Prudential Insurance Loses

For loyal customers, a special deal: Pay more, get nothing. That's the deal Prudential Insurance agents sold clients for years, tricking them into replacing policies with more expensive ones, though the "upgrade" brought zero benefit. For this act of generosity (toward itself), Prudential earned a pricey penance. The company agreed a few weeks back to fork over $410 million, to compensate policyholders. Nearly half a billion dollars is not what you would call small change.Disturbing as this episode is, it's only one in a series of ethics scandals at Prudential Insurance of Newark, N.J., and its subsidiary, Prudential Securities (formerly Prudential- Bache). The massive sum of $410 million is a fraction of what shoddy ethics cost the firm. When a whole raft of overvalued and underperforming limited partnerships collapsed -- after Pru-Bache sold them as "safe and secure" investments -- the resulting fines and lawsuits totaled an astonishing $1.5 billion. As New York Times reporter Kurt Eichenwald wrote in his book Serpent on the Rock, it was "the costliest fraud scandal for any investment house in the history of Wall Street." Add in the $70 million Prudential Insurance paid to repurchase mortgage securities (after -- surprise -- misrepresenting their true risk to buyers), and the total cost of poor ethics is about $2 billion. So far. Still outstanding are scores of lawsuits by policyholders and whistleblowers. While Prudential's costs are high, the costs to others are far higher. The partnerships were sold for $8 billion, and investors received pennies on the dollar for this. One elderly investor had a nervous breakdown. Fannie Victor, a sightless old woman, lost life savings of $100,000 and her home. Brokers who put family and friends into the deals found relationships shattered. A former regional director for Pru-Bache committed suicide. Broker Betty Allen of Orlando, Fla., sued Prudential in August 1995, saying the company's lies about the partnerships destroyed her business. (Prudential's lawyers conceded, in a written statement, that fraudulent sales literature had been knowingly distributed.) Allen sold $12 million of the partnerships, and saw the accounts of her best customers ravaged. In the tally of losses, one should include the 2,000 Prudential employees who lost jobs in 1995 -- in a restructuring forced upon the firm, after losses from the partnership scandal.It adds up to a mountain of mind-boggling, life-destroying catastrophes. How did Prudential create it? It's so counter-intuitive it's hard to believe: The company focused too much on financial performance. That's the surprising but vital lesson in the Prudential story: Financial performance cannot be the sole barometer of success. In fact, financials can be insidiously misleading. Great financial statements can disguise trouble, and actually create disaster.If you're only looking at the speedometer, don't be surprised when you smack into a mountain. As Gandhi said, "There's more to life than increasing its speed." There's more to business than making money. And until we get this, disasters will keep clubbing us over the head. Mostly, we're not getting it. Consider how the debacle began at Bache & Co. (later to become Prudential-Bache). Scrupulous tax-shelter manager Stephen Blank was forced out, for "not turning out enough product." He refused to sell deals of dubious quality, Eichenwald writes. So the company brought in James Darr, a hard-charger, who steamrolled over objections by subordinates, and brought out the deals. When due diligence employees turned down a proposal, he went around them. When managers raised objections to his tactics, they were pushed out.Prudential was persuaded to investigate Darr twice, but gave him a clean bill of health -- which strengthened his hand. Besides, the speedometer said his department was zooming, so the parent company wasn't inclined to tamper. Darr was celebrated and promoted.Brought in to oversee him, as chairman of Pru-Bache, was George Ball -- fresh from his massive check-kiting scheme at E.F. Hutton (which helped Hutton zoom for quite awhile). And overseeing Ball was Prudential itself, the company that gave its loyal customers that special deal: pay more, get nothing.Every compass of the company pointed toward "more money," and that compass led Prudential directly into a crackup. What's extraordinary is how few see this, even today. Consider the recent comment from Hardwick Simmons, chief executive of Prudential Securities: "I still don't believe that there was a systemic problem." Mostly, they're not getting it. Watch for clubbing to continue.


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