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 3 accounting for this. I think at the time that 4 while we looked at, as Rick says in Point No. 2 5 which is your point, that if you terminate a swap, 6 you book a loss or a gain, since we did not have a 7 termination of the swap, Rick's judgment -- and I 8 concurred with it -- was that we didn't need to 9 deal with the accounting as you would with 10 futures. 11 Q. Where does it say that? I don't see 12 any mention of futures contracts in this 13 memorandum. 14 A. I'm saying the accounting in Point 15 No. 2 is the same as you would get in accounting 16 for a futures contract under 80. 17 Q. It doesn't say anything about my 18 example, Point 2. All Point 2 says, "We do 19 believe that GAAP and RAP would require loss 20 recognition of the cost of the swap agreement 21 being terminated concurrently with the securities 22 sale. Terminated is defined as closing the swap 12288 1 and paying the broker for any inherent loss in the 2 contract." Okay. That's one example. 3 My example that I gave you isn't that 4 example, is it? And that -- what happened here 5 isn't that example? 6 A. No, it's not that example. 7 Q. That paragraph does not address the 8 situation that I've raised with you, does it? 9 That addresses a situation where the swap was 10 closed out in a different way, by paying the 11 broker who's the counter-party to the transaction. 12 A. Right. 13 Q. I'm talking about a situation where 14 there is a third party involved. There is a 15 mirror swap. 16 That doesn't address the question of a 17 mirror swap, does it? 18 A. No. 19 Q. Okay. Now, if USAT was able to 20 quantify the loss that it incurred on those two 21 swap transactions, one of which mirrored the 22 other, would a futures contract be the next 12289 1 closest analogy for accounting purposes? 2 A. Probably. 3 Q. Now, on Item No. 3, it says "United's 4 use of the mirror wasn't anything that seemed to 5 fit comfortably within recognized GAAP." 6 Do you see that? 7 A. Yes. 8 Q. What does that refer to? What does -- 9 when you use the term "doesn't seem to fit 10 comfortably" -- 11 A. I don't know. 12 Q. Does it mean that there was no 13 literature directly in point for swap contracts? 14 A. I don't know what he meant. 15 Q. Now, I'd like to direct your attention 16 to the last sentence, last paragraph. "Given the 17 facts and circumstances, it does not appear to me 18 that we have any firm rules that would require any 19 1987 loss recognition" -- 20 MR. SCHWARTZ: 5. 21 MR. NICKENS: 1985. 22 MR. GUIDO: 1985. Excuse me. 12290 1 Q. (BY MR. GUIDO) -- "loss recognition 2 to offset United 1985 gain. United understands 3 the economic reasoning for doing so, however, and 4 has agreed to start offsetting all such gains in 5 1986 so that their spreads will not be distorted." 6 My first question is: What are the 7 facts and circumstances that's referred to there? 8 A. I don't recall. 9 Q. This memorandum talks about a rather 10 unique situation where the client was obligated to 11 do something because of regulatory purposes, does 12 it not? 13 A. I don't know. 14 Q. If it does, would it have been 15 significant whether or not its claim of the 16 regulatory purpose was true or not? 17 A. Ask me that again, please. 18 Q. If this -- the conclusions that you and 19 Mr. Millinor reached were based in part upon the 20 fact that the client was forced to do this 21 transaction because of a regulatory purpose, would 22 it be significant to ascertain whether or not 12291 1 their claim of a regulatory purpose was correct or 2 not? 3 A. I don't know the answer to that. 4 Q. So that as an auditor, are you 5 obligated to ascertain, if you determine a factor 6 is material, whether or not that factor is correct 7 or not? 8 A. As a general proposition, yes. 9 Q. Now, was any effort made, to your 10 knowledge, to ascertain whether or not the 11 regulatory purpose that was claimed for the 12 transaction was an accurate claim or not? 13 A. I don't know. 14 Q. It says that "United has agreed to 15 start offsetting all such gains in 1986 so that 16 their spreads will not be distorted." 17 Do you see that? 18 A. Yes. 19 Q. Okay. Do you know whether or not 20 United actually followed through with that? 21 A. I have no idea. 22 Q. Do you know whether or not United 12292 1 recognized gains on sales of mortgage-backed 2 securities in 1986, the first quarter of 1986? 3 A. I don't recall. 4 Q. Do you recall that United was obligated 5 to restate its earnings sometime in 1986? 6 A. Yes, I do. 7 Q. And was it required to recognize gains 8 that it had previously deferred? 9 A. I believe so. 10 Q. Did United begin -- prior to the 11 restatement that it did in the middle of the year, 12 did it recognize losses on its swap transactions 13 to match the sales that were made -- the gains 14 that were made on the sales of the mortgage-backed 15 securities? 16 A. I don't know Ken. 17 Q. At this point in time, I'd like to turn 18 your attention to a document that I've marked as 19 A13036. 20 A. Is that in the same binder? 21 Q. It's in the same binder. 22 (Discussion off the record.) 12293 1 MR. GUIDO: Your Honor, it starts with 2 those that do not have an exhibit number. And 3 I'll have to do these documents by the dates and 4 the descriptions. But I basically am just going 5 to move these documents into the record. 6 These are more of the documents similar 7 to those that we discussed with Mary Mims 8 yesterday. 9 THE COURT: Well, do they have exhibit 10 numbers? 11 MR. GUIDO: I'm going to assign them 12 exhibit numbers now, Your Honor. 13 THE COURT: Oh, okay. 14 MR. GUIDO: Starting with the document 15 that is March 4th, 1986, from Diane Steimers to 16 distribution. It's Bates stamped CN719305 through 17 7193 -- 313, Your Honor. 18 I would like to move the admission of 19 that document as A13036. 20 MS. CLARK: No objection. 21 THE COURT: Well, I haven't found it 22 yet. Which binder is it in? 12294 1 MR. GUIDO: It's in Binder 3, Your 2 Honor, at the back of Binder 3. It's at the very 3 back. It's where they start those without the 4 numbers at the very end. 5 6 (Discussion off the record.) 7 8 THE COURT: So, this document is marked 9 A13036? 10 MR. GUIDO: Yes, Your Honor. 11 THE COURT: Received. 12 MR. GUIDO: Then, Your Honor, I'd like 13 to go two documents back into that binder, which 14 is a document dated February 25th, 1986, from 15 Diane Steimers to distribution. And it's Bates 16 stamped CN719355 through CN719363. 17 I'd like to move the admission of that 18 as Exhibit A13030, Your Honor. 19 MR. NICKENS: Could you give us the 20 date again? 21 MR. GUIDO: February 25th, 1986. 22 Then the -- 12295 1 MS. CLARK: I have no objection to 2 that. 3 THE COURT: Received. 4 MR. GUIDO: Then the next document is 5 the subsequent document dated February 18th, 1986, 6 another memo from Diane Steimers to distribution. 7 That's Bates stamped CN719402 through CN719410. 8 I'd like to move the admission of that 9 document as A13031, Your Honor. 10 THE COURT: What's the date of that 11 document? 12 MR. GUIDO: February 18th, Your Honor, 13 1986. 14 MS. CLARK: No objection to that one. 15 MR. GUIDO: And Your Honor, I'd like to 16 move the admission of the next document in the 17 packet, February 11, 1986, another memo from Diane 18 Steimers to distribution. It's Bates stamped 19 CN719447 through CN719449. 20 And I'd like to move the admission of 21 that as A13032, Your Honor. 22 MS. CLARK: No objection, Your Honor. 12296 1 THE COURT: Received. 2 3 (Discussion off the record.) 4 5 MR. GUIDO: Your Honor, at this point 6 in time, because of time, I would like to just 7 move some exhibits into the record because the 8 exhibits, in a sense, speak for themselves; but I 9 will be asking some questions about them. 10 I'd like to first start with the first 11 document in the book which is Exhibit B1298 and 12 it's the 1986 audit planning memorandum for United 13 Financial Group dated October 31, 1986. It's 14 Bates stamped CN523293 through CN523388. I'd like 15 to move the admission of that document, Your 16 Honor. 17 MS. CLARK: No objection, Your Honor. 18 THE COURT: Received. 19 MR. GUIDO: Then, Your Honor, the next 20 document has already been admitted at Tab 1003, 21 and I'd like to move to the third document which 22 has not been admitted. That document is a packet 12297 1 of materials that are Bates stamped OWJ00294 2 through OWJ00298. Those are Peat Marwick work 3 papers that were prepared by the accountant in 4 charge, Tiedt, T-I-E-D-T, and it's for the 5 period -- UFG second quarter period ended 6 6/30/1986. 7 I'd like to move that as Exhibit 8 A13010, Your Honor. 9 MS. CLARK: No objection. 10 THE COURT: Received. 11 MR. GUIDO: The next document is also 12 from Peat Marwick's work papers and it is a -- it 13 looks like it's -- 11/26/1986 is the date. And 14 it's a memo regarding interest rate swaps and it's 15 Bates stamped OWJ00303 through 305. 16 I'd like to move that as Exhibit 17 A13039, Your Honor. 18 MS. CLARK: Your Honor, no objection to 19 A13039. I'm told that A13010 has already been 20 received. 21 THE COURT: Under that number? 22 MS. CLARK: Yes, Your Honor. 12298 1 MR. GUIDO: I'm sorry. I missed that. 2 Then the third document, Your Honor, is A13040, 3 and it is -- it looks like it's mortgage-backed 4 securities/reverse repo. I can't read the other 5 word. It's 6/30 nineteen-eighty -- I think it 6 says 1985, Your Honor. It's OWJ01302. And then 7 the -- 8 MS. CLARK: No objection to A13040. 9 THE COURT: Received. 10 MR. GUIDO: Then the next document is 11 A13041. This is United Savings Association of 12 Texas investment policy draft for 6/10/85. I'd 13 like -- it's Bates stamped OWJ01310 through 14 OWJ01313. 15 I'd like to move the admission of that 16 document, Your Honor. 17 MS. CLARK: No objection. 18 THE COURT: Received. 19 MR. GUIDO: Then there is a document at 20 the back of the book. It's A13042, Your Honor. 21 It is a memo from Dave Kungl, K-U-N-G-L, to the 22 work papers, February 17th, 1988, on Peat Marwick 12299 1 stationery. That's OWJ01491 through OWJ01500. 2 I'd like to move the admission of that 3 document, Your Honor. 4 MS. CLARK: No objection. 5 THE COURT: Received. 6 MR. GUIDO: Then the next document I'd 7 like to move into admission, Your Honor, is 8 A13043, which is the next-to-the-last -- it's -- I 9 guess it's the next document, Your Honor. And 10 this document, I'm not certain whether or not it's 11 been admitted under a different form. 12 I'd like to move the admission of this 13 rendition of this document as A13043. It is Bates 14 stamps OWJ01501 through OWJ01510. 15 MS. CLARK: No objection. 16 THE COURT: Received. 17 Q. (BY MR. GUIDO) Now, Mr. Claiborne, do 18 you recall the issue of trading versus investment 19 coming up in the course of the 1987 audit of 20 United Financial Group? 21 A. Yes. 22 Q. And do you recall that there was a 12300 1 substantial turnover in the USAT mortgage-backed 2 security portfolio in 1986? 3 A. Yes. 4 Q. And do you recall that it was that 5 substantial turnover that prompted the issue of 6 the proper accounting for the mortgage-backed 7 security portfolio? 8 A. Yes. 9 Q. And do you recall whether USAT notified 10 Peat Marwick of the reasons for the turnover in 11 the mortgage-backed security portfolio in 1986? 12 A. No, I don't recall. 13 Q. Do you recall whether they told the 14 staff of Peat Marwick that the reason for the 15 turnover in the portfolio was that they had to 16 rebalance the portfolio to adjust for changes in 17 the prepayment speeds of the mortgage-backed 18 securities? 19 A. No, I don't recall that. 20 Q. If the work papers had indicated that 21 the auditors had been told that the turnover in 22 the portfolio was due to the fact that the 12301 1 portfolio needed to be rebalanced to adjust for 2 changes in the prepayment speeds of the 3 mortgage-backed securities, do you have any reason 4 to doubt the accuracy of that recorded statement? 5 A. No. 6 Q. Were you ever told that the reason for 7 the turnover in the portfolio in 1986 was because 8 USAT was selling out of that portfolio in order to 9 recognize gains to bolster profits at quarter and 10 year end in order to bolster its capital levels? 11 A. I think there was some discussion of 12 that in our working papers someplace. 13 Q. That you were told that? 14 A. Let me look for a minute. (Witness 15 reviews the document.) There was -- no, I'm not 16 sure about that now that I think about it. I 17 don't think so. 18 Q. I mean, this is the packet -- you're 19 referring to the packet of materials that I sent 20 you? 21 A. Yes. 22 Q. Okay. I don't recall any of that in 12302 1 the packet of materials, do you? 2 A. No. 3 Q. And this is the packet of materials 4 that deals with 1986? 5 A. Okay. 6 Q. And so, unless it's in here, you don't 7 recall ever being told that? 8 A. That's correct. 9 Q. The only recollection was your 10 incorrect recollection from this packet of 11 materials? 12 A. That's right. 13 MR. GUIDO: Your Honor, I have no 14 further questions for this witness. 15 THE COURT: Ms. Clark, you are going to 16 cross-examine? 17 MS. CLARK: Yes, I am, Your Honor. 18 Would you like us to start now? 19 THE COURT: Yes. 20 21 EXAMINATION 22 12303 1 Q. (BY MS. CLARK) Good morning, 2 Mr. Claiborne. 3 A. Good morning. 4 Q. We have met a couple of times to talk 5 about your work as an auditor for USAT, have we 6 not? 7 A. Yes. 8 Q. We met once in New York, and then we 9 met again here in Houston when you came down for 10 your testimony; is that correct? 11 A. Yes. 12 Q. Are you originally from Houston? 13 A. Pardon me? 14 Q. Are you originally from Houston? 15 A. Was I born in Houston? 16 Q. Yes. 17 A. No. 18 Q. You were not. Where are you from? 19 A. Arkansas. 20 Q. Did you come here when you first joined 21 Peat Marwick? 22 A. Yes. 12304 1 Q. You mentioned that you first became 2 involved with USAT as part of the Kaneb due 3 diligence. 4 Can you tell the Court what Kaneb was 5 or is? 6 A. Was. In -- principally in the oil 7 service business, but it diversified -- and I've 8 forgotten the year now -- through its acquisition 9 of United Savings. 10 Q. Okay. And do you recall when it was 11 that Kaneb acquired United Savings? 12 A. No, I don't. I think it may have been 13 early Eighties. 14 Q. And ultimately, what happened to 15 Kaneb's investment in United Savings? 16 A. They spun it off to the shareholders. 17 Q. And do you recall when that was? 18 A. No, I don't. 19 Q. Did you become -- did Peat Marwick 20 become the outside auditors for United Financial 21 Group, the parent company of USAT, after the Kaneb 22 acquisition or upon the Kaneb acquisition? 12305 1 A. Yes. 2 Q. And Peat Marwick had previously been 3 Kaneb's outside auditors, as well? 4 A. That's correct. 5 Q. So, is that how it is that Peat Marwick 6 came to be the outside auditors for 7 United Financial Group? 8 A. Yes. 9 Q. And did you become involved with the 10 audits of United Financial Group at the same time 11 Peat Marwick began to be the outside auditor? 12 A. I don't believe so. I don't believe 13 that during the Kaneb period, that I was -- I 14 don't believe I was the concurring partner for 15 Kaneb. So, I wouldn't have been involved in the 16 day-to-day audit of United Savings during that 17 period of time. 18 Q. Do you recall when you became the 19 concurring or the SEC review partner for 20 United Financial Group? 21 A. At the time it was spun off by Kaneb. 22 Q. And when was that? 12306 1 A. I think it was early Eighties. I can't 2 remember whether the acquisition was late 3 Seventies or early -- the acquisition may have 4 been late Seventies and the spin-off, 5 mid-Eighties, someplace in there. 6 Q. Tell me -- tell us how Peat Marwick 7 selects or selected back then the people who would 8 perform the function of SEC review partner or 9 concurring partner. 10 A. The SEC partners for the firm were 11 selected by a committee in New York based on 12 technical skills and experience in dealing with 13 securities matters. 14 Q. Do you recall how many years of 15 auditing experience you had had by the time your 16 firm selected you as an SEC reviewing partner? 17 A. Probably 13 -- well, probably closer to 18 15 years. 19 Q. And in that capacity, you had actually 20 been involved with USAT for several years before 21 you became the engagement partner on the 1986 22 audit; is that correct? 12307 1 A. That's correct. 2 Q. So, you would have been generally 3 familiar with the nature of its business; is that 4 correct? 5 A. Yes. 6 Q. And would you have had occasion to meet 7 the members of management in the course of your 8 role as concurring or SEC review partner? 9 A. Yes. The senior management. 10 Q. When you became the auditor on the 1986 11 audit, did you have a whole team of people from 12 Peat Marwick who assisted you in that audit? 13 A. Yes. We had a group of -- the 14 principal players were in Houston. There was a 15 senior manager that was the lead, and then he had 16 another manager and a staff underneath him. That 17 was the Houston contingent. And then in New York, 18 we had another group that was designated to deal 19 with United on issues that were emerging issues 20 like hedging and the investment versus trading 21 question. 22 Q. Let's start with your team in Houston. 12308 1 Who was the senior person on the team 2 under you? 3 A. In '86 and I think continuing into '87, 4 it was Joe Parsons. 5 Q. And do you know how long he had been 6 auditing or had been involved in audits of USAT by 7 the time you became the engagement partner in 8 1986? 9 A. I think he had been involved in one 10 capacity or another since its acquisition by 11 Kaneb. 12 Q. And I think Mr. Guido mentioned someone 13 named Tiedt, T-I-E-D-T. 14 Are you familiar with that name? 15 A. Yes. 16 Q. Who is Mr. Tiedt? 17 A. He was, at the time, the senior 18 accountant in charge of the audit of USAT. 19 Q. And do you know how long he had been 20 involved in auditing USAT at that point? 21 A. Throughout his career, which was fairly 22 brief, I think he had been with us maybe four or 12309 1 five years. 2 Q. Do you know whether he was also 3 involved in the audits of other financial 4 institutions that were being audited out of the 5 Houston office? 6 A. Yes. 7 Q. And was that also true of Mr. Parsons? 8 A. Yes. They both spent full time dealing 9 with thrifts. 10 Q. Do you recall any of the other 11 individuals who were on your team here in Houston? 12 A. At one point, there was -- and it may 13 have been when Joe left the firm -- Dave Kungl, 14 K-U-N-G-L, who was -- had been the senior -- had 15 been on the United account again during his career 16 with the firm. And I think when Joe left, then he 17 became the lead manager or the senior manager on 18 the account. 19 Q. Was Mr. Kungl also involved in the 20 audits of other thrifts? 21 A. Yes. 22 Q. Was he working exclusively in thrift 12310 1 audits? 2 A. Yes. 3 Q. Do you recall any of the other 4 individuals on the audit team? 5 A. No, I don't. 6 Q. Do you remember approximately how large 7 the audit team was? 8 A. Well, it varied in size depending on 9 the time of year; but it was, at its peak, 10 probably -- probably eight to ten people. And 11 then we also utilized their internal audit staff. 12 So, we had another group of people. I don't 13 recall how large their staff was that also worked 14 in our direction during the course of the audit. 15 So, probably 15, 20 people would be at the high 16 end. 17 Q. Peat Marwick also did quarterly reviews 18 of United Financial Group; is that correct? 19 A. Yes. 20 Q. And would the same team be involved in 21 carrying out the quarterly review process? 22 A. Same people -- some of the same people. 12311 1 Not all of the people. 2 Q. And would you as engagement partner 3 also be involved in the quarterly review process? 4 A. Yes. 5 Q. What would your role be in that? 6 A. Reviewing the conclusions that were 7 reached by Joe Parsons or Dave Kungl, depending on 8 who it was. 9 Q. Let's talk about the team in New York. 10 What office or department in New York 11 was involved in the USAT audit process? 12 A. It's called the -- it's in our national 13 office. It's called the Department of 14 Professional Practice, which is a group of some 15 accounting, some auditing, some SEC experts. It's 16 about 50, 60 people, all partners or managers that 17 deal with different accounting issues. And there 18 was, I think, two or three people, partners from 19 that group that were assigned to work with United 20 on different -- or to work with us on different 21 United issues. 22 Q. Was that typical for audits of thrifts 12312 1 during that period that a -- a specific team from 2 the Department of Professional Practice would be 3 designated to provide assistance to the auditors? 4 A. Yes. 5 Q. That wasn't something unique to USAT? 6 A. No. 7 Q. Or to -- who were the members who were 8 designated to work with you on your audits of UFG? 9 A. In New York? 10 Q. Yes. 11 A. The lead partner was a guy by the name 12 of Bob Mills, M-I-L-L-S, who was our leading 13 expert on -- on both hedge accounting and the 14 issue of investment versus trading. There were a 15 couple other partners that were involved: Walter 16 Erickson, who was in charge of the firm's thrift 17 practice in the United States, and Walter Schutze, 18 a partner in that department, as well, who worked 19 very closely with all -- with financial services 20 clients. 21 Q. They were all members of the Department 22 of Professional Practice? 12313 1 A. With the exception of Eric -- Walter 2 Erickson, who was in charge of the thrift 3 practice. He was actually in our national office, 4 but not in the department. He was more of a 5 business guy than he was accounting. 6 Q. Were the people in the Department of 7 Professional Practice selected from the entire 8 firm nationwide or worldwide to provide expertise 9 on particular issues that would come up in the 10 course of auditing your audit clients? 11 A. They were selected from mostly the 12 United States, but for those reasons. 13 Q. Can you tell us a bit about Bob Mills 14 whom you described as an expert in hedge 15 accounting and investment trading? What was 16 his -- versus trading accounting. 17 What was his background? 18 A. Financial services. He came out of our 19 Philadelphia office and had worked with a number 20 of the major banks in Philadelphia and had also 21 spent some time on the First Boston account 22 working on these same kinds of issues with them. 12314 1 So, he was moved from a client service position 2 into the national office to be a resource on these 3 kinds of issues. 4 Q. Do you know whether he had any 5 positions in any of the accounting profession 6 committees or advisory boards? 7 A. I think he was -- he was our member of 8 the -- there were a couple of task forces that 9 were going on during this -- the '85-'86-'87 10 period dealing with these issues. And he 11 represented our firm on both the investment side 12 as well as the -- the task force of the AICPA that 13 was dealing with the issue of financial 14 instruments. 15 Q. How about Mr. Schutze? What was his 16 background? 17 A. He had been an engagement partner for 18 some time. He joined the FASB as a member of the 19 FASB and was a member of that organization for 20 about seven years and then returned to the firm 21 where he was a partner until he became the chief 22 accountant at the Securities and Exchange 12315 1 Commission. 2 Q. Was being a member of the FASB a 3 full-time job? 4 A. Yes. 5 Q. And that was -- that was an 6 organization which had some authority in setting 7 the accounting standards for the accounting by 8 SEC-registered companies; is that correct? 9 A. Yes. 10 Q. Is there any higher authority than the 11 FASB board with respect to generally-accepted 12 accounting principles? 13 A. Well, theoretically, the SEC could 14 establish accounting principles under law but has 15 always indicated that the FASB is their designated 16 group to promulgate accounting principles. 17 Q. And do you recall when Mr. Schutze 18 served as a member of the FASB? 19 A. He became a member on -- at the time of 20 the formation of the board, which I think was in 21 the mid-Seventies. 22 Q. And do you recall when he returned to 12316 1 Peat Marwick after his service on the FASB? 2 A. Early Eighties. 3 Q. During the time that he was back at 4 Peat Marwick -- you mentioned seven years. He 5 came back for seven years before he went to the 6 SEC? 7 A. Well, no. He was on the FASB board for 8 seven years. 9 Q. Oh, I see. 10 A. And then he rejoined the firm. And so, 11 he was probably with us about 10 years from that 12 point until he went to the Securities and Exchange 13 Commission. 14 Q. During the time that Mr. Schutze was 15 assisting you and your audit team, USAT audit, do 16 you know whether he had any positions on any 17 committees or advisory boards or other 18 professional bodies in the accounting profession? 19 A. He was a member of what is called the 20 Accounting Standards Executive Committee, which is 21 a committee of the American Institute of CPAs that 22 deals with accounting issues. It writes 12317 1 statements of position, which is a type of 2 authoritative literature on different issues. 3 Q. And then I believe you said that he -- 4 after 10 years of being back at Peat Marwick, he 5 again left to take a position at the SEC. 6 Can you explain what position that was? 7 A. There is -- on the staff at the 8 commission -- a position called chief accountant, 9 which is the -- which the person in that position 10 is responsible for dealing with accounting issues 11 that come to the commission through the registrant 12 process and has established as policy for 13 accounting matters and the like. 14 Q. I think the final name that you 15 mentioned is Mr. Erickson. 16 Can you tell us about Mr. Erickson? 17 A. Yes. He was originally in our Chicago 18 office, and he worked in the thrift industry as a 19 partner in our firm for many, many years. And in, 20 I believe, the early -- the late Seventies came to 21 New York to take over as the head of the thrift 22 practice in the US. 12318 1 Q. What did that position entail? 2 A. It was his responsibility for dealing 3 with major client matters, to know our significant 4 clients, to be involved in issues that came up, 5 particularly those that had -- not the day-to-day 6 issues, but those that had broad industry 7 implications, he was involved in. And he was a 8 member of the AICPA. I think it was called the 9 savings and loan committee that wrote the audit 10 guide for thrifts. 11 Q. Now, Mr. Erickson and Mr. Schutze are 12 the two people who are mentioned in Mr. Millinor's 13 memo about the accounting for the swaps at the end 14 of 1985; is that correct? 15 A. Correct. 16 Q. Those are the people that he consulted 17 in reaching a conclusion about the appropriate 18 accounting for the swaps. 19 Is that -- those are the same 20 individuals? 21 A. Yes. 22 Q. Who were your primary clients at USAT 12319 1 during the time that you were the concurring 2 review partner and the engagement partner? 3 A. My what? 4 Q. Your primary contacts with the client. 5 A. My primary contact was with Mike Crow, 6 who was the chief financial officer of United 7 Financial Group and USAT. 8 Q. What do you know about -- what did you 9 know about his background and experience in that 10 role? 11 A. He came with Jerry Williams when Jerry 12 became president. They both were with First City 13 Bank in Houston, and Mike had been -- Jerry had 14 actually been the chief financial officer at First 15 City and I think Mike had worked for Jerry while 16 they were there. And then when Jerry came over to 17 United, he brought Mike with him. So, he was -- 18 and before that, he was with Arthur Andersen for a 19 number of years. 20 Q. What was the nature of your contact 21 with Mr. Crow? 22 A. On issues that came up, he would call 12320 1 and I spent a fair amount of time with him either 2 on the phone or face-to-face meetings on different 3 things that United was working on. To find out 4 what our position on a matter would be, he would 5 call me and then I would get the right players 6 involved to help him make a decision. 7 Q. So, would your contact often be 8 initiated by Mr. Crow as opposed to you contacting 9 him about some problem or issue? 10 A. Yeah. In fact, the typical situation 11 would be his calling me to see how we feel about 12 something or if we had seen a particular kind of 13 transaction or whatever. 14 Q. And would these calls pertain to the 15 proper accounting for transactions that the 16 company was considering entering into? Would that 17 be the nature of the -- 18 A. Yes. 19 Q. -- inquiry? 20 A. Yes. 21 Q. Did this happen very often? 22 A. Yes. Very often. 12321 1 Q. Would you say that it appeared to be 2 their practice to consult the outside auditors 3 when considering entering into transactions that 4 might have accounting implications? 5 A. Yes. 6 Q. Did you ever have any contact with a 7 man named Jim Wolfe during your role as a 8 concurring or engagement partner at -- 9 A. Yes. Not nearly as often as I dealt 10 with Mike; but yes, I knew Jim and was in a number 11 of meetings over the years with him. 12 Q. Do you know what Jim Wolfe's background 13 is? 14 A. Yes. He was with our firm. He was in 15 our thrift practice, and I believe that he was a 16 manager at the time he left us to join United. 17 So, he would have been with us seven, eight years 18 or something before he went to United as their 19 controller. 20 Q. Did he ever work on an audit where you 21 were the engagement or concurring partner prior 22 to -- other than USAT? 12322 1 A. Yes. 2 Q. So, he actually had worked under you 3 while at Peat Marwick? 4 A. Yes. 5 Q. And did you form any impression of Jim 6 Wolfe's capabilities in the role that he was 7 performing once he went -- left Peat Marwick and 8 went over to USAT? 9 A. Yes. I thought he did -- I thought he 10 did he a good job. He was a very conscientious 11 person. 12 Q. Did you have any dealings that you can 13 remember with any of the respondents in this case? 14 And in case you don't know who are the 15 respondents, I'll list them for you. 16 Did you have any dealings with the 17 general counsel, Art Berner? 18 A. Yes. 19 Q. Can you tell us about those contacts? 20 A. Well, he was responsible for all of 21 the -- under his direction -- the filings of the 22 10Qs and 10Ks. He was also involved in the audit 12323 1 committee meetings that we attended in setting 2 agendas and determining those kinds of things. 3 So, we had a fair amount of contact with him. 4 Q. And was he the person that you would go 5 to if you wanted an explanation of a transaction 6 or event that you saw reflected in the books and 7 records? 8 A. No, not unless there were some -- if it 9 was an accounting issue, we would, of course, go 10 to Mike Crow. And most of the time, Mike Crow was 11 sort of our contact. At least, at my level, it 12 was Crow. With Parsons, it was probably Jim 13 Wolfe. And then if there were legal issues, then 14 Art Berner would get brought into the picture. 15 Q. Another respondent in this case is 16 named Jenard Gross. 17 Did you have any contact with 18 Mr. Gross? 19 A. A limited amount. His -- he -- I've 20 forgotten exactly when he came in. He was mostly 21 involved -- he got involved with us only to the 22 extent there were real estate transactions or 12324 1 something because that was his background. And 2 so, he -- that's where his interests were. 3 So, he was involved in most of the real 4 estate things. Other than that, we would have 5 gone to other people. And I'm not even sure he 6 attended audit committee meetings. He may have 7 attended some of them. 8 Q. When -- when a matter came up regarding 9 real estate, you had contact with him. 10 Can you recall what the nature of the 11 contact was? 12 A. No. There were a couple of people 13 underneath Jenard in real estate. One of them, I 14 remember his name was David Graham. And there was 15 somebody else -- and I can't remember his name -- 16 that actually did the day-to-day real estate 17 stuff. If we were looking at a real estate 18 transaction and had some question about it and 19 maybe couldn't resolve it with David or the other 20 person, then Jenard would get involved. A fairly 21 limited amount of contact with him. 22 Q. Another respondent is Charles Hurwitz. 12325 1 Did you have any contact with him? 2 A. No. He was never involved in anything 3 that -- any issues that we dealt with. 4 Q. A person named Ronald Heubsch? 5 A. I don't even know who that is. 6 Q. Okay. And Barry Munitz, did you have 7 contact with Mr. Munitz? 8 A. We had some. I think he came to some 9 of the audit committee meetings. He was never 10 involved in any of the accounting discussions or 11 anything like that because it wasn't his 12 background, as I recall. 13 So, his was mostly -- we might be at 14 the same meeting or at an annual shareholders' 15 meeting or something like that and have some 16 contact with him, but not in terms of the audited 17 financial statements. 18 Q. And again, he would not be the person 19 you would go to if you had a question about a 20 transaction that was reflected on the books and 21 records of USAT; is that correct? 22 A. That's correct. 12326 1 MS. CLARK: Your Honor, I am going to 2 move next into a substantive area, and I suggest 3 this would be a good time for a break. 4 THE COURT: All right. We'll adjourn 5 until 1:30. 6 7 (Luncheon recess.) 8 9 THE COURT: Be seated, please. 10 We'll be back on the record. 11 Ms. Clark, you may continue with your 12 cross-examination. 13 MS. CLARK: Thank you, Your Honor. 14 Q. (BY MS. CLARK) Mr. Claiborne, 15 before -- at the very end of Mr. Guido's 16 examination, he asked you some questions about an 17 issue relating to trading versus investment 18 treatment of the mortgage-backed securities 19 portfolio at USAT. 20 Do you recall that? 21 A. Yes. 22 Q. And did he -- and he asked you whether 12327 1 USAT had notified Peat Marwick about the reasons 2 for the turnover. 3 Do you recall that? 4 A. Yes. 5 Q. I believe you testified that there had 6 been substantial turnover in the portfolio in 1986 7 and that that is the reason why the issue 8 presented itself as an auditing issue for that 9 fiscal year; is that correct? 10 A. Yes. 11 Q. Do you recall whether the client was 12 seeking your guidance on that issue as to how to 13 account for the -- its mortgage-backed securities 14 portfolios? 15 A. I don't really recall how the 16 discussion initially got started, but I know that 17 I had a number of discussions with Mike Crow, at 18 his request, to discuss -- kind of given the fact 19 that GAAP was kind of mushy and we didn't really 20 know exactly where it was, kind of what the 21 boundaries were, and what they should be doing in 22 order to stay within where we thought the 12328 1 boundaries were at the time. 2 Q. What do you mean by saying "the 3 boundaries were kind of mushy"? 4 A. Well, GAAP was -- and this whole issue 5 was in a state of evolution. There really wasn't 6 much guidance. If you looked at the thrift audit 7 guide that was in effect at the time, it didn't 8 even deal with the subject. You could look at the 9 bank audit guide and it did have some guidance, 10 but was not very helpful. 11 So, one of the reasons that I testified 12 earlier that we had some folks from New York 13 involved was that they were, in turn, going to 14 meetings with the other accounting firms and with 15 regulators and so forth trying to see where all 16 this was going to go. And so, they were kind of 17 up to speed whereas we in Houston weren't as up to 18 speed. So, we were trying -- everybody was trying 19 to kind of figure out where we were headed and 20 what the rules were at any given moment in time. 21 Q. I'd like to spend some time going over 22 the rules with you a little bit later, but let me 12329 1 just follow up on that for a second. 2 Did you ultimately give the client some 3 advice at its request concerning the trading 4 versus -- so-called trading versus investment 5 issue? 6 A. Yes. Joe Parsons wrote a memorandum 7 that was -- I think it was in early '87 -- that he 8 put together with the help of our people in New 9 York to give to United Savings to kind of tell 10 them where we were and what we thought they should 11 be doing in order to document their position and 12 so forth. 13 Q. I'm going to ask you to look at a 14 document that's previously been received in 15 evidence. It's Exhibit B3933. Mr. Farley will 16 obtain a copy and provide it to you. It's at 17 Tab 1008. 18 The first page of this document is a 19 memo from Mike Crow to Bruce Williams and Jim 20 Wolfe. This is a document that existed in this 21 form in the Peat Marwick work papers, but the 22 attachment to the document is a memo from Joe 12330 1 Parsons to Mike Crow. 2 Is this the guidance that Peat Marwick 3 gave to United in January 1987 that you were 4 referring to? 5 A. Yes. 6 Q. And it shows that you received a carbon 7 copy of the document? 8 A. Yes. 9 Q. Is that correct? 10 A. Yes. 11 Q. Did you agree with the approach that 12 was set forth in this memo? 13 A. Yes. 14 Q. The notice of charges in this case, 15 Mr. Claiborne -- that's the complaint in this 16 case -- alleges that USAT misled its auditors 17 about the nature and intent of transactions in the 18 mortgage-backed securities portfolio. 19 MS. CLARK: That's at Paragraphs 203 to 20 209, Your Honor. 21 Q. (BY MS. CLARK) And then it says in 22 Paragraph 210 the following: "As a consequence, 12331 1 USAT's auditors did not require the portfolio to 2 be mark-to-market and, as described above, 3 respondent's sales of MBSs were not for the 4 limited purposes respondents described to the 5 USAT's auditors but were traded actively to create 6 losary accounting gains offset by unrecognized 7 losses on the swaps in order to create the false 8 appearance that USAT satisfied its net worth 9 requirements." 10 That is one of the charges against 11 respondents in this case, that they misled the 12 auditors about the nature, intent of the 13 transactions in the portfolio and, as a result, 14 you didn't require them to mark the portfolio to 15 market and the respondents were able to create a 16 losary appearance that they were satisfying the 17 net worth requirements. 18 I would like to talk with you for a 19 minute about how did USAT report what was going on 20 in its mortgage-backed securities portfolio. And 21 I'd like to use one of the documents that 22 Mr. Guido questioned you about for that purpose. 12332 1 It's Exhibit A7009. It's a 1986 financial 2 statement. 3 Do you have that document in front of 4 you? 5 A. Yes. 6 Q. Do you recall -- I believe that's the 7 document that Mr. Guido asked you about in terms 8 of where was it disclosed what the accounting 9 treatment was for the mortgage-backed securities. 10 A. Yes. 11 Q. These are the audited financial 12 statements of United Savings for September -- 13 sorry -- December 31, 1986 and 1985. I'd like you 14 to turn to Page 2 of the document. I'm not going 15 to use Bates stamps because I think we still have 16 some confusion about the Bates stamp numbers. So, 17 I'm referring to the pages as they were marked on 18 the original document. 19 What does that page show? What is that 20 schedule? 21 A. It's a -- 22 MR. GUIDO: What page? 12333 1 MS. CLARK: Page 2 of the document. 2 A. That's the statement of financial 3 condition of United Savings and its subsidiaries 4 as of December 31, '86 and '85. 5 Q. (BY MS. CLARK) Is that a balance 6 sheet? 7 A. Yes. 8 Q. And on that, you can see the 9 mortgage-backed securities as well as the 10 investment securities listed as assets, can you 11 not? 12 A. Yes. 13 Q. And does that -- that shows the amount 14 of ---dollar amount of each of those categories of 15 assets? 16 A. Yes. 17 Q. Now, where would you go to find out 18 whether that dollar amount reflects market value 19 or historical cost or something else? 20 A. To the notes to the financials. 21 Q. Okay. And what portion of the notes? 22 A. Note 1, basis of presentation and 12334 1 summary of significant accounting policies. 2 Q. And there is a -- that's on Page 6 of 3 the document? 4 A. Correct. 5 Q. And I believe you identified the first 6 sentence under investment securities as the 7 explanation for what the -- what the method of 8 accounting was? 9 A. That's correct. 10 Q. If you look at the next page -- two 11 pages over, Mr. Claiborne, Page 8, there is a 12 footnote on investment securities. 13 Do you see that? 14 A. Yes. 15 Q. Can you also tell from looking at the 16 disclosure in Footnote 2 whether the amount shown 17 in the balance sheet is the market value or not? 18 A. Yes. 19 Q. And how can you tell that? 20 A. For investment securities identified in 21 Note 2, it shows the carrying amount in the 22 left-hand column under the heading 1986 and market 12335 1 value in the column to the right. 2 Q. So, that would indicate to a reader of 3 the financial statement that the securities are 4 being carried at historical cost rather than 5 current market? 6 A. Yes. 7 Q. Okay. Turn over to the next page. 8 Is the same type of information 9 available about the mortgage-backed securities 10 portfolios? 11 A. Yes. 12 Q. So, that indicates for 1986 that the 13 aggregate carrying value of the mortgage-backed 14 securities portfolios is $2,696,947, correct? 15 A. Correct. 16 Q. And that corresponds to the number on 17 the balance sheet on Page 2? 18 A. Correct. 19 Q. And then the next column over tells you 20 what the market value is; is that correct? 21 A. Yes. 22 Q. And in this case, the market value is 12336 1 somewhat more than the carrying value? 2 A. Correct. 3 Q. So, if you wanted to know what the -- 4 what the balance sheet would look like if it 5 were -- if these portfolios were mark-to-market, 6 you would simply have to go to the footnotes and 7 check and see what the market value is; is that 8 correct? 9 A. Yes. 10 Q. All right. Let's go to Page 3 of the 11 document. 12 What is that page? 13 A. The consolidated statement of -- 14 statements of operations for United and 15 subsidiaries for the year ending December 31, '86 16 and '85. 17 Q. And does that basically show the income 18 and expenses of the company? 19 A. Yes. 20 Q. And can you tell from looking at this 21 page the extent to which USAT has been recognizing 22 gains on the sale of mortgage-backed securities 12337 1 during the year? 2 A. Yes. 3 Q. And where would you find that? 4 A. Under "non-interest income," the third 5 line, "gain on sale of mortgage-backed securities 6 and loans." 7 So, that would be both -- within that 8 caption would be the gains on sales of both 9 mortgage-backed securities and loans that were 10 sold during the year. 11 Q. And how about investment securities? 12 Is that same information available there? 13 A. Yes, the following line. 14 Q. So, if you wanted to see the extent of 15 activity, sales activity, resulting in -- would 16 this be a net number? 17 A. Yes. That's just the gain, not -- 18 Q. So, if you wanted to know the extent to 19 which gains on sales of mortgage-backs and 20 investment securities were contributing to the 21 profitability as reported in this financial 22 statement, this is the page you would go to? 12338 1 A. That's correct. 2 Q. Turn over to Page 5, if you would. 3 What is that page? 4 A. The statement of changes in financial 5 position for the years ended '86 and '85 of United 6 Savings and subsidiaries. 7 Q. And does that show both the sources of 8 funds and the uses of funds by USAT during the 9 year? 10 A. Yes. 11 Q. If you wanted to know how much money 12 USAT collected on the sales of mortgage-backed 13 securities, could you find out from this page? 14 A. Yes. 15 Q. And how much was that in this year? 16 A. If you look under the -- following the 17 line -- well, it's -- after "operations," the 18 fourth line, "sales of mortgage-backed 19 securities," 4,780,000,000. 20 Q. Okay. And the same would be true for 21 investment securities? You could get the 22 information from this table, also? 12339 1 A. Yes. 2 Q. And you could compare this to the total 3 amount of mortgage-backs or investment securities 4 if that was something of interest to you? 5 A. Yes. 6 Q. And likewise, can you tell how much 7 dollar volume of purchasing was going on on each 8 of those two categories of assets? 9 A. Yes. 10 Q. And in this case, it looks as if the 11 sale of mortgage-backed securities was the single 12 largest source of funds shown on this statement of 13 changes in financial position, doesn't it? 14 A. Yes. 15 Q. I think Mr. Guido asked you about the 16 disclosure on the interest rate exchange 17 agreements. I'm not -- I actually don't recall 18 whether it was on this document or one of the 19 others. Let me ask you to turn to Page 15 and 20 look at Footnote 10. 21 Is that a footnote disclosure on USAT's 22 swaps? 12340 1 A. Yes. 2 Q. Look at the first two paragraphs. Does 3 it appear to you that they have disclosed the 4 mirror swap in the second paragraph in this 5 footnote disclosure? 6 A. Yes. 7 Q. Now, let me ask you this: If you 8 wanted to figure out whether USAT had incurred a 9 loss with respect to the swaps that were on its 10 portfolio, could you -- is this the kind of 11 information that you would look to to determine 12 what the loss was? I'm referring specifically to 13 the information concerning the fixed rates that 14 USAT was paying on its -- what we'll call the 15 mirror -- in comparison to the rates -- the fixed 16 rate it was receiving on the original swaps, if 17 you follow that question. 18 A. What was the question again? 19 Q. The second paragraph is the 20 $230 million of mirror swaps, correct? 21 A. Yes. 22 Q. That indicates what USAT was paying as 12341 1 a fixed rate on the mirror swaps, correct? 2 A. Yes. 3 Q. The paragraph before relates to the 4 original swaps where USAT was receiving fixed and 5 paying variable rates, correct? 6 A. Yes. 7 Q. Is that the information that you would 8 need if you wanted to know at any given time what 9 USAT's net position was in its swaps? 10 A. Yes. 11 Q. And this is part of the financial 12 statement that Peat Marwick audited, this 13 footnote? 14 A. That's correct. 15 Q. As best you recall, were these kinds of 16 disclosures also made in the 1987 financial 17 statements of USAT? 18 A. I don't recall. 19 Q. Do you recall whether the balance sheet 20 information was presented concerning the 21 historical -- the amount of mortgage-backed 22 securities and the amount of investment securities 12342 1 at historical cost in 1987? 2 A. Yes. 3 Q. Do you recall whether the 1987 4 financial statements disclosed the amounts of the 5 gains on sales of mortgage-backed securities and 6 investment securities? 7 A. Yes. 8 Q. Do you recall whether the 1987 9 financial statements disclosed the amount of 10 proceeds of ---dollar amount of proceeds of sales 11 of each of those kinds of assets? 12 A. Yes. 13 Q. And do you recall whether there would 14 have been a disclosure concerning the status of 15 the -- of USAT's swaps -- 16 A. Yes. 17 Q. -- in 1987? So, basically, the same 18 kind of information was disclosed in the 1987 in 19 regard to all of these matters, correct? 20 A. That's correct. 21 Q. Now, as I indicated, one of the charges 22 in the case is that USAT's management misled the 12343 1 auditors. And there have been questions in this 2 hearing about the auditors relying on client 3 representations concerning intent. That is, 4 management's representations concerning intent. 5 Isn't it true, Mr. Claiborne, that the 6 auditors actually audit the transactions of the 7 client company? 8 A. That's correct. 9 Q. And in the case of USAT, Peat Marwick, 10 the audit team, came in and audited the actual 11 transactions as shown on the books and records of 12 the company? 13 A. That's correct. 14 Q. And you would look at the underlying 15 books and records to see what had occurred and 16 even go to the transaction documents themselves 17 when you felt that was important to the audit work 18 that you were doing? 19 A. That's correct. 20 Q. Would that be fair? 21 A. (Witness nods head affirmatively.) 22 Q. So, it wouldn't really be possible to 12344 1 mislead the auditors about how many sales there 2 were, correct? You would look and find out for 3 yourself how many sales there were? 4 A. That's correct. 5 Q. And you couldn't be misled about when 6 the sales occurred. You would look at the 7 underlying documents and you would see when during 8 the year or when during the quarter those sales 9 occurred, correct? 10 A. Correct. 11 Q. And you couldn't be misled about 12 whether those sales resulted in a gain or a loss. 13 That would be something that the auditors would 14 look at? 15 A. That's correct. 16 Q. And of course, the dollar amounts 17 involved, that would also be within the scope of 18 what you would look at in the course of your 19 audit, correct? 20 A. Correct. 21 Q. So, if, for example, USAT were selling 22 mortgage-backed securities of one coupon and 12345 1 simultaneously buying mortgage-backed securities 2 of a slightly different coupon, that's something 3 that the auditors would see in the course of the 4 audit, correct? 5 A. Yes. 6 Q. And if USAT were selling 7 mortgage-backed securities or any other asset at 8 the end of the year and recognizing gains on those 9 sales, that's something that the auditors would 10 see in the course of the audit, correct? 11 A. Correct. 12 Q. Mr. Guido asked you if anybody ever 13 told you that the reason for the turnover in the 14 mortgage-backed securities portfolio in 1986 was 15 that USAT was selling mortgage-backs to recognize 16 gains to bolster profits. 17 Do you remember that question? 18 A. I think so, yes. 19 Q. And I think your initial answer was you 20 thought you might have seen something like that in 21 the work papers. And then after further exchange, 22 you indicated that, at least in the work papers 12346 1 Mr. Guido sent you before your testimony, you 2 didn't remember seeing anything to that effect; is 3 that correct? 4 A. Correct. 5 Q. Now, would you agree with me that if 6 information is in the Peat Marwick work papers, if 7 it's recorded in Peat Marwick's work papers, then 8 Peat Marwick knew it? 9 A. Somebody at Peat Marwick knew it. 10 Q. And so, if information that you didn't 11 see because Mr. Guido didn't send it to you before 12 your testimony would indicate that Peat Marwick 13 was aware of certain things, you wouldn't dispute 14 that that was the case if it was in the work 15 papers? 16 A. Correct. 17 Q. Now, auditors follow certain pretty 18 standard approaches in going in to audit a 19 company. And one of those is that you would 20 always look at the minutes of the board of 21 directors and of the operating committees of the 22 company. 12347 1 Is that a fair statement, that that 2 would be pretty much standard operating procedure 3 in any audit? 4 A. Yes, as far as the board and most of 5 the operating committees. There may have been 6 some that deal with subjects that aren't relevant 7 to the audits that we might not. 8 Q. And one of the committees that you 9 would always look at without fail would be the 10 investment committee or the asset/liability 11 committee. 12 Would that be true? 13 A. Yes. 14 Q. And, in fact, this is one way, I 15 suppose, that a client actually communicates with 16 the auditors. That is to say, a client would 17 record what's going on in the minutes with the 18 expectation that, without fail, the auditors would 19 come in and read the minutes, correct? 20 A. Yes. 21 Q. In 1986 and 1987, were the 22 mortgage-backed securities portfolios and the 12348 1 corporate securities portfolios considered to be a 2 significant audit area for USAT? 3 A. Yes. 4 Q. So, that would be one area that would 5 receive the particular attention of the audit team 6 and of the manager and the partner in the course 7 of the audit. 8 Is that a fair statement? 9 A. Yes. 10 Q. And, in fact, those areas did receive 11 particular attention in the 1986 and 1987 audits. 12 True? 13 A. True. 14 Q. Now, in your role as engagement 15 partner, you didn't read every piece of paper that 16 your team read? 17 A. No. 18 Q. Fair? 19 A. (Witness nods head affirmatively.) 20 Q. Would you have personally read the 21 minutes of the investment committee, for example? 22 A. I may have read some where Joe, the 12349 1 manager at the time, would have suggested that I 2 read them because they had something in there that 3 he thought I should see. But as a general 4 proposition, no. 5 Q. As a general proposition, how would the 6 responsibility for reviewing the minutes of an 7 operating committee be allocated within the team? 8 A. Well, the senior accountant would be 9 the person to look at them in detail; but the 10 manager is also required to read all of them. 11 Q. Would you then trust them to bring to 12 your attention information that is important for 13 you to know in your role of determining whether 14 the financial statements were presented fairly? 15 A. Yes. 16 Q. And do you believe that Joe Parsons and 17 his team would have done that -- 18 A. Yes, I do. 19 Q. -- appropriately? 20 A. Yes. 21 Q. You have confidence that they would 22 have brought to you anything that was significant 12350 1 to the presentation of USAT's financial condition 2 in the financial states? 3 A. I do. 4 Q. Mr. Claiborne, do you believe that -- 5 well, let me go back one step. 6 In both the 1986 and the 1987 audits, 7 Peat Marwick concluded that with respect to the 8 mortgage-backed securities portfolio and the 9 corporate securities portfolio, that the financial 10 statements were correctly presented; is that true? 11 A. That is true. 12 Q. Do you believe that that conclusion was 13 a correct conclusion? 14 A. I do. 15 Q. Mr. Guido asked you some questions 16 about analogous rules. 17 Do you recall that? 18 A. Yes, I do. 19 Q. And in regard to the -- I think what 20 Mr. Guido called the hierarchy of GAAP. 21 Do you remember a question about that? 22 A. Yes, I do. 12351 1 Q. I think you answered that once you get 2 beyond the pronouncement of the Financial 3 Accounting Standards Board that there are a 4 variety of other sources of GAAP and that those 5 other sources are pretty much a level field is, I 6 think, the term you used? 7 A. That's correct. 8 Q. That would include the industry audit 9 guides? 10 A. Yes. 11 Q. And would it include analogous rules 12 from other areas of accounting literature? 13 A. Yes. 14 Q. And would it include industry practice? 15 A. Yes. 16 Q. And all of those and other things are 17 sources that auditors can look to to determine 18 what the proper GAAP treatment on a particular 19 issue might be; is that correct? 20 A. That's correct. 21 Q. Recognizing that there may be times 22 when you would look to analogous rules as a source 12352 1 of GAAP, let me ask you this: Can you just take a 2 rule that's promulgated for one kind of industry 3 and automatically apply it in a different 4 industry? 5 A. No, you cannot. 6 Q. Can you take a rule that's promulgated 7 or -- promulgated for one kind of asset and apply 8 it to a different kind of asset? 9 A. Not necessarily. 10 Q. For example, equity securities and debt 11 securities. The rules might not apply equally to 12 both, correct? 13 A. That's true. 14 Q. And over the course of time, the 15 accounting profession has developed particular 16 rules for particular kinds of assets. And you 17 just can't sort of turn around and automatically 18 apply them to other kind of assets. Fair? 19 A. Yes. 20 Q. And would that also be true for 21 financial instruments like options and swaps and 22 futures, the kinds of instruments that Mr. Guido 12353 1 was talking about? 2 A. That's correct. 3 Q. You would have to carefully evaluate 4 whether the rules in one area provide any guidance 5 at all with respect to another area. You just 6 couldn't automatically apply them. 7 Is that fair? 8 A. Yes. 9 Q. And you would also want to look at 10 industry practice before you just automatically 11 jump and apply something from another kind of 12 asset or instrument. 13 Would that be fair? 14 A. Yes. 15 Q. It's also -- is it true that the 16 accounting rules change over time? 17 A. Yes. 18 Q. What does the accounting profession go 19 through before it changes an accounting rule? 20 A. Well, if we're talking about the FASB, 21 there's one process. If you're talking about an 22 audit guide, there is a different process. But if 12354 1 you're talking about a standard that the Financial 2 Accounting Standards Board issues, there is, first 3 of all, a discussion memorandum that is published 4 asking people -- soliciting comments and thoughts 5 about how a particular issue should be dealt with. 6 Then there is an exposure draft which sets forth 7 what the preliminary views of the board are. 8 There is a comment period, typically public 9 hearings, and then there is a standard that's 10 issued following that. 11 Q. Have you ever heard the term "due 12 process" used in the accounting profession? 13 A. Sure, yes. 14 Q. What does that mean? 15 A. Just what I described: A process of 16 allowing people to comment and not just a -- a 17 process to go through to make sure that everybody 18 has a fair hearing of their views before a 19 conclusion is reached. 20 Q. Do you have any understanding as to why 21 the accounting profession uses this due process 22 procedure before it makes a change in accounting 12355 1 rules? 2 A. Why? 3 Q. Yes. 4 A. Well, the thought is to -- is to -- 5 with the SEC's participation, to allow all sides 6 of an issue to be heard and discussed before 7 arriving at a decision. 8 Q. Can a change in accounting rules have 9 an effect on the way businesses conduct their 10 business? 11 A. Yes, it often does. 12 Q. In fact, a change in accounting rules 13 could have a very dramatic effect on the economic 14 practices of the business entities in our country. 15 Is that fair? 16 A. Yes. 17 Q. And is that one reason why there is a 18 due process procedure before the accounting rules 19 are changed? 20 A. Yes. 21 Q. Now, going back to USAT again in 1986 22 and 1987, the time when Peat Marwick was providing 12356 1 advice to the -- to the client about this 2 investment versus trading issue, do you recall 3 that the accounting rules on how to account for 4 securities at thrifts were under scrutiny and in 5 the process of reconsideration? 6 A. During 1986 and '87? 7 Q. Yes. 8 A. Yes, they were. 9 Q. In fact, in Mr. Parsons' memo, the 10 document we just looked at, he says pretty much 11 exactly that, doesn't he, in the second paragraph 12 where he talks about how the accounting basis for 13 similar portfolios has been under scrutiny by the 14 regulatory and GAAP accounting authorities? 15 A. Yes. 16 Q. Do you know what he was referring to in 17 regard to the scrutiny by regulatory and GAAP 18 accounting authorities? 19 A. Well, there were -- at the time that 20 this was going on, I believe there was another 21 AICPA audit guide in process that was going 22 through -- I've forgotten exactly what stages it 12357 1 was in then, but it was underway and this was one 2 of the major issues that they were going to try to 3 deal with because at the time, at this time, back 4 in this period of time, banks had one set of 5 rules, thrifts had a different set of rules, and 6 mortgage bankers may have had a third set. I 7 don't recall. But the three were certainly not in 8 harmony at the time. So, there was a move afoot 9 to bring all of those rules into -- into 10 agreement. 11 Q. Recognizing that the rules were fuzzy 12 or -- and in flux at the time, can you explain to 13 the Court what you recall the practice generally 14 was in the thrift industry with regard to 15 accounting for investments in securities or in 16 mortgage-backed securities? 17 A. Well, at the time, the investment 18 securities were to be carried at amortized cost, 19 period. There was then a requirement that you 20 look at activity in a particular security or 21 something, a security that you didn't intend to 22 hold for the foreseeable future but at some point 12358 1 you might sell, to see if it would be carried at 2 less, to see if the market value were less than 3 cost in some circumstances. You would then 4 provide an allowance for loss to reduce the 5 carrying value of the portfolio or of that 6 security to what you ultimately thought you would 7 realize when it came time to dispose of it. 8 Q. Do you recall whether banks and thrifts 9 were engaging in substantial purchases and sales 10 out of their investment portfolios and still 11 carrying them at amortized historical costs during 12 this period of mid-1980s? 13 A. Yes. 14 Q. And do you recall anything about how 15 important the gains on sales of securities out of 16 investment portfolios were to the profitability of 17 the thrift industry in the 1985, '86, '87 period? 18 A. I don't recall the specific 19 percentages, but they were -- my characterization 20 of it would be very significant. It would 21 probably be a substantial -- probably over half, 22 at least, of the income of -- if you took the 12359 1 larger publicly-traded thrifts and looked at their 2 income statements, my guess would be that it would 3 be -- well over half of their income would be from 4 gains on sales of securities or mortgage-backs. 5 Q. And do you recall whether any of them 6 marked those portfolios to market? 7 A. To my knowledge, none did. 8 Q. None did? 9 A. I say that if they had a trading 10 portfolio, they would have marked it to market, 11 but that's different. 12 Q. And what do you mean by "trading 13 portfolio"? 14 A. Well, if you -- when I said every 15 investment securities carried at amortized cost, 16 that's true. But if you -- some financial 17 institutions would acquire securities with an 18 intent to dispose of them in a very short period 19 of time. And in those circumstances, they put 20 those securities into what they call a trading 21 portfolio because that was their intent, was to 22 move in and out of a security very -- in a matter 12360 1 of a few days or something. And those securities 2 were carried at market. 3 Q. Were many thrifts engaging in that kind 4 of a trading operation during those days? 5 A. The larger ones, yes. They typically 6 had -- not nearly in terms of size -- approaching 7 the size of an investment portfolio, but most of 8 them had some sort of trading operation. 9 Q. You indicated to Mr. Guido, I think, 10 that you had gone back and reviewed the savings 11 and loan -- thrift savings and loan audit guide as 12 one of the documents that you reviewed prior to 13 your testimony today? 14 A. Yes. 15 Q. I'd like to ask you a few questions 16 about that, if I might. 17 MS. CLARK: Let's give him the actual 18 book. We've copied it for everybody else. It 19 might be easier for you to use the book. 20 Q. (BY MS. CLARK) Mr. Claiborne, is that 21 the industry audit guide that applied to the 22 savings and loan industry as of 1987? 12361 1 A. Yes. 2 Q. That's the fourth edition, is it? 3 Fourth revised edition issued in 1987? 4 A. Yes. 5 Q. Do you recall what this guide provided 6 with respect to how mortgage-backed securities 7 were to be treated for accounting purposes? 8 MR. GUIDO: Your Honor, before we get 9 into any specifics about the document, do you move 10 its admission? 11 MS. CLARK: Yes. Thank you. I move 12 its admission. Your Honor, it has been marked as 13 Exhibit B4187. 14 THE COURT: Received. 15 A. The answer is that they were to be 16 treated as investment securities. 17 Q. (BY MS. CLARK) Let me ask you to look 18 at, if you would, Page 2 3. In the middle of the 19 page, there is a paragraph beginning "Investments 20 in pass-through certificates." 21 Would you read that paragraph? 22 A. To myself or out loud? 12362 1 Q. To yourself. Thank you. 2 MR. GUIDO: Which paragraph? 3 MS. CLARK: It's the middle paragraph 4 on Page 23, "Investments in pass-through 5 securities." 6 Q. (BY MS. CLARK) Does that refresh your 7 recollection how the mortgage-backed pass-through 8 certificates were to be accounted for, at least 9 under the language of this edition of the thrift 10 audit guide? 11 A. Yes. 12 Q. What was that? 13 A. They are to be accounted for consistent 14 with interest in real estate loans. 15 Q. Now, I'll ask you actually to go ahead 16 and look at the back of the book at Appendix B, 17 which is 861, and I think I have a yellow tab 18 there to help you find the spot. That's a 19 statement of position of the AICPA accounting 20 standards division; is that correct? 21 A. Yes. 22 Q. If you will look at Page 149 and 152, 12363 1 please. 2 Does that indicate that in September of 3 1986 the AICPA finally got around to mandating 4 that mortgage-backed securities even be treated as 5 securities rather than as loan participations? 6 A. Yes. 7 Q. So, it wasn't until September of 1986 8 until the accounting authorities even viewed 9 mortgage-backed securities as securities at all 10 rather than participating loans? 11 A. Correct. 12 Q. Let's stay with this 861 for a moment 13 and turn to Page 149. There is a Paragraph 29 14 there that discusses how mortgage-backed 15 securities are accounted for in mortgage banking 16 operations. 17 Can you recall: How were 18 mortgage-backed securities accounted for in 19 mortgage banking operations? 20 A. Paragraph 29 says it's at the lower of 21 cost or market. 22 Q. There is a reference there to 12364 1 certificates held for sale. 2 Was that a concept that was used in the 3 mortgage banking industry to classify securities 4 including mortgage -- particularly mortgage-backed 5 securities? 6 A. Yes. 7 Q. And the accounting treatment for assets 8 held for sale was not mark-to-market but lower of 9 cost or market? 10 A. Correct. 11 Q. And this guide does not suggest that 12 thrifts should classify their mortgage-backed 13 securities under this set of categories of held 14 for sale, correct? 15 A. Correct. 16 Q. That was a concept that applied to 17 mortgage banking operations but not to thrifts? 18 A. Correct. 19 Q. And do you know what -- how mortgage 20 banking operations were defined for accounting 21 purposes? 22 A. I don't recall. 12365 1 Q. Do you recall that FAS 65 defined 2 mortgage banking operations as originating and 3 acquiring mortgage loans to sell to permanent 4 investors? Does that sound right? 5 A. Yes. 6 Q. Okay. And also servicing mortgage 7 portfolios? 8 A. Yes. 9 Q. And that's not what we're talking about 10 when we're talking about an investment portfolio 11 and a thrift. That's an entirely different kind 12 of business? 13 A. That's correct. 14 Q. And was there any held for sale 15 category for thrift institutions at the time of 16 the thrift audit guide that we're looking at here: 17 1987? 18 A. I don't believe so. 19 Q. Take a look at Page 19 back in the 20 guide, if you would, please. 21 Do you see there is a section of the 22 guide that relates to investments in securities? 12366 1 A. Yes. 2 Q. The first sentence of that section says 3 that "securities may be held for investment or in 4 certain instances in a trading portfolio." 5 Was that your understanding, as well? 6 A. Yes. 7 Q. So, there were just two categories. 8 There was investment or trading. No third 9 category of held for sale at that time? 10 A. At that time, that's correct. 11 Q. Now, if you look at the discussion in 12 that section on investment securities on Page 19, 13 it talks about how there may -- "At thrifts, there 14 may be regular purchases and sales of investment 15 securities." It talks about how they can be 16 repo'd, arbitraged, and the like; is that correct? 17 A. Correct. 18 Q. Now, how does the guide say that the 19 investment securities should be accounted for? 20 Look on Page 20. 21 A. At amortized cost. 22 Q. So, even though it recognizes that the 12367 1 securities may be regularly bought and sold, 2 repo'd, arbitraged, and the like, it still 3 mandates that they be accounted for at amortized 4 cost, at least as of 1987; is that correct? 5 A. Correct. 6 Q. Now, if you go to the bottom of 20 and 7 the top of 21, there is a discussion about an 8 allowance for a decline in the value of the 9 securities. 10 Is this discussion what you were 11 referring to in your testimony just a few minutes 12 ago about how if you do not have the intent to 13 hold the security or if you have the intent to -- 14 let me just ask you to explain it rather than 15 trying to summarize your testimony. 16 Can you explain what the guide is 17 saying about intent and what effect -- or what 18 relevance it has to the accounting? 19 A. Well, if your intent is to hold to -- 20 well, let me say it differently. If your intent 21 is at some time to dispose of the security prior 22 to its maturity and you anticipate, based on 12368 1 current market values, that that's going to result 2 in a loss, you would provide for that loss at that 3 point in time. 4 Q. The guide talks about how if you're 5 holding a debt security, the value of that 6 security is going to go up and down, up and down, 7 up and down because it's going to depend on 8 current market rates, correct? 9 A. Correct. 10 Q. And so, what the guide says is: As 11 long as you don't have an intent to sell that 12 security into the market, that fluctuation in the 13 value does not need to be charged against -- you 14 don't have to write down the value of that 15 security. 16 Is that a fair summary? 17 A. Yes. 18 Q. Now, is that because there is no 19 probable loss on the security at that time? 20 A. That's right. That would have been the 21 standard under the literature which dealt with 22 losses, which was Standard No. 5 that dealt with 12369 1 losses and the like. 2 Q. Was that the approach that was followed 3 in the thrift industry in 1986 and 1987 -- 4 A. Yes. 5 Q. -- with respect to investment 6 securities held by thrifts? 7 A. Yes. 8 Q. As long as you do not intend to or, I 9 suppose, do not have to sell the security into the 10 market, you do not need to recognize a loss by 11 writing down the security because of changes in 12 market value due to interest rate fluctuations. 13 Is that a fair summary? 14 A. Yes. 15 Q. And is this the only reference to the 16 concept of intent to hold that there was in the 17 thrift guide at that time? 18 A. Yes. 19 Q. Was there any guidance in the thrift 20 guide about when, if ever, you would have to mark 21 the whole portfolio to market? 22 A. No. 12370 1 Q. And that's not what's being discussed 2 here when they talk about intent to hold. That's 3 one security, correct? 4 A. That's right, an individual security. 5 Q. Okay. So, there is no guidance in this 6 book. Joe Phillips turned to the bank audit guide 7 in that memo, didn't he, because he couldn't find 8 anything relevant in the thrift guide. 9 And I believe you testified that under 10 the hierarchy of GAAP, that's an acceptable source 11 to go to if you do not have any directly 12 applicable authority; is that right? 13 A. That's correct. 14 Q. Did I say Joe Phillips? I'm sorry. To 15 correct the record, it's Joe Parsons who was the 16 manager of that audit; is that right? 17 A. That's right. 18 Q. Let's look at the bank guide and see 19 what it says. First of all, let me ask you if you 20 can identify this as the industry audit guide for 21 the audit of banks issued by the AICPA, second 22 edition, issued in 1984? 12371 1 A. Yes. 2 MS. CLARK: I offer Exhibit B4195, Your 3 Honor. 4 MR. GUIDO: No objection, Your Honor. 5 THE COURT: Received. 6 Q. (BY MS. CLARK) Have you ever heard 7 the terms bank GAAP and thrift GAAP? 8 A. Yes. 9 Q. What does that mean? 10 A. Well, at this period of time, these 11 guides were -- were written by -- well, during 12 this time, these guides were written by -- 13 principally by committees of practitioners in a 14 particular industry. And the people that dealt 15 with the bank audit guide were different people 16 than who did the thrift audit guide. 17 So, as a result, through this period of 18 time, what was an acceptable practice for banks 19 may not have been for thrifts and vice versa. 20 Q. Were there, in fact, differences 21 between the way GAAP applied to thrifts and the 22 way it applied to banks during this period? 12372 1 A. Yes. 2 Q. And I believe one example of such a 3 difference is that banks, already in 1984, were 4 accounting for mortgage-backed securities as 5 securities and not loans; is that correct? 6 A. That's correct. 7 Q. And there would be other differences in 8 the way that GAAP applied to the two different 9 industries, correct? 10 A. Yes. 11 Q. Just the way there would be differences 12 between the way GAAP applied to thrifts on the one 13 hand and mortgage banking operations on the other? 14 A. That's correct. 15 Q. So, you can't automatically apply the 16 rules in one industry to another industry without 17 carefully considering whether they are the most 18 appropriate to apply, correct? 19 A. Correct. 20 Q. Let me ask you, if you would, please, 21 to turn to Page 30 of the bank -- well, turn to 22 Page 29, which is the beginning of the chapter on 12373 1 investment securities. 2 Is this the chapter that would govern 3 how banks, anyway, would account for 4 mortgage-backed securities? 5 A. Yes. 6 Q. Now, if you would, turn to the next 7 page, Page 30. 8 What does it say about how banks were 9 to account for debt obligations which -- would 10 mortgage-backed securities be considered a kind of 11 debt obligation? 12 A. Yes. 13 Q. Would that also be true for high-yield 14 bonds, for example? Would they be debt 15 obligations? 16 A. Yes. 17 Q. So, this chapter would govern both 18 kinds of securities? 19 A. That's correct. 20 Q. So, what did the bank guide say about 21 how mortgage-backed securities and high-yield 22 bonds were to be accounted for? 12374 1 MR. GUIDO: What page are you on again? 2 MS. CLARK: I'm on Page 30, the section 3 under the heading "accounting." 4 A. At cost. 5 Q. (BY MS. CLARK) That would be 6 amortized historical cost? 7 A. Correct. 8 Q. Now, does the bank guide give any 9 guidance as to when debt securities need to be 10 written down because of an unrealized decline in 11 market value? 12 A. Yes. 13 Q. What's that guidance? 14 A. That if it -- it then becomes a test of 15 your intent and ability to hold the security if 16 you do not intend or you -- or you must sell it in 17 the foreseeable future and that would be at a 18 loss, then you record that loss. 19 Q. And what language in particular are you 20 referring to on this page? 21 A. Under the heading "accounting," the 22 third paragraph beginning "It may be necessary to 12375 1 dispose." 2 Q. Uh-huh. In the paragraph before, there 3 is a reference, also, to the ability and intent to 4 hold these securities on a long-term basis. 5 Do you see that? 6 A. Yes. 7 Q. And is that the same idea that you're 8 talking about? 9 A. Right. Just different words. Same 10 idea. 11 Q. And can you tell: Is this the -- is 12 this the guidance from the bank audit guide that 13 Joe Parsons used by analogy when he tried to 14 formulate some advice for USAT in his 1987 memo? 15 A. Yes. 16 Q. Do you recall what the bank audit guide 17 provided with respect to this idea of 18 characterizing a portfolio, an entire portfolio, 19 as either investment or trading? 20 A. I don't believe the bank audit guide 21 dealt with that. 22 Q. Maybe this will refresh your 12376 1 recollection. If you look on Page 32 under 2 "securities gains and losses" -- 3 A. (Witness reviews the document.) Okay. 4 Q. Does the bank audit -- did the bank 5 audit guide provide any guidance on the question 6 of when a -- an entire portfolio would have to be 7 characterized as trading and mark-to-market? 8 A. In the third paragraph, it talks about 9 if there is substantial turnover. 10 Q. Let's just read that into the record. 11 It says "If there is substantial turnover in the 12 investment portfolio, management's intention and 13 experience determine whether a trading function is 14 occurring and the appropriate classification and 15 valuation method to be used." 16 Is that the paragraph that you're 17 referring to? 18 A. Yes. 19 Q. And is that another portion of this 20 guide that Mr. Parsons turned to for guidance by 21 analogy? 22 A. Yes. 12377 1 Q. Turn, if you would, to Page 40, 2 Chapter 6. 3 Do you see in that very first paragraph 4 that there is a discussion about what trading was. 5 MR. GUIDO: Which page are you on? 6 MS. CLARK: Page 40. 7 A. Yes. 8 Q. (BY MS. CLARK) And what does the bank 9 audit guide say about what trading was? 10 A. Are you talking about the very first 11 paragraph on the page? 12 Q. Yes. 13 A. By trading for their own account or 14 selling securities to customers. 15 Q. The paragraph of the bank audit guide 16 relating to trading securities says that 17 "Commercial banks are permitted to underwrite and 18 deal in certain securities. Banks involved in 19 those activities seek to earn a profit by trading 20 for their own account or selling the securities to 21 customers. A markup in price known as a spread 22 represents compensation to the bank for 12378 1 distributing and making a market in the 2 securities." 3 Mr. Claiborne, was there anything else 4 in this bank audit guide that provided any 5 definition of what trading constituted for 6 purposes of the trading versus investment 7 categories? 8 A. No, I don't believe so. 9 Q. This was the guidance that existed at 10 that time? 11 A. Right. 12 Q. Do you recall that Peat Marwick 13 provided guidance to its own auditors on what 14 trading was, what it constituted? 15 A. Yeah. In our depository institutions 16 guide? Is that what you're referring to? 17 Q. Let me ask you to look at a document 18 that was produced by Peat Marwick from its work 19 papers in the USAT audit. It's Exhibit B4198? 20 MR. GUIDO: Pardon? Again? 41 -- 21 MS. CLARK: 4198. 22 MR. NICKENS: B. "B" as in boy. 12379 1 (Discussion off the record.) 2 3 Q. (BY MS. CLARK) Mr. Claiborne, can you 4 identify this as an excerpt from the Peat Marwick 5 Depository Institution's Practice Guide as of 6 October 1985? 7 A. Yes. 8 MS. CLARK: Your Honor, I offer exhibit 9 B4198. 10 MR. GUIDO: No objection, Your Honor. 11 THE COURT: Received. 12 Q. (BY MS. CLARK) What guidance did this 13 Depository Institution's Practice Guide provide 14 with respect to what trading involved, trading 15 securities? 16 A. On the second page of what you handed 17 out under the heading Section 3316, trading 18 securities, in the Paragraph .01, there is a 19 discussion of what trading securities are. 20 Q. And would you read to the Court, 21 please, what trading securities were in 22 October 1985 as far as the Peat Marwick guide was 12380 1 concerned? 2 A. "Trading securities are purchased for 3 resale to customers over a short period of time. 4 The institution acts as a dealer, attempting to 5 make a profit by selling the securities at a price 6 higher than the price that it paid. This markup, 7 known as spread, represents compensation to the 8 institution for distributing the securities and 9 assuming the risk of changing market conditions 10 during the distribution period. Generally, 11 trading activities occur in larger commercial 12 banks, and securities involved are US Government 13 and municipal obligations. Because of the 14 speculative and volatile nature of the trading 15 securities portfolio, the account usually 16 constitutes a relatively small portion of total 17 securities and the balance may fluctuate widely 18 during the short term." 19 Q. Was that your understanding, 20 Mr. Claiborne, in 1986 and 1987 when you were the 21 engagement partner on the USAT audit, of what a 22 trading function within the meaning of the bank 12381 1 audit guide was? That is to say, attempting to 2 make a profit by selling securities at a price 3 higher than the price paid and the rest of this 4 definition in the Peat Marwick guide? 5 A. Yes. 6 Q. As far as you know, did any 7 accounting -- any accounting or regulatory 8 authority ever put forward a different definition 9 of trading than the one that's found in this 10 Peat Marwick guide? I don't mean the exact same 11 words, but did any authority ever put forward a 12 different definition in substance than the one 13 that the Peat Marwick audit guide had in 1985? 14 A. Not that I'm aware of. 15 Q. As far as you know, that has been the 16 definition of a trading function from 1985 up 17 until today? 18 A. Yes. 19 Q. So, even though the rules in this area 20 have changed, as you have testified, the 21 definition of trading securities as acquiring 22 securities to resell them in the short-term to 12382 1 make a quick profit is the same now as it was in 2 1985 and throughout that period? 3 A. That's correct. 4 Q. And that was, in fact, the concept that 5 Mr. Parsons included in the guidance that he 6 provided to USAT in January 1987; is that correct? 7 A. Yes. 8 Q. He talked about short-term gains and 9 intent to deal in securities for profit. 10 Is that the concept that Mr. Parsons 11 was conveying to the client about what trading was 12 at that time? 13 A. Yes. 14 Q. And, in fact, is that the definition 15 that Peat Marwick applied in auditing USAT's 16 mortgage-backed securities and high-yield bond 17 activities in the 1986 and 1987 audits? 18 A. Yes. 19 Q. And Peat Marwick carefully considered 20 all the evidence and ultimately concluded that 21 USAT's securities and mortgage-backed activities 22 did not constitute a trading function that would 12383 1 require mark-to-market treatment; is that fair? 2 A. That's correct. 3 Q. That's what happened, correct? 4 A. Yes. 5 Q. In the course of reaching that 6 conclusion, Mr. Claiborne, did you consult with 7 the experts? 8 A. Yes. 9 Q. Which experts did you consult with 10 about that, whether you were applying the right 11 definition to trading when you audited those 12 financial statements in 1986 and '87? 13 A. Most of our discussions were with Bob 14 Mills, who was in the group I testified about 15 earlier. 16 Q. Okay. And did he concur with the 17 advice that you were giving the client in that 18 regard? 19 A. Yes. 20 Q. Now, do you recall, Mr. Claiborne, that 21 just about the time that you were signing off on 22 the 1987 USAT audit, the financial institution 12384 1 regulators issued a proposed new policy on 2 accounting for debt securities? 3 A. I remember that, yeah. 4 Q. And what do you recall about that 5 policy? 6 A. I believe that it still dealt with the 7 concept of a trading portfolio and investment 8 portfolio, just the two buckets concept again, and 9 was not significantly different, I don't believe, 10 than where we were at the time. 11 Q. Let me ask you, if you would, to look 12 at an exhibit that we've marked as B4193. 13 Mr. Claiborne, this is a composite exhibit, as we 14 say. This is a combination of a document that we 15 obtained from the files of USAT and a more legible 16 copy of part of the document which is stapled at 17 the back of the document. So, let me just 18 describe what's in the document and then I'm going 19 to offer it. 20 The first part of it is a Coopers & 21 Lybrand banking advisory dated March 17, 1988, 22 with the names of some of the USAT employees on 12385 1 the upper right-hand corner. And obviously 2 someone has highlighted and made a good part of it 3 illegible. 4 And then attached to that is a banking 5 issuance dated April 14, 1988, from the 6 Comptroller of the Currency on the subject of 7 selection of securities dealers and unsuitable 8 investment practices. 9 And that has, as an appendix to that 10 document -- we are now up to CN101330 -- an FFIEC 11 supervisory policy statement on the selection of 12 securities dealers and unsuitable investment 13 practices. 14 And that goes on for several more pages 15 and then you get to a repeat of the Coopers & 16 Lybrand banking advisory which is legible which 17 did not come from the files of USAT, which I found 18 somewhere else. Okay? 19 MS. CLARK: I would like to offer this 20 Exhibit B4193 in evidence. 21 MR. GUIDO: Are the last three pages 22 essentially CN101323, 101324, 101325. 12386 1 MS. CLARK: No. I have 333, 334, and 2 335 as the last three pages. 3 MR. GUIDO: That wasn't my question. 4 MS. CLARK: Oh, I beg your pardon. 5 Yes, indeed. It's a copy that hasn't been 6 obscured by highlighting. 7 MR. GUIDO: So that the last three 8 pages that do not have Bates stamps are another 9 copy of CN101323, CN101324, CN101325? 10 MS. CLARK: Yes. 11 MR. GUIDO: No objection, Your Honor. 12 THE COURT: Received. 13 Q. (BY MS. CLARK) Mr. Claiborne, as I 14 have been describing the document, have you had a 15 chance to look at it? 16 A. Yes. This is different than the one I 17 was thinking about. Go ahead. 18 Q. Let me -- let's skip over the part 19 that's not legible and go to the part that begins 20 on No. CN101326, which is the Comptroller of the 21 Currency banking circular which incorporates by 22 reference the appendix to the FFIEC supervisory 12387 1 statement. 2 Do you know -- do you remember, I 3 should say, what the FFIEC was? 4 A. The -- you mean what that acronym 5 stands for? 6 Q. Yes. 7 A. The Federal Financial Institution 8 Examination Council, which is -- was trying to 9 harmonize practices in the banking arena. 10 MS. CLARK: Before we begin to discuss 11 this, Your Honor, would you like to take a break 12 at this point, or shall we continue? 13 THE COURT: We'll take a short recess. 14 15 (A short break was taken.) 16 17 THE COURT: Be seated, please. Back on 18 the record. 19 MS. CLARK: Thank you, Judge Shipe. 20 Q. (BY MS. CLARK) Mr. Claiborne, who 21 were the members of the FFIEC? 22 A. The financial regulators. 12388 1 Q. Would that include the office of the 2 comptroller of the currency and the federal 3 reserve and, at this time, the Federal Home Loan 4 Bank Board? 5 A. Yes. 6 Q. Do you see that the appendix to the 7 FFIEC supervisory policy statement defines trading 8 in an investment portfolio on Page CN101330? 9 A. It defines what again? 10 Q. Trading in the investment portfolio. 11 A. Yes. 12 Q. And how does it define trading in the 13 investment portfolio? 14 A. "High volume of purchase and sale 15 activity which would be considered in light of a 16 holding period for short-term price movements." 17 Q. Is that consistent with your 18 understanding of what trading was at the time you 19 conducted the audits of USAT's securities and 20 mortgage-backed securities portfolio in 1986 and 21 '87? 22 A. Is it consistent with what again? 12389 1 Q. The standard that you applied in 2 auditing USAT in 1986 and '87. 3 A. Yes. 4 Q. You see there's a reference to gains 5 trading in the next paragraph? 6 A. Yes. 7 Q. Is that a term that you were familiar 8 with in 1986 and '87? 9 A. Yes. 10 Q. And does the definition of gains 11 trading in this document comport with what was 12 understood by "gains trading" in 1986 and '87? 13 A. Yes. 14 Q. And specifically, it says that "Gains 15 trading is characterized by the purchase of a 16 security as an investment and the subsequent sale 17 of that same security at a profit within several 18 days or weeks." 19 Is that what you understood "gains 20 trading" to mean at the time you did the USAT 21 audits? 22 A. Yes. 12390 1 Q. Let's go over -- I'm going to ask you 2 to look at a clean copy of the Coopers & Lybrand 3 advisory which is at the end of this exhibit. 4 Do you recall what the reaction of the 5 banking and thrift industries was to the issuance 6 of the supervisory -- proposed supervisory policy 7 by the Federal Financial Institutions Examinations 8 Council in March of 1988? 9 A. That it would result in a significant 10 change in the way accounting -- or what securities 11 would be classified as investment versus trading. 12 Q. And that is, in fact, what the Coopers 13 & Lybrand advisory says on the first page under 14 the heading, "Issue: Federal regulators intend to 15 restrict investment activities of banks and 16 thrifts," correct? 17 A. Correct. 18 Q. You mentioned that you did recall a 19 supervisory initiative in this general time frame 20 after you had signed off on the 1987 USAT audit. 21 Let me ask you to look at another document and see 22 if that might be the initiative that you're 12391 1 remembering. It's marked as Exhibit B4204. This 2 particular version of the policy -- well, let me 3 start over again. 4 This is a document from the files of 5 USAT. It has the name "Jim Wolfe" written in the 6 upper right-hand corner of the first actual page 7 of the document. There is some handwriting, and 8 there are some things scratched out. It is a 9 letter from the association of thrift holding 10 companies to Mr. Jenard Gross at UFG dated June 9, 11 1988. 12 Now, again, this is after the 1987 13 audit had been completed and the financial 14 statements issued for 1987, correct? 15 A. Correct. 16 Q. This letter transmitted a proposed rule 17 that was approved in draft by the Federal Home 18 Loan Bank Board on June 9, 1988, correct? 19 A. Yes. 20 Q. Could you take a minute and look at 21 this document and see if that's the supervisory 22 initiative that you recall from this general time 12392 1 frame? 2 A. (Witness reviews the document.) 3 Q. I'm sorry. I forgot to offer the 4 document. 5 MS. CLARK: Your Honor, I offer 6 Exhibit B4204. 7 MR. GUIDO: No objection, Your Honor. 8 THE COURT: Received. 9 10 (Long pause.) 11 12 THE COURT: Is there a question 13 pending? 14 MS. CLARK: Yes, there is, Your Honor. 15 Q. (BY MS. CLARK) Is this the policy 16 initiative that you were recalling from this 17 general time frame? 18 A. Yes. 19 Q. Mr. Claiborne, what was it that the 20 Federal Home Loan Bank Board was proposing with 21 respect to changes in the accounting for 22 investment securities held by thrifts in June of 12393 1 1988? 2 A. The thrust of this is that the thrifts 3 would follow existing GAAP; that is, the turning 4 intent and so forth. And it would be required to 5 have a much -- to have certain documentation with 6 respect to their practices and so forth. 7 Q. Let me ask you to please turn to 8 Page -- let's see -- 17 of the document, which is 9 a portion of the actual language of the 10 proposal -- proposed policy. 11 Do you see there is a reference to a 12 category called "assets held for sale"? 13 A. Yes. 14 Q. Does that refresh your recollection as 15 to whether this was a proposal to change the 16 accounting practices or not? 17 A. Yes, it was -- it was to change. I had 18 forgotten about this. Yes. 19 Q. So, do you recall that sometime after 20 the 1987 audit had been completed, that the thrift 21 regulatory agency issued a proposal to basically 22 change the accounting approach toward thrift 12394 1 investment securities to include a new category of 2 assets held for sale? 3 A. Yes. 4 Q. And until this time, it had not been 5 proposed that thrifts would have such a category, 6 correct? 7 A. That's correct. 8 Q. Prior to this time, there was the old 9 two part system or two bucket system of trading 10 versus investment. 11 Now, take a look back on Page 9 of the 12 document. There is a discussion of intent. What 13 intent was the Federal Home Loan Bank Board 14 proposing to be required for the carrying of 15 securities as investments? 16 A. I'm sorry. Would you ask that again? 17 Q. Yes. What intent was being proposed as 18 the test for an investment securities accounting 19 treatment? 20 A. Well, the intent for -- the 21 description, I think, was intent -- the intent or 22 ability to hold for the foreseeable future was the 12395 1 terminology that was used. 2 Q. What did that mean? 3 A. Well, in my mind, it meant that your 4 intent was to -- one, you weren't trading; so, you 5 didn't put it in that bucket. And if you didn't 6 have any intention to sell in the near term, that 7 you would then throw it into this hopper. 8 Q. The new bucket would be securities that 9 you -- sorry -- the investment bucket would now be 10 securities that you didn't have a current intent 11 to sell in the short term? 12 A. Right. 13 Q. All right. Turn to Page 12 and, if you 14 would, please, look at the bottom of 12 and the 15 top of 13. Were the federal thrift regulators 16 proposing that thrifts immediately implement the 17 new policy that was issued in June of 1988? 18 A. No. 19 Q. What were they recommending? 20 A. That if your auditors have approved 21 your current practices, that you were to continue. 22 Q. Continue until the policy was 12396 1 finalized? 2 A. Correct. 3 Q. You mentioned that in preparing for 4 your testimony, you reviewed some literature 5 prepared by Mr. Lucas. I'm going to ask you to 6 look at Exhibit B4200, which is a copy of three 7 pages from the Federal Register in March of 1989 8 pertaining to the proposal that we've just talked 9 about, the Federal Home Loan Bank's proposal for a 10 new rule for accounting for investment securities. 11 Is the Mr. Lucas that you referred to 12 before the same Mr. Lucas whose letter appears on 13 the -- beginning on the middle column of this 14 federal register publication: Timothy S. Lucas, 15 director of research and technical activities of 16 the Financial Accounting Standards Board? 17 A. Yes. 18 Q. What was the reaction of the Financial 19 Accounting Standards Board staff to the Federal 20 Home Loan Bank Board's proposed new accounting 21 policy with respect to investment securities? 22 A. As he states on the second -- well, on 12397 1 the second page discussing the term for the 2 foreseeable future, that the board's intent and 3 the substance of the literature, the then current 4 literature, that they believe that it requires a 5 positive intent to hold a security to maturity, 6 which is significantly different from the 7 foreseeable future. 8 Q. How is it different? 9 A. Well, if you intend to hold it to 10 maturity, that means you don't intend to sell it 11 at all. You don't intend to sell it, period. 12 Whereas, the foreseeable future is something less 13 than that. If you're not going to sell it in the 14 short term, then your intent is to hold it for the 15 foreseeable future. 16 Q. Mr. Lucas was disagreeing with the 17 Federal Home Loan Bank Board's proposal? 18 A. Correct. 19 Q. Do you know who Danny Wall was? 20 A. He was the head of the Federal Home 21 Loan Bank Board, as I recall. 22 Q. Do you see Mr. Wall's response to the 12398 1 position that was articulated by Mr. Lucas? 2 A. I see it. I don't recall what he said. 3 Q. Let me just -- first, I had better 4 offer Exhibit B4200. 5 MR. GUIDO: No objection, Your Honor. 6 THE COURT: Received. 7 Q. (BY MS. CLARK) This letter from 8 Mr. Danny Wall back to Mr. Lucas expresses the 9 view that the view that "based upon the comment 10 letters we have received and our own research, we 11 cannot overemphasize the extent to which financial 12 entities in many industries and their 13 practitioners have focused upon the concept of 14 foreseeable future (as included in literature 15 reviewed by the FASB) and the lack of a current 16 intent to sell securities as the basis for the use 17 of amortized cost accounting. We believe the 18 FASB's clarification of GAAP as expressed in your 19 response letter will result in significant changes 20 in reporting practices for many industries." 21 Do you see that? 22 A. Yes. 12399 1 MR. GUIDO: What line are you on and 2 what paragraph? What numbered paragraph? 3 MS. CLARK: In the middle column of the 4 page, the second page of the exhibit, Page 11737. 5 There's a letter from Danny Wall to Timothy Lucas, 6 and I'm reading from the bottom paragraph of that 7 column. 8 MR. GUIDO: The middle column, starts 9 7, Paragraph 7, of FASB. 10 Q. (BY MS. CLARK) Mr. Claiborne, was it 11 your view, as well, that imposing a requirement 12 that a company have a positive intent to hold to 13 maturity would result in significant changes in 14 the reporting practices for many industries? 15 A. Yes. 16 Q. And would it have resulted in 17 significant changes in reporting practices for the 18 thrift industry? 19 A. Yes. 20 Q. Turn to the last page of this exhibit, 21 if you would, please, on the right-hand column, 22 Paragraph 10, numbered Paragraph 10. This is a 12400 1 paragraph of Mr. Lucas's response to Mr. Wall's 2 letter. In that, Mr. Lucas states as follows: 3 "Present practice is to carry at market those 4 securities held for immediate sale when the 5 primary objective is to earn a dealer's spread 6 between the bid and asked prices. When the 7 primary objective is to realize a holding gain, 8 assets held for indefinite periods of time (and 9 not intended to be held to maturity) are carried 10 at the lower of cost or market." 11 Do you see that? 12 A. Uh-huh. (Witness nods head 13 affirmatively.) 14 Q. Now, that is consistent with the 15 definition of trading that Peat Marwick applied in 16 the 1986-'87 audits, correct? 17 A. Correct. 18 Q. Now, what was not available to Peat 19 Marwick in 1986 or '87 was this new category of 20 assets held for an indefinite period of time and 21 not intended to be held to maturity. That simply 22 didn't exist for thrifts at that time, correct? 12401 1 A. Correct. 2 Q. So, what he was proposing was a change 3 in the accounting at thrifts to add -- basically, 4 to divide up the old investment category into the 5 new positive intent to hold category and a new 6 category, at least for thrifts, of assets held for 7 an indefinite period of time. Is that your 8 understanding? 9 A. Correct. 10 Q. This was in March of 1989, correct? 11 A. Yes. 12 Q. Which is a full year after the USAT 13 audit in 1987 was completed. 14 Did the AICPA ultimately substitute a 15 procedure to issue new authoritative guidance on 16 the question of debt securities held by financial 17 institutions? 18 A. Yes. 19 Q. Was there a proposed statement of 20 position that was issued as an exposure draft the 21 next year in May of 1990? 22 A. Yes. 12402 1 Q. Let me ask you, if you would, please, 2 to look at Exhibit B4191. Is this the exposure 3 draft that was issued by the AICPA Accounting 4 Standards Executive Committee in May of 1990 with 5 respect to this issue of how financial 6 institutions should account for debt securities? 7 A. Yes. 8 Q. What approach did this exposure draft 9 take to the question of classifying such 10 securities? 11 A. If you look at the summary, which is 12 the second page of the document, there are four 13 bullets there that describe or summarize the 14 accounting that was proposed by this which does 15 include the category of -- of assets held for 16 sale. Excuse me. 17 MR. GUIDO: Excuse me, Your Honor. I 18 hate to interrupt, but I think that Ms. Clark 19 forgot to move the admission of one of the last 20 two documents, either this one or the previous one 21 before she got into the text. 22 MS. CLARK: Let me make sure that these 12403 1 are all offered. 4191, may I offer that, 2 Your Honor? 3 MR. GUIDO: No objection, Your Honor. 4 THE COURT: Received. 5 MS. CLARK: I believe, actually, B4200 6 was received, Mr. Guido. 7 THE COURT: Yes, it was. 8 Q. (BY MS. CLARK) How did the exposure 9 draft propose to define the category of securities 10 that would be given investment accounting 11 treatment? 12 A. Intent, ability to hold to maturity. 13 Q. Take a look at the second bullet point 14 and see if that refreshes your recollection about 15 the exact treatment they were proposing? 16 A. I'm sorry. It has "foreseeable future" 17 as opposed to "hold to maturity." 18 Q. So, the AICPA Accounting Standards 19 Executive Committee adopted the foreseeable future 20 approach to investment securities in 1990? 21 A. Yes. 22 Q. Turn to Page 9. There's a section 12404 1 labeled "conclusions." 2 Do you see that? 3 A. Yes. 4 Q. Can you tell us what the AICPA proposed 5 in May 1990 with respect to what kinds of 6 securities should be classified as trading 7 securities? 8 A. Paragraph 10. 9 Q. Yes. 10 A. If they are bought and held for the 11 purpose of selling them in the short term. 12 Q. Is that the standard that Peat Marwick 13 applied to the USAT audit back in 1986 and '87? 14 A. Yes. 15 Q. So, that has not changed during the 16 discussion of this issue. That one part of the 17 auditing rule hasn't changed, has it? 18 A. That's correct. 19 Q. Did the Financial Accounting Standards 20 Board ultimately decide to issue a new official 21 pronouncement of GAAP in the form of a FASB 22 statement on this issue? 12405 1 A. Yes. 2 Q. When did that happen? 3 A. I believe it was in '94. 4 Q. Exhibit B4194. Mr. Claiborne, 5 Exhibit B4194 is a document consisting of the 6 cover of a book entitled, "Original pronouncements 7 accounting standards as of June 1, 1997, Volume 8 1," and then Pages 1548 through 1571 of that book. 9 Can you identify this as the Financial 10 Accounting Standards Board Statement No. 115 on 11 the subject of accounting for certain investments 12 in debt and equity securities issued May 1993? 13 A. Yes. 14 MS. CLARK: I offer this document, 15 Your Honor. 16 MR. GUIDO: No objection, Your Honor. 17 THE COURT: Received. 18 Q. (BY MS. CLARK) Mr. Claiborne, would 19 you explain to us what the Financial Accounting 20 Standard Board ultimately decided to do with this 21 issue that had been under discussion and debate 22 for the previous several years as we have seen? 12406 1 What rule did they ultimately settle on? 2 A. A three-prong approach. If trading 3 was -- the definition of it has been always -- and 4 is unchanged -- the trading portfolio. If you 5 have the intent and ability to hold to maturity, 6 then it is an investment securities; and all 7 others go into an "available for sale" category. 8 Q. So, the Financial Accounting Standards 9 Board adopted the part of Mr. Lucas's proposal 10 about reserving investment security treatment for 11 portfolios where you have a positive intent to 12 hold until maturity, correct? 13 A. Correct. 14 Q. It kept the old definition of a trading 15 portfolio, which was to -- when you purchase a 16 sale with the intent of reselling it in the short 17 term for a profit as a result of rapid price 18 movements, correct? 19 A. Correct. 20 Q. And then everything was -- everything 21 else that was left was now going to be designated 22 as "available for sale"? 12407 1 A. Correct. 2 Q. Okay. How were the three types of 3 securities to be accounted for under this new 4 pronouncement? 5 A. The investment category is to be at 6 amortized cost, the "available for sale" at market 7 value, and trading at market value. For trading 8 at market value, gains and losses, realized and 9 unrealized, flow through the statement of income 10 whereas for available for sale for unrealized 11 gains and losses, the charge or credit is directly 12 to stockholder's equity. 13 Q. Do you know why they decided not to 14 charge the unrealized gains and losses in the 15 "available for sale" type of portfolio directly to 16 earnings? 17 A. Well, there are a number of reasons. 18 The one that I remember, I think, is the 19 volatility issue. A lot of the financial 20 institutions were concerned that -- that having a 21 large part of their securities portfolio at 22 market, day in and day out, would result in an 12408 1 income stream that is very volatile. 2 Q. So, the compromise was to show the 3 interim changes in value of these securities as an 4 adjustment to the equity line of financial 5 statements? 6 A. Correct. 7 Q. But not to run it through the P&L or 8 the profit and loss statement of the company? 9 A. Until realized. 10 Q. Until realized. And what does that 11 mean? Until the securities are actually sold? 12 A. Right. 13 Q. There have been lots of questions in 14 this hearing about the accounting for certain 15 kinds of transactions that are discussed in the 16 minutes and records of USAT; and in particular, 17 there's been discussion about the proper 18 accounting for transactions in which securities 19 are disposed of or sold for profit. I think 20 Mr. Guido asked you a question about that, as 21 well. 22 There's also been discussion about the 12409 1 proper accounting treatment for transactions in 2 which -- well, the reference has been to value 3 trading, which is exchanging one coupon security 4 for another to try to improve yield, take 5 advantage of market anomalies. And there's been a 6 suggestion that these kinds of transactions should 7 have led USAT's management to classify the 8 mortgage-backed securities portfolio as a trading 9 portfolio and to mark the whole portfolio to 10 market. 11 Mr. Claiborne, isn't it clear that 12 these types of transactions were not, in fact, 13 characteristic of trading portfolios? 14 A. That's correct. Under this standard, 15 they would have -- under 115, those kinds of 16 transactions would fall into "available for sale" 17 category. 18 Q. Okay. So, if Peat Marwick had FASB 115 19 to work with back in 1986 and '87 and had applied 20 this standard which was promulgated in 1983 to the 21 '86 and '87 activities, the result would have 22 been, with respect to transactions such as you 12410 1 were asked about, that the question was then 2 should it be an "available for sale" portfolio? 3 Did you follow my question? 4 A. Yes. That's correct. 5 Q. Is that correct? 6 A. Yes. 7 Q. But that category simply wasn't 8 available at that time? It didn't exist in 1986 9 and '87; isn't that correct? 10 A. Correct. 11 Q. Do you know, Mr. Claiborne, what the 12 OTS's current rules are regarding the treatment of 13 unrealized gains and losses in a portfolio 14 accounted for as available for sale? 15 A. Sorry. Do I know what their -- 16 Q. Their current rules are regarding the 17 treatment of unrealized gains and losses in the 18 "available for sale" portfolio. 19 A. Well, the accounting is the same. I 20 think the only distinction as I recall, is that in 21 determining regulatory capital there's an 22 adjustment for some portion of that -- some part 12411 1 or all -- I don't recall which of that amount -- 2 which is directly in stockholder's equity. 3 Q. Can you explain what you just said? 4 A. The financial statements would look 5 exactly the same; but for generally-accepted 6 accounting purposes, what you have in 7 stockholder's equity would include 100 percent of 8 this unrealized gain or loss on the "available for 9 sale" category. I believe that the financial 10 institution regulators take that amount of 11 stockholder's equity and make an adjustment to it 12 to remove a part of that gain or loss in 13 determining what regulatory capital is. 14 Q. Let me just try a simple example and 15 see if we can make this clear. 16 Let's say that a company -- a thrift 17 has $10 million of capital and it has an 18 "available for sale" portfolio, a portfolio of 19 securities that are available to be sold for 20 various purposes, and the market price has moved 21 so that if they sold the portfolio today, they 22 would have a million-dollar loss if they sold it 12412 1 today. 2 Now, that million-dollar loss is not 3 realized because they didn't sell it. Right? 4 A. Right. 5 Q. What happens to that $1 million on the 6 financial statements? What happens to the 7 financial statements as a result of that 8 1-million-dollar unrealized gain on the "available 9 for sale" portfolio -- 10 MR. NICKENS: Loss. 11 Q. (BY MS. CLARK) I'm sorry. Loss. 12 A. Your 10-million-dollar stockholders' 13 equity would be reduced by a million dollars. 14 Q. Now, that's what would show on the 15 financial statement that's reported, correct? 16 A. Correct. 17 Q. It wouldn't affect the reported income, 18 just the equity? 19 A. Correct. 20 Q. Now, the institution is calculating its 21 minimum regulatory capital under the OTS's rules. 22 What would happen to that million dollars? 12413 1 A. I think -- I don't deal with thrifts 2 anymore, but I think some portion of that million 3 dollars is eliminated or adjusted in determining 4 what the minimum regulatory capital -- what the 5 actual regulatory capital is. 6 Q. And by "eliminated," meaning you would 7 add it back in. Right? 8 A. I think so, yeah. 9 Q. So, you would subtract it for the 10 reporting; but you would add it back in for the 11 actual calculations? 12 A. I don't recall whether it was all of it 13 or some part of it. 14 Q. All right. I have questions on a 15 couple of more things and then I'm just going to 16 ask you to identify some documents and then we'll 17 be done. 18 You were asked quite a few questions 19 about swaps by Mr. Guido. 20 Do you recall that? 21 A. Yes. 22 Q. And specifically, his questions focused 12414 1 on whether the swaps that were left over when USAT 2 Mortgage Finance sold $350 million of 3 mortgage-backed securities in late 1985, whether 4 those remaining swaps should have been -- the 5 losses on those swaps should have been recognized 6 currently as a loss against income. 7 Do you recall that? 8 A. Yes. 9 Q. And the issue was whether putting a 10 mirror swap in place for those remaining unmatched 11 swaps constituted a termination which would have 12 required to take the loss at that point. Right? 13 A. Right. 14 Q. Now, on that issue, I believe your 15 testimony was that the guidance wasn't clear, that 16 the experts in New York were consulted, and that 17 you-all used your best judgment, and you concluded 18 that the mirror did not require the recognition of 19 the loss on those -- what had become unmatched 20 swaps, correct? 21 A. That's correct. 22 Q. And as far as you know today, that was 12415 1 the correct call, at least under the accounting 2 guidance that existed at that time? 3 A. At that time, yes. 4 Q. Mr. Guido also asked you if USAT 5 recognized losses on swaps the following year when 6 USAT sold mortgage-backed securities and replaced 7 them by lower coupon securities. 8 Do you recall that? 9 A. Yes. 10 Q. And he pointed out that when the 11 securities were sold and replaced by lower coupon 12 securities, that USAT recognized gains, correct? 13 A. Right. 14 Q. And he asked you whether it also 15 recognized losses on swaps in connection with 16 those sales, correct? 17 A. Correct. 18 Q. Now, if USAT didn't terminate the swaps 19 but just left them in place and continued to pay 20 out money every month to the swap county-party, 21 why would they recognize a loss? Can you think of 22 any reason why they would recognize a loss in that 12416 1 circumstance when there's no termination? 2 A. No. 3 Q. As far as you are aware, the 4 appropriate treatment, at least at that time, was 5 that when they would pay out the money every 6 month, they would charge that as an expense 7 against income, correct? 8 A. Correct. 9 Q. Are you aware of any accounting 10 guidance on that subject that was available at the 11 time? 12 A. With respect to early -- well, there 13 was an EITF issue on early termination of swaps; 14 and then there was another EITF that dealt with 15 swap accounting. 16 Q. Let me ask you to look at what we've 17 marked as B4212. I'm sorry. I misspoke. 18 I would like you to look at B4214. 19 A. (Witness reviews the document.) 20 Q. Is this the EITF that you were 21 referring to that dealt with the question of the 22 proper accounting for swaps where there was no 12417 1 corresponding liability or asset? 2 A. Right. On the second page, at the top 3 of the page, the sentence that says, "Members 4 noted diversity in practice where there is no 5 underlying debt liability on the balance sheet of 6 the company entering into the transaction." 7 Q. And this was the response of the -- of 8 the authorities to a question about what 9 accounting should be given when -- when a company 10 holds a swap without any underlying assets or 11 liability, correct? 12 A. Correct. 13 Q. And the answer essentially was, "We 14 can't answer that question. There is no rule on 15 that that we can provide you"? 16 A. Correct. 17 Q. And in that circumstance, do you 18 believe that the accounting that USAT followed, 19 which was not to recognize the losses on its swap 20 portfolio until termination, was consistent with 21 GAAP as it was -- existed at that time? 22 A. Yes. 12418 1 MS. CLARK: I offer, Your Honor, 2 Exhibit B4214. 3 MR. GUIDO: No objection, Your Honor. 4 THE COURT: Received. 5 Q. (BY MS. CLARK) And, in fact, USAT 6 accounted -- USAT never used hedge accounting in 7 any form for its swap agreements during the time 8 you were involved in the audit of USAT; is that 9 correct? 10 A. I think that's correct. 11 Q. Those swaps were not designated against 12 specific assets and liabilities. They were macro 13 hedges, as Mr. Guido asked you about? 14 A. Correct. 15 Q. Mr. Guido asked you whether you had any 16 involvement in auditing the text of the 10K 17 disclosures apart from the financial statements; 18 and you said, no, that was not part of what you 19 audited. 20 Wasn't it also your practice, however, 21 to read the 10K disclosures, to review them, and 22 to make suggestions where you thought changes were 12419 1 appropriate? 2 A. Our responsibility was to review or to 3 read; and if there was anything that we read that 4 was inconsistent with what was in the financials, 5 to point that out to management. 6 Q. So, if you saw something in the 10K 7 that was inconsistent with your understanding of 8 the proper -- of the facts as you knew them, it 9 would have been your practice to point that out to 10 USAT; is that correct? 11 A. That's correct. 12 Q. What was the auditor's involvement in 13 USAT's regulatory reporting -- that is, USAT's 14 reporting to the Federal Home Loan Bank Board? 15 A. None. 16 Q. Let me ask you to take a look at 17 Exhibit B1385. Mr. Claiborne, can you identify 18 this as a work paper from the USAT audit for the 19 year 1986 -- 20 A. Yes. 21 Q. -- including copies of some regulatory 22 reports that USAT was submitting to the federal 12420 1 regulators? 2 A. Yes. 3 Q. And can you tell me why it is these 4 documents were copied and put into the work 5 papers? 6 A. Well, we're interested in their 7 reporting from the standpoint of looking to see 8 whether they are reporting -- that they are in 9 compliance with -- what they report is in 10 compliance with the capital requirements and so 11 forth. 12 Q. So, you didn't audit that, per se; but 13 you monitored it to see whether there was any 14 information in there that was significant to what 15 you were doing? 16 A. Right. 17 Q. Let me ask you to look at 18 Exhibit B1588, please. 19 MS. CLARK: I'm sorry. I'm trying to 20 speed up, and I'm leaving out -- what was the last 21 number? 22 May I offer B1385, Your Honor? 12421 1 MR. GUIDO: No objection, Your Honor. 2 THE COURT: Received. 3 Q. (BY MS. CLARK) Mr. Claiborne, this is 4 a copy from the correspondence file of a letter 5 that you directed to Jenard Gross on April 29th, 6 1987, from the Peat Marwick work papers. 7 MS. CLARK: First of all, I would like 8 to offer the document in evidence. 9 MR. GUIDO: No objection, Your Honor. 10 THE COURT: Received. 11 Q. (BY MS. CLARK) In that letter, you 12 advise Mr. Gross that in the management letters 13 relating to the 1984, 1985, and 1986 examinations 14 of USAT's consolidated financial statements, that 15 you had uncovered no material weaknesses. 16 Was that accurate that in your audits, 17 you had uncovered no material weaknesses in the 18 association's system of accounting controls during 19 those years? 20 A. That is correct. 21 Q. And what is the significance of that? 22 A. Well, this is a required communication 12422 1 with the client. From the client's perspective, 2 it's of interest because it's typically given to 3 the audit committee to help them in discharging 4 their responsibilities because if the client had a 5 material weakness, which is a defined term which 6 means that your internal controls are not 7 functioning such that reliable financials are 8 going to be produced, it would be an issue for 9 both the company and the audit committee if such 10 an issue came up. 11 Q. Was it Peat Marwick's conclusion -- at 12 least for the 1985, 1986, and 1987 years -- that 13 the association's books and records were 14 sufficient to generate financial information that 15 you could audit and give a clean opinion on -- 16 sorry. That's not the question I meant to ask -- 17 that you had discovered no material controls 18 weaknesses that would undermine your ability to 19 use the association's books and records for your 20 purposes? 21 A. That's correct. 22 Q. Please look at Exhibit B4151. 12423 1 A. (Witness reviews the document.) 2 Q. Can you identify Exhibit B4151 as a 3 document from the Peat Marwick work papers of a 4 memo of a conference with a supervisory agent in 5 February of 1988? 6 A. Yes. 7 Q. And as far as you know, does this memo 8 accurately reflect a meeting that you had with 9 Mr. Neil Twomey of the Federal Home Loan Bank of 10 Dallas? 11 A. Just a second. I haven't seen this 12 before. Let me -- at least in a while. (Witness 13 reviews the document.) Okay. Yes. 14 MS. CLARK: Your Honor, I offer B4151. 15 MR. GUIDO: No objection, Your Honor. 16 Q. (BY MS. CLARK) Attached to the first 17 page is another -- 18 THE COURT: Received. 19 Q. (BY MS. CLARK) Attached to the first 20 page is another handwritten memo of a meeting, 21 this time with the examiners. Can you identify 22 that as a memorandum to the Peat Marwick work 12424 1 papers reflecting a meeting that was had with the 2 Federal Home Loan Bank of Dallas examiners? 3 A. Yes. 4 Q. It's been pointed out to me that the 5 first page purports to reflect a phone conference 6 rather than a meeting; is that correct? 7 A. Yes. 8 Q. And this is the kind of memo that you 9 or your staff would make to the work paper files 10 in the regular course of business to reflect 11 important communications that you had had with the 12 regulators? 13 A. Yes. 14 Q. Mr. Claiborne, now I'm just going to 15 ask you to identify some documents from the work 16 papers and offer them in evidence. 17 The first one is B4197. Can you 18 identify this as a document from the Peat Marwick 19 work papers for the quarterly review of UFG in the 20 third quarter of 1986? 21 A. Yes. 22 MS. CLARK: I offer that in evidence, 12425 1 Your Honor. 2 MR. GUIDO: Your Honor, I object to the 3 admission of this copy. It has handwritten 4 notations on the last -- Page KPMG 026343 that are 5 not legible. 6 THE COURT: Do you have a copy that is 7 legible? 8 MS. CLARK: Your Honor, I'll read the 9 handwriting into the record; in particular, the 10 two entries that are pertinent to our inquiry 11 here: "Mortgage-backed security activity: As in 12 the past, very active. United sold entire 13 portfolio 9/86. Recognized gain on this date. 14 Investment security activity: Very active. Sales 15 at end of third quarter to boost third quarter 16 earnings." 17 Is that the language you couldn't read, 18 Mr. Guido? 19 MR. GUIDO: Yeah. Under 20 "mortgage-backed securities activity," I don't 21 think you've finished that sentence. 22 MS. CLARK: "Recognized gain on trade 12426 1 date basis." 2 MR. GUIDO: What is it that's right 3 after that? 4 MS. CLARK: I believe that says "C." I 5 should actually not be reading it. If the witness 6 can read it. I have spent some time reading it; 7 so, I think I've accurately read it. 8 Q. (BY MS. CLARK) Mr. Claiborne, have I 9 accurately read the handwritten notations on these 10 work papers as far as you can tell? 11 A. The best I can tell. 12 Q. Okay. 13 THE COURT: Received. 14 MS. CLARK: I need Exhibit B4211, 15 please. 16 Q. (BY MS. CLARK) Mr. Claiborne, can you 17 identify Exhibit B4211 as a portion of the 18 Peat Marwick work papers for the 12/31/86 audit 19 entitled, "Minutes: Caywood Christian portfolio." 20 The reference is on the third page of the 21 document. 22 A. On the third page? 12427 1 Q. Yes. You have a better version? 2 A. What does it say here? (The witness 3 reviews the document.) Okay. 4 MS. CLARK: Your Honor, I offer 5 Exhibit B4211. 6 MR. GUIDO: I object, Your Honor. I 7 can't read anything of the two paragraphs on the 8 first page on the copy that I have because of some 9 highlighting. 10 THE COURT: Well, I think we'll have 11 to -- if this is the best copy we have, we'll have 12 to deal with it. 13 MS. CLARK: Your Honor, that is 14 acceptable. We do not offer the portion that's 15 been obscured by highlighting. What I am offering 16 is the exhibit as part of the Peat Marwick work 17 papers. Let's go on. 18 MR. GUIDO: I'm sorry. I don't know 19 what you're referring to. Are you just talking 20 about -- you're only offering the piece that's a 21 part of the minutes that's this foldout? 22 MS. CLARK: Mr. Guido, I am offering 12428 1 the document as is. But I'm not offering it for 2 the truth of the matter as asserted in those 3 paragraphs that you can't read. 4 THE COURT: I'm told that these minutes 5 are already in the record without the underlining 6 or obliterations, whatever you want to call it. 7 MS. CLARK: Yes, Your Honor. 8 MR. GUIDO: The minutes do not include 9 this last page, which I also can't read. What 10 portion of this are you offering? If it's the 11 portion of the foldout, the last page that's 12 typewritten, and that's all you're offering of 13 this document, I have no objection to that 14 portion. If it is the handwritten portion or the 15 illegible portion on the first page, I object. 16 MS. CLARK: Your Honor, we will not 17 rely on the obscured portion of the first page or 18 the part that Mr. Guido says he can't read from 19 the handwritten portion in connection with this 20 document. 21 THE COURT: All right. Received. 22 MR. GUIDO: To make the record clear, 12429 1 you're not offering Paragraphs 2 and 3, KPMG 2 020074, and for the handwritten portion on the 3 accountant's ledger sheet KPMG 020076, that 4 portion is not being offered. 5 No objection with that condition, 6 Your Honor. 7 THE COURT: Received. 8 MR. GUIDO: It's Paragraphs 3 and 4 in 9 the first page. 10 MS. CLARK: Exhibit B4157, please. 11 Q. (BY MS. CLARK) Mr. Claiborne, can you 12 identify Exhibit B4157 as a portion of the 13 Peat Marwick work papers for the USAT audit for 14 the period ended 12/31/86? 15 A. Yes. 16 MS. CLARK: I offer Exhibit B4157. 17 MR. GUIDO: No objection, Your Honor. 18 THE COURT: Received. 19 Q. (BY MS. CLARK) Exhibit B4148. 20 Mr. Claiborne, can you identify Exhibit B4148 as a 21 portion of the Peat Marwick work papers for the 22 audit -- for the fourth quarter review of USAT in 12430 1 1987? 2 A. I think you said fourth quarter. It's 3 third quarter, yes. 4 Q. If you look at the last page of the 5 document, does it appear that this is actually 6 part of the fourth quarter review? 7 A. It does. You're right. It says third, 8 but it's fourth. 9 MS. CLARK: I offer B4148, Your Honor. 10 MR. GUIDO: No objection, Your Honor. 11 THE COURT: Received. 12 Q. (BY MS. CLARK) Mr. Claiborne, can you 13 identify Exhibit B428 -- sorry -- B4208 as a 14 letter from Art Berner to Peat, Marwick, Mitchell 15 dated November 4, 1986, which has been copied and 16 included in the work papers of Peat Marwick? 17 A. Yes. 18 MS. CLARK: I offer B4208, Your Honor. 19 MR. GUIDO: No objection. 20 THE COURT: Received. 21 Q. (BY MS. CLARK) Mr. Claiborne, Exhibit 22 B4105 is a portion of the documents produced to us 12431 1 by Peat Marwick. Can you identify it as the work 2 paper copies of various minutes of UFG pertaining 3 to the 12/31/86 audit of the company? 4 A. Yes. 5 MS. CLARK: I offer B4105, Your Honor. 6 MR. GUIDO: No objection, Your Honor. 7 THE COURT: Received. 8 Q. (BY MS. CLARK) 4106. Mr. Claiborne, 9 can you identify Exhibit B4106 as a portion of the 10 Peat Marwick work papers collecting various 11 minutes of UFG for the period -- for the audit 12 period 12/31/86? 13 A. Yes. 14 MS. CLARK: I offer B4106, Your Honor. 15 MR. GUIDO: No objection. 16 THE COURT: Received. 17 Q. (BY MS. CLARK) 4094. Mr. Claiborne, 18 can you identify Exhibit B -- can you identify 19 Exhibit B4094 as a collection of minutes of UFG, 20 the first page of which has been initialed by Joe 21 Parsons? 22 A. Yes. 12432 1 MS. CLARK: I offer B4094. 2 MR. GUIDO: Your Honor, may I make a 3 suggestion? If we're going to be putting in a 4 number of investment committee meetings, why don't 5 we just read them all into the record. I do want 6 to address October of '96. I have no objection to 7 all of the others. 8 MS. CLARK: Those would include 9 Exhibit B4094, Exhibit 4079, which is the first 10 page of which says "UFG investment committee 11 minutes 12/31/86." I offer that, Your Honor. 12 THE COURT: Let's take one at a time 13 even though it's by stipulation so it's clear. 14 All right. Exhibit B4079 is received. 15 MS. CLARK: Exhibit B4112. 16 THE COURT: Exhibit B4112 is received. 17 MS. CLARK: Your Honor, I would like 18 the witness to identify these as portions of the 19 work papers of Peat Marwick. The purpose of 20 offering these documents is to establish that they 21 are part of the work papers of Peat Marwick. 22 Q. (BY MS. CLARK) So, with respect to 12433 1 4079, can you identify that package of documents 2 as coming from the Peat Marwick work papers? 3 A. Yes. 4 Q. And is that also true of 4112, 5 Mr. Claiborne? 6 A. Yes. 7 MS. CLARK: Has that one been received, 8 Your Honor: 4112? 9 THE COURT: Yes. 10 MS. CLARK: Then the last one is 11 Exhibit B4132. 12 Q. (BY MS. CLARK) Can you identify this 13 as a portion of the Peat Marwick work papers, 14 Mr. Claiborne? 15 A. Yes. 16 THE COURT: All right. Exhibit B4132 17 is received. 18 MS. CLARK: Thank you, Mr. Claiborne. 19 I have no further questions, Your Honor. 20 THE COURT: Do you have some redirect? 21 MR. GUIDO: I do, Your Honor. Could we 22 take a five-minute break? 12434 1 THE COURT: Let's take a short break. 2 3 (Short break.) 4 5 THE COURT: Be seated, please. We'll 6 be back on the record. 7 Mr. Guido, you have some redirect? 8 MR. GUIDO: Yes, Your Honor. I would 9 like to address Exhibit B4197, Your Honor, which 10 was a paper that was shown to the witness toward 11 the end. 12 Q. (BY MR. GUIDO) The second page -- 13 excuse me. The third page of the document, the 14 Bates stamp KPMG 026347, Mr. Claiborne, do you see 15 the entry, Item No. 4, on that page? 16 A. I thought you said 7. What's your 17 number. 18 Q. 45. I'm sorry. Excuse me. See the 19 entry, Item No. 4 -- 20 THE COURT: I think we better make it 21 clear for the record. I'm not sure what you're 22 referring to. 12435 1 MR. GUIDO: Okay, Your Honor. Exhibit 2 B4197, the third page of the document which is 3 Bates stamped KPMG 026345, Your Honor. 4 THE COURT: Thank you. 5 Q. (BY MR. GUIDO) I want to direct your 6 attention to Item No. 4, "investment securities 7 activity." Was that something different than 8 mortgage-backed securities activity? 9 A. I believe so, yes. 10 Q. I would like to direct your attention 11 to the Exhibit No. A7009, which is the audited 12 financial statement for that year, and direct your 13 attention to -- if I can find it -- the notes that 14 are on Page 8 and 9 of that document and ask you 15 whether or not the categories that are under the 16 notes, Note 2, on Page 8 of Exhibit 7009, 17 "investment securities." 18 Would it be fair to assume that 19 investment securities on Page 8 of Exhibit 7009 is 20 what's being referred to on KPMG 026345, 21 Exhibit B4197? 22 A. Yes. 12436 1 Q. And would it be fair to conclude that 2 the mortgage-backed securities that are referred 3 to on Exhibit B4197 are the same mortgage-backed 4 securities that are referred to in Note 9 of 5 Exhibit 7009 on Page 9 of the audited financial 6 statements? 7 A. Yes. 8 Q. Okay. The -- turning back to the 9 investment securities, it talks about US 10 Government and federal agency securities, trading 11 account, and corporate debt and other securities. 12 Do you see that? 13 A. Yes. 14 Q. That's under "investment securities." 15 Is it your understanding that the 16 turnover in the high-yield bond portfolio at USAT 17 in 1986 was due to sales of securities because of 18 questions that arose about the credit quality of 19 various instruments? 20 A. I don't recall. 21 Q. Okay. You don't recall what the reason 22 for the turnover was? 12437 1 A. No. 2 Q. Okay. The -- I would like to direct 3 your attention to Binder No. 4 that I gave you 4 earlier. I would like to direct your attention to 5 the document that has been introduced as 6 Exhibit B1298, which I think is at the 7 beginning -- it's the audit planning memorandum 8 for 1986 -- and direct your attention to Bates -- 9 refer you to Page 22 of the document which is 10 CN523315 which discusses mortgage-backed 11 securities. It says, "The balance of 12 mortgage-backed securities, June 30, 1986, was 13 1.9 billion as compared to 1.2 billion and 14 .5 billion in December 31, '85 and '84 15 respectively." 16 MS. CLARK: Mr. Guido, I cannot find 17 the reference. Is it Page 22 of the planning 18 memo. 19 MR. GUIDO: Page 22 of the planning 20 memo, which is Exhibit B1298. It's the very last 21 paragraph under "mortgage-backed securities." I 22 have it as the audit planning memorandum dated 12438 1 October 31, 1986. That's what I introduced. Let 2 me give you -- do you have another set over here? 3 You have our binder. 4 5 (Discussion held off the record.) 6 7 MS. CLARK: Mr. Guido, I'll just 8 listen. Proceed. 9 Q. (BY MR. GUIDO) It says, "In addition 10 to the overall increase in the balance, 11 significantly all mortgage-backed securities and 12 been sold" -- I presume that means had been 13 sold -- "and replaced with lower yielding 14 securities to better match the securities of the 15 association satisfies liabilities." 16 Do you see that? 17 A. Yes. 18 Q. Is that your understanding of the 19 reason for the sale of the mortgage-backed 20 securities? 21 A. I don't recall. 22 Q. Do you have any reason to dispute the 12439 1 accuracy of that statement in the planning 2 memorandum? 3 A. No, I don't. 4 Q. I would like to direct your attention 5 to Exhibit A13010, which is the memorandum from 6 Barry Teidt or Mr. Teidt -- I don't know whether 7 his first name is Barry. 8 A. Barry, yeah. 9 Q. -- and direct your attention to the 10 second paragraph of the document, the first 11 sentence. It says, "During 1986, United has been 12 turning over their portfolio monthly of MBSs in an 13 attempt to match the MBS estimated maturities with 14 the maturities of the interest rate swaps 15 associated with the reverse repos that the MBSs 16 are collateralizing." 17 Do you see that? 18 A. Yes. 19 Q. Do you recall that fact? 20 A. No, I don't. 21 Q. Do you have any reasons to dispute the 22 accuracy of that conclusion? 12440 1 A. No, I don't. 2 Q. I would like to direct your attention 3 to Exhibit 13039; and that's a Peat Marwick work 4 paper, as well. And under "discussion," do you 5 see that -- in the second paragraph, it says, 6 "USAT entered into the swap agreements as a macro 7 hedge of the available interest rates they were 8 paying on the debt (reverse repos)." 9 Do you see that? 10 A. Yes. 11 Q. Do you recall that fact in your review 12 of the work at USAT? 13 A. No, I don't. 14 Q. Okay. Then I would like to direct your 15 attention to the document that's B2785 at 16 Tab 1010. I think it's another handwritten work 17 paper document. And that says -- it may be 18 difficult, your copy, to read it. But I have 19 written it from the -- let me get you Tab 1010. I 20 think there's a legible copy of the document 21 there. 22 In the second paragraph of the 12441 1 document, it says, "Williams informed me" -- "with 2 regard to establishing a trading portfolio account 3 for junk bonds, Williams informed me that such an 4 account was not established because they were not 5 currently trading the junk bonds." 6 Do you recall obtaining that 7 information from USAT? 8 A. No. 9 Q. And I would like to direct your 10 attention to Tab 1 -- I'm sorry -- 893, B1481, 11 which is the management letter of February 6th, 12 1987. And it's at Tab 893. On Page 4 of the 13 document, which is Bates stamped OW156943, at the 14 top, it says, "A separate trading account has not 15 been established for corporate debt securities 16 since management has not entered into such trading 17 account activity." And that's a management letter 18 from Peat Marwick with the exhibit. 19 Can you tell me what the significance 20 of Peat Marwick recording that fact in the 21 management letter was? 22 A. That's not actually our fax. That's a 12442 1 response from the company that you're -- that you 2 just read. 3 Q. When you put it in the management 4 letter, is that a fact that you're relying upon in 5 terms of providing advice to the client? 6 A. Let me reread the comment. (Witness 7 reviews the document.) 8 MR. GUIDO: Your Honor, B1481, I've 9 been told, is Tab 902, not Tab 893. 10 A. Would you repeat your question? 11 Q. (BY MR. GUIDO) What is the 12 significance of Peat Marwick putting that 13 information in the management letter? 14 A. Well, this is part, as you recall, of 15 the advice that Joe Parsons had given to Mike Crow 16 back in January and is part of what we thought 17 they should do to document their practices. And 18 we wanted to bring to the attention of the audit 19 committee that -- that they had not done that. 20 Q. In that, they are representing to you 21 that they were not trading the corporate debt 22 securities, the high-yield bond securities? 12443 1 MS. CLARK: Objection. That 2 mischaracterizes what the letter says, Your Honor. 3 Q. (BY MR. GUIDO) What does it say? 4 THE COURT: Do you want to have the 5 witness read it? 6 Q. (BY MR. GUIDO) What does that sentence 7 say other than they are not trading the high-yield 8 bond portfolio? 9 A. Which sentence? 10 Q. The first sentence on Page 4 of 11 Exhibit 1481. 12 A. It means what it says, as far as I 13 know. 14 Q. And is that statement that they were 15 not trading the high-yield bond portfolio or the 16 corporate debt securities portfolio? 17 A. Yes. 18 Q. Now, I would like to turn your 19 attention to Exhibit A10690, which is Tab 563. 20 Do you recall instructing or 21 recommending to or advising USAT that they needed 22 to put on the record a policy as related to junk 12444 1 bonds to avoid mark-to-market treatment? 2 A. I think that was a part of Joe's 3 memorandum to them back in January of '87. 4 Q. And that sets out the various points or 5 policies with regard to the mortgage-backed 6 securities, does it not? 7 A. What are you talking about now, Joe's 8 letter? 9 Q. No. I'm talking about the attachment 10 to the Crow memo to Art Berner. 11 A. It deals with corporate debt security. 12 Q. And it sets out a policy for the 13 corporate debt securities. Right? 14 A. Yes. 15 Q. And it sets out a policy that was 16 recommended by Peat Marwick to avoid 17 mark-to-market treatment? 18 A. We recommended they establish a policy. 19 It's their policy, not ours. 20 Q. Okay. And I would like to direct your 21 attention to Exhibit B1455, which I think is the 22 next document in there. It's a Joe Parsons memo 12445 1 to work papers, January 29th, '87. And it's 2 Exhibit B1455. Page 2 of the document, it says, 3 "What is the expectations that the MBS will be 4 traded? Under what circumstances would the MBS be 5 traded?" 6 "Note: I thought that it was important 7 to establish that the MBS would not be traded or 8 at least there would be minimal trading activity. 9 If the MBS were to be traded, it would appear that 10 the hedge positions should be considered to be 11 speculative." 12 Do you see that? 13 A. Yes. 14 Q. And it says, "Lorenson stated that the 15 MBS would not be traded under any circumstances." 16 Do you see that? 17 A. Yes. 18 Q. Okay. And that's to the work papers. 19 Is that a representation that's included in the 20 work papers as the relevant information that 21 Peat Marwick thought it should rely upon in 22 reaching its conclusions that the accounting 12446 1 statements were appropriately recorded according 2 to GAAP? 3 A. It would certainly be part of it. 4 Q. Now, I would like to direct your 5 attention to the document that's B1410 at Tab 910, 6 I hope. 7 MR. NICKENS: You got that one. 8 A. Where am I? Which book? 9 Q. (BY MR. GUIDO) Same book. You're 10 right before the Art Berner memo or Mike Crow/Art 11 Berner memo. It's probably two in front of where 12 you were. 13 MS. CLARK: I'm sorry, Mr. Guido, 14 I'm -- 15 MR. NICKENS: I have it. 16 Q. (BY MR. GUIDO) That's it. Do you 17 remember when you were discussing with Mary Clark 18 the investment trading advice that you provided to 19 USAT in January of 1987? And it talks about the 20 accounting guidance. It says, "Substantially, all 21 GAAP accounting guidance is provided by the AICPA 22 audit of banks, industry and audit guide (the 12447 1 guide). Management's intent appears to be the 2 prevailing factor in determination of the 3 appropriate accounting. Intent of investment and 4 trading portfolios are summarized from the guide 5 as follows." 6 Does this reflect the conclusion at 7 Peat Marwick that the appropriate accounting 8 literature in this situation was the bank audit 9 guide that Mary Clark showed you? 10 A. I'm sorry. Would you repeat that 11 again? 12 Q. Does this reference indicate that the 13 appropriate GAAP literature to be referred to by 14 management at USAT was the bank industry and audit 15 guide? 16 A. Well, as we discussed earlier, the 17 thrift audit guide didn't include this. I 18 wouldn't say it exactly as you said it, but I 19 think that this is where we looked to give them 20 some help on where we thought they ought to go. 21 Q. Now, is the reason why the thrift audit 22 guide didn't cover this issue of mortgage-backed 12448 1 securities to the extent to which the bank audit 2 guide did is because thrifts hadn't been investing 3 in such instruments for a very long period of 4 time? It had been primarily banks that had been 5 engaged in this activity? 6 A. I don't recall. 7 Q. Now, I would like to direct your 8 attention to -- I think it's Page 43 of that 9 guide. I thought Ms. Clark was very thorough in 10 going through -- 11 A. Which guide? 12 Q. The bank audit guide, which is 13 Exhibit B4195. 14 A. Got it. 15 Q. It says, "The internal" -- the last 16 paragraph. "The internal accounting control 17 considerations and auditing procedures for trading 18 accounts are the same as for investment 19 securities, with the additional considerations of, 20 one, controls to ensure that management's intent 21 in regard to the purpose of security purchases is 22 designated promptly in the bank's records and 12449 1 historical experience involving completed 2 transactions support management's intent and, two, 3 audit procedures to test trading activity." 4 Do you see that? 5 A. Yes. 6 Q. Is that your understanding of the 7 guidance that was provided in the bank audit guide 8 for auditing the trading versus investment 9 account? 10 A. Yes. 11 Q. Now, Ms. Clark went through a number of 12 various renditions of definitions of trading 13 versus investment; and one of the issues that she 14 discussed with you in terms of all of that 15 post-literature, post-'85, '86 literature was a 16 controversy about whether or not there had to be a 17 positive intent to hold to maturity as opposed to 18 an intent to hold for the foreseeable future. 19 Do you recall that literature? 20 A. Yes. 21 Q. And what was it about that that raised 22 an issue for thrifts in terms of if the literature 12450 1 said you had to hold to maturity? Were the 2 expected lives of mortgage-backed securities ever 3 the 30 years that those mortgages underlying 4 those -- 5 A. No. 6 Q. -- mortgage-backs would exist? Was 7 that the issue? Was that the problem the thrifts 8 had? 9 As a practical matter, you could never 10 hold a mortgage-backed security to its maturity 11 because of prepayments of the underlying 12 mortgages; isn't that correct? 13 A. You could have an intent to hold it to 14 maturity. Once it prepays, it prepays. 15 Q. The audit guide says you look at 16 experience. The literature says you look at 17 experience -- 18 A. It's in a different context. The 19 experience means the experience of the 20 association -- at least to me, it means the 21 experience of the association in whether they are 22 actively trading where their expressed intent was 12451 1 something else. You not only look at their intent 2 but you look at their actions to see if their 3 actions follow what they said as opposed to -- a 4 mortgage-backed prepayment is not something a 5 financial institution can control. 6 Q. I understand that. What I'm talking 7 about is that controversy which is reflected in 8 that communication between Danny Wall and 9 Mr. Lucas? 10 A. Uh-huh. 11 Q. That was -- which was Exhibit B4200. 12 Was that issue that was being discussed between 13 the two of them the question of whether or not the 14 rules should be intent to hold to maturity as 15 opposed to intent to hold for the foreseeable 16 future? 17 A. That was the issue. 18 Q. That was the issue there? 19 A. Yes. 20 Q. It wasn't the difference between 21 trading versus investment? It was how you define 22 maturity or long duration? 12452 1 A. It's a definition of what goes into 2 your caption called "investment securities." 3 Q. Now, looking back at Exhibit B3933, the 4 advice that was provided which is at Tab 1008 in 5 this packet of materials I gave you, what is the 6 duration that you use in there? 7 A. I don't recall. 8 Q. Look at -- under "accounting guidance," 9 do you see the summary, the Bullet Point 1? "If 10 the intent (and the ability) is to hold securities 11 on a longer term basis, with the objective being 12 an optimum balance between credit quality, 13 liquidity and income, the portfolio would be 14 considered an investment account." 15 Do you see that? 16 A. Yes, I do. 17 Q. You used the term "longer term basis." 18 Is two weeks a longer term basis? 19 A. I don't know. 20 Q. Is a month a longer term basis? 21 A. I don't know the answer to that. 22 Q. Well, you did provide advice to USAT, 12453 1 did you not, at this point in time? 2 A. We did. 3 Q. And you didn't know what "longer term 4 basis" meant? 5 A. I don't think that's defined in any 6 literature. 7 Q. What did you mean by it? 8 A. It's not my memo. 9 Q. It has a CC on it. You were the 10 partner in charge at this time period, were you 11 not? 12 A. I certainly was. 13 Q. And it was sent to a client. Right? 14 A. It was. 15 Q. Did you review it before it went out? 16 A. No, I didn't. 17 Q. Did Joe Parsons have the authority to 18 send memorandum out on behalf of Peat Marwick? 19 A. Absolutely. 20 Q. He did? 21 A. (Witness nods head affirmatively.) 22 Q. Now, you were asked about a number of 12454 1 definitions of trading versus investment that were 2 promulgated that were discussed subsequent to the 3 date of this; and you were shown a number of 4 documents. Let me direct your attention to 5 another one of those documents, Exhibit B4193, 6 which is the Coopers & Lybrand banking advisory. 7 A. Got it. 8 Q. Now, this says -- and look at 9 Page CN101326. 10 A. (Witness complies.) 11 Q. "In terms of giving the background for 12 addressing this issue, the comptroller of the 13 currency says the depository institution 14 regulators have become aware of speculative 15 activity which has taken place in a number of 16 depository institutions investment portfolios." 17 Do you see that? 18 A. Yes. 19 Q. Do you recall that being an issue that 20 the regulators raised at that time? 21 A. Yes. 22 Q. And do you recall that they felt that 12455 1 they needed to clarify what they believed were the 2 existing rules so that people would cease that 3 speculative activity which they thought was an 4 unsafe and unsound practice? 5 A. Is that a question? 6 Q. Is it your understanding that they 7 sought to clarify the rules in order to 8 circumscribe activity which the regulators thought 9 was speculative activity? 10 A. It's my view that they wanted to change 11 the rules. 12 Q. Now, take a look at the trading and the 13 investment portfolio definition on CN101330. See 14 the definition of trading? It says, "Trading in 15 the investment portfolio is characterized by a 16 high volume of purchase and sale activity which, 17 when considered in light of a short holding period 18 for securities, clearly demonstrates management's 19 intent to profit from short-term price movements." 20 Do you see that? 21 A. Yes. 22 Q. I think you testified to Mary Clark 12456 1 that that's your understanding what the standard 2 was when you audited USAT in 1986 and '87; is that 3 correct? 4 A. I don't recall that this is -- we 5 weren't looking at the definition here. We were 6 looking at the bank audit guide. I don't recall 7 if this was consistent with that or not. 8 Q. You don't recall testifying an hour ago 9 that that paragraph was your understanding of what 10 the standard was in 1986? 11 A. No, I don't. 12 Q. Didn't you testify earlier that the 13 bank audit guide didn't have a definition of 14 trading, did it? (sic) 15 A. It does. 16 Q. What was that definition? 17 A. I'm looking for it now. The definition 18 in the bank audit guide is -- 19 Q. At what page? 20 A. I'm sorry. Page 40 under the heading 21 "trading securities." 22 Q. What does that say? 12457 1 A. "Commercial banks are permitted to 2 underwrite and deal in certain securities. Banks 3 involved in those activities seek to earn a profit 4 by trading for their own account or selling the 5 securities to customers." 6 Q. Whereabouts on Page 40 do you see that? 7 A. The first paragraph under the heading 8 "trading securities," Chapter 6, Page 40. 9 Q. "Commercial banks are permitted to 10 underwrite and deal in certain securities. Banks 11 involved in those activities seek to earn a profit 12 by trading for their own account or selling the 13 securities to customers." 14 Does it say anything about what the 15 definition of trading is, what it's characterized 16 by? 17 A. The definition and characteristics are 18 different. 19 Q. Does it mean a turnover in the 20 portfolio, in your own account? It says "for 21 their own account." 22 A. You could have a trading security with 12458 1 one security. 2 Q. Okay. This language here that you 3 refer to in the bank audit guide says that trading 4 is trading for one's own account. So, that means 5 any transaction in the account that was held for 6 the profit or loss of the thrift would have been a 7 trading account under that definition? That's the 8 way I read it. 9 MS. CLARK: Objection, Your Honor. I 10 don't believe he's asking questions. 11 THE COURT: All right. 12 Q. (BY MR. GUIDO) How does that define 13 the term "trading"? 14 A. I don't see any other definition. 15 Q. Doesn't the definition of trading at 16 the time in 1985 essentially mean that there are 17 purchases and sales in the account, whatever it's 18 denominated, in order to realize capital gains, 19 unrealized capital gains? 20 A. All securities would be trading if you 21 defined it that way. 22 Q. I said over a short period of time? 12459 1 A. I think my understanding or 2 recollection of the definition that we were using 3 back in those days was that it was -- it was more 4 of your intent at the time you acquired a 5 security, what your intent was -- 6 Q. That clearly isn't what we just read. 7 MR. EISENHART: Your Honor, I object to 8 him cutting the witness off. 9 MR. GUIDO: I'm sorry. You can finish 10 your answer. 11 THE COURT: Had you finished your 12 answer? 13 THE WITNESS: I don't recall. 14 Q. (BY MR. GUIDO) Look at Page 43 again 15 of the bank audit guide. That doesn't say that 16 the client can say, at Trade 1, "I'm not going to 17 trade," and then trade its head off and not record 18 that account as a trading account, does it? 19 MR. NICKENS: Your Honor, that's not a 20 proper question. We know what it doesn't say, and 21 he's just arguing with the witness. 22 MR. GUIDO: I think this is a very 12460 1 significant question. 2 MR. NICKENS: That still doesn't permit 3 him to argue the witness. 4 MR. GUIDO: I don't think I'm arguing 5 with the witness, Your Honor. I asked him a 6 question. 7 THE COURT: Restate your question. 8 Q. (BY MR. GUIDO) You're telling me that 9 the bank audit guide which you've cited as the 10 authoritative literature in a Peat Marwick paper 11 says that all you need to look to as a thrift 12 institution in deciding whether to classify 13 something trading versus investment is what you 14 say at the outset and that's all the client has to 15 worry about, what they say at the outset? 16 A. I didn't say that. Go ahead and finish 17 your question. 18 Q. You didn't say that? 19 A. No, I didn't. 20 Q. Now, is the historic experience of a 21 client a relevant factor to ascertain the client's 22 intent? 12461 1 A. Yes, it is. 2 Q. And is the turnover in the portfolio, 3 the frequency and magnitude of the turnover, one 4 of the things that one would look to to ascertain 5 whether the portfolio was trading versus 6 investment? 7 A. Yes. 8 Q. Is one of the things one would look to 9 to ascertain whether the portfolio is trading 10 versus investment is the client's intent for the 11 sales out of that portfolio? 12 A. Is that one of the factors? Is that 13 your question? 14 Q. Yes. 15 A. Yes. 16 Q. Now, I would like to direct your 17 attention to the financial statements that both 18 Ms. Clark and I asked you to take a look at. I 19 think it's A7009. 20 A. Is it in that book? 21 Q. I think it's in Book No. 2. Ms. Clark 22 asked you a number of questions about disclosure. 12462 1 Assume for purposes of these questions 2 that the swap portfolio at USAT contained an 3 embedded loss of $122 million. Would that have 4 been a material fact to the financial statements 5 here? 6 MS. CLARK: Mr. Guido -- I object, 7 Your Honor. "Embedded loss" is an ambiguous term. 8 Does he mean on a particular day that -- the value 9 of swaps can change from one day to the next. 10 MR. GUIDO: On December 31, 1986, I'm 11 asking this witness to assume that there's an 12 embedded loss in the swap portfolio of 13 $122 million. 14 Is that clear enough for you, 15 Ms. Clark? 16 MS. CLARK: Yes. Thank you, Mr. Guido. 17 Q. (BY MR. GUIDO) On that day, would 18 that be material? 19 A. To what? 20 Q. To the financial statements of USAT. 21 A. If you were going to record a loss, 22 yes. The fact that there is a loss -- 12463 1 Q. $122 million, is that a significant 2 fact given the financial condition of this 3 institution? 4 A. It's certainly a fact. I don't know 5 how significant it is. 6 Q. Now, can you show me anywhere where 7 that fact appears or a comparable fact of the 8 losses that were embedded in the swap portfolio 9 held by USAT? 10 A. No, I can't. 11 Q. Okay. And why not? 12 A. As far as I know, there's no such 13 disclosure. 14 Q. So, that wasn't disclosed then? 15 A. I have no idea whether it was even a 16 fact. 17 Q. Now, let me turn to another question. 18 If -- if you take a look at Page 6, that 19 disclosure under "investment securities," if 20 USAT's portfolio was, in fact, a trading portfolio 21 and not an investment portfolio, would this 22 statement at the bottom of Page 6 have been true 12464 1 or false: "Investments in United States 2 Government and federal agency securities, 3 corporate debt securities, and other interest 4 bearing securities are carried at cost"? 5 A. What's your question again? 6 Q. Would it have been true or false that 7 that statement that's made on there accurately 8 reflects GAAP? 9 A. Do I believe this statement reflects 10 GAAP? 11 Q. No. If USAT's mortgage-backed 12 securities portfolio had, in actuality, been a 13 trading portfolio, would the statement 14 "investments in United States Government and 15 federal agency securities, corporate debt 16 securities, and other interest bearing securities 17 are carried at cost," would it have been accurate 18 to characterize that as in conformity with GAAP? 19 A. Assuming what you said is true, yeah, 20 it would not be. 21 Q. Okay. Now -- 22 THE COURT: How much more do you have? 12465 1 MR. GUIDO: Your Honor, I think it's 2 only a few minutes. I was just going to go 3 through my notes quickly. 4 Q. (BY MR. GUIDO) I would like to direct 5 your attention to -- I think it's in Binder No. 4. 6 It's Exhibit B4214 which Ms. Clark initially 7 offered and then withdrew. 4212. Must be 8 Volume 3? 9 A. Not in here. 10 Q. It must be in that one. 11 A. Which one? 12 MS. CLARK: Mr. Guido, I believe you 13 misspoke. I think you meant to say 4212. 14 MR. GUIDO: Yeah. Did I say 4212? 15 MS. CLARK: You said 4214. 16 MR. GUIDO: I meant 4212. 17 18 (Discussion held off the record.) 19 20 MR. GUIDO: All right. I would like to 21 move the admission of B4212, Your Honor. 22 MS. CLARK: Your Honor, I'm not exactly 12466 1 sure how that is redirect, but no objection. 2 THE COURT: Received. 3 Q. (BY MR. GUIDO) You were asked some 4 questions about the accounting for swaps by 5 Ms. Clark. 6 Do you remember that? 7 A. Yes. 8 Q. And that the -- and you were shown 9 B4214 when discussing swap transactions. I would 10 like to direct your attention to B4212, which 11 says, if you look under "hedged transactions," 12 "The task force reached a consensus that gains and 13 losses on terminated interest rate swaps that were 14 accounted for as hedges should not be recognized 15 immediately in income because the termination of 16 an interest rate swap accounted for as a hedge is 17 closely analogous to a terminated futures hedge 18 described in Statement 80." 19 Is that the reference to FAS 80? 20 A. Yes. 21 Q. So that the Emerging Issues Task Force 22 concluded in 84-7 that FAS 80 is an analogous 12467 1 piece of literature to ascertain what GAAP was 2 when accounting for swaps. Is that a fair 3 characterization? 4 A. I think it's only referring to gains an 5 losses on terminated swaps. 6 Q. But it says for that purpose, it's an 7 analogous piece of literature. Right? 8 A. That is correct. 9 Q. Now, I think we discussed FAS 80 10 earlier with regard to how it said one should 11 account for macro hedges of futures -- with 12 futures contracts as opposed to micro hedges. 13 Do you recall that discussion? 14 A. I do. 15 Q. And is it your understanding that macro 16 hedges, any unrealized losses in those futures 17 contracts had to be recognized at the time they 18 occurred? 19 A. That's correct. 20 Q. And that micro hedges did not have to 21 be recognized at that time, but they were 22 amortized over whatever the life of the specific 12468 1 asset or liability was hedged with those? 2 A. Correct. 3 MR. GUIDO: Thank you, Mr. Claiborne. 4 Thank you, Your Honor. I have no further 5 questions. 6 MS. CLARK: Your Honor, I have four 7 questions. 8 THE COURT: All right. 9 10 FURTHER EXAMINATION 11 12 Q. (BY MS. CLARK) With respect to the 13 intent that you are looking at -- when determining 14 whether a portfolio was a trading portfolio, when 15 you look at subsequent transactions, 16 Mr. Claiborne, are you looking to see whether 17 those subsequent transactions indicate that the 18 securities had been bought originally with and 19 held for the purpose of selling them in the near 20 term with the objective of generating profit on 21 short-term difference in prices? Is that what 22 you're looking for when you look at subsequent 12469 1 transactions? 2 A. If I understood that correctly, yes. 3 Q. Please, if you can, find Exhibit 1455 4 again. That is the Joe Parsons memo in the work 5 papers dated January 29, 1987. 6 A. I have it. 7 Q. Mr. Guido asked you to look at the 8 second page of the document, I believe, concerning 9 what are the expectations that the MBS will be 10 traded. 11 Do you recall that? 12 A. Yes. 13 Q. Now, look at the first page of the 14 document. Do you see that what's being discussed 15 here is a particular hedge program involving 16 Ginnie Mae put options -- Mr. Claiborne? 17 A. Yes. 18 Q. Do you recall that Peat Marwick was 19 asked to give guidance to USAT on the accounting 20 for a particular program that they were intending 21 to implement that involved using as hedges EURO 22 dollar futures, EURO dollar puts, and Ginnie Mae 12470 1 puts? 2 A. I do remember that. 3 Q. And that's what this memo relates to? 4 A. That's correct. 5 Q. Please see if you can find in front of 6 you again Exhibit B1481, which is the 7 February 6th, 1987 letter to the board of 8 directors. 9 A. I have it. 10 Q. Turn to Page 4, if you would, please. 11 A. (Witness complies.) Okay. 12 Q. Mr. Guido asked you about the first 13 sentence on that page. 14 Do you recall that? 15 A. Yes, I do. 16 Q. What the client is said to have 17 responded to the Peat Marwick letter is as 18 follows: "A separate trading account has not been 19 established for corporate debt securities since 20 management has not entered into such trading 21 account activities." 22 Do you interpret that to be in light of 12471 1 the discussion that we had earlier about the 2 standards that had developed and been applied in 3 the accounting profession to define what trading 4 account activities are or were, I should say? Is 5 that how you would interpret that reference to 6 trading account activities? 7 A. Yes. 8 Q. Finally, Mr. Guido asked you some 9 questions about when, with respect to terminated 10 swaps, gains or losses would be recognized; and I 11 believe the language he used was that they would 12 be recognized at the time they occurred. 13 Did you mean by that at the time they 14 were realized upon disposition or termination of 15 the swap? 16 A. Yes. 17 MS. CLARK: Thank you, Your Honor. I 18 don't have any further questions. 19 MR. GUIDO: No further questions, 20 Your Honor. 21 THE COURT: All right. Thank you, 22 Mr. Claiborne, you may step down. We'll adjourn 12472 1 until 9:00 tomorrow morning. 2 3 (Whereupon at 5:11 p.m. 4 the proceedings were recessed.) 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 12473 1 STATE OF TEXAS COUNTY OF HARRIS 2 REPORTER'S CERTIFICATION 3 TO THE TRIAL PROCEEDINGS 4 I, Marcy Clark, the undersigned Certified 5 Shorthand Reporter in and for the State of Texas, 6 certify that the facts stated in the foregoing 7 pages are true and correct to the best of my ability. 8 I further certify that I am neither 9 attorney nor counsel for, related to nor employed 10 by, any of the parties to the action in which this 11 testimony was taken and, further, I am not a 12 relative or employee of any counsel employed by 13 the parties hereto, or financially interested in 14 the action. 15 SUBSCRIBED AND SWORN TO under my hand 16 and seal of office on this the 18th day of June, 17 1998. 18 ____________________________ MARCY CLARK, CSR 19 Certified Shorthand Reporter In and for the State of Texas 20 Certification No. 4935 Expiration Date: 12-31-99 21 22 12474 1 STATE OF TEXAS COUNTY OF HARRIS 2 REPORTER'S CERTIFICATION 3 TO THE TRIAL PROCEEDINGS 4 I, Shauna Foreman, the undersigned 5 Certified Shorthand Reporter in and for the 6 State of Texas, certify that the facts stated 7 in the foregoing pages are true and correct 8 to the best of my ability. 9 I further certify that I am neither 10 attorney nor counsel for, related to nor employed 11 by, any of the parties to the action in which this 12 testimony was taken and, further, I am not a 13 relative or employee of any counsel employed by 14 the parties hereto, or financially interested in 15 the action. 16 SUBSCRIBED AND SWORN TO under my hand 17 and seal of office on this the 18th day of June, 18 1998. 19 _____________________________ SHAUNA FOREMAN, CSR 20 Certified Shorthand Reporter In and for the State of Texas 21 Certification No. 3786 Expiration Date: 12-31-98 22