Some regulators concluded that Schechter’s own numbers showed that the firm was throwing massive legal resources into fighting the claims of investors who refused to accept the cheap class-action settlements.
The meeting came to an amicable end, with agreements that the firm would voluntarily provide documents to the task force. As everyone headed for the exits, Nancy Smith approached Muller with a question she thought better to ask in private.
“Why aren’t you guys going after Darr?” she asked. “You’ve been pretty derogatory about him and willing to lay blame on him. Why not go after him?”
“After all this is over, we probably will,” Muller replied. “But right now, we both have our hands on the grenade, and if either Darr or the firm lets go, we both blow up.”
Judge Livaudais’s courtroom in downtown New Orleans was packed with lawyers. It was February 9, 1993, the second day of hearings on the fairness of the class-action settlement involving the energy income partnerships. Edward Grossmann, the lead class-action lawyer, and the Davis, Polk lawyers for Prudential Securities had been the chief architects of the settlement. Over two days, they presented witnesses who proclaimed the deal’s high quality.
A range of plaintiffs’ lawyers had spent the entire hearing attacking the settlement as inadequate and the result of too little digging by Grossmann. Not a single sworn deposition had been taken in the case, they said. How could Grossmann know the value of the case without having questioned witnesses under oath? On top of that, the plaintiffs’ lawyers argued that aggressive efforts should be made to sell the partnerships’ oil reserves for the benefit of investors rather than just turning them over to a new public company run by Graham. As e
vidence of the settlement’s inadequacy, the lawyers stressed that close to twelve thousand investors had already rejected it—a huge number for a class action. And hanging over the proceedings like a sword was the protest from Klein and the other state regulators.
Grossmann, a heavyset man with an aggressive personality, approached the podium and looked up at the judge. He was ready to present his closing arguments. A lot was at stake; his law firm stood to make millions if the deal was approved.
“This settlement has met with an unusual assault and unprecedented critical press coverage,” Grossmann said. “But it has been received with overwhelming approval by the class. All told, 125,000 of the 137,000 investors approved.”
The statement reflected the twisted logic of class-action lawyers. No investor had approved the settlement. Instead, 125,000 investors had, for whatever reason, not sent in letters asking to opt out of the deal. The number of investors who had received the settlement notification, read it, understood it, realized that they had to write the court to refuse the deal, and knew that they had to write three separate letters to do so was almost certainly negligible. But in Grossmann’s argument, even investors whose notification forms had been mailed to the wrong address had “approved” the settlement by not responding.
“It is irrefutable that 125,000 people believe that this is the best way to resolve their claims,” Grossmann said. “If it is not approved, it is not clear that they will get any recovery of any kind.”
Grossmann turned to the issue of the state regulators and the concerns raised by Klein’s letter. He did little to hide his contempt for their unwanted intrusion.
Serpent on the Rock Page 53
