Serpent on the Rock.

On August 31, 1995, the Wall Street Journal wrote, "Prudential Securities Inc.'s long-running legal saga from soured limited partnerships is nearing its final chapter." The newspaper indicated that the total amount of legal claims and costs was likely to exceed $1.5 billion.

The story of this scandal, perhaps Wall Street's biggest disaster, is set forth in Serpent on the Rock, by Kurt Eichenwald, who wrote about the events for the New York Times. The book is written in a highly readable style, and the subject is well documented and thoroughly researched.

The misfortune at the securities firm (then known as Prudential-Bache) arose from a financial idea that was good in theory: Through the vehicle of limited partnerships, the investing public could participate in deals that had previously been available only to large players. In practice, the Prudential-Bache partnerships led to financial disaster. The book points out that through aggressive marketing, the partnerships were touted as "safe" alternatives to certificates of deposit, and many unsophisticated investors lost their entire investments. Furthermore, the deals were so badly structured, they had virtually no possibility of showing a profit.

The book convincingly argues that the fault was not that of the stockbrokers who sold the partnerships to their customers. The brokers relied on the marketing materials provided by their superiors at Prudential-Bache.

The flawed partnerships were the product of problems at high levels. For example, executives ignored the doubts of their own due-diligence investigators in order to issue one partnership after another.

The central figure in the book is the former head of the firm's partnership group, who according to Eichenwald, abused his position from the start by receiving secret compensation from the general partners. He stocked his private wine cellar with wines billed to the partnerships and chartered helicopters at partnership expense to avoid the indignity of driving to sales meetings.

Although the book is aimed primarily at businesspeople or investors, it contains much of interest to trial lawyers. One theme is the supposed inadequacy of the class action system to deal with a scandal of this magnitude. According to the author, a class action helps the attorneys for the class as well as the defendant, while leaving the plaintiffs with little benefit.

Eichenwald argues that the attorneys have a financial incentive to achieve a quick settlement with little work, and if the amount of damages is large enough, a settlement of pennies on the dollar will still allow the attorney representing the class to obtain a substantial fee. Knowing this tendency, a defendant views the class action as the best method to settle the claims for a fraction of their true value. The plaintiffs, who often lack the sophistication to opt out of the class, will end up suffering.

In the Prudential-Bache case, a large part of the settlement funds stemmed from actions brought by regulators rather than from private class actions. Thus, while much of the business and political community says it regards the class action as a vehicle for plaintiffs' lawyers to prosecute frivolous claims, this book presents the reverse argument: A class action is a mechanism to allow a defendant to avoid paying meritorious claims.

There are a few areas where the book could have been more useful to attorneys. Eichenwald discusses several specific instances in which a Prudential-Bache prospectus contained a "smoking gun" defect (such as failure to disclose a felony conviction of a general partner) in the firm.

Although the author mentions these omissions, he gives little evidence of how the prospectuses portrayed the level of risk in the investments. It would have been helpful had he included detailed excerpts from at least one prospectus to show how much risk, if any, was disclosed to investors while the sales materials were promising "conservative" investments.

Also, the author at times uses language that strikes this reader as overly aggressive. For example, he writes, "The sales point was a heinous and seductive lie." Legal writers, at least, often believe it is better to let the facts speak for themselves, rather than describe the facts with value-laden adjectives.

Perhaps the most suggestive fact is set forth at the end of the book. The Bache executive who was head of the partnership group negotiated at the outset of his career a contract that would pay him part of the ongoing cash flow from the partnerships. After 1990, when the scandal was already well known, Prudential-Bache continued to pay the executive more than $2 million based on his employment contract.

The book, published in 1995, indicates these payments have not ceased. Although Prudential-Bache fought lawsuits brought by investors with hardball tactics (including suing the attorney who brought many of the claims), the company evidently did not want litigation with its former executive.

One wonders whether there are facts behind the scandal that have not yet been published.

John S. Jaffer is a member of Wilson, Johnson son & Jaffer in Sarasota, Florida.