12190 1 UNITED STATES OF AMERICA Before the 2 OFFICE OF THRIFT SUPERVISION DEPARTMENT OF THE TREASURY 3 In the Matter of: ) 4 ) UNITED SAVINGS ASSOCIATION OF ) 5 TEXAS, Houston, Texas, and ) ) 6 UNITED FINANCIAL GROUP, INC., ) Houston, Texas, a Savings ) 7 and Loan Holding Company ) ) OTS Order 8 MAXXAM, INC., Houston, Texas, ) No. AP 95-40 a Diversified Savings and ) Date: 9 Loan Holding Company ) Dec. 26, 1995 ) 10 FEDERATED DEVELOPMENT CO., ) a New York Business Trust, ) 11 ) CHARLES E. HURWITZ, ) 12 Institution-Affiliated Party ) and Present and Former Director ) 13 of United Savings Association ) of Texas, United Financial Group,) 14 and/or MAXXAM, Inc.; and ) ) 15 BARRY A. MUNITZ, JENARD M. GROSS,) ARTHUR S. BERNER, RONALD HUEBSCH,) 16 and MICHAEL CROW, Present and ) Former Directors and/or Officers ) 17 of United Savings Association of ) Texas, United Financial Group, ) 18 and/or MAXXAM, Inc., ) ) 19 Respondents. ) 20 21 TRIAL PROCEEDINGS FOR JUNE 18, 1998 22 12191 1 A-P-P-E-A-R-A-N-C-E-S 2 ON BEHALF OF THE AGENCY: 3 KENNETH J. GUIDO, Esquire Special Enforcement Counsel 4 PAUL LEIMAN, Esquire SCOTT SCHWARTZ, Esquire 5 BRUCE RINALDI, Esquire RICHARD STEARNS, Esquire (Not present) 6 and BRYAN VEIS, Esquire (Not present) of: Office of Thrift Supervision 7 Department of the Treasury 1700 G Street, N.W. 8 Washington, D.C. 20552 (202) 906-7395 9 ON BEHALF OF RESPONDENT MAXXAM, INC.: 10 FRANK J. EISENHART, Esquire 11 of: Dechert, Price & Rhoads 1500 K Street, N.W. 12 Washington, D.C. 20005-1208 (202) 626-3306 16 13 DALE A. HEAD (in-house) 14 Managing Counsel MAXXAM, Inc. 15 5847 San Felipe, Suite 2600 Houston, Texas 77057 16 (713) 267-3668 17 ON BEHALF OF RESPONDENT FEDERATED DEVELOPMENT CO. AND CHARLES HURWITZ: 18 RICHARD P. KEETON, Esquire 19 KATHLEEN KOPP, Esquire of: Mayor, Day, Caldwell & Keeton 20 1900 NationsBank Center, 700 Louisiana Houston, Texas 77002 21 (713) 225-7013 22 12192 1 ON BEHALF OF RESPONDENT FEDERATED DEVELOPMENT CO., CHARLES HURWITZ, AND MAXXAM, INC.: 2 JACKS C. NICKENS, Esquire 3 of: Clements, O'Neill, Pierce & Nickens 1000 Louisiana Street, Suite 1800 4 Houston, Texas 77002 (713) 654-7608 5 ON BEHALF OF JENARD M. GROSS: 6 PAUL BLANKENSTEIN, Esquire 7 MARK A. PERRY, Esquire of: Gibson, Dunn & Crutcher 8 1050 Connecticut Avenue, N.W. Washington, D.C. 20036-5303 9 (202) 955-8500 10 ON BEHALF OF BERNER, CROW, MUNITZ AND HUEBSCH: 11 JOHN K. VILLA, Esquire MARY CLARK, Esquire 12 PAUL DUEFFERT, Esquire (Not present) of: Williams & Connolly 13 725 Twelfth Street, N.W. Washington, D.C. 20005 14 (202) 434-5000 15 OTS COURT: 16 HONORABLE ARTHUR L. SHIPE Administrative Law Judge 17 Office of Financial Institutions Adjudication 1700 G Street, N.W., 6th Floor 18 Washington, D.C. 20552 Jerry Langdon, Judge Shipe's Clerk 19 REPORTED BY: 20 Ms. Marcy Clark, CSR 21 Ms. Shauna Foreman, CSR 22 12193 1 2 EXAMINATION INDEX 3 Page 4 JERRY CLAIBORNE 5 Examination by Mr. Guido................12194 6 Examination by Ms. Clark................12303 7 Further Examination by Ms. Clark........12468 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 12194 1 P-R-O-C-E-E-D-I-N-G-S 2 (9:04 a.m.) 3 THE COURT: Be seated, please. The 4 hearing will come to order. 5 Mr. Guido, are you going to be the 6 counsel this morning? 7 MR. GUIDO: Yes, Your Honor. 8 THE COURT: All right. Call your 9 witness. 10 MR. GUIDO: At this point in time, Your 11 Honor, we would like to call Jerry Claiborne. 12 13 JERRY CLAIBORNE, 14 15 called as a witness and having been first duly 16 sworn, testified as follows: 17 18 EXAMINATION 19 20 Q. (BY MR. GUIDO) Good morning, 21 Mr. Claiborne. 22 A. Good morning. 12195 1 Q. Would you state your full name for the 2 record, please. 3 A. Jerry Wayne Claiborne. 4 Q. And where did you attend college? 5 A. Baylor University. 6 Q. Okay. And what degree do you have? 7 A. BBA, major in accounting. 8 Q. Do you have any post-graduate degrees? 9 A. Stanford University, summer program. 10 Q. And what degree do you have? 11 A. None. 12 Q. And subsequent to your graduation from 13 college, did you obtain any professional degrees 14 or licenses? 15 A. CPA. 16 Q. And when was that? 17 A. 1966. 18 Q. Where were you first employed? 19 A. By whom? 20 Q. By whom were you first employed? 21 A. Oh, KPMG Peat Marwick. 22 Q. And have you been with KPMG 12196 1 Peat Marwick at all times since then? 2 A. Yes. 3 Q. Okay. And what were you first hired 4 as? What position? 5 A. Assistant accountant. 6 Q. And did you subsequently move on to a 7 different position? 8 A. Yes. 9 Q. And when was that? 10 A. 1966. 11 Q. And what was that position? 12 A. Senior accountant. 13 Q. And subsequent to that, did you move on 14 to another position? 15 A. Yes. 16 Q. What was that? 17 A. Supervisor. 18 Q. And what year was that? 19 A. 1968. 20 Q. And then did you move on to another 21 position after that? 22 A. Yes. 12197 1 Q. And what was that? 2 A. Manager. 3 Q. When was that? 4 A. 1969 or '70. 1970. 5 Q. Okay. And did you subsequently move on 6 to another position after that? 7 A. Yes. 8 Q. What was that? 9 A. Partner. 10 Q. When was that? 11 A. 1973. 12 Q. And have you been a partner ever since? 13 A. Yes. 14 Q. Now, when did you first become a 15 partner in charge of audits of savings and loans? 16 A. It would have been about 1976. 17 Q. Which savings and loan? 18 A. There were a number of them. I don't 19 recall the names of them. 20 Q. What office were you with at the time? 21 A. Houston. 22 Q. Houston? At all times up until this 12198 1 point in time, were you in the Houston office? 2 A. No. 3 Q. No? Where were you before that? What 4 other offices? 5 A. From 1970 to '73, I was in our 6 executive office in New York. 7 Q. And then you moved to Houston? 8 A. Yes. 9 Q. What was the reason for moving to the 10 Houston office? 11 A. The program I was in in New York was a 12 rotational program. I went from Houston to 13 New York and then returned. 14 Q. So, you were originally hired in the 15 Houston office? 16 A. That's correct. 17 Q. And then you went to New York for a 18 period of time and then returned to Houston? 19 A. Correct. 20 Q. And you were in the Houston office at 21 all times up until recently? 22 A. Until last October. 12199 1 Q. Okay. And you were a partner in the 2 Houston office until last October? 3 A. Correct. 4 Q. Were you ever in charge of the office 5 in Houston? 6 A. No. 7 Q. Who was the partner in charge of the 8 office in Houston? 9 A. When? 10 Q. During the period of time that you were 11 a partner. Let me rephrase that because that may 12 be too big a period of time. 13 From 1980 through 1990. 14 A. I believe in 1980, it would have been 15 Frank Marsh, M-A-R-S-H. Later on in there, he was 16 succeeded by David Kirkpatrick. 17 Q. And were those the two partners in 18 charge of that office during that time period? 19 A. I think so. 20 Q. Who's the partner in charge of the 21 office today? 22 A. Jack Taylor. 12200 1 Q. How long has he been in that position? 2 A. Three or four years. 3 Q. Now, you said that you began audits of 4 savings and loans in 1976, became partner in 5 charge? 6 A. Yes, that's correct. 7 Q. Excuse me. Had you done any audit work 8 on savings and loans prior to that time? 9 A. Yes. Since 1965. 10 Q. Now, who were the clients in 1976 when 11 you were the partner in charge of the audits of 12 savings and loans? 13 A. Seems like there was one called Bay 14 City. There was another one over in east Texas in 15 Port Arthur, and I think there was one in Orange. 16 I just don't recall the others. 17 Q. When did you first become involved in 18 the audits of United Savings Association of Texas? 19 A. In the audits? 20 Q. Uh-huh. 21 A. In what capacity? 22 Q. Any capacity. 12201 1 A. When it was acquired from -- it was 2 acquired by Kaneb Corporation. 3 Q. So, that's when you first became 4 involved in the audits of United Savings 5 Association of Texas? 6 A. I was involved at that time in the due 7 diligence capacity. 8 Q. What do you mean by the "due diligence 9 capacity"? 10 A. Assisting Kaneb in looking at the 11 financials and doing some background work on the 12 thrift. 13 Q. Had Peat Marwick represented Kaneb or 14 been at Kaneb as a client prior to that time? 15 A. Yes. 16 Q. Okay. Now, in 1985, were you involved 17 in the audit of United Savings Association of 18 Texas? 19 A. Yes. 20 Q. In what capacity? 21 A. As -- it was a combination position as 22 the -- what we call an SEC reviewing partner and 12202 1 as the concurring partner. 2 Q. What's the difference? 3 A. A concurring partner is a second 4 partner who is involved but is not the engagement 5 partner but is involved in kind of looking over 6 the shoulder of the engagement partner concurring 7 on decisions that are made that may be 8 significant, looking at the financials, whereas an 9 SEC reviewing partner is both a concurring partner 10 and somebody who is empowered by the firm to sign 11 off on the inclusion of the firm's audit report in 12 a filing with the Securities and Exchange 13 Commission. 14 Q. Now, as the concurring partner or the 15 reviewing partner, was your responsibility just to 16 ascertain whether or not the audit steps in Peat 17 Marwick's audit procedures had been followed; or 18 did it include something more? 19 A. It was less. 20 Q. Pardon? 21 A. Less than that. 22 Q. Okay. Now, what was that? 12203 1 A. Well, the engagement partner is 2 responsible for ascertaining that the audit 3 procedures are followed and he's -- he or she is 4 responsible for signing the firm's audit report 5 and all of those kinds of things. 6 The concurring partner's role is to 7 look at the financial statements, to review what's 8 called a completion memorandum -- it may have had 9 a different title back in those days -- which just 10 kind of summarizes the very critical or -- the 11 things that were important in the course of the 12 audit, and it describes what was done. And the 13 concurring partner looks at that and agrees or 14 disagrees with what was done and also looks at the 15 financial statements. 16 Q. So, when you look at the financial 17 statements or when you looked at them as a 18 concurring partner, what was your -- what were you 19 supposed to be looking for? 20 A. To look to see that the disclosures 21 looked complete, the things that were typical of 22 thrifts -- financials statements, for example -- 12204 1 that no disclosures and the like were there, that 2 the descriptions were appropriate, and so on. 3 Q. So, would it be fair to say that your 4 responsibility was to make sure that the reporting 5 standards had been met in terms of completeness? 6 A. No, that wouldn't be fair to say. 7 Q. No, that wouldn't be fair to say? 8 Well, how would you describe it then? 9 A. I did describe it. If you want me to 10 describe it again, it's to look at the financial 11 statements to see that the disclosures are 12 appropriate for the type of entity that it is, to 13 look at the summary memo that describes the work 14 that was done in the very significant areas, and 15 to generally say that, based on what you read, 16 that the financial statements look complete and so 17 on. 18 Q. How were you to ascertain whether or 19 not the disclosures were appropriate? What did 20 you look to to determine that? What was the 21 standard that you used, or standards? 22 A. Well, there are industry audit guides. 12205 1 Internally, we have a number of publications and 2 checklists and so forth that people complete that 3 the reviewer would look at. 4 Q. So, when you reviewed the financial 5 statements, you reviewed them to see whether or 6 not the steps that Peat Marwick had set out had 7 been complied with? 8 A. No. 9 Q. No? What standards did you look to? 10 A. There is an audit guide -- if we're 11 talking in the case of a thrift, there is an audit 12 guide that talks about financial statement 13 disclosures. 14 Q. A Peat Marwick audit guide? 15 A. No, sir. An AICPA audit guide. Then 16 the firm had, at various times, different manuals 17 that included illustrative financial statements 18 for thrifts that would include the typical 19 disclosures that you would see. And then we had a 20 checklist that the senior accountant would 21 complete and that the manager and partner would 22 look at. 12206 1 The concurring partner would also look 2 at that which basically says if you have this type 3 of deposit account or loan or -- that these are 4 the disclosures you would expect to see. And that 5 checklist is derived from -- basically from the 6 industry audit guide. 7 Q. Now, was there anything else that you 8 did as a concurring partner when you reviewed the 9 financial statements and the papers that were 10 prepared? 11 Did you review anything else other than 12 the financial statements themselves? 13 A. Yes. 14 Q. What was that? 15 A. The memorandum that's prepared at the 16 conclusion of the audit by the staff that 17 describes the work that was done in the more 18 significant areas of the audit. 19 Q. And what was the purpose for reviewing 20 that as the concurring partner? 21 A. To concur with the decisions that were 22 made by the engagement team in those areas. 12207 1 Q. The substance of the conclusions or 2 that the steps that were set out in the audit plan 3 had been followed? 4 A. The substance. 5 Q. The substance. 6 Now, would that include review of the 7 substance of the conclusions reached with regard 8 to major accounting issues? 9 A. Yes. 10 Q. Now, in 1985, had you previously 11 attended any courses on accounting for 12 mortgage-backed securities? 13 A. Not that I recall. 14 Q. Had you attended any courses on the 15 audit of hedging programs? 16 A. No. 17 Q. Had you attended any courses on the use 18 of futures as hedging instruments? 19 A. No. 20 Q. Had you attended any courses on the 21 accounting for futures contracts? 22 A. No. 12208 1 Q. Had you attended any courses on the 2 hedging with swap contracts? 3 A. No. 4 Q. Had you attended any courses on the 5 accounting for swap contracts? 6 A. Yes. 7 Q. And where was that? 8 A. Peat Marwick. 9 Q. And when was that? 10 A. We had about a three-day conference 11 every year on accounting issues for thrifts. So, 12 it would have probably been in the summer of -- 13 probably the summer of '84, perhaps '85. 14 Q. Was any literature distributed at that 15 conference? 16 A. I have no idea. 17 Q. You don't recall? 18 A. No. 19 Q. Did you have any experience, prior to 20 1985, with the audit of institutions that held 21 mortgage-backed securities? 22 A. Yes. 12209 1 Q. Which ones? 2 A. Ones that we were the auditors for in 3 Houston. I don't recall all the names. 4 Q. And how many were there? 5 A. In 1985, there were probably more than 6 20. 7 Q. Prior to 1985, were there still more 8 than 20? 9 A. Sure. 10 Q. Okay. Now, with regard to those 11 institutions, excluding USAT, did any of them have 12 what has been denominated as a risk-controlled 13 arbitrage? 14 A. I don't recall. 15 Q. Prior to your work at USAT, had you 16 ever audited a risk-controlled arbitrage 17 portfolio? 18 A. No. 19 Q. Have you ever taken any courses on the 20 economics of futures contracts? 21 A. No. 22 Q. Have you ever taken any courses on the 12210 1 economics of swap contracts? 2 A. No. 3 Q. Have you ever taken any courses on the 4 economics of mortgage-backed securities? 5 A. I don't believe so. 6 Q. Have you ever taken any courses on how 7 to ascertain the value of mortgage-backed 8 securities? 9 A. No. 10 Q. Now, subsequent to 1985, were you 11 involved in any audits of USAT? 12 A. Subsequent to '85? 13 Q. Uh-huh. 14 A. Yes. 15 Q. The '85 audit. 16 A. Subsequent to the '85 audit, yes. 17 Q. And which audits was that? 18 A. 1986 and 1987. 19 Q. Were you involved in an '88 audit? 20 A. We didn't complete an '88 audit. 21 Q. Was an '88 audit begun? 22 A. I believe so. 12211 1 Q. Were you the partner in charge of the 2 '86 audit? 3 A. '86? 4 Q. Uh-huh. 5 A. I was one of the partners in charge of 6 it. 7 Q. Okay. Who was the other partner in 8 charge? 9 A. There were actually two others in '86. 10 Rick Millinor began the year -- and left the 11 firm -- I'm not sure when -- I think maybe in the 12 summer or fall of '86. Lee Mitchell succeeded 13 Rick very briefly. And I've forgotten what 14 exactly happened, but then I followed him sometime 15 in the late fall of '86. 16 Q. Were you the partner that signed off on 17 this -- I think you referred to it as maybe the 18 completion memo? 19 A. In nineteen -- which year? 20 Q. '86. The '86 audit. 21 A. Yes. 22 Q. And are you the -- were you the partner 12212 1 in charge of the 1987 audit? 2 A. Yes. 3 Q. And were you the partner in charge of 4 the 1988 audit or the portion that was done? 5 A. Yes. 6 Q. Have you had any discussions with 7 anyone about your testimony in this case? 8 A. Yes. 9 Q. Have you reviewed documents that people 10 have provided you in this case? 11 A. Yes. 12 Q. Have you reviewed documents that I have 13 provided you in this case? 14 A. Yes. 15 Q. Have you reviewed documents that 16 counsel for the respondents have provided you in 17 this case? 18 A. Yes. 19 Q. Have you had discussions with counsel 20 for the OTS? 21 A. Yes. That's you, I assume? 22 Q. Me. 12213 1 A. Yes. 2 Q. Have you had discussions with counsel 3 for the respondents? 4 A. Yes. 5 Q. Have you had discussions with anyone 6 else? 7 A. Our counsel. 8 Q. Have you had discussions with anyone 9 within Peat Marwick? 10 A. Yes. Our counsel. 11 Q. Okay. Anyone besides your counsel? 12 A. No. 13 Q. Have you had any discussions in any 14 capacity with the people in the Houston office 15 about your testimony in this case? 16 A. No. 17 Q. Have you had any discussions with 18 anyone about your testimony in this case from the 19 technical group in New York of Peat Marwick? 20 A. No. 21 Q. Have you attempted to ascertain on your 22 own what the literature provides on any issues 12214 1 that were raised with you by counsel for the 2 respondents or by me? 3 A. Yes. 4 Q. Okay. And what literature did you 5 review? 6 A. I looked at the savings and loan 7 audit -- AICPA, savings and loan audit guide that 8 was in effect in 1986 and '87. I looked at some 9 of the Emerging Issues Task Force issues that 10 dealt with some of the subjects that you had asked 11 questions about in documents that I had looked at. 12 That's all that I recall. 13 Q. Did you look at the bank audit guide 14 that was in effect in 1986-'87? 15 A. Yes, I did. 16 Q. Did you look at any literature that had 17 been written by any staff members of FASB on any 18 potential issues in this litigation? 19 A. I did look at -- I think it was 20 something that was written by Tim Lucas who is the 21 senior staff guy at the FASB that dealt with the 22 issue of accounting for investment securities. 12215 1 Q. Did you review any articles that were 2 written by Keith Richon? 3 A. What was the name of the article? I 4 don't -- I don't remember. 5 Q. Now, does Pete Marwick do any audit 6 work or any accounting work for MAXXAM? 7 A. No. 8 Q. Does it do any work for Federated? 9 A. Federated what? 10 Q. Federated Development Corporation owned 11 by Charles Hurwitz. 12 A. No. 13 Q. Does it do any work for Kaiser 14 Aluminum? 15 A. No. 16 Q. Does it do any work for Pacific Lumber? 17 A. Not that I'm aware of. 18 Q. Now, I want to ask you some questions 19 about the hierarchy of GAAP. 20 Can you tell us: Who is the ultimate 21 authority to promulgate generally-accepted 22 accounting standards? 12216 1 A. Today? 2 Q. Today. 3 A. The Financial Accounting Standards 4 Board. 5 Q. Okay. And who was that in 1985-'86? 6 A. Who was that? Who were the members? 7 Q. No. I'm sorry. Who was responsible 8 for promulgating the standards in 1985-'86? 9 A. The same. 10 Q. And did you review, prior to your 11 testimony today, a document called FAS 80? 12 A. Yes. I've read it several times. 13 Q. Okay. And was that a document that was 14 promulgated by the Financial Accounting Standards 15 Board? 16 A. Yes. 17 Q. Did -- what is -- or where does the 18 FASB, Financial Accounting Standards Board, obtain 19 its authority to promulgate generally-accepted 20 accounting standards? 21 A. Well, ultimately from the Securities 22 and Exchange Commission. 12217 1 Q. So, does the Securities and Exchange 2 Commission have the authority to alter the 3 standards that are set by the Financial Accounting 4 Standards Board? 5 A. Yes. 6 Q. What is the Emerging Issues Task Force? 7 A. It is a group of practitioners 8 principally, both those from -- when I say that, I 9 mean they are people that are working -- there are 10 accountants that are auditors in public accounting 11 firms such as mine, and there are people who are 12 preparers of financial statements that are 13 members, controllers, chief financial officers of 14 some of the major companies in the United States. 15 Q. And who appoints those members? 16 A. The -- ultimately, the Financial 17 Accounting Foundation. 18 Q. And what is the Financial Accounting 19 Foundation? 20 A. It's the overseer of the FASB. 21 Q. And what is their function within the 22 hierarchy of GAAP? 12218 1 A. What is their function? Their function 2 is to provide guidance or, in effect, to establish 3 generally-accepted accounting principles for 4 issues which arise which may not be of a broad 5 enough interest for the board itself to consider 6 or they may be dealing with issues that the board 7 has not gotten to yet; but they are issues that 8 are on the table today that both preparers and 9 auditors of financial statements have to deal 10 with. So, it's their job, if they can, to reach a 11 consensus on what generally-accepted accounting 12 principles should be for a given issue. 13 Q. The title is "Emerging Issues." Does 14 that mean that it's new issues that are coming 15 before -- coming up that haven't been directly 16 addressed by FASB? 17 A. They may not necessarily be new issues, 18 but they are issues that -- there's some either 19 diversity in practice typically or it's an issue 20 that the board has looked at in a very broad sense 21 but in a very narrow sense as it may be applicable 22 to one industry or perhaps one type of financial 12219 1 instrument or something like that. There is not 2 enough guidance in the literature. So, they come 3 up with a position. 4 Q. Now, what is the client's 5 responsibility for the accuracy of the financial 6 statements that are prepared? 7 A. Well, the financial statements are the 8 client's. 9 Q. What is the auditor's responsibility? 10 A. To express an opinion about whether 11 those financials are presented in conformity with 12 generally-accepted accounting principles. 13 Q. Now, how is the auditor to ascertain 14 whether or not they have been prepared in 15 conformity with generally-accepted accounting 16 principles? 17 A. Through tests of transactions, of 18 looking at the -- of looking at the accounting 19 principles that the client has adopted that are 20 disclosed in their financial statements. There 21 are a number of different ways that you reach that 22 conclusion. 12220 1 Q. How does the auditor ascertain the 2 accuracy of the factual basis for the financial 3 statements? 4 A. The accuracy of the factual basis. 5 Through auditing. 6 Q. And what does the auditor look to to 7 ascertain the accuracy of the statements? What 8 kind of evidence does -- is there a standard 9 that -- 10 A. Well, there are auditing standards that 11 are auditor has to follow in auditing the 12 financial statements that deal with different 13 aspects of the auditor's work. I don't know how 14 specific you want to be. 15 Q. Well, what is it that the auditor looks 16 to? Take, for example, on the books, there are 17 $2 billion worth of mortgage-backed securities. 18 How does the auditor ascertain whether 19 or not that is a true statement? 20 A. Well, there would be an audit program 21 written for that particular area that would 22 describe all of the things that the auditor would 12221 1 do to determine the existence of the securities, 2 to determine the value of the securities, and 3 those kinds of things. 4 Q. Is the auditor, in using the 5 literature's language, obligated to look to 6 competent evidential material? 7 A. Yes. 8 Q. And what does competent evidential 9 material include? 10 A. It would depend on what you're looking 11 at. 12 Q. Well, in terms of -- what are -- what 13 could be included within that term using the -- 14 A. Confirmation that we're talking about 15 securities that are held by a custodian, send a 16 confirmation to the custodian saying "Do you 17 really have these securities" and give them a list 18 of the securities they are supposed to have and 19 they would typically respond and say, yes, we have 20 those or we don't. 21 Q. Okay. With regard to an investment 22 portfolio, what sorts of things is the auditor 12222 1 directed to look to? 2 A. Well, as to existence to find out who 3 has the securities, find out if they are not 4 pledged, that they are owned by the savings 5 association, if that's what we're talking about 6 here, if they have the appropriate securities and 7 the appropriate denominations and so forth. And 8 then we would look to valuation specialists to 9 evaluate those or to some service or perhaps we 10 have some of those capabilities internally. 11 Q. What is the auditor directed to look to 12 to ascertain whether the transactions that are on 13 the financial statements are transactions that 14 were authorized by the appropriate people in the 15 institution audited? 16 A. Well, typically, in a thrift, there 17 would be -- it would be an investment committee 18 that would -- maybe that name or asset/liability 19 committee -- goes under different names -- but 20 that group typically determines the -- approves 21 the transactions both from a strategic standpoint 22 in specific transactions that have been entered 12223 1 into. 2 Q. Now, how does the -- or is the auditor 3 obligated to document the work that it did when it 4 audited the financial statements? 5 A. Yes. 6 Q. And how does it do that? 7 A. It can do it in a number of different 8 ways. It can do it in terms of what we would call 9 an audit program that somebody initials when they 10 carried out -- which is a listing of steps that 11 you have done typically initialed by the person 12 doing the work. It could be a memorandum in a 13 file describing what was done. 14 Q. Is the auditor obligated to document 15 the competent evidential material that it relied 16 upon in issuing its opinion? 17 A. We typically do that. I don't recall 18 that that's a requirement. The reason that we do 19 is for third parties that might want to have some 20 occasion to look at our files, we typically do 21 that. 22 Q. And you don't recall whether or not 12224 1 there was a requirement -- 2 A. That you keep -- 3 Q. An auditing requirement? 4 A. That you keep -- that you have a file? 5 Q. Uh-huh. 6 A. No, because we typically destroy the 7 files after a few years. So, we don't keep them. 8 Q. Is there anything that requires -- or 9 any orders or directives of the SEC that require 10 those files be kept for a period of time? 11 A. No. 12 Q. Are there any orders of the OTS that 13 require those files to be kept for a period of 14 time? 15 A. Yes. 16 Q. And what is that time period? 17 A. It's either five or six years. I don't 18 recall which. 19 Q. How do you know that? 20 A. How do I know that's the requirement? 21 Q. Uh-huh. 22 A. It seems to me that in the case of our 12225 1 firm, when -- that we have an agreement with the 2 OTS that we would keep the files for five years. 3 Q. Is there a consent order? 4 A. Yes. 5 Q. Now, what are the work papers of an 6 auditor? What's in the work papers? 7 A. Typically, things such as copies of 8 client documents that you might want to keep in 9 your -- keep a copy of in your file. There are 10 memorandums of discussions with the client people. 11 There are listings of transactions that the people 12 in the audit team may have looked at. Maybe other 13 things, as well. I don't recall. 14 Q. Does -- do the work papers include the 15 auditor's recordation of the competent evidential 16 material that it gathered? 17 A. At least a discussion of it. 18 Q. Now, who promulgates the auditing 19 standards that are applicable to an auditor? 20 A. The auditing standards board, which is 21 a part of the American Institute of CPAs. 22 Q. And is that typically known as GAAS or 12226 1 generally-accepted auditing standards? 2 A. Yes. 3 Q. And that the standards that are 4 promulgated by FASB or referred to generally as 5 the generally-accepted accounting standards? 6 A. It's part of it. 7 Q. Part of it. What else is a part of 8 generally-accepted accounting standards? 9 A. Emerging Issues Task Force issues, 10 Industry Audit Guide that might be applicable, 11 industry practice. All of those things are part 12 of generally-accepted accounting practices. 13 Q. Is there a hierarchy of those that one 14 looks to if they conflict? 15 A. Yes. 16 Q. Where do the committees of the AICPA, 17 the industry committees, fit in that hierarchy? 18 A. Well, everything -- once you get past 19 the FASB and the Accounting Principles Board, 20 audit guides and EITF issues and all those things 21 are kind of more or less on a level field. 22 Q. Are they referred to as industry 12227 1 literature? 2 A. Yes. 3 Q. And where does the actual practice of 4 practitioners fit in that hierarchy? 5 A. Well, it can actually -- well, you 6 typically think of it as being maybe on the 7 level -- or at least I do -- on the level of an 8 industry audit guide or industry stuff, but it can 9 actually fit anyplace if you have the situation 10 where you -- in fact, the literature discusses a 11 situation somewhere you might have in a particular 12 case, it's your judgment that GAAP is wrong for 13 that particular kind of transaction. You're 14 directed to follow what you think is correct. 15 Q. So, you -- you as an auditor or an 16 accountant are totally free to disregard 17 pronouncements of the Financial Accounting 18 Standards Board? 19 A. No. 20 Q. No? What is it that -- you say GAAP is 21 wrong that you can exercise your own judgment? 22 A. There is a discussion in the 12228 1 literature -- I've forgotten what exactly 2 specifically it says, but it talks about that you 3 can and should deviate from GAAP if you have a 4 particular kind of situation where GAAP is just 5 not correct for that. 6 Q. Is that the provision that says that 7 the auditor should make sure that the financial 8 accounts reflect the substance, not the form of 9 the transaction? 10 A. I don't believe it uses those words. 11 Q. You don't believe the literature uses 12 the term -- makes a distinction between form and 13 substance? 14 A. I thought you were asking about the 15 GAAP hierarchy. 16 Q. No. You -- I'm sorry. I thought I was 17 asking a question to help elaborate your last 18 answer. 19 You said that there were times that 20 you're allowed to deviate from the literature -- 21 A. Yes, I did. 22 Q. -- if you decide in your own opinion 12229 1 that the literature is incorrect. 2 A. I did say that. 3 Q. And what I'm trying to find out is when 4 you're allowed to do that. And is one of the 5 times that you're allowed to do that when the form 6 of the transaction doesn't reflect the substance? 7 A. Not exactly. You would always -- I 8 mean, GAAP or GAAS would always tell you to deal 9 with the substance of the transaction in order to 10 determine what the accounting should be. So, it's 11 really an auditing issue forum versus substance 12 rather than an accounting issue. 13 Q. So that -- now, are there other files 14 that are kept in the audit files besides work 15 papers at Peat Marwick? 16 A. We typically have -- I mean, they are 17 all working papers, but they are -- in our firm, 18 they are split into what we call working papers 19 which are the copies of documents and audit 20 programs and those kind of things that deal 21 specifically with the audit. Then we have what we 22 call permanent files which are documents that 12230 1 might be -- have continuing significance from one 2 year to the next. Might be copies of -- of 3 bylaws, minutes of meetings, that kind of thing. 4 And then we have a third set of binders which are 5 called -- third set of files which are called 6 general files which typically deal with 7 administrative kinds of things and the conclusion 8 memorandums and those kinds of things. 9 Q. Mr. Claiborne, I've given you a binder 10 of documents that include the financial statements 11 of UFG and USAT. The first one in that binder is 12 an audited -- it's a 10K filed with the Securities 13 and Exchange Commission for the fiscal year ended 14 December 31, 1984. It's been marked as 15 Exhibit A3020. 16 MR. GUIDO: I would like to move at 17 this time, Your Honor, Exhibit A3020 which I 18 understand has not been admitted in the record. 19 MS. CLARK: No objection, Your Honor. 20 THE COURT: Where does that come in 21 this folder that you just gave me? 22 MR. GUIDO: It's the first tab, Your 12231 1 Honor. 2 THE COURT: Well, mine says 3032. 3 THE WITNESS: Mine does, too. 4 MR. GUIDO: 302 -- 5 THE WITNESS: 3032. 6 MR. GUIDO: Mine says 3020, Your Honor. 7 I think that -- 8 MS. CLARK: Mr. Guido, I think when the 9 notebooks got put together, there may have just 10 been a mistake because the first document in mine, 11 as well, is a 10K. It's simply not the document 12 that you referred to. What's your second 13 document? 3021? 14 MR. GUIDO: 3021. 15 MS. CLARK: It was just a mistake. The 16 first document got put in wrong. 17 MR. GUIDO: So, it is 3032? 18 MS. CLARK: The first one in the book 19 is 3032, not the one you wanted it to be. 20 MR. GUIDO: Okay. I'm sorry, Your 21 Honor. For some reason, someone tabbed my binder 22 incorrectly. 12232 1 I'd like to move the admission, Your 2 Honor, of Exhibit A3032, which is the first 3 document in the binder which is the 10K for 4 December 31st, 1984. 5 MS. CLARK: Mr. Guido, I'm sorry to 6 interrupt again, but the first document in the 7 binder is not a 10K. It's a 10Q. And it's marked 8 Exhibit 3032. 9 MR. GUIDO: All right. Well, I move -- 10 Your Honor, I move the 10Q, 3032, into evidence. 11 THE COURT: Well, the document that's 12 in my folder is not -- is a Form 10K. 13 THE WITNESS: Mine, as well. 14 MS. CLARK: Your Honor, assuming that 15 what's been marked as 3032 is a 10K filed by 16 United Financial Group for the fiscal year 1984, 17 although I don't have it in my book, I have no 18 objection to it being admitted and I'd just ask 19 that I be provided a copy to follow along. 20 THE COURT: Well, there is an 21 Exhibit A3020 that's in evidence. It is a 10K for 22 the fiscal year ending December 31, 1984. It's 12233 1 the same document that's in my folder. 2 MR. GUIDO: Okay, Your Honor. My 3 people didn't have it as reported as that, and 4 that the document, the 10K for 1984, I was just 5 putting into the record. I'm not going to ask the 6 witness any questions. If it's already in the 7 record, we can ignore the document. Hopefully, 8 the next document is marked correctly: A3021. I 9 have in my binder a 10K for the year ended 10 December 31, 1985. It's my understanding -- and I 11 can be incorrect on this -- that that has not been 12 admitted. If it has not been admitted, I move its 13 admission, Your Honor. 14 MS. CLARK: I believe that we moved it 15 its admission with Mr. Williams and it was 16 objected to and not received. But we have no 17 objection to it being received now. 18 THE COURT: All right. Received. 19 Q. (BY MR. GUIDO) And I'd like to direct 20 your attention, Mr. Claiborne, to the document 21 that has been marked as A7003, which is audited 22 financial statements for -- consolidated 12234 1 statements of financial condition for United 2 Savings Association of Texas, Inc. and the 3 subsidiary with a letter -- an opinion letter of 4 February 28th, 1984, from Peat, Marwick, Mitchell 5 & Company into the record. 6 MS. CLARK: No objection. 7 MR. GUIDO: And then A -- 8 THE COURT: Received. 9 MR. GUIDO: 7005, Your Honor, is 10 consolidated financial statements and 11 consolidating information for United Savings 12 Association of Texas and subsidiaries for 13 December 31, 1984 and 1983. 14 I move the admission of that document, 15 Your Honor. 16 MS. CLARK: No objection. 17 THE COURT: Received. 18 MR. GUIDO: And then the third is 19 A70078, Your Honor, which is the consolidated 20 financial statements and consolidating information 21 for United Savings Association of Texas and its 22 subsidiaries dated December 31, 1985, and includes 12235 1 the '85-'84 time period. 2 I move the admission of is that 3 document, Your Honor. 4 MS. CLARK: No objection. 5 THE COURT: Received. 6 MR. GUIDO: The next document is A7009, 7 Your Honor, which is the consolidated financial 8 statements and consolidating information for 9 United Savings Association of Texas and 10 subsidiaries for December 31, 1986 and 1985. 11 I move the admission of that document, 12 Your Honor. 13 MS. CLARK: No objection. 14 THE COURT: Received. 15 MR. GUIDO: Then the last document that 16 I'm going to move in, Your Honor, is the 17 consolidated financial statements and 18 consolidating information for December 31, '87 and 19 '86 for United Savings Association of Texas. And 20 I have that marked as A10774. 21 I move the admission of that document, 22 Your Honor. 12236 1 MS. CLARK: Your Honor, is the Bench 2 copy a complete document? I seem to only have two 3 pages in mine. 4 THE COURT: Well, the CN stamp runs 5 from 30285 to CN530312, but I don't see an 11 and 6 312 is blank. Everything in between looks okay. 7 MS. CLARK: Your Honor, we have no 8 objection to admitting the financial statements 9 for the 1987 fiscal year provided that it's a 10 complete document, and perhaps we can get one 11 substituted. 12 Are you going to be asking questions 13 about it, Mr. Guido? 14 MR. GUIDO: I am. Do you want to make 15 a copy of mine? It has my comments where I'm 16 going to ask the questions. 17 18 (Discussion off the record.) 19 20 THE COURT: All right. I'll receive 21 that document. 22 Q. (BY MR. GUIDO) Your Honor, I'd like 12237 1 now to go back and direct your attention, 2 Mr. Claiborne, to A7003. And I want to direct 3 your attention to the first page of that document. 4 It has a handwritten signature, Peat, Marwick, 5 Mitchell & Company on the -- do you see that? 6 It's dated February 28th, 1984. 7 A. Yes. 8 Q. Now, can you tell us what that letter 9 is? 10 A. That is an auditor's opinion on the 11 financial statements. 12 Q. Okay. Is that the -- an opinion letter 13 in a form that is that has been directed by an 14 authorized body of the AICPA? 15 A. Yes. 16 Q. And what is that entity that 17 promulgates the standards that the opinion letters 18 must meet? 19 A. The Auditing Standards Board. 20 Q. And that is of the AICPA? 21 A. Correct. 22 Q. Now, I want to direct your attention to 12238 1 the first paragraph, the last sentence. It says, 2 "Our examinations were made in accordance with 3 generally-accepted auditing standards and 4 accordingly included such tests of the accounting 5 records and such other auditing procedures as we 6 considered necessary in the circumstances." 7 Do you see that? 8 A. Yes. 9 Q. What does that refer to? 10 A. I don't understand your question. 11 Q. Well, it says that they were made in 12 accordance with generally-accepted auditing 13 standards. 14 Are those the standards that were 15 promulgated by that committee, the Auditing 16 Standards Board of the AICPA? 17 A. Yes. 18 Q. Now, in the next paragraph, it says, 19 "In our opinion, the aforementioned consolidated 20 financial statements present fairly the financial 21 position of United Savings Association of Texas 22 and subsidiary at December 31, 1982 and '83, and 12239 1 the results of their operations and changes in 2 their financial position for the years that ended 3 in conformity with generally-accepted accounting 4 principles applied on a consistent basis." 5 Do you see that? 6 A. Yes. 7 Q. Now, are the generally-accepted 8 accounting principles that are referred to there 9 those that you've just testified about? 10 A. I'm sorry. Was that a question? 11 Q. Pardon? 12 A. Did you ask a question? 13 Q. Yeah. Were they these -- these 14 generally-accepted accounting principles, are 15 those the hierarchy of GAAP that we've just talked 16 about? 17 A. Yes. 18 Q. Now, I'd like to direct your attention 19 to Page 8 of the consolidated statements, which is 20 Bates stamped CN530397. 21 Do you see the entry under "investment 22 securities"? It says "USAT carries its investment 12240 1 in United States government, federal agency, and 2 other interest-bearing securities at cost. Since 3 it is management's intent to hold these securities 4 to scheduled maturity, a evaluation allowance has 5 not been provided in the accompanying consolidated 6 financial statements. Marketable equity 7 securities, substantially all acquired in 1983, 8 are carried at the lower of cost or market value. 9 At December 31, 1983, the market value of 10 marketable equity securities exceeded cost. 11 Aggregate market value of investment securities at 12 December 31, '83 and 1982 approximated 13 $114,027,000 and $24,408,000 respectively." 14 Do you see that? 15 A. Yes. 16 Q. And where does -- who is the person 17 responsible or the entity responsible for that 18 information that's provided in financial 19 statements? 20 A. Who is the entity? 21 Q. Uh-huh. 22 A. United Savings Association of Texas. 12241 1 Q. Now, is that what's referred to as part 2 of the notes of the consolidated financial 3 statements? 4 A. Yes. 5 Q. Now, is it the auditor's responsibility 6 to audit the accuracy of the notes to the 7 financial statements? 8 A. Yes. 9 Q. Now, I'd like to move to Exhibit A7007. 10 That also is -- contains a letter, an opinion 11 letter, dated January 31, 1986, which is at Bates 12 stamp CN53035. 13 Do you see that? 14 A. Yes. 15 Q. And I want to direct your attention to 16 Page Bates stamped CN530359. It's a note that 17 says "securities sold under repurchase 18 agreements." 19 Do you see that? 20 A. Yes. 21 MS. CLARK: Mr. Guido, pardon me, but 22 our copy for some reason are from a different 12242 1 Bates series. So, could you give us the number in 2 the document itself so that we can find what 3 you're talking about more quickly, please? 4 MR. GUIDO: It's -- this one doesn't 5 have any -- mine doesn't have any pagination on 6 it. It's Note 4. I'll do this by note number, 7 Ms. Clark. 8 MS. CLARK: We're missing that page. 9 I'm sorry, Your Honor. We are missing Note 4. 10 MR. GUIDO: I'm sorry. 11 12 (Whereupon Ms. Clark was 13 handed the document.) 14 15 MS. CLARK: Thank you, Your Honor. I 16 think we're together now. 17 THE COURT: All right. 18 Q. (BY MR. GUIDO) Now, look to the 19 next-to-the-last paragraph. It says "At 20 December 31, 1985, USAT was a party to interest 21 rate exchange agreements with remaining terms of 22 six months to 10 years covering an aggregate of 12243 1 $230 million nominal principal amount of 2 liabilities and providing for payments of variable 3 rates of interest based on the yield on three 4 month US treasury securities or the three-month 5 limited interbank offering rate, 'LIBOR,'" close 6 quote, period. 7 "At December 31, '85, the weighted 8 average variable interest rate being paid was 9 8.18 percent. USAT in turn was receiving a 10 weighted average fixed rate of 8.83 percent on the 11 230-million-dollar nominal amount at December 31, 12 1985." 13 Who was responsible for providing that 14 information in the notes to the financial 15 statements? 16 A. United Savings Association of Texas. 17 Q. And what was the -- Peat Marwick's 18 responsibility to audit the accuracy of this 19 statement? 20 A. Well, we audit the -- you say 21 "accuracy." We audit the financial statements as 22 it's a note that's part of it. So, our auditing 12244 1 procedures would encompass that disclosure. 2 Q. Now I'd like to direct your attention 3 to A7009, which is the audited financial 4 statements for the year ending December 31, 1986. 5 Is this the audit that you were the 6 partner in charge at the time the opinion letter, 7 which is dated February 6th, 1987 -- it's the 8 second page of the document, CN -- Bates stamped 9 CN530262? 10 A. Yes. 11 Q. Okay. You're the person that signed on 12 behalf of Peat Marwick? 13 A. Yes. 14 Q. Now, I'd like to direct your attention 15 to the -- Page 6 of the document, which is Bates 16 stamped CN530267, under "investment securities." 17 It says, "Investments in United States government 18 and federal agencies securities, corporate debt 19 securities, and other interest-bearing securities 20 are carried at cost. Marketable equity securities 21 included as trading account securities are carried 22 at current market value. Gains or losses on the 12245 1 sale of trading account securities (based on the 2 carrying value of specific securities sold.) And 3 adjustments to market value are included in gain 4 on sale of investment securities in the 5 consolidated statements of operation. Marketable 6 equity securities not included as trading account 7 securities are carried at the lower of cost or 8 market value. An allowance for estimated losses 9 in the corporate debt securities portfolio has 10 been provided based on industry data or similar 11 instruments, the composition of the portfolio, 12 historical portfolio performance, and other 13 factors." 14 Now, whose responsibility was it to 15 provide that information in the financial 16 statements? 17 A. United Savings Association of Texas. 18 Q. And what was Peat Marwick's 19 responsibility with regard to that statement? 20 A. They were part of the financial 21 statements that we audited. 22 Q. So, you're obligated to apply the 12246 1 auditing standards to that statement? 2 A. Yes. 3 Q. Now, it says, "Investments in United 4 States government and federal agencies 5 securities." 6 What does that refer to? 7 A. Those are securities that were part of 8 the investment portfolio of United Savings 9 Association of Texas. 10 Q. What's a federal agency security? 11 A. They are short-term instruments of the 12 federal agency like Ginnie Mae, Fannie Mae. 13 Q. Fannie Maes and Ginnie Maes. Are 14 Fannie Maes and Ginnie Maes what are typically 15 referred to as mortgage-backed securities? 16 A. No. They are agency securities. 17 Q. In 1986, did USAT own any 18 mortgage-backed securities? 19 A. I believe so. 20 Q. And they carried them on a certain 21 basis, did they not? 22 A. Yes. 12247 1 Q. Huh? 2 A. Yes. 3 Q. And the financial statements to be -- 4 to contain all the disclosures should disclose the 5 basis on which they are recorded on the books, 6 shouldn't they? 7 A. If they are material, you would expect 8 to see that kind of disclosure. 9 Q. And at the end of 1986, how large were 10 they? 11 A. I have no recollection. 12 Q. Let's take a look at Page 13, CN530274. 13 See where it says "securities sold under 14 repurchase agreements"? 15 A. Yes. 16 Q. Are repurchase agreements a form of 17 financing? 18 A. Yes. 19 Q. And the title to the underlying 20 instrument is held by the entity that puts them 21 out under reverse repurchase agreement? 22 A. Yes. 12248 1 Q. And the total for 1986 is $950 million, 2 is it not? 3 A. Yes. 4 Q. Is that material? 5 A. Yes, I think so, in my opinion. 6 Q. Okay. Where in this financial 7 statement does it disclose the basis for which 8 that figure is reported, whether at cost or 9 market? 10 A. These are liabilities we're talking 11 about? 12 Q. No. The underlying securities you just 13 testified, under repurchase agreement, are held by 14 USAT. They are assets. 15 A. Right. 16 Q. Okay. Where in that document does it 17 disclose what the basis for the reporting of that 18 figure is? 19 A. Well, the figure itself is reported in 20 Note 3. I'll have to go back and reread this to 21 see what the disclosures are with respect to the 22 basis. They are carried at cost. 12249 1 Q. And where do you see that? 2 A. Note 1. 3 Q. Under what? 4 A. Bates stamp 530355. 5 Q. 530 -- 6 A. 355. 7 Q. Give me that -- 8 A. 530355. 9 10 (Discussion off the record.) 11 12 Q. (BY MR. GUIDO) I was reading from 13 CN530267 which talks about the basis of 14 presentation? 15 A. That's what I meant to refer to. It 16 discloses they are carried at cost. 17 Q. And where are they referred to in that 18 paragraph? 19 A. Under "federal agency securities." 20 Q. Okay. So, your testimony earlier that 21 federal agency securities did not include 22 mortgage-backed securities was incorrect? 12250 1 A. Yes, that's correct. 2 Q. Now, go to Page 15 of the document, 3 which is CN53026 -- 530276. 4 Do you see the paragraph, "Note 10 5 interest rate exchange agreements"? 6 A. Yes. 7 Q. Who was responsible for preparing that 8 information? 9 A. United Savings Association of Texas. 10 Q. What was Peat Marwick's responsibility 11 with regard to that information? 12 A. We audited the financials of which 13 that's a part. 14 Q. The next document I'd like to show you 15 is in another binder. It is at Tab 719. It's 16 A3022, which is the 10K for United Financial Group 17 dated December 31, 1986. 18 MS. CLARK: Mr. Guido, I'm sorry. I 19 don't quickly find it. Do you have an extra 20 binder I could use? 21 22 12251 1 (Whereupon Mr. Nickens handed 2 Ms. Clark a binder.) 3 4 MR. GUIDO: Have you found the 5 document, Ms. Clark? 6 MS. CLARK: Thank you. Yes. 7 Q. (BY MR. GUIDO) I would like you to 8 turn to Page -- 9 THE COURT: Would you state the exhibit 10 number again, please? 11 MR. GUIDO: Your Honor, it is Tab 719, 12 A3022. 13 Q. (BY MR. GUIDO) And I'd like you to 14 turn to Bates stamp UFG 05468. And it's in an 15 auditor's report, and it says Peat, Marwick, 16 Mitchell & Company, Houston, Texas, February 6, 17 1987. 18 Are you the partner in charge who 19 signed that opinion letter? 20 A. Yes. 21 Q. Now, this is part of a 10K that was 22 filed by UFG. And there are -- there is a 12252 1 discussion in that document prior to the auditor's 2 report. I'd like to direct your attention to 3 certain pages of that. 4 Page 11 of the document, which is Bates 5 stamped UFG05438, the paragraph at the top right 6 above "real estate development activities," do you 7 see that paragraph? 8 A. Yes. 9 Q. Let's switch back to the page before 10 because it will help explain that paragraph. It 11 says, "Hedging programs: For information 12 concerning the company's strategy to match 13 interest rate sensitivities and maturities of its 14 asset and liabilities (I.e., its GAAP position), 15 see management's discussion asset/liability 16 management." 17 Then it says "Since 1984, the 18 association has been attempting to alleviate the 19 difficulties created by existing long-term fixed 20 rate assets and short-term floating rate 21 liabilities through other things, utilization of 22 interest rate swaps, and other interest rate 12253 1 hedging techniques. An interest rate swap is a 2 transaction which can be applied to either assets 3 or liabilities through which two parties exchange 4 a series of cash flows representing interest 5 payments. The exchange of payments is based upon 6 an agreed nominal principal amount. Neither party 7 to the exchange assumes any liability for 8 principal or advances any capital. Each party 9 remains liable for its obligations on the original 10 borrowing. Typically, a swap is collateralized in 11 an amount ranging from 10 to 20 percent of the 12 nominal principal amount to guarantee performance. 13 The association believes that the indices utilized 14 to base the interest rate payments on the swaps 15 (primarily the London interbank offering rate) 16 Correlate generally with the repricing mechanisms 17 of its short-term liabilities. Many of the swap 18 transactions were entered into by the association 19 in order to maintain or improve its overall GAAP 20 position at the time the association began 21 significantly increasing its mortgage-backed 22 securities financed by repurchase agreements." 12254 1 Do you see that? "By entering into 2 these hedging programs, the association was able 3 to acquire mortgage-backed securities without 4 deteriorating its current GAAP position. However, 5 the effect of adding the interest rate swaps has 6 been to maintain the association's interest 7 expense during a period of falling interest rates. 8 For information concerning such hedging 9 techniques, see Note 10 of Notes to Consolidated 10 Financial Statements." 11 Whose responsibility was it to make 12 that statement in this 10K? 13 A. United Financial Group. 14 Q. And what was Peat Marwick's 15 responsibility to audit that statement? 16 A. None. 17 Q. None? So that that statement is not a 18 statement that Peat Marwick is obligated to audit? 19 A. Correct. 20 Q. Now, let's go to the next page, 21 Page 13, UFG05440, Page 13. 22 Do you see where it says 12255 1 "mortgage-backed securities"? 2 A. Yes. 3 Q. "During the period from December 31, 4 1984, through December 31, 1986, the association's 5 investment in mortgage-backed securities 6 guaranteed as to payment of principal and interest 7 by Ginnie Mae, Fannie Mae, or Freddie Mac 8 increased from 419.2 million to 2.7 billion. Such 9 securities required to obtain an interest rate 10 spread between payments received on such 11 securities and interest payable on borrowings made 12 to fund their purchase. See management's 13 discussion and Note 3 of Notes to Consolidated 14 Financial Statements. Such securities which are 15 typically long-term in nature are used as 16 collateral for borrowings with various 17 institutions. Among such borrowings are 18 repurchase agreements which are typically 19 short-term in nature. Since a long-term fixed 20 rate investment is being funded by a short-term 21 liability, a substantial level of interest rate 22 risk is present in the transaction which is then 12256 1 reduced through hedging activities. See Hedging 2 Programs, Management Discussion, Use of Funds, 3 Mortgage-backed Securities and Note 7 of Notes to 4 Consolidated Financial Statements." 5 Whose responsibility was it for that 6 statement? 7 A. United Financial Group. 8 Q. What was Peat Marwick's responsibility 9 to audit that statement? 10 A. None. 11 Q. Now, look at UFG -- Bates stamp UFG 12 05456 in the second paragraph at the top. 13 MS. CLARK: Mr. Guido, what's the page 14 of the document? We have a different Bates 15 series. 16 MR. GUIDO: Mine is sort of blocked 17 out. I think it's 29. It's 29. 18 Q. (BY MR. GUIDO) Now, I'd like to 19 direct your attention to the first full paragraph 20 that says -- this is in a section, Item 7, 21 "Management's discussion and analysis of financial 22 condition and results of operations." And then 12257 1 it's subcategory "Asset/liability management." 2 And on the second page, on Page 29, the second 3 sentence says, "Much of the company's growth since 4 1984 has been in the form of arbitrages designed 5 to produce a hedged net interest spread between 6 mortgage-backed securities and various funding 7 sources such as securities sold under repurchase 8 agreements, preferred stock of special purpose 9 finance subsidiaries bearing floating rate, 10 dividend rates, and short-term CDs. In an effort 11 to manage the interest rate risk involved with 12 these arbitrages, the company entered into a 13 number of interest rate hedging programs, 14 primarily interest rate agreement swaps, and to a 15 lesser degree, interest rate cap and collar 16 programs." 17 Who was responsible for that statement 18 in the 10K? 19 A. United Financial Group. 20 Q. And what was Peat Marwick's 21 responsibility to audit that statement? 22 A. None. 12258 1 Q. And then on Page 32, Bates stamp 2 UFG05459, do you see the paragraph 3 "mortgage-backed securities"? 4 A. Yes. 5 Q. There's two paragraphs under that. 6 Who's responsibility was it for those two 7 paragraphs? 8 A. United Financial Group. 9 Q. Now, what was Pete Marwick's 10 responsibility? 11 A. None. 12 Q. Now, I'd like to turn to the opinion 13 letter again, which is Page 41 of the document. 14 My first question is: Is everything prior to Page 15 41 text that was the responsibility of USAT to 16 provide in that filing? 17 A. I haven't reviewed it all, but 18 typically -- 19 MR. NICKENS: UFG, Your Honor. 20 MR. GUIDO: UFG. Excuse me. 21 A. It would typically -- I haven't looked 22 at all these pages, but it would ordinarily be the 12259 1 registrant's responsibility. 2 Q. (BY MR. GUIDO) Okay. Now, then we 3 get to this Page 41, which is the auditor's 4 report. And I want to direct your attention to 5 the notes to the financial statements, I think at 6 Page 48 -- 46, and it's UFG05473. And it has at 7 the bottom the statement with regard to investment 8 securities. 9 Do you see that statement? 10 A. Yes. 11 Q. It starts, "Investments in United 12 States government and federal agency securities, 13 corporate debt securities, and other 14 interest-bearing securities are carried at cost," 15 and then it goes on. 16 Whose responsibility was it for that 17 statement? 18 A. United Financial Group. 19 Q. And what was Peat Marwick's 20 responsibility for that? 21 A. We audited the financials of which that 22 note is a part. 12260 1 Q. Now, why was Peat Marwick responsible 2 for auditing that statement and not the earlier 3 statements that I read into the record? 4 A. The earlier statements are not part of 5 the financial statements or the notes. 6 Q. Now I'd like to turn to another issue 7 and direct your attention to a document that's 8 already been put in the record as Tab 586. I 9 think it's been admitted as Exhibit B819 or 10 there's another number for it in the various 11 exhibit list, T4153. It's Rick Millinor's 12 handwritten memorandum dated January 31, 1986, to 13 typewritten form. I think it's in part of the -- 14 this binder I'm about to hand you, which is Volume 15 No. 3. 16 17 (Discussion off the record.) 18 19 Q. (BY MR. GUIDO) Is this a document 20 that was provided to you by me through your 21 counsel? 22 A. Yes. 12261 1 Q. And is this a document that you've 2 discussed with me previously? 3 A. Yes. 4 Q. Is this a document that you've 5 discussed with counsel for respondents previously? 6 A. Yes. 7 Q. Now, I'd like to direct your attention 8 to the first paragraph. It says, "As discussed in 9 a memo from Joe Phillips dated 1/10/1986, United 10 sold some mortgage-backed securities in 1985 that 11 were included in their interest rate swap program. 12 The securities were sold at a gain and were sold 13 only because United had to unwind a single-purpose 14 subsidiary that didn't meet with regulatory 15 approval." 16 Did you discuss this matter with Rick 17 Millinor? 18 A. Yes. 19 Q. Okay. Now, why was this document 20 prepared? It says it's in PMM work paper Z-56. 21 A. Typically, there is a memorandum or a 22 memorandum is prepared when there is an issue that 12262 1 we have discussed to document the discussion or 2 the base -- the facts in our conclusion. 3 Q. Now, this is a document that refers to 4 securities that were sold at a gain. 5 Was the purpose of this document to 6 document the appropriate accounting for that gain? 7 A. No. I think the purpose of this is to 8 discuss the -- rather than the gain, to discuss 9 the swap that was in place. 10 Q. Well, look at the third paragraph. It 11 talks about issues that were discussed with Walter 12 Erickson. And under No. 1, it says "Under no 13 circumstances would GAAP require or even permit 14 the deferral of the gain on sale of securities 15 whether in a swap program or not." 16 That's really addressing the accounting 17 for the gain on the sale of the mortgage-backed 18 securities, isn't it? 19 A. Yes, it is. 20 Q. So that one of the purposes of this 21 memorandum was to document the accuracy of the 22 accounting for the gain on the sale of those 12263 1 mortgage-backed securities, wasn't it? 2 A. It was a secondary reason, yes. 3 Q. And the -- look at the document -- the 4 last document in the packet, the January 10th memo 5 to the file by Joe Phillips. 6 Why was that part of this packet? 7 A. Why was that in our files? Is that 8 your question? 9 Q. Yeah. Why was that in the files? 10 A. Just part of the documentation related 11 to these transactions that represented, as I 12 recall, at least Joe Phillips' view of what the 13 accounting should have been. 14 Q. Is that part of what I've referred to 15 as competent evidential material? 16 A. Yes. 17 Q. That the auditor's obligated to look to 18 in reaching its conclusions on whether or not the 19 financial statements are reported fairly in 20 accordance with GAAP? 21 A. Yes. 22 Q. Now, look at the second paragraph. It 12264 1 says, "Although United matches up their securities 2 with their swaps on a macro basis, no specific 3 identification exists between any single security 4 or group of securities and any single swap 5 agreement. They are free to trade the securities 6 included in the swap program without violating the 7 swap agreement." 8 Do you see that? 9 A. No, I'm lost. 10 Q. The second paragraph -- 11 A. Which memorandum are we looking at? 12 Q. Back to the Rick Millinor memorandum. 13 Excuse me. 14 A. Okay. I'm sorry. 15 Q. That was my fault. I'm sorry. 16 Do you see that? 17 A. Just a minute. Let me read it. 18 (Witness reviews the document.) Yes, I've read 19 it. 20 Q. What does the term "matches up their 21 securities with their swaps on a, quote, macro 22 basis" mean? 12265 1 A. Well, they are not specifically 2 identified. 3 Q. And what is the significance of being 4 specifically identified as not being specifically 5 identified? 6 A. The accounting. 7 Q. And what is the difference in the 8 accounting? 9 A. Well, in -- at this point in the 10 evolution of the accounting literature dealing 11 with interest rate swaps and these kinds of 12 transactions, there was very little accounting -- 13 or accounting guidance in the -- in the -- in the 14 accounting world. 15 So, the -- Rick is trying to lay out 16 the facts that would then lead us to a conclusion 17 on -- given this particular transaction, what the 18 accounting should be. 19 Q. Well, the term "macro" in terms of 20 accounting literature in general, that refers to a 21 hedge that isn't specifically identified with 22 specific assets or liabilities; is that correct? 12266 1 A. Yes. 2 Q. Okay. And the term "micro" in the 3 accounting literature, what does that refer to? 4 A. It would mean it's specific. 5 Q. Okay. Now, for purposes of a futures 6 contract at the time, what was the significance of 7 classifying a futures hedge as a macro hedge? 8 MS. CLARK: Your Honor, I believe 9 Mr. Guido misspoke. He referred to a futures 10 contract, and I think -- 11 MR. GUIDO: No. I was referring to a 12 futures contract, Ms. Clark. 13 MS. CLARK: Oh, okay. I thought since 14 you were talking about a document about swaps -- 15 MR. GUIDO: I was talking about a 16 futures contract. 17 Q. (BY MR. GUIDO) Mr. Millinor (sic), 18 what was the consequence for accounting purposes 19 of a futures contract that was classified as a 20 macro hedge under the accounting literature at 21 this time? 22 A. For a futures contract, I don't recall. 12267 1 Q. Did you review FAS 80 in preparation 2 for your testimony? 3 A. Quite some time ago. 4 Q. Does FAS 80 say that if you do not 5 specifically designate the futures contract as a 6 hedge of a specific asset or liability, you have 7 to recognize the gain or loss on that futures 8 contract at the time? 9 A. Yes, I think so. 10 Q. You don't defer it and you don't tie it 11 to anything. Right? 12 A. Right. 13 Q. So, that's the consequence of 14 designating a futures contract as a macro hedge? 15 Talking about futures contracts. I'm not talking 16 about swaps. 17 A. I'm sorry. Did you ask a question? 18 Q. Yes. So, the consequences of 19 designating it as -- a futures contract as a macro 20 hedge is that the gain or loss on that transaction 21 had to be recognized at the time that the gain or 22 loss was reflected in the market? 12268 1 A. Correct. 2 Q. And if it was a micro hedge, it could 3 be deferred and accounted for in conjunction with 4 the asset and liability that it was hedging? 5 A. It would have been, yes. 6 Q. Now, the last sentence in this says, 7 "Because United was close to the regulatory growth 8 limits, they didn't have the option of simply 9 buying more securities at the S&L level to cure 10 the imbalance." 11 Do you see that? 12 A. Yes. 13 Q. Okay. And what is the imbalance that's 14 being referred to? 15 A. It's discussed in the preceding 16 sentence. 17 Q. And that says "Because the foresale of 18 securities left an imbalance between the 19 securities portfolio and the swap agreements, 20 United entered into a mirror swap that offset the 21 imbalance position." 22 Do you see that? 12269 1 A. Yes. 2 Q. Okay. What's a mirror swap? 3 A. Offsetting. 4 Q. So, it's just buying the opposite side 5 of the transaction? 6 A. Correct. 7 Q. Now, what is the consequence of an 8 offsetting transaction if one owns a futures 9 contract? If you buy an offsetting position, what 10 is the accounting consequence? 11 A. We're talking about futures, not 12 options? 13 Q. Just futures. 14 A. For swaps? Ask the question one more 15 time, then. 16 Q. What is the consequence, if you own a 17 futures contract -- you long a futures contract 18 and then you go into the Chicago Board of Trade, 19 you buy a futures contract. So, you're long a 20 futures contract. And then you turn around and 21 you go to that market and you sell another futures 22 contract. 12270 1 A. What's the question? 2 Q. What is the accounting consequence of 3 that? Do you recognize the gain or loss on the 4 transaction at that point in time? 5 A. I believe so. 6 Q. Okay. And if you buy a futures 7 contract at the Chicago Board of Trade and you're 8 long a futures contract to the Chicago Board of 9 Trade and you go to Singapore Futures Exchange and 10 you sell the identical contract, an offsetting 11 contract, what's the accounting consequence? 12 A. I'm not certain of that one. 13 Q. Do you know whether or not when you 14 sell your futures contract that you purchased from 15 the Chicago Board of Trade whether or not you're 16 selling the same contract that you purchased? 17 A. I'm sorry. You'll have to ask that 18 again. 19 Q. If you purchase a futures contract at 20 the Chicago Board of Trade, there's somebody on 21 the other side of that futures contract, is there 22 not? 12271 1 A. Yes. 2 Q. Okay. When you go back to the Chicago 3 Board of Trade and you sell a futures contract, 4 the same month, the same commodity, is the 5 counter-party to that transaction the same 6 counter-party to the transaction where you bought 7 that swap? 8 A. Not necessarily. 9 Q. Okay. And what is the accounting 10 treatment for that transaction when you do the 11 sale? 12 MS. CLARK: Your Honor, Mr. Guido again 13 referred to a swap. And I think to keep the 14 record clear that we need to clarify. 15 Are you still talking futures, or are 16 you talking swap? 17 MR. GUIDO: I'm only talking futures 18 contracts. Swaps are not traded on the Chicago 19 Board of Trade. I'm sorry. 20 MS. CLARK: I understand that. I just 21 wanted to keep the record clear. 22 A. You'll have to repeat the question. 12272 1 Q. (BY MR. GUIDO) If you purchase a 2 futures contract on the Chicago Board of Trade -- 3 let's say it's for oats for delivery in October -- 4 and you go back to the Chicago Board of Trade a 5 month later and you sell a futures contract at the 6 same amount for oatsoats at the Chicago Board of 7 Trade, what's the consequence of the transaction? 8 A. Accounting? 9 Q. Uh-huh. 10 A. I think you would recognize whatever 11 gain or loss you have in the contract. 12 Q. Now, let's go to the last sentence of 13 this. It says "Because United was close to their 14 regulatory growth limits, they didn't have the 15 option of simply buying more securities at the S&L 16 level to cure the imbalance." 17 Do you see is that? 18 A. Yes. 19 Q. Now, did you ever discuss with them why 20 they didn't just sell the swap contracts that were 21 imbalanced? 22 A. No, I didn't. 12273 1 Q. Did it ever enter in your mind to ask 2 them? 3 A. It wasn't my job. 4 Q. And why wasn't it your job to ask them 5 that question? 6 A. I wasn't the engagement partner this 7 year. 8 Q. You were -- did you -- it says, "I 9 discussed" -- the last sentence says, "I discussed 10 my conclusion on this matter with Jerry Claiborne, 11 and he concurred." 12 Did you ever raise that issue with Rick 13 Millinor? 14 A. I don't recall. 15 Q. Now, look at Item No. 2 -- 16 THE COURT: Mr. Guido, this may be a 17 good time for a recess. We'll take a short 18 recess. 19 20 (A short break was taken.) 21 22 THE COURT: Be seated, please. We'll 12274 1 be back on the record. 2 Mr. Guido, I understand you have an 3 agreement that you're going to finish by noon? 4 MR. GUIDO: Yes, Your Honor. I'm going 5 to -- I'm not going to cover all the materials 6 that are in that binder that I just gave you, Your 7 Honor. 8 THE COURT: There's another problem. 9 You're referring to Bates numbers on the exhibits 10 that are in the folders which seem to be different 11 from the ones that are on the exhibits that have 12 been admitted. And this is going to create a 13 discrepancy in the record between the exhibits and 14 the transcript Bates numbers that are cited. I 15 think you'd better refer to the Bates numbers that 16 are on the -- where an exhibit has been received, 17 to the received numbers rather than the numbers 18 that are in the binder. 19 MR. GUIDO: That -- I think that 20 pertains to one document. The 198610K, Your 21 Honor. I think that only applies to one document 22 because the others had not previously been 12275 1 introduced, I thought. And if so, I will just 2 reintroduce the document as a slash 1, whatever 3 the number is. But as I recall, it's only the 4 198610K that that applies to. Let me check my 5 binder. 6 MS. CLARK: One solution, Judge Shipe, 7 would be overnight, we could compare the documents 8 that he's introduced and referred to by Bates 9 numbers with the ones that have been admitted and 10 simply put on the record orally tomorrow what the 11 correct numbers were so that the record will be 12 clear rather than filling the record with more 13 paper. 14 THE COURT: Yeah. I don't want to 15 delay matters or go back over what we've covered. 16 I just raise it -- that may be a good solution, if 17 we can make a record of discrepancies or match 18 them up somehow. 19 MR. GUIDO: I do think that it's only 20 one document, though, Your Honor. I mean, I -- 21 earlier today, I discussed -- we had that problem 22 with A3032, but I didn't discuss that document at 12276 1 all. Then we -- we discussed A3021, Your Honor. 2 I didn't do anything with that. Then we had a 3 bunch of documents which were the USAT audited 4 financial statements that I put in. Those were 5 the 7000 series, the A7003, 7005, 7007, 7009, and 6 there's one other number. 7007. And then I had a 7 document A10774, Your Honor. None of those had 8 been previously admitted. 9 The only admitted document, Your Honor, 10 that I discussed was the 10K where I specifically 11 went into the 10Ks, which are A3002. That was for 12 the fiscal year ending -- it's just one 13 document -- for the fiscal year ending 1986, Your 14 Honor. 15 What I would like to do to just speed 16 the process is just designate that document as a 17 new document, which would be A3022/1, Your Honor. 18 MS. CLARK: Your Honor, it may be that 19 only one of the documents that we've had this 20 problem with today was previously received in 21 evidence. But prior to the hearing beginning, we 22 jointly stipulated to sort of official copies of 12277 1 various kinds of documents like minutes and 10Ks 2 and so on. And so, the ones that have been 3 premarked with exhibit numbers and on which we 4 have been working and relying throughout the 5 preparation and during the hearing are now 6 different from the ones he's offered in evidence. 7 So, I think the best solution would be 8 for us to regroup overnight and present a proposal 9 tomorrow to correct the record on these issues. 10 MR. GUIDO: Your Honor, just looking at 11 this document, this looks like the document that 12 was introduced. It uses UFG Bates stamp numbers, 13 and I didn't have access to a UFG Bates stamp 14 number other than the official set of documents 15 that we had. 16 I think that the only ones that pertain 17 to, Ms. Clark, where you had different Bates stamp 18 numbers were the USAT financial statements. 19 MS. CLARK: My suggestion, since we 20 have a witness that would really like to finish 21 today, that we do sort this out overnight. 22 THE COURT: I agree. We'll move on. 12278 1 MR. GUIDO: Thank you, Your Honor. 2 Q. (BY MR. GUIDO) I'd like to direct 3 your attention to the third paragraph of 4 Exhibit B819, which is at Tab 586. 5 It says, "After learning of these 6 transactions, I felt that some accounting 7 questions existed as to the proper treatment for 8 GAAP. I talked to Walter Erickson and Walter 9 Schutze about this topic and learned the 10 following: One, under no circumstances would GAAP 11 require (or even permit) the deferral of the gain 12 on the sale of securities whether in a swap 13 program or not." 14 Then it says, "Two, we do believe that 15 GAAP and RAP would require loss recognition of the 16 cost of the swap agreement being terminated 17 concurrently with the securities sale. Terminated 18 is defined as closing the swap and paying the 19 broker for any inherent loss in the contract." 20 Then it says, "Three, United's use of a 21 mirror wasn't anything that seemed to fit 22 comfortably within recognized GAAP." 12279 1 And -- did you discuss those points 2 with Mr. Millinor? 3 A. I don't recall. 4 Q. Okay. Did you discuss them with 5 Mr. Erickson or Mr. Schutze? 6 A. I don't believe I did. 7 Q. Was it your view that United's use of a 8 mirror wasn't anything that seemed to fit 9 comfortably within recognized GAAP? 10 A. Is that my view? 11 Q. Uh-huh. 12 A. Well, I don't -- I don't know exactly 13 what he was trying to say here. I suppose he was 14 trying to say that there wasn't any GAAP that he 15 could look at that talked about mirrors. 16 Q. Now, did Peat Marwick concur in the 17 accounting for the swaps that United Savings 18 Association had applied? 19 A. I'm sorry. You'd have to be -- are we 20 talking about the subject of this memo? Are you 21 talking about -- 22 Q. The subject of this memo. The 12280 1 accounting for the swaps that were -- was done by 2 USAT. 3 A. Well, our conclusion, as Rick stated 4 here, was that there wasn't any GAAP that would 5 require any loss recognition because there wasn't 6 any loss. They didn't pay anybody to terminate 7 the swap. 8 Q. In the example that I gave you of the 9 purchase of a futures contract in the Chicago 10 Board of Trade and the sale of a similar futures 11 contract -- 12 A. Yes. 13 Q. If that transaction occurred through a 14 separate brokerage house, how would they be 15 accounted for? 16 A. In your example? 17 Q. Uh-huh. My example -- 18 A. The trading futures? 19 Q. Futures contracts. Not swaps. Futures 20 contracts. 21 A. Right. 22 Q. You do a transaction through 12281 1 Merrill-Lynch. You buy a futures contract through 2 Merrill-Lynch. 3 A. Yeah. 4 Q. Then you sell one through Kidder 5 Peabody, if it still exists, or Salomon Brothers. 6 A. Your question is? 7 Q. Do you recognize the gain or loss at 8 that time? 9 A. I think so, yes. 10 Q. Okay. And do you pay anybody for any 11 gain or loss at the time that that transaction 12 occurred if they are through two different 13 brokerage houses? 14 A. Yes. There is a cost associated with 15 each. 16 Q. When you buy one and you pay. Right? 17 A. Right. 18 Q. Do you have a gain or loss on that 19 transaction? 20 A. Are you talking about a futures 21 transaction? 22 Q. Futures transaction. 12282 1 A. Yes. 2 Q. Now, when you buy a swap contract, you 3 enter into a swap contract, you enter into a 4 contract that provides you with an obligation to 5 make certain payments. Right? 6 A. Right. 7 Q. And if you enter into a swap 8 transaction with another party that is exactly the 9 opposite of that transaction, what is the economic 10 effect of that transaction? 11 A. Well, it typically -- swap, you're 12 moving either from a fixed payment system to a 13 variable or vice versa. 14 Q. Okay. So, if you have a swap and you 15 enter into it on day one and the interest rates 16 are at X level and you then, six months later, 17 enter into a mirror swap and interest rates are at 18 Y level, have you made or have you lost money on 19 that swap transaction? 20 A. You'd have to go back over it. I 21 wasn't anticipating that question. 22 Q. If at day one -- let's say interest 12283 1 rates are -- short-term interest rates are at 2 8 percent. Long-term interest rates are at 3 10 percent. And you are the paying party at 4 10 percent interest rates at day one. Six months 5 later, you do exactly the opposite, and you are 6 the paying party on the short-term interest rates 7 and you're the receiving party on the fixed 8 interest rates and interest rates have reversed so 9 that you're paying 10 percent for the short-term 10 and receiving 8 at the long. 11 What is the economic consequence of 12 that transaction? 13 A. If I follow you, I think you have a 14 loss. 15 Q. Now, did GAAP at the time provide any 16 guidance, in your view, on how you account for 17 that transaction? 18 A. For the futures -- 19 Q. No. The swap. 20 A. -- or the swap? There were two pieces 21 of literature that I recall that dealt with swaps. 22 One -- there were both Emerging Issues Task Force 12284 1 issues. Both -- one dealt with the early 2 termination of a swap, and the other also dealt 3 with swaps. And I think it concluded that with 4 respect to swaps that were, in effect, naked 5 swaps -- in fact, like this is at this point -- 6 that practice was not settled. Those are not the 7 correct words, but the practice was -- there was 8 diversity in practice in accounting. 9 Q. Now, what is the obligation of the 10 auditor when there is diversity in practice and 11 there is no literature that is expressly in point? 12 A. My view is you use your best judgment. 13 Q. Okay. And would your best judgment 14 include looking to the closest analogous 15 situation? 16 A. It would include that. 17 Q. Okay. Were futures contracts, in your 18 view at that time, the closest analogous 19 situation? 20 A. Well, it's difficult to answer that 21 because FAS 80, which applied to futures, only 22 applied to futures that were traded on an 12285 1 exchange. 2 So, when you get into something that 3 has no market or ready market, like a futures 4 contract, I'm not sure that's exactly analogous. 5 Q. What difference does that make in terms 6 of gain recognition? What is it -- what do you 7 think is not analogous between a swap and a 8 futures contract? 9 A. Well, if you were to try to measure the 10 loss without terminating the swap, it would be, in 11 my view, difficult to do. Whereas if you have a 12 futures, you have a very easy mechanism to 13 determine what your loss is. 14 Q. Well, this was in 1985, was it not, 15 when -- 16 A. Yes. 17 Q. This was January of 1986 when you were 18 looking at this issue? 19 A. Yes. 20 Q. USAT had people who were responsible 21 for managing its mortgage-backed security and swap 22 portfolio, did it not? 12286 1 A. I believe so. 2 Q. Okay. Did you ever go to them and ask 3 them what the loss was on the swap side? 4 A. No, I didn't. 5 Q. Okay. Did Mr. Millinor? 6 A. I have no idea. 7 Q. If they had ascertained -- were able to 8 ascertain what the loss was, would it have been -- 9 would futures contracts have been the next closest 10 analogy in your view? 11 A. Ask me that again. I missed the first 12 part. 13 Q. If they themselves knew what the loss 14 was on the swap transaction, they were able to 15 quantify that loss to their own satisfaction, 16 would the futures contract, the accounting for the 17 futures contract, have been the next closest 18 analogy? 19 A. You mean in terms of saying "you must 20 book a loss"? 21 Q. Uh-huh. Or book a gain, whatever the 22 transaction showed. 12287 1 A. You know, I don't recall at the time -- 2 in fact, I don't even know how United did the