The most important thing we earn is your trust." That Prudential Securities advertising slogan rang a bit hollow last week after the company agreed to pay the largest penalty ever levied against a brokerage for defrauding small investors. Prudential said it would repay at least $330 million to customers across the U.S. who lost money on the company's limited partnerships in the 1980s. The firm will pay another $41 million in fines. Even those hefty sums might be little more than a down payment: in settling with the Securities and Exchange Commission, Prudential said it will fully compensate all investors who can show they were bilked in some $8 billion worth of partnership deals dating back to 1980. Moreover, the company is all but handing over its checkbook to Irving Pollack, 75, a Washington attorney and former SEC commissioner, who will determine the size of each award, if Prudential's offers prove unacceptable to investors.
The sweeping case was virtually unprecedented among SEC actions, which are typically narrower in scope. "In effect, the SEC reviewed a course of conduct that stretched over a decade and said it was systematically bad," noted Joel Seligman, a University of Michigan law professor. Concedes a Prudential spokesman: "We made some real mistakes in terms of how the partnerships were marketed and sold." In all, some 400,000 individual investors lost money on the deals.
While Prudential neither admitted nor denied that it broke the law, its arrangement with the SEC commits it to a punishing regimen of repayment of losses that the agency says Prudential Bache foisted on its customers. (Pru Bache is the old name for the securities unit of Prudential Insurance.) The deals involved more than 700 partnerships ranging from energy exploration to commercial real estate, ventures that normally attract sophisticated, high- income investors.
Parceling out compensation to the victims will now cost the company some $20 million in administrative expenses over the next three years. Pollack will earn $20,000 a month for supervising a cadre of lawyers, accountants and financial appraisers hired at his discretion on the Pru's dime, who will sift through customers' claims. "If you're a widow for whom the purchase of a risky oil-and-gas partnership was inappropriate and you were told it was safe, you're very likely to get compensation," says Thomas Newkirk, an associate SEC enforcement director who worked on the case. "But this is not money from heaven; people will have to prove their claims."
The $330 million compensation fund will also cover any court cases that Prudential settles after July 1, 1993. That provision grandfathered in a $120 million award that the company two weeks ago agreed to pay in a class-action suit in New Orleans. Since the fund has no ceiling and no statute of limitations will apply, it is unlikely that $330 million will cover all claims. But if there is any money left, it will revert to the U.S. Treasury. The one silver lining for the chastened firm: Prudential can write off the compensation payments as a tax-deductible business expense and thereby leave other taxpayers to foot part of the bill.