15342 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 JULY 20, 1998 22 15343 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 6 and BRYAN VEIS, Esquire 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 15344 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 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 . 15345 1 2 3 INDEX OF PROCEEDINGS 4 5 MICHAEL CROW 6 Continued Examination by Mr. Guido......15346 7 . 8 . 9 . 10 . 11 . 12 . 13 . 14 . 15 . 16 . 17 . 18 . 19 . 20 . 21 . 22 . 15346 1 P-R-O-C-E-E-D-I-N-G-S 2 (10:00 a.m.) 3 THE COURT: Be seated, please. 4 The hearing will come to order. Unless 5 there are preliminary matters, we will continue 6 with the examination of the witness by Mr. Guido. 7 MR. GUIDO: Thank you, Your Honor. 8 9 CONTINUED EXAMINATION 10 11 Q. (BY MR. GUIDO) Good morning. I would 12 like to have you take a look at Exhibit B377, 13 which is at Tab 242. 14 Now, do you recall I asked you some 15 questions Friday afternoon regarding your 16 experience and the experience of others with 17 regard to mortgage-backed securities portfolios? 18 A. Yes, sir, I do. 19 Q. As of May of 1985, that time period, 20 what had been your exposure to the management of 21 mortgage-backed securities portfolios? 22 A. I had certainly never been a portfolio 15347 1 manager in terms of buying and selling 2 mortgage-backed securities. My exposure prior to 3 that time had been principally in the area of 4 learning about the securities, attending Salomon 5 Brothers type presentations, other brokerage 6 firms' presentations. And I was on the investment 7 committee at my prior company, First City; and I 8 don't -- I just really don't remember whether we 9 did any mortgage-backed securities there or not. 10 If we did, it wasn't a major portion. 11 Q. I think you testified that you had been 12 put on the asset/liability committee. 13 Do you recall that? 14 A. At United, yes, sir, I do. 15 Q. Who asked you to serve on that 16 committee? 17 A. I don't remember. I expect that it was 18 Mr. Williams or Mr. Gross. 19 Q. And you served on the strategic 20 planning committee? 21 A. Yes, sir. 22 Q. And who was it that asked you to serve 15348 1 on that committee? 2 A. Gerald Williams. 3 Q. And you also served on the 4 asset/liability committee, I think you testified 5 to? 6 A. Yes, sir. 7 Q. And who asked you to serve on that 8 committee? 9 A. That was either Gerald Williams or 10 Jenard Gross. 11 Q. Now, when you were asked to serve on 12 those committees, did they explain to you what 13 input they expected from you in the course of 14 those meetings? 15 A. In terms of the strategic planning 16 committee, Gerald Williams and I had worked 17 together for a long time in a prior company; and 18 we were both fairly plain spoken. So, Gerry 19 wasn't the kind of guy that gave a big elaborate 20 explanation. It was just, "We're having this 21 meeting. Show up. Bring your calculator and your 22 pad." 15349 1 And in terms of the asset/liability 2 committee or the asset/liability committee, if I'm 3 giving the right term, the committee that was kind 4 of subordinate to the investment committee, as 5 best I recall, that was the -- the charter of that 6 committee was to be a working committee where 7 financial people, investment portfolio managers, 8 and the funding people, the people that raised the 9 liability side, would get together and talk and 10 that sort of thing. 11 And I have a vague memory that prior to 12 that, we had had a -- something called a liability 13 pricing committee to set deposit rates and that 14 sort of thing. And someone came up with probably 15 a good idea that, you know, instead of setting 16 deposit rates and liability pricing in a vacuum, 17 it would be a wise decision to get both the asset 18 and liabilities side together. 19 Q. Okay. Now, what about the investment 20 committee? What were you told your role or your 21 contribution was expected to be in the investment 22 committee? 15350 1 A. I really don't remember in that area. 2 I don't have a recollection. I think Gerry 3 Williams communicated that to me, and I just 4 simply don't remember those discussions. 5 Q. Did you ever become the supervisor, the 6 direct supervisor, of any managers of any of the 7 securities portfolios? 8 A. Yes, sir, I did. 9 Q. When and over whom? 10 A. That would have been after Gerald 11 Williams left the association. I became the 12 direct supervisor of Sandy Laurenson, which was 13 over the mortgage-backed securities area, and 14 became the direct supervisor, I believe, at a 15 later time, Eugene Stodart, who was over the 16 high-yield bond area. When I say "supervisor," 17 I'm talking about an administrative supervisor. 18 You know, we certainly talked a lot. I always 19 viewed position limits and investment authority 20 and that sort of thing to come from the investment 21 committee. 22 Q. Well, what was your role as the 15351 1 supervisor of Sandy Laurenson, for example? 2 A. The normal -- it seemed to be -- to me, 3 to be the normal supervisory responsibility with 4 the exception that the investment committee kind 5 of gave her the marching orders in terms of, "Yes, 6 you can," or, "No, you can't buy this $100 million 7 of securities," that sort of thing. 8 Q. Was your responsibility to ensure that 9 she complied with the investment committee 10 policies? 11 A. My responsibility -- and I got the 12 treasury department to help me -- was to monitor 13 the mortgage-backed securities area to make sure 14 we met our position limits and that sort of thing. 15 Q. Did she have the authority to initiate 16 a trade that had not been approved by either you 17 or Bruce Williams? 18 A. Sure. 19 Q. Did she have the authority to initiate 20 trades where the trade tickets had not been signed 21 by either you or Bruce Williams authorizing the 22 transaction? 15352 1 A. Sure. 2 Q. Did you review trade tickets that Sandy 3 Laurenson had initiated and indicated your 4 approval by initializing those trade tickets? 5 A. I don't remember that to be a common 6 practice. I probably did review and initial the 7 trade tickets. But as a matter of convenience, I 8 think many of the trade tickets were initialed by 9 people in the -- in the trading room, the 10 investment -- what we called the trading room. 11 Q. Who were the people in the trading 12 room? 13 A. That was Mr. Huebsch, Mr. Huebsch's 14 staff. There were several people on his staff 15 that were equity arbitrage type traders that the 16 name escapes me. Clint Carlson is one of them. 17 There were -- Lauren Jordan, who was a high-yield 18 bond type person. For a time, I believe the head 19 of high-yield bonds sat in the trading room; and I 20 think that person also had an office. Then there 21 was Sandy Laurenson and Jack Falconi, and then 22 there were some other -- there were some other 15353 1 people, but those are the ones that I can remember 2 right now. 3 Q. Where were you and Bruce Williams 4 located? In the trading room? 5 A. No, sir. The office was arranged to 6 where my office would have been, oh, physically, I 7 would say about the length from here to the 8 elevator or maybe from here to the rest room. And 9 myself -- I had an office, and then Bruce Williams 10 had the office next door to me. 11 Q. How would you characterize the 12 frequency with which you signed trade tickets for 13 trades that were initiated by Sandy Laurenson? 14 A. I don't remember. I just don't 15 remember. I don't think it was every day, but I 16 don't have a memory as to -- 17 Q. Was it every day for a period of time? 18 A. Sir, I just -- I don't remember. You 19 know, I certainly -- I'm quite confident I signed 20 trade tickets. But in terms of the frequency and 21 so forth, I don't remember. 22 Q. Did you ever review any trade tickets 15354 1 in preparation for your testimony in this 2 proceeding? 3 A. I don't remember that. I certainly may 4 have. I've looked at a -- at a blizzard of paper; 5 so, I may have. 6 Q. Do you remember the issue with regard 7 to the maturity matching credit that came up in 8 the course of your deposition? 9 A. I absolutely remember that. 10 Q. Did you review any trade tickets with 11 regard to those transactions? And I'm talking 12 recently, prior to your testimony in this 13 proceeding. 14 A. I don't remember looking at trade 15 tickets. I may have. I just don't -- 16 Q. You just don't remember? 17 A. No, sir. I remember looking at other 18 documents and so forth related to maturity 19 matching credit. 20 Q. Do you have an MBA? 21 A. Yes, sir. 22 Q. And what did you -- what was your focus 15355 1 in the course of getting your MBA? 2 A. The MBA program was management, and it 3 was a quantitative-type management. 4 Q. What do you mean "quantitative-type 5 management"? 6 A. There were -- I believe there were two 7 programs where I went to school, and one of them 8 was a human resources type approach. And then 9 there were -- there was a -- it was either called 10 quantitative management or industrial management 11 or something like that that was more of an 12 economics approach to management. 13 Q. What do you mean by "economics approach 14 to management"? 15 A. Quantitative. 16 Q. Do you mean like using calculus? 17 A. Well, using numbers, stuff like time 18 and motion study correlation analysis, that sort 19 of thing. 20 Q. Did you study financial instruments and 21 how they operate? 22 A. In my -- in my school program? 15356 1 Q. Uh-huh, in the MBA program. 2 A. Yes, sir, I believe I had some courses 3 in that. 4 Q. Okay. Did you study the use of 5 regression analyses? 6 A. I believe I studied that, yes, sir. 7 Q. Do you know the use of regression 8 analyses -- or did you study the use of regression 9 analyses when evaluating hedge transactions? 10 A. I don't remember that, no, sir. In 11 terms of my college? 12 Q. I'm talking about your MBA program. 13 A. Oh. I don't remember studying that. I 14 remember studying regression analysis and 15 statistical-type techniques; but as to -- relating 16 that to hedging instruments, no, I don't remember 17 any such studies. 18 Q. Now, you indicated that there was -- 19 where did you get your MBA? 20 A. Texas Tech University. 21 Q. You indicated that there was a human 22 resources MBA subcategory when you were there. 15357 1 Right? 2 A. Well, I may have mischaracterized it. 3 It probably had a fancy name. I doubt they called 4 it human resources. But that -- yes, that's the 5 best of my memory. 6 Q. You said you did something that was 7 sort of quantitative analysis, in that branch -- 8 A. It was a quantitative curriculum, yes, 9 sir. 10 Q. Was that mostly production related? 11 Industrial production related? 12 A. It was largely industrial production 13 related. Yes, I would say that's a fair 14 characterization. 15 Q. And was that primarily focused on how 16 one structures production facilities in the 17 industrial plant or company? 18 A. I certainly -- I remember having some 19 courses similar to that. And I remember, for 20 example, Ford Motor Company was hot on that major; 21 and I believe that that's why Arthur Anderson 22 hired me, because of that particular program they 15358 1 liked for whatever reason. 2 Q. How many years did it take you to get 3 your MBA? 4 A. I believe one year and two summers, 5 full time. 6 Q. Did you write a thesis? 7 A. It was either a thesis or it was a 8 management report which seemed to me to be about 9 the same thing. It was one of those two, yes, 10 sir. 11 Q. What do you mean "a management report"? 12 A. Well, it was a long -- 50- to 100-page 13 document doing some research on a certain topic. 14 Q. Now, when you were asked to supervise 15 Sandy Laurenson, why were you told that you were 16 being asked to supervise Sandy Laurenson? 17 A. I don't remember anyone coming and 18 expressing it in those terms. It kind of -- it 19 just -- it started out -- as I believe, I was 20 asked to go call the investment banking houses, 21 like First Boston, Salomon Brothers, Goldman, and 22 start trying to recruit a -- a manager that would 15359 1 specialize on mortgage-backed securities/hedging. 2 Q. What did you understand your 3 responsibilities to be as Sandy Laurenson's 4 supervisor? 5 A. To -- what did I understand? 6 Q. Uh-huh. 7 A. The normal supervisory relationship 8 with the caveat that -- you know, normally, a 9 supervisor pretty much directs all of an 10 individual's efforts. But in this case and in the 11 case of Mr. Stodart, they received their -- their 12 substantive direction from the investment 13 committee, which I was a member. 14 Q. Now, going back to your graduate 15 degree, was there another branch of the MBA 16 programs that were offered at the time that dealt 17 with finance? 18 A. Yes, sir. I believe there was an MBA 19 in finance. 20 Q. Your MBA isn't in finance, is it? 21 A. No, sir, it is not. 22 Q. And what did the finance entail? 15360 1 A. I really -- I know I had finance 2 courses. But in terms of what their MBA program 3 consisted of, I -- I don't know. 4 Q. Do you have a CPA? 5 A. Yes. Well, I was a CPA from '71 or so 6 through '94, I believe. 7 Q. And why are you no longer a CPA? 8 A. The State of Texas increased the fees 9 very substantially on non-practicing CPAs, and I 10 wasn't an active or a practicing CPA from 1989 11 forward or about 1990 forward. And it was going 12 to cost me, as best I recall, 1500 bucks a year to 13 maintain the CPA certification. So, I opted to do 14 what was called a voluntary revocation of the CPA 15 certificate, which means that I can be reinstated 16 by paying all of my back fees and getting up to 17 speed on my continuing education but I do not have 18 to retake the CPA exam, which sounded like a 19 pretty good deal because I don't want to take that 20 test again. 21 Q. Now, when you supervised Sandy 22 Laurenson, was one of your responsibilities to 15361 1 make sure that the activities that she engaged in 2 didn't impair the integrity of the portfolios? 3 A. Could you repeat that question, please? 4 Q. Was one of your responsibilities as the 5 supervisor of Sandy Laurenson to make sure that 6 the actions that she took didn't impair the 7 integrity of the portfolios? 8 A. I would say I would certainly be -- 9 that would be part of my responsibility, but I 10 would consider that specific question to fall more 11 in the area of the investment committee's 12 responsibility, which certainly I was a member. 13 Q. What do you understand the phrase 14 "preserve the integrity of the portfolio" to 15 include? 16 A. That's a -- I don't know. 17 Q. Why did you answer the question then? 18 A. You asked it, and I was trying to -- 19 I'll attempt to be more precise, Mr. Guido. I 20 apologize. 21 Q. Thank you. 22 Did you -- was one of your 15362 1 responsibilities as a supervisor of Sandy 2 Laurenson to ensure that the portfolio did not 3 have to be reclassified from an investment to a 4 trading portfolio? 5 A. I'm not sure that was one of my 6 responsibilities. I certainly shared in the 7 responsibility to make sure that the various 8 portfolios we had, including Ms. Laurenson's 9 portfolio, were accounted for properly. 10 Q. And was one of the accounting issues 11 whether or not the portfolio would be classified 12 as a trading versus an investment portfolio? 13 Excuse me. Portfolios, plural. 14 A. Portfolios. That seemed to be a -- the 15 accounting rules were -- or there were various 16 exposure drafts and proposals being floated during 17 this time period. So, the answer to your question 18 is: Yes, I was very aware of the issue that there 19 were various proposals on accounting. So, I 20 was -- tried to be on top of that issue. 21 Q. Were you asked to serve on the 22 investment committee in order to provide an 15363 1 accountant's perspective to the activities that 2 were supervised by the investment committee? 3 A. No one ever told me that. 4 Q. Did it -- did you understand that that 5 was one of your responsibilities of sitting on the 6 investment committee? 7 A. I would understand that most any 8 committee I sat on, including the investment 9 committee, that my responsibility was to bring a 10 quantitative/accounting viewpoint or expertise to 11 the -- to that particular committee. 12 Q. Okay. And who were the members of the 13 committee again? 14 A. Of the investment committee? 15 Q. Uh-huh. 16 A. I believe it was Art Berner, the three 17 portfolio managers which would have been -- they 18 changed at various points in time. But high-yield 19 bonds was Gene Stodart; mortgage-backed 20 securities, Sandy Laurenson; equity arbitrage was 21 Ron Huebsch; Gerry Williams. Jenard Gross, I 22 believe, served as chairman. I'm sure I've left 15364 1 one or more persons out, but those are the names 2 that come to mind. 3 Q. Okay. Which of those people had 4 accounting experience? 5 A. The accounting experience would have 6 been Gerry Williams who certainly had accounting 7 experience. And Bruce Williams was a CPA, but he 8 was more of a -- I don't think Bruce ever worked 9 for a CPA firm or worked as an accountant similar 10 to Jim Wolfe. He was more of a financial analyst 11 and performance tracking type guy. 12 Q. Okay. So, it was the two of you that 13 had the accounting experience? 14 A. Myself and Gerald Williams. 15 Q. Okay. 16 A. And Bruce knew a lot about accounting 17 because he was a CPA, but his focus was more 18 performance tracking. 19 Q. What about Ron Huebsch? 20 A. To my knowledge, Ron wasn't an 21 accountant. 22 Q. Had he previously been a portfolio 15365 1 manager for many years? 2 A. Yes, sir. That's my understanding, 3 yes. 4 Q. And he had previously been the 5 supervisor of the mortgage-backed security 6 manager, Joe Phillips? 7 A. Yes, sir. 8 Q. Why did you become the portfolio 9 manager and not Mr. Huebsch when Sandy Laurenson 10 joined? 11 A. Factually, I can't answer that. I 12 just -- I don't know. 13 Q. Now, he had previously been the 14 portfolio manager of the high-yield bonds after 15 Joe Phillips had left, had he not? 16 A. After Joe left, the best of my memory 17 is we had a guy named Terry Dorsey come in and act 18 as the manager of high-yield bonds. And it could 19 have been that Ron acted as manager, but Terry 20 Dorsey was plugged in there somewhere. 21 Q. Why did you become the supervisor of 22 the manager of the high-yield bond portfolio when 15366 1 Gene Stodart took over the management of the 2 portfolio? 3 A. I don't know that -- I don't know. I 4 mean, it -- to try to answer more fully, I had 5 been responsible for going out and doing the same 6 type of -- calling the investment houses. And 7 after Mr. Phillips left, we had to replace someone 8 to -- to take over the high-yield bond portfolio. 9 I believe I'm the one that called the investment 10 banking houses and said, "Well, who do you" -- you 11 know, "Who do you use to hire high-yield bond type 12 guys?" And the name Higby Associates started 13 coming up again, and we had used them for the 14 mortgage-backed securities people. 15 And so, I contacted the head hunter; 16 and I believe I was responsible for getting them 17 in and starting the search for a high-yield bond 18 person. And then as to who told me and when and 19 why the high-yield bond person would report to me, 20 I don't know. 21 Q. Do you know how to evaluate a 22 high-yield bond, the efficacy of investing in a 15367 1 high-yield bond? 2 A. I had never -- I've never been a 3 portfolio manager of high-yield bonds; so, I'm 4 certainly not an expert in that area. I have some 5 understanding of corporate bonds and the ratings 6 and that sort of thing, but I've certainly never 7 been a portfolio manager. 8 Q. Do you know what the ratings mean, the 9 significance of the ratings? 10 A. I believe I do. 11 Q. Okay. What is it? 12 A. Investment grade is triple B and above. 13 And I believe a bank and thrift under current 14 standards can invest in double B and above 15 securities -- I'm sorry -- triple B and above 16 securities. The so-called high-yield or junk 17 categories were below triple B. And the higher 18 the rating -- the highest rating is triple A. I 19 think there are very, very few companies then or 20 now that have triple A ratings. 21 Q. Well, let's take the high-yield bonds. 22 What's the range, the high-yield bond range, for 15368 1 the junk bond ratings? 2 A. As best I remember -- and it's been 3 many years since I've paid any attention to 4 high-yield bonds. But the range I remember was 5 double B and B. And then I think there's a rating 6 that's C, but I'm not -- "C," I'm not sure exactly 7 what that means. It's certainly worse than double 8 B and B. 9 Q. What's the difference between double B 10 and B? 11 A. Double B would be in the opinion of 12 Moody's and/or Standard & Poors -- or maybe Finch 13 also rated bonds at this time. I'm not sure. But 14 a double B would be a higher rating, a higher 15 quality company. Things like their debt coverage 16 would be better, their business would be more 17 stable, those sorts of things. 18 Q. Have you ever done a due diligence to 19 underwrite the extension of capital or the 20 extension of credit -- excuse me -- to a 21 corporation? 22 A. To the extension of credit to a 15369 1 corporation? The only experience I would have 2 had -- in terms of underwriting, no, sir. The 3 only possible response to your question -- I'm not 4 sure I understand the question. But I did work on 5 a subordinated debt issue, a proposed subordinated 6 debt issue that United -- either United Savings or 7 United Financial Group proposed to do in the 8 '86-'87 time frame. And I think that would have 9 been rated in the high-yield bond category. I'm 10 not positive of that. 11 Q. Did you work on that, begin, in early 12 1986? 13 A. I don't remember the time frame, but I 14 remember the issue. 15 Q. Was it about the time of the so-called 16 rolldown? 17 A. I don't remember. 18 Q. Had you ever heard of something called 19 the Black-Schoels model? 20 A. Yes, sir, I have. I certainly can't 21 explain it. 22 Q. Did you ever apply it? 15370 1 A. I think that was an options related 2 model; but no, sir, I've never applied it. I may 3 have -- no. In terms of a practical application, 4 no. 5 Q. Did you -- have you ever -- do you know 6 what a thing called the option adjusted spread 7 model is? 8 A. Yes, sir. 9 Q. What is that? 10 A. Option adjusted spread or option 11 adjusted spread model is a model that takes a 12 security such as a mortgage-backed security; and 13 it takes various paths or various probabilities 14 that the option, as best I understand it, will be 15 exercised. And there can be a number of different 16 paths such as 50 or maybe more than 50 and it 17 assigns probabilities to those paths and it 18 discounts all those back. And the net result is 19 you get something like an option adjusted spread. 20 And I know that the option adjusted spread model 21 or the option adjusted spread number that you get 22 out of one model -- for example, Salomon Brothers' 15371 1 model -- certainly probably is going to differ 2 from another brokerage firm or your own model. 3 Q. And why is that? 4 A. I can't get into the details of that. 5 I don't understand it to that depth. But I'm 6 presuming that they use different levels of 7 assumptions. 8 Q. And what kind of assumptions go into an 9 option adjusted spread model? Do you know? 10 A. No, sir. I can't give all the elements 11 of an option adjusted spread model. 12 Q. Do you know any of them? 13 A. I think that some of them would be 14 certainly the coupon of the security. I think you 15 would have the level of the collateral relative to 16 the market, and then you would have various 17 prepayment assumptions. So, for example, if 18 Salomon Brothers' model assumed that the most 19 probable prepayment rate on a certain security 20 was, for example, 10 CPR and First Boston had the 21 same security and their base level assumption was 22 an 8 CPR, then you're going to get a different 15372 1 option adjusted spread number. 2 Q. Do you know how the people who 3 construct option adjusted spread models determine 4 the probability that any prepayment is likely or 5 not likely? 6 A. No, sir. 7 Q. Do you know whether or not they even 8 bother to try? 9 A. I don't -- don't know. 10 Q. Why did you say that they put a 11 prepayment model into an option adjusted spread 12 model based on their views of the probability of 13 prepayments? 14 A. I was attempting to give you some idea 15 of what I knew on option adjusted spread models, 16 and I was trying to be cooperative. 17 Q. Now, what is your understanding about 18 the relationship between the prepayment speeds of 19 the mortgage-backed security portfolio and 20 interest rates? 21 A. The -- my understanding is that there 22 are many things -- there are several things that 15373 1 determine prepayment speed but that interest rates 2 have a -- a large effect on prepayment speeds and 3 that as rates decline and become very low, 4 prepayment speeds tend to accelerate. And 5 conversely, if rates go up and/or reach a very 6 high level, prepayment speeds tend to slow down. 7 Q. What was your understanding of how 8 prepayment speeds would change in the middle of 9 1985 if interest rates declined 200 basis points? 10 A. As -- to get to that specific, I don't 11 know. I can't remember getting that -- you know, 12 it's very difficult for me to remember what I knew 13 and when I knew it. I don't know. 14 Q. If you don't remember, you don't 15 remember. 16 A. Yes, sir. 17 Q. And you don't remember? 18 A. I don't remember. 19 Q. Do you recall attending any 20 presentations prior to May of 1985 in which you 21 were receiving information about how prepayment 22 speeds operated? 15374 1 A. Is this prior to Joe's portfolio being 2 formed? 3 Q. Yes. 4 A. Okay. I remember attending the Salomon 5 Brothers presentation, and I have a -- a vague 6 memory of attending other presentations. But the 7 Salomon Brothers presentation sticks in my mind 8 more. 9 Q. Take a look at Exhibit B377 which I put 10 in front of you when I started these questions. 11 A. Okay. Yes, sir. 12 Q. Do you know who requested Salomon 13 Brothers to submit this proposal to USAT? 14 A. No, sir. 15 Q. Do you recall whose idea it was to 16 expand investments in mortgage-backed securities 17 at USAT in the October 1984 time period? 18 A. No. I really can't be specific as to a 19 person or group. But my memory is that a lot of 20 people attended this -- this presentation; and 21 during this time frame, I think a number of 22 individuals were enthusiastic about expanding the 15375 1 mortgage-backed area, including myself. 2 Q. So -- who were the people that attended 3 this meeting? You? 4 A. I'm sure I'm leaving somebody out 5 but -- or a whole lot of people out. It was a 6 pretty large meeting. It was myself, Gerry 7 Williams, Sonny Bentley. I believe -- I think 8 Mr. Gross was there, but I'm not positive. 9 Mr. Hurwitz. I think Dr. Munitz was there. I 10 think David Barrett was there. I think Charles 11 Patterson was there. I think Bruce Williams and 12 Jim Wolfe were there. I think either Graham or 13 Childress was there. And that's pretty much 14 that -- I don't remember anybody else. 15 Q. What about Ron Huebsch? 16 A. I left him out. I don't remember Ron 17 being there, but it -- it -- I would be kind of 18 surprised if he wasn't there. 19 Q. What was Salomon Brothers asked to do 20 that led to the preparation of B377? 21 A. I don't know what they were asked to do 22 because I didn't ask them to do it, and I don't 15376 1 know who did or what body. I know -- I think at 2 this time, they were -- I believe they were 3 helping us on the branch sale that was going to 4 occur at the end of '84. I may have my years off. 5 But they were pretty involved with United during 6 this time frame, if my memory is correct. 7 Q. Okay. Now, have you reviewed 8 Exhibit B377 in preparation for your testimony? 9 A. No, sir, I have not. 10 Q. When was the last time you saw the 11 document? 12 A. About -- I think I saw this about an 13 hour ago when somebody asked me if I had reviewed 14 it or looked at it; and I said, "No." 15 Q. Now -- was that your counsel? 16 A. Yes, sir. 17 Q. Now, let me direct your attention to 18 the Bates stamp 25 -- excuse me -- 253022. Do you 19 see where it says, "United Savings Association of 20 Texas. (1), Discussion of growth strategy"? 21 A. Yes, sir. 22 Q. Take a look at the next page which is 15377 1 CN253023. Do you see the strategy that's set out 2 there? It says, by bullet points, "Grow balance 3 sheet by raising cash, buying assets and financing 4 them, (2), Manage asset/liability mismatch," 5 subbullet, "shorten assets, lengthen liabilities, 6 manage gap." Then it says, "Create profits," 7 subbullet, "Create arbitrage spreads," subbullet, 8 "Acquire high-yield investments/enter new 9 businesses." 10 Do you see that? 11 A. I see that. 12 Q. Did you work with Salomon Brothers when 13 they were putting together their proposal in 14 October of 1984? 15 A. This proposal? 16 Q. Yes. 17 A. No, sir. As best I remember -- and 18 again, I may have my time frames off. But I was 19 working pretty heavily with a guy named Stephen 20 Pierce with Salomon Brothers, and we were working 21 on the Independent American branch sale. And part 22 of that branch sale had to do with a cash flow 15378 1 bond; and so, that was the focus of my attention. 2 So, I didn't -- I think this was -- this document 3 was more of a Bob Maum and Dan Kearney -- and they 4 were two partners with Salomon Brothers -- 5 creation. Who they worked with at United, I don't 6 know. 7 Q. You don't know who they worked with? 8 A. No, sir. 9 Q. Now, the -- what is your understanding 10 about -- when it says "manage asset/liability 11 mismatch"? And it talks about shortening assets. 12 Do you know what that refers to? 13 A. I do not. 14 Q. Take a look at CN253040 and see if that 15 refreshes your recollection. 16 A. (Witness reviews the document.) 17 Q. See where it says "shortening the 18 assets"? 19 A. I do. 20 Q. It says, "Shortening the term of the 21 portfolio is not difficult. One need only look to 22 the composition of mortgage loans being originated 15379 1 today to understand why. Over the last nine 2 months, approximately two-thirds of the total 3 single-family conventional residential loan 4 production nationwide was adjustable rate. 5 Salomon Brothers is currently in the marketplace 6 with sizable offerings of one-year adjustable rate 7 mortgages (ARMs), which would provide a three-year 8 corporate yield of 13-and-one-quarter percent 9 assuming interest rates remained at today's 10 levels." 11 Do you see that? 12 A. I do see that. 13 Q. Does that refresh your recollection of 14 what was meant by shortening the term of the 15 portfolio? 16 A. It doesn't refresh my recollection. I 17 know what they are talking about here now. It 18 seems to me that when they say, quote, "shorten 19 assets," if I'm interpreting this correctly, they 20 are more -- they really are talking about having 21 interest rate sensitivity on the asset side so 22 that those assets would reprice. The actual 15380 1 maturity might not change. But instead of a fixed 2 rate asset, you would have a variable rate asset. 3 Q. To more closely match the liabilities 4 that the institution had. Right? 5 A. That -- yeah. Typically in a thrift 6 during this time period and in the early Eighties, 7 most of the liabilities were -- were short-term 8 deposits and borrowings. And most of the mortgage 9 loans tended to be fixed rate 15- or 30-year 10 instruments. 11 Q. Now, do you recall attending any 12 discussions where the prepayment speeds were 13 discussed in relationship to different coupons of 14 securities? 15 A. I remember that being discussed 16 certainly during the time of the Smith Breeden 17 era. 18 Q. I want to keep you prior to the spring 19 of 1985. Okay? 20 A. Okay. 21 Q. We'll get to Mr. Breeden and his 22 colleagues in a little while. 15381 1 A. Okay. 2 Q. Sticking to what you knew in the spring 3 of 1985, you indicated that one of the things that 4 you knew was that information that you obtained at 5 a Salomon Brothers presentation on October 24th, 6 1984; is that correct? 7 A. Yes, sir. 8 Q. And Exhibit B377 is the written 9 rendition of that presentation, is it not? 10 A. It appears to be. 11 Q. Okay. 12 A. But I might -- to be clear, I don't 13 remember it being -- I guess it was, but I didn't 14 remember it to be such an all-encompassing 15 strategy session. What I took away from the 16 meeting was more of a mortgage-backed securities 17 structured arbitrage type program, but that's just 18 my memory. 19 Q. I'm sorry. I didn't understand you. 20 A. That is just my memory. I guess we 21 must have talked about more than that. 22 Q. Well, I mean, how long did this meeting 15382 1 last? Do you recall? 2 A. I remember it was a pretty long 3 meeting. 4 Q. And people from Salomon Brothers made a 5 presentation, did they not? 6 A. They did. 7 Q. Was that a lengthy presentation? 8 A. I can't really -- I don't remember how 9 long it was, but it seemed to me that it was a -- 10 it was a pretty long meeting. 11 Q. Okay. Did they use slides or overheads 12 to explain things to you? 13 A. I don't remember whether there were 14 slides or not. 15 Q. Did they hand out material to you? 16 A. The only thing I remember is Bob Maum 17 getting up and writing on a little easel-type 18 deal. His writing was hard to read. 19 Q. You're not disputing that Exhibit B377 20 is one of the pieces of material that you received 21 from Salomon Brothers, are you? 22 A. No, sir. Not at all. 15383 1 Q. Now, I would like to direct your 2 attention to another page, C253042. 3 MR. VILLA: Could you give us the 4 number again? 5 MR. GUIDO: CN253042. 6 Q. (BY MR. GUIDO) Do you see the 7 discussion of high coupon mortgage securities? 8 A. I do. 9 Q. It says, "Refinancing activity has had 10 a major effect on the high coupon mortgage 11 security sector of the secondary market. 12 Prepayment rates of these securities have climbed, 13 as borrowers refinance their loans at lower 14 mortgage rates. Housing turnover has been 15 precipitated by the availability of ARMs with 16 first year below market teaser rates. Given the 17 current interest rate environment, the high coupon 18 issues are probably best viewed as short-term 19 investment alternatives with values that can be 20 gauged by the yield spread to the Treasury yield 21 curve." 22 Do you see that? 15384 1 A. I do see that. 2 Q. Do you know what that refers to? 3 A. I don't remember it. The best of my 4 reconstruction of what this says today is that 5 they are talking about that high coupon relative 6 to the current coupon, whatever the current coupon 7 was -- but if you got into real high coupon 8 mortgage-backs, that the duration of those 9 securities would be relatively short. 10 Q. So that the prepayment rates would 11 increase significantly to make the durations 12 relatively short? 13 A. Because of higher prepayments on those 14 high coupon securities, the duration would be 15 relatively short. 16 Q. How does a high coupon security become 17 a high coupon security? 18 A. Changes in interest rates. 19 Q. So, in other words, if it's bought at 20 the current market -- let's say 13 percent -- and 21 interest rates dropped significantly, it would 22 become a high coupon security, correct? 15385 1 A. Agreed. 2 Q. Was that your understanding in the 3 spring of 1985? 4 A. I can't say definitively what my 5 understanding was during this time frame. 6 Q. Is that what's reflected in this 7 paragraph that I just read you? 8 A. Where they are talking about high -- 9 could you repeat that question? 10 Q. High coupon mortgage securities. 11 A. Yeah. What I think they are talking 12 about is that whatever the current coupon 13 mortgage-backed security was, they are taking a 14 significant ratchet up and saying if you go into 15 high coupon mortgage securities, prepayment rates 16 are going to be high; and, therefore, the duration 17 would be relatively -- or the average life is 18 going to be short. 19 THE COURT: We'll take a short recess. 20 21 (Whereupon, a short break was taken 22 from 11:05 a.m. to 11:26 a.m.) 15386 1 THE COURT: Be seated, please. We'll 2 be back on the record. 3 Mr. Guido. 4 MR. GUIDO: Thank you, Your Honor. 5 Q. (BY MR. GUIDO) Now, when you attended 6 the Salomon Brothers presentation, what did you 7 understand the purpose of you attending that 8 presentation to be? 9 A. I don't remember. It wouldn't have 10 been uncommon during those days -- I was very busy 11 with doing other things -- that Gerry Williams 12 would have just said, "Come to this meeting. 13 Bring a calculator and a pad." I mean, it -- if 14 there was any purpose, I don't remember. 15 Q. What were you doing in the fall of 16 1985? What were you focused on in terms of your 17 job responsibilities? 18 THE COURT: Are you saying '85? 19 MR. GUIDO: '84. Excuse me, 20 Your Honor. 21 A. Well, my primary focus during that time 22 period was -- in the prior year's audit report, we 15387 1 had had a material weakness in internal control. 2 So, my primary function was to get that corrected. 3 And that involved hiring new people, converting 4 the computers, changing procedures; and that was 5 my primary focus, and financial reporting, 6 installing a budgeting system, that sort of thing. 7 Q. (BY MR. GUIDO) Was there a strategic 8 planning group that had been set up by that time? 9 A. I don't remember what time frame that 10 occurred. Certainly, there was a strategic 11 planning committee that was formed, yes, sir. But 12 I -- I can't peg a time for you. 13 Q. Okay. Now, when you attended this 14 presentation in the fall of 1984, was one of the 15 purposes for you and the others to learn how 16 mortgage-backed securities work? 17 A. I don't remember -- I simply don't 18 remember anybody communicating a purpose. I mean, 19 I -- you know, Mr. Williams, who was my boss, 20 wasn't a "sit down and explain it" type guy, that 21 "Here's why I'm asking you to do this and here's 22 why you're attending this meeting." It was just, 15388 1 "Do it." So, you know, I tried to do it. 2 Q. Remember your notes of May 1st, 1985, 3 that we talked about which set out the mission 4 statement for United Financial Group? Do you 5 remember that? 6 A. That was the strategic planning 7 committee? 8 Q. Yes. 9 A. Yes, sir, I do remember that. 10 Q. Do you remember the discussion about 11 mortgage-backed securities as being one of the 12 proposed investments in the mission statement? 13 A. I think I remember that, yes, sir. 14 Q. Now, prior to that time of that mission 15 statement, did you and the others who were part of 16 the strategic planning committee attempt to learn 17 how mortgage-backed securities operate? 18 A. The others, I can't -- I can't say. I 19 can't characterize what they tried to learn. 20 Q. Well, what about you? 21 A. During this time frame, quite -- the 22 best of my memory is I was working 12 hours a day 15389 1 on my primary focus and on Saturday. So, I can't 2 say that I recall attending courses or anything 3 like that on mortgage-backed securities. 4 Q. Well, you did say you attended this 5 session or a session with Salomon Brothers. 6 A. Oh, I attended this session. I thought 7 you meant outside of this session. 8 Q. When I asked you about your 9 understanding of mortgage-backed securities, you 10 cited the Salomon Brothers presentation and others 11 that you attended, did you not? 12 A. Okay. Yes, sir. Excuse me. I thought 13 you were meaning outside of -- yes. We 14 attended -- I have a vague recollection of 15 attending other meetings/presentations from 16 national brokerage firms having to do with 17 mortgage-backed securities. 18 Q. But you specifically mentioned the 19 Salomon Brothers presentation. Do you recall 20 that? 21 A. That's the one I remember, yes, sir. 22 Q. So, is it fair to assume that Salomon 15390 1 Brothers was the source of the information that 2 USAT had at its disposal when it began to invest 3 in mortgage-backed securities? 4 A. When Joe Phillips started the program? 5 Q. Yeah. April of 1985 or the spring of 6 1985 when he started. 7 A. I don't know. I would assume that 8 since Mr. Phillips was apparently instructed to 9 start such a mortgage-backed securities arbitrage 10 program, that he had done additional legwork; but 11 factually, I don't know. 12 Q. I didn't ask you what the -- I just 13 asked you whether or not the Salomon Brothers 14 presentation would have been part of the knowledge 15 that you-all at USAT had when you decided to 16 invest in mortgage-backed securities and had Joe 17 Phillips go out and do so? 18 MR. VILLA: Objection. I think he said 19 "the source," not one of the sources. I think 20 that's the reason the witness answered the 21 question the way he did. 22 THE COURT: Let's have the question 15391 1 again. 2 Q. (BY MR. GUIDO) Was the Salomon Brothers 3 presentation one of the sources of information 4 that USAT relied upon when it began investing in 5 mortgage-backed securities? 6 A. Yes, sir. 7 Q. Let's take a look at some of the 8 statements that are in here in terms of how the 9 market operates. 10 Look at CN253077. Look at the bottom 11 of the page. It talks about high coupon 12 mortgage -- 13 MR. NICKENS: Your Honor, at least my 14 copy stops at 3073 and resumes at 104. I don't 15 know why that would be but -- does anyone have a 16 copy -- 17 MR. BLANKENSTEIN: Mine is like that, 18 as well. 19 THE COURT: Does the witness have 20 CN253077? 21 THE WITNESS: I do, yes, sir. 22 MR. NICKENS: Thank you, Your Honor. 15392 1 Mr. Villa's book has it. 2 Q. (BY MR. GUIDO) This is a section under 3 high coupon mortgage securities as short-term 4 investments. 5 Do you see that? 6 A. I see that. 7 Q. Do you remember our discussion about 8 high coupon mortgage securities? 9 A. I do. 10 Q. It says, at the bottom of the page, "At 11 current prepayment rates, the spreads of high 12 coupon mortgages to the Treasury yield curve are 13 significantly wider than those of other mortgage 14 issues, reaching 250 basis points or more. A 15 margin exists for these issues to have prepayment 16 rate increases and still provide reasonably 17 favorable spreads to governments. This prepayment 18 rate margin is as much as 20 to 30 percent for 19 certain issues." 20 Do you see that? 21 A. I do. 22 Q. Now, does that indicate to you that the 15393 1 magnitude of the prepayment increases that can 2 occur if there is a drop in interest rates from 3 current coupons to lower coupon interests? 4 MR. NICKENS: With regard to high 5 coupon mortgages, Your Honor? Is that the 6 question? 7 MR. GUIDO: No. I asked the witness a 8 question about high coupon mortgages previously; 9 and I think he testified that high coupon 10 mortgages come about because of a decline in 11 interest rates, Mr. Nickens. 12 MR. NICKENS: Your Honor, Mr. Guido 13 reads the witness a paragraph about high coupon 14 mortgages and then asks him a -- inexact questions 15 about mortgages generally. If the witness is to 16 focus on the paragraph, he would be answering as 17 to high coupons whereas now Mr. Guido tells us 18 that his question was not directed to the 19 paragraph he asked the witness to read. I believe 20 that's misleading the witness. 21 THE COURT: All right. Let's have the 22 question again. 15394 1 Q. (BY MR. GUIDO) Is it your 2 understanding, after having read this paragraph, 3 that prepayment speeds for mortgages that are high 4 coupon mortgages can exceed 20 to 30 percent? 5 A. That isn't what I get from this 6 paragraph, no, sir. 7 Q. Okay. Now, let's go to the paragraph 8 that talks about call protection at CN253070. Do 9 you see where it says, "For both of the investment 10 options discussed, single-family home mortgages 11 and commercial mortgages, we use seasoned low rate 12 mortgages as examples." 13 Do you see that? 14 A. I see that. 15 Q. Now, what does "seasoned" mean in 16 referring to mortgage-backed security pools? 17 A. That would mean the underlying loans 18 would have been outstanding for quite some time, 19 several years. 20 Q. What's the significance of that? 21 A. The significance is, for example, if 22 you could find mortgage-backed pools that had been 15395 1 seasoned -- namely, the home loans were old -- and 2 they had already been through one rate decline 3 cycle and those homeowners had not refinanced, 4 then I believe it's felt that the -- there's 5 somewhat of a burnout-type situation. In other 6 words, their propensity to refinance in another 7 rate decline would be less than a new mortgage. 8 Q. Okay. Now, what does the phrase 9 "discount" mean? 10 A. Discount would mean a coupon that is 11 below the so-called current coupon. An example 12 would be if the Fannie Mae 10s are currently 13 trading at par, then a Fannie Mae 8 would trade at 14 a discount dollar price such as 96 or 95, 15 something like that. 16 Q. Okay. And is an 8 percent in that 17 hypothetical viewed as a discount? 18 A. That would be a discount in that 19 hypothetical. 20 Q. Now, go back to the previous page. 21 Okay? See where it -- CN253069, the second 22 paragraph -- I think it's the second paragraph at 15396 1 the top. It says -- someone has put highlighter 2 on mine; so, it's hard to read. 3 "As this analysis indicates," do you 4 see that? 5 A. I do not. Oh, I do see that, yes, sir. 6 Q. "The profits on the arbitrage stand up 7 to a surprising degree under an assortment of 8 tests relating to the market price of the 9 mortgages, the general level of interest rates, 10 and the timing of interest rate fluctuations. In 11 other words, the duration match provides a 12 significant degree of protection against interest 13 rate movements." 14 Do you see that? 15 A. I do see that. 16 Q. Do you know what that's referring to? 17 A. Well, the general category is under 18 so-called whipsaw risk, more general rate 19 movements. 20 Q. Do you know what "duration match" 21 refers to when discussed in relationship to 22 mortgage-backed securities? 15397 1 A. Yes, sir. 2 Q. What is that? 3 A. Duration is a measurement of the -- of 4 a security or a financial instrument movement in 5 price relative to a change in market rates. 6 Q. Or does it refer to the expected life, 7 depending on prepayment speeds? 8 A. I think it's more of a movement -- 9 duration measures price sensitivity given a change 10 in market rates. In my way of thinking or what 11 I -- average life would be more of what I believe 12 you were speaking of. 13 Q. How does the price of the instrument 14 get calculated in relationship to interest rates 15 if it isn't in terms of the expected length of the 16 investment? 17 A. I think duration is expressed in terms 18 of years, but what I believe duration is is the 19 change in price of the security or the financial 20 instruments, given a certain change in interest 21 rates. And typically, a very short duration 22 will -- if interest rates move, the price 15398 1 volatility will be fairly small. If you have a 2 very significantly long duration or high duration, 3 then the price sensitivity will be large. 4 Q. Okay. Let's take that understanding 5 that you have. 6 A. Okay. 7 Q. And look at this paragraph. Is this 8 paragraph essentially saying, then, that the value 9 of the mortgage-backed security in terms of its 10 price won't change very much under a spectrum of 11 interest rate changes? 12 A. What was that question again, please? 13 Q. Is this paragraph essentially saying 14 that the price, the value of the mortgage-backed 15 security, will not change very much under this 16 arbitrage hypothetical that Salomon Brothers is 17 presenting based on fluctuations in interest 18 rates? 19 A. Just focusing in on that one sentence, 20 it says, "In other words, the duration match 21 provides a significant degree of protection 22 against interest rate movements." 15399 1 Q. Okay. Do you recall when I showed you 2 the paragraph that said they were using seasoned 3 lower rate mortgages -- i.e. discount mortgages -- 4 for their hypothetical. 5 Do you recall that? 6 A. I remember you showed me that in one 7 section of this. I don't know whether it's for 8 this hypothetical or not. I just don't know. I'm 9 perhaps a bit confused. 10 Q. Let's look at the next sentence on the 11 paragraph that I just -- underneath the paragraph 12 I just read to you. It says, "The ability to take 13 advantage of a positive spread arbitrage on a 14 risk-controlled basis is not limited to discount 15 residential loans." 16 Do you see that? 17 A. I see that. 18 Q. Does that refresh your recollection 19 that what this paper is discussing is interest 20 rate fluctuations and their impact on the value of 21 the mortgage-backed security portfolio when the 22 portfolio consists of seasoned lower rate or 15400 1 discount mortgage-backs? 2 A. I guess -- I certainly see the 3 sentence, and this paragraph is talking about 4 seasoned discount commercial mortgages. So, I'm 5 not sure if that answer is -- if I've been 6 responsive to your question. 7 Q. Well, do you recall the rolldown at 8 USAT? Let's roll ahead a little bit. 9 Do you recall the rolldown? 10 A. I do. 11 Q. Do you recall what precipitated the 12 rolldown? 13 A. Increasing velocity of prepayments or 14 the CPRs went up very significantly, well in 15 excess of the -- the modeled anticipated 16 prepayments. And that -- you know, one of the 17 major reasons for that was the declining interest 18 rates. 19 Q. What model? 20 A. I suppose our overall expectation of 21 prepayments whenever the program was set up 22 because, as I recall, on Day 1, there was a rough 15401 1 duration match between the mortgage-backed 2 securities and the interest rate swap type 3 instruments. 4 Q. What was the initial portfolio, in your 5 understanding? 6 A. What was it? 7 Q. Yeah. What was the initial interest 8 rate of the mortgage-backed security portfolio? 9 What was it composed of? 10 A. To the best of my understanding or 11 recollection, it was a roughly 500-million-dollar 12 asset size investment in mortgage-backed 13 securities pools; and they were funded by reverse 14 repurchase agreements. And to control the 15 interest rate risk, interest rate swaps were put 16 in place that basically fixed the liability cost 17 rate and that that model as I'm describing it or 18 that -- that arbitrage was roughly duration 19 matched. 20 Q. And what was the duration that it was 21 matched to? 22 A. I think it was about seven years, but I 15402 1 could be mistaken there. 2 Q. How was the seven years ascertained? 3 What was it assumed the seven years would relate 4 to? 5 A. The seven years would relate to what, 6 sir? 7 Q. You said you bought swaps to extend the 8 liabilities out seven years. Right? 9 A. Well, we entered into swaps to 10 provide -- and the swaps basically had the effect 11 of us paying a fixed rate, and we were earning a 12 fixed rate coupon typically on the asset side. 13 And that was your spread. 14 Q. Where did you come up with the seven 15 years? What's the seven years? 16 A. It's floating around somewhere in my 17 brain. I don't -- I mean, I can't say -- you 18 asked to the best of my recollection, what the 19 duration was and -- 20 Q. Seven years was what came out; is that 21 what you're saying? 22 A. Yes, sir. That's my memory. If -- I 15403 1 mean, it could be -- you know, I'm not perfect. 2 It could be five years. 3 Q. Let's take seven years. Let's assume 4 that your memory is accurate on the seven years. 5 My question is: What is your understanding of why 6 seven years was picked as the time period for the 7 swaps? 8 MR. NICKENS: Your Honor, I object. 9 They have testified about duration. Duration is 10 not a measurement of time, although it can, in 11 certain circumstances, be used as a substitute for 12 that. The question doesn't relate to the answer. 13 If the duration was seven, that would indicate 14 that a drop of interest rates at 100 basis points 15 in the securities market value would change by 16 7 percent. Mr. Guido's question about time does 17 not relate to the witness' testimony about 18 duration. 19 MR. GUIDO: Your Honor, I have listened 20 very patiently to what I refer to as speaking 21 objections. May I finish, Mr. Nickens? 22 MR. NICKENS: Yes, sir. 15404 1 MR. GUIDO: I would ask the Court to 2 instruct counsel if they are going to make an 3 objection, to make an objection that is a legal 4 objection and not testify. I just asked this 5 witness a question. He said that they picked 6 seven years. They didn't talk about any interest 7 rate factor. He didn't talk about any spreads. 8 The witness said seven years. I'm trying to ask 9 the witness a question of where he came up with 10 seven years. 11 It seems to me that Mr. Nickens is only 12 attempting to confuse this witness and to confuse 13 the testimony. And I think that -- I'm asking 14 you, Your Honor, to instruct counsel to limit 15 their objections to legal objections or the 16 question is misleading. But I do find it highly 17 objectionable that counsel has repeatedly engaged 18 in what's referred to as speaking objections in a 19 blatant attempt to coach witness' answers. 20 Your Honor -- 21 MR. NICKENS: How much time do we have 22 for this? You're objecting to my speaking 15405 1 objections -- okay. 2 MR. GUIDO: I'm making a legal point, 3 Mr. Nickens. And is that one needs only to go to 4 the basic trial tactics book to see what the 5 strategy is that the respondents' counsel are 6 engaged in, Your Honor. It seems to me if 7 Mr. Nickens has an objection, he should explain 8 what the objection is in terms of what the legal 9 objection is to the question. To characterize 10 something as misleading -- and in this case, it's 11 a blatant misrepresentation of what my question 12 was of this witness. I asked the witness how he 13 ascertained the seven years. I didn't get into a 14 discussion about duration or anything. I only 15 asked the witness one simple question: Where did 16 you come up with the seven years and how did you 17 pick it? 18 And I find that these objections, 19 Your Honor, that have come up repeatedly by 20 counsel for the respondents to be nothing other 21 than an effort to coach witnesses' responses. And 22 I think that the Court should instruct them to 15406 1 limit their objections to a legal objection or if 2 there's a problem with the phrasing of the 3 question, that it's a leading question, to just 4 say it because I can respond to that. And that 5 is -- I am dealing with a respondent who is an 6 adverse witness, Your Honor. 7 So, we're asking for instructions from 8 the Court to advise counsel it's inappropriate to 9 make the objections that they are making which are 10 basically sometimes testifying about the facts or, 11 two, attempting to confuse the record or to 12 confuse the Court and we believe are not 13 appropriate under the rules of this proceeding. 14 MR. NICKENS: May I respond, 15 Your Honor? 16 THE COURT: Yes, you may. 17 MR. NICKENS: We have been here going 18 on two hours. I've made two objections. The 19 first one was that the witness had been read a 20 paragraph and had been asked a question that 21 didn't have anything to do with the paragraph. I 22 believe the question was misleading. If any 15407 1 instructions are appropriate, it would be to 2 instruct Mr. Guido to ask questions that are 3 relevant and that are not misleading to the 4 witness. 5 My second objection, Mr. Guido just 6 stated that he had not asked the witness about 7 duration. And, in fact, just a few questions 8 before, he asked him to define it. The witness 9 tried to explain to Mr. Guido that he was mistaken 10 as to the meaning of duration or that at least the 11 witness and Mr. Guido had a different 12 understanding. He went on to explain that 13 although duration is expressed in terms of years, 14 it is, in fact, a measurement of price elasticity 15 which I believe has been firmly established in 16 this record over the last 17 weeks at various 17 points. And then Mr. Guido goes on to ask him, 18 "Well, how did you come up with the term, the 19 duration, of seven years," having asked him 20 earlier that they would last for seven years. 21 That is the misleading aspect of the question. 22 I resent, I must say, in light of the 15408 1 questions, the fact that my two objections would 2 be regarded by or be characterized by Mr. Guido as 3 coaching the witness. The witness doesn't need 4 any coaching to respond to these questions, but 5 the record should be clear that when responding to 6 a question, that they are talking about the same 7 thing. And Mr. Guido is simply mistaken about 8 what duration is, or he is deliberately trying to 9 mislead the witness and the record as to the 10 nature of that -- that concept, which the witness 11 has expressed to him in his testimony. 12 MR. GUIDO: Your Honor, I only asked 13 the witness how he came up with the seven years. 14 THE COURT: Well, my recollection is he 15 said he didn't know; so, let's have the next 16 question. 17 Q. (BY MR. GUIDO) You don't recall how 18 seven years were derived? 19 A. The answer to the question is I don't 20 know. That was Mr. Phillips -- I recall the 21 Salomon Brothers presentation, and then I assume 22 Mr. Phillips got marching orders from someone or 15409 1 some committee or some -- somebody on the totem 2 pole above me to go out and do this arbitrage. 3 And I would -- I don't know factually, but I would 4 assume that Mr. Phillips studied the problem and 5 determined that a duration of seven years was 6 appropriate, if my memory of a seven-year duration 7 is correct. 8 And like I've tried to explain, it may 9 not be correct. But whatever it was, whether it 10 was seven years, five years, or eight years -- 11 THE COURT: And what do you understand 12 the seven-year duration to be? 13 THE WITNESS: The duration would be 14 the -- a measurement of the sensitivity -- excuse 15 me -- the sensitivity of the instrument to changes 16 in interest rates. And so, a seven-year duration, 17 it's just expressed in years; but it's not average 18 life. It's not a maturity type concept. Whenever 19 investment people talk about it, they talk about, 20 like, well, a seven-year duration is going to have 21 more price movement given a change in interest 22 rates than a two-year duration. 15410 1 That's about as -- the best I can 2 explain it. It's kind of a -- it's a pretty hairy 3 concept to get involved with. 4 Q. (BY MR. GUIDO) Was the purpose of the 5 swap to match some other duration, however you're 6 using the term? 7 A. I really wasn't involved in the 8 mechanics of determining -- I may not have even 9 known what duration or average life or maturity or 10 kinds of coupons Mr. Phillips was going to get 11 into. And in terms of the hedging instruments he 12 used, I just don't know why Mr. Phillips opted to 13 go with the -- those kind of swaps. 14 Q. Let's go back to your understanding. 15 A. Yes, sir. 16 Q. Okay. These were mortgage-backed 17 securities that were purchased using what 18 financing tool? 19 A. Reverse repurchase agreements. 20 Q. And were those short-term repricing 21 instruments? 22 A. They were. 15411 1 Q. And the mortgage-backed securities, 2 were those fixed rate mortgage-backed securities? 3 A. My memory is they were fixed rate. 4 Q. Okay. Was the use of the swap designed 5 to hedge the difference in the repricing of the 6 mortgage-backed securities and the reverse repos? 7 A. Swaps were entered into to control that 8 interest rate risk. 9 Q. Okay. And that this "seven" figure, 10 okay -- we'll take Mr. Nickens's objection, and 11 we'll factor out what that means. It either means 12 time or sensitivity, one or the other. 13 A. It means one or the other. 14 Q. Is that "seven" figure designed in some 15 way to match a similar figure for the 16 mortgage-backed security pool? 17 A. I don't know what -- what Mr. Phillips 18 did in the designing of the structured arbitrage. 19 I don't know whether he -- he chose the swaps to 20 make them duration matched exactly. But my memory 21 is at the end of the day, they were very, very 22 close in terms of duration match. 15412 1 Q. Okay. Fine. When they were first put 2 on? 3 A. Yes, sir. 4 Q. In the spring of 1985? 5 A. Whenever we started Joe's portfolio. 6 Q. Now, were those mortgage-backed 7 securities seasoned mortgage-backed securities? 8 A. I don't remember. I don't know whether 9 I would have known at the time. 10 Q. Okay. Were those mortgage-backed 11 securities current coupon mortgage-backed 12 securities? 13 A. I don't know. 14 Q. Okay. If Mr. Phillips has testified 15 that they were current coupon newly-issued 16 mortgage-backed securities, do you have any reason 17 to dispute his testimony? 18 A. If that's what Mr. Phillips testified 19 to and he remembers it, I have no reason to 20 dispute it whatsoever. 21 Q. What happened to interest rates between 22 the time the mortgage-backed security portfolio 15413 1 was put on and December of -- when it was put on 2 in the spring of 1985 and December of 1985? 3 A. I can't be specific as to the date, 4 December of 1985. But I remember after Joe's 5 portfolio was put on that interest rates fell 6 sharply. 7 Q. And did prepayments increase because of 8 that? 9 A. Interest rates increased -- 10 THE COURT: Excuse me. 11 THE WITNESS: I'm sorry. 12 THE COURT: You said interest rates 13 increased? 14 THE WITNESS: I apologize. Prepayment 15 rates increased, and that was because of the 16 declining interest rates and other factors. But 17 certainly, the decline in interest rates was a -- 18 was a big reason. 19 Q. (BY MR. GUIDO) Was the decline in 20 interest rates a precipitating factor that 21 resulted in the increase in prepayments? 22 A. My opinion was if you looked at all the 15414 1 factors, that interest rates would have been the 2 dominant factor. 3 Q. Okay. Now, do you recall an entity 4 called USAT Mortgage Finance that was created at 5 the end of 1985? 6 A. This was the sub that was created and 7 then collapsed? 8 Q. That's correct. 9 A. Yes, sir, I do recall that. 10 Q. I want to show you a number of 11 documents. One is at Tab 570. It's A10574. The 12 next one is A1619 at Tab 501. The next is A1620 13 at Tab 502. The next is A1621 at Tab 503. The 14 next is A1622 at Tab 504. The next is A1623 at 15 Tab 505. The next is A10582 at Tab 1131. The 16 next is A5010, which is at Tab 557. The next is 17 B690, which is at Tab 585. The next is 1625, 18 A1625, which is at Tab 507. The next is A1624, 19 which is at Tab 506. The next is at Tab 1133, 20 which is A13008. 21 THE COURT: Would you repeat that, 22 please? 15415 1 MR. GUIDO: It's A13008, Your Honor, 2 which is at Tab 1133. 3 THE COURT: Thank you. 4 MR. GUIDO: Let me start with those. I 5 will also have documents that I'm going to 6 introduce into the record as we move through this 7 packet of documents, Your Honor. 8 THE COURT: It will take us a moment to 9 get these documents. 10 Mr. Guido, you may continue. 11 MR. GUIDO: Thank you, Your Honor. 12 Q. (BY MR. GUIDO) Now, Mr. Crow, I would 13 like to direct your attention to the document 14 that's at Tab 570, which is A10574. It's a 15 memorandum from Mike Crow to G.R. Williams dated 16 October 24, 1985. 17 Do you see that? 18 A. I do. 19 Q. Did you write that memoranda? 20 A. I don't remember it. But that's my 21 signature; so, I'm assuming I did. 22 Q. Have you had an opportunity to review 15416 1 that memoranda prior to your testimony today? 2 A. I believe I've seen this memo in the 3 last couple of weeks. 4 Q. Have you read the document in the last 5 couple of weeks? 6 A. I don't -- I don't remember. I've 7 certainly seen it. As to whether I read the 8 entire document, I just don't remember. 9 Q. Do you know what the documents pertains 10 to? 11 A. I believe I'm giving Gerald Williams, 12 my boss, an update as to financing sub. 13 Q. Does this document relate to the 14 discussions that led up to the creation of USAT 15 Mortgage Finance in 1985? 16 A. I think it does. 17 Q. Okay. And why was it that you were 18 preparing this memorandum on the creation of this 19 financing sub? 20 A. I really don't remember. Probably, 21 Mr. Williams told me to. 22 Q. Well, were you the supervisor of Joe 15417 1 Phillips at the time? 2 A. No, sir. 3 Q. Did you sit on the investment committee 4 at the time? 5 A. I sat on the investment committee. As 6 to the exact time frame, I don't -- I don't 7 remember when I started on the investment 8 committee. 9 Q. Prior to the creation of the investment 10 committee, who supervised investments for USAT? 11 A. Prior to the formation of the 12 investment committee, factually, I don't know. I 13 made some assumptions, but I don't know. 14 Q. What do you mean you made some 15 assumptions? 16 A. Well, I had assumed that it would be 17 Mister -- Mr. Huebsch and Mr. Phillips and they 18 would basically get their direction or policy 19 direction from -- either an investment committee 20 was established or the executive committee, one of 21 the higher-up type committees. 22 Q. I asked you a question -- prior to the 15418 1 investment committee was my question. Put that 2 aside. 3 Where did they get their direction 4 then? 5 A. Well, factually, I don't know because 6 during this time frame, Gerry Williams would just 7 come down from the -- from the mountain, so to 8 speak, from that highest level of -- of management 9 and tell me kind of what to do and what happened. 10 And so, I can't say who gave Mr. Phillips and 11 Mr. Huebsch direction. I'm assuming that it was 12 the people in the executive committee, but I don't 13 know that. 14 Q. Well, let me take you through some of 15 these paragraphs; and maybe that will help clarify 16 your -- or refresh your recollection. 17 It says, "Among other things, the 18 following items are key elements of qualifying 19 financing subs: (1), that securities are issued 20 from the financing sub, (2), that the cash 21 proceeds resulting from issuance of the securities 22 are advanced back to the parent, and (3), that the 15419 1 assets and liabilities of the financing sub are 2 duration matched so as to result in minimal 3 interest rate risk." 4 Do you see that? 5 A. I see that. 6 Q. Now, at this point in time, on 7 October 24th, 1985, what was your understanding of 8 the structure of the financing sub and its assets 9 and liabilities? 10 A. What I do remember? 11 Q. Uh-huh. 12 A. Nothing. 13 Q. Now, let's take the next paragraph. It 14 says, "Given these key requirements for regulatory 15 non-consolidation of the financing sub with the 16 parent," okay, "we have determined that our 17 present mortgage-backed securities financed with 18 reverse repurchase agreements and the associated 19 interest rate swaps will not meet the necessary 20 criteria." 21 Do you see that? 22 A. I see that. 15420 1 Q. What's the "we" that's being referred 2 to there? 3 A. I don't know. That probably would have 4 been, just remembering back generally, how we 5 worked in those days. That probably would have 6 been me and Pledger, Jim Pledger, and Art Berner 7 and Jim Wolfe and Bruce Williams. But I can't 8 remember specifically. 9 Q. Now, do you remember USAT Mortgage 10 Finance, how it was structured? 11 A. I remember the basics, yes. 12 Q. Why don't you tell us what the basics 13 were. 14 A. The basics that I remember is that it 15 was -- it was a subsidiary of mortgage-backed 16 securities that were funded with reverse 17 repurchase agreements. And I believe there 18 were -- it -- I believe there were swaps put on 19 maybe at the parent level, but I think that was at 20 the USAT level. 21 Q. The swaps were put on. Is that your 22 understanding? 15421 1 A. That's my memory. 2 Q. To provide a hedge -- 3 A. To control the interest rate risk. 4 Q. Between the reverse repos and the 5 mortgage-backed securities. Right? 6 A. To basically perform the same kind of 7 function as Joe's portfolio. 8 Q. Now, let's go back to the first 9 sentence. It says, "Among other things, the 10 following items are key elements of qualifying 11 financing subs." And it talks about those three 12 requirements. 13 What was the consequence of having USAT 14 Mortgage Finance to be classified as a financing 15 sub? 16 A. I think the -- this exercise was the 17 objective -- was to have a subsidiary that would 18 not be consolidated for liability growth purposes. 19 Q. Okay. 20 A. That's the -- you know, I think that 21 was the point of the financing sub. 22 Q. Okay. Now, as of October 24th, 1985, 15422 1 is it fair to say that you concluded that a 2 mortgage-backed security portfolio financed with 3 reverse repurchase agreements and hedged with 4 swaps would not qualify as a financing sub? 5 A. Well, let me -- let me read this thing 6 fairly carefully then. (Witness reviews the 7 document.) It looks like to me that we're talking 8 about -- in the paragraph that starts "as an 9 alternative," that would be a structure that, for 10 whatever reason, we thought would work. 11 Q. Now, that's not what I'm asking you. 12 A. Okay. 13 Q. I'm just asking you whether it was your 14 conclusion in this memoranda, as I read that 15 sentence -- okay? 16 A. Which sentence are we talking about? 17 Q. The second paragraph, "Given these key 18 requirements for regulatory non-consolidation," do 19 you see that paragraph? 20 A. I do. 21 Q. That mortgage-backed securities 22 financed through reverse repurchase agreements and 15423 1 the interest rate risk between the reverse 2 repurchase agreements and the mortgage-backed 3 securities being hedged with swaps would not 4 qualify as a financing subsidiary. 5 A. Just -- I don't have a memory of this. 6 But just from reading that paragraph, it looks 7 like that I did conclude that because, quote, "The 8 key factor is that no cash would be advanced back 9 to the parent by 'pushdown' this transaction from 10 USAT to the financing sub." Excuse me. 11 Q. But you concluded at this point in time 12 that a subsidiary that contained mortgage-backed 13 securities financed with reverse repurchase 14 agreements, the interest rate risk of which was 15 hedged with swaps, would not qualify as a 16 financing subsidiary? 17 MR. VILLA: Objection. That's 18 misleading because it leaves out the reason that 19 he reached the conclusion. 20 MR. GUIDO: There goes one of those 21 speaking objections again. I asked the witness 22 whether or not he concluded it. I asked him 15424 1 whether or not it concluded it would qualify. 2 That's all I'm asking, Your Honor. 3 THE COURT: If you're asking as a 4 general proposition, I'm not sure that's what the 5 statement says. I'll sustain the objection. 6 Restate your question. 7 Q. (BY MR. GUIDO) Now, what was the reason 8 that you concluded that a subsidiary consisting of 9 mortgage-backed securities financed with 10 repurchase agreements, the interest rate risk of 11 which was hedged with swaps, would not qualify as 12 a financing subsidiary? 13 A. Well, I don't remember from the events. 14 But from looking at this memo, it appears that, 15 quote, "The key factor is that no cash would be 16 advanced back to the parent by 'pushdown' this 17 transaction from USAT to the financing sub. Cash 18 could not be raised because the mortgage-backed 19 securities are already encumbered by the present 20 repurchase agreements used to finance their 21 purchase." That appears to me to be the reason. 22 Q. Let's go through those steps. One is 15425 1 to qualify as a financing subsidiary, securities 2 have to be issued by the financing subsidiary. 3 Right? 4 A. That is what Item No. 1 in the first 5 paragraph says, yes, sir. 6 Q. Okay. Now, what's a security. What's 7 the reference to a security? 8 A. I don't know. I don't know how a 9 security would be defined. I just don't remember 10 all of these details in the depth we're getting 11 into. 12 Q. You did create USAT Mortgage Finance. 13 Right? 14 A. I do remember that. 15 Q. How did it meet these criteria, these 16 three criteria on Paragraph 1? How did it meet 17 those three criteria? 18 A. Well, sir, I don't remember. I think 19 that certainly during this time period, as I -- as 20 I remember -- as I recall, we had Mr. Pledger, who 21 was a good regulatory lawyer. We had Mr. Berner, 22 who was a good lawyer; and they had, I would 15426 1 assume, outside people helping them. And I was 2 handling the financial part of it. But as to how 3 something qualified or didn't qualify from a 4 regulatory standpoint, you know, from a -- from a 5 proposed regulation, I wouldn't -- that wouldn't 6 have been my call. 7 Q. Well, you mentioned -- 8 A. I would have relied on those 9 individuals. 10 Q. Now, you said that there was 11 Mr. Pledger, who was a good regulatory attorney, I 12 think is what you just said. Right? 13 A. Yes, sir. 14 Q. And Art Berner who was a good lawyer. 15 Right? 16 A. I think -- I thought and think 17 Mr. Berner is a good lawyer. 18 Q. Now, had Mr. Berner had any regulatory 19 experience at this time? 20 A. I don't know exactly what Mr. Berner's 21 experience was. I viewed -- I think his 22 background was more securities law, but I -- I 15427 1 don't factually know. 2 Q. Mr. Pledger was USAT's regulatory 3 counsel in October of 1985, wasn't he? 4 A. I think Mr. Pledger -- Mr. Pledger was 5 our regulatory -- I viewed him to be our 6 regulatory counsel until he left. 7 Q. So, if he were still there, you would 8 have viewed him as your regulatory counsel; is 9 that right? 10 A. If I had a regulatory question, I would 11 go to Mr. Pledger typically. 12 Q. Turn to the second page. Tell me who's 13 copied on this document. 14 A. Mr. Berner is copied. 15 Q. Why not Mr. Pledger? 16 A. I don't know. I think Mr. Pledger 17 reported to Mr. Berner. So, you know -- but -- I 18 don't know why I didn't copy Mr. Pledger. 19 Q. I mean, this is talking about 20 regulations in very explicit details and your 21 summary of what you think the structure would be 22 that would and would not qualify. Right? 15428 1 A. It's certainly talking about structure 2 in some detail, yes, sir. 3 Q. Now, do you see where it says, "The key 4 factor," which Mr. Villa pointed out to the Court, 5 "that no cash would be advanced back to the parent 6 by 'pushdown' this transaction from USAT to the 7 financing sub"? 8 Do you see that? 9 A. I see that. 10 Q. What's that referring to? 11 A. I don't remember what this term 12 "pushdown" is. I just simply don't remember. 13 Q. I mean, your summary of the regs -- I 14 mean, the regs in the first paragraph don't at all 15 make reference to pushdown, do they? 16 A. I don't see that term used, no, sir. 17 Q. Now, do you see the alternative that's 18 discussed there? 19 A. I do. 20 Q. Can you tell us what that alternative 21 was? 22 A. Not really. I'm sure I understood it 15429 1 at the time, but I am not sure I understand it 2 now. 3 Q. Well, it says, "As an alternative, it 4 is our present intent to place approximately 80 to 5 100 million of unencumbered mortgage-backed 6 securities in the financing sub, as well as 7 approximately 50 million of newly purchased 8 mortgage-backed securities" -- 9 MR. VILLA: I think that was 150 10 million. 11 Q. (BY MR. GUIDO) -- "150 million in 12 additional newly purchased mortgage-backed 13 securities in the financing sub that could be 14 acquired through our present borrowing capacity." 15 Do you see that? 16 A. I see that. 17 Q. What does that refer to? 18 A. My interpretation is that -- and again, 19 I don't remember this; but my interpretation is -- 20 is that we would take 80 to 100 million probably 21 in USAT and put it in this finance sub and then 22 purchase an additional 150 million in newly 15430 1 purchased mortgage-backed securities. That's my 2 interpretation. 3 Q. Now -- then it goes on to talk about an 4 interest rate swap agreement between USAT and the 5 financing sub. 6 Do you see that? I'll read the whole 7 sentence. "The interest rate swap agreement 8 between USAT and the financing sub would be 9 structured so as to hedge the transaction on a 10 duration basis as closely as possible." 11 Do you see that? 12 A. I do. 13 Q. Then it says, "Of course, on a 14 consolidated basis, this interest rate swap is 15 without subs. So, we would add interest rate 16 collars of the parent to protect the additional 17 interest rate risk as a result of purchasing 18 incremental mortgage-backed securities financed 19 with reverse repurchase agreements." 20 Do you see that? 21 A. I do see that. 22 Q. Now, why -- what do you mean by -- that 15431 1 on a consolidated basis, the interest rate swap is 2 without substance? 3 A. As best I can tell from reading this, 4 an interest rate swap between a parent and a 5 subsidiary, upon consolidation, would just 6 disappear. It wouldn't technically disappear, but 7 it wouldn't be -- as opposed to an interest rate 8 swap with a true outside third party. 9 Q. All right. Now, it talks about -- it 10 talks about purchasing an interest rate collar. 11 What is your understanding of what an 12 interest rate collar was at that time? 13 A. As best I remember, an interest rate 14 collar was a little bit similar to an interest 15 rate cap in that you -- I think the association -- 16 or the purchasing party would buy a -- a -- buy a 17 contract. And the upper band -- if interest rates 18 got past that upper band strike price, then the 19 owner of that collar would start getting paid the 20 difference between the strike price and wherever 21 interest rates went. And then there was a lower 22 band or a lower number and quite -- I don't 15432 1 remember how the lower band worked, but I know 2 there was a band in there. 3 Q. So, if interest rates would go up above 4 a certain amount, there would be payments to USAT 5 if it was the purchaser of a collar? 6 A. Similar to an interest rate cap, I 7 believe. 8 Q. And if interest rates went below a 9 certain coupon, USAT would have to pay; is that 10 true? 11 A. That's where I get confused. If 12 that's -- I get confused whether USAT would have 13 to pay or whether USAT would receive. I just 14 don't know. 15 Q. You don't know? 16 A. I don't know. 17 Q. Did you ever know? 18 A. I think I probably knew at this time, 19 yes, sir, because Mr. Williams was the kind of 20 guy -- if you didn't know what you were talking 21 about, he would stick it back down your throat. 22 Q. Now, I would like to ask you questions 15433 1 about how collars and caps differ, if you know. 2 And to help you with that, I have a document that 3 I've marked as A13048, which is a letter dated 4 July 31st, 1985, or a memo from Joe Phillips and 5 Ron Huebsch to the executive committee. 6 THE COURT: We'll adjourn until 7 2:00 o'clock. 8 9 (Whereupon, a lunch break was taken 10 from 12:34 p.m. to 2:04 p.m.) 11 12 THE COURT: We'll be back on the 13 record. 14 Mr. Guido. 15 MR. GUIDO: Thank you, Your Honor. I 16 would like to move the admission of A13408 which 17 is a memo from Joe Phillips to Ron Huebsch. The 18 subject, interest rate caps. 19 MR. VILLA: No objection, Your Honor. 20 THE COURT: Received. 21 Q. (BY MR. GUIDO) Now, at the time that 22 USAT Mortgage Finance was created, you testified 15434 1 there was a mention to collars in the memorandum 2 that you wrote, October 24th, 1985. 3 Do you recall that? 4 A. I remember that, yes, sir. 5 Q. Were you also knowledgeable or were you 6 aware that interest rate caps were available at 7 that time in order to hedge the interest rate risk 8 that's created by funding a mortgage-backed 9 security portfolio with reverse repurchase 10 agreements? 11 A. I think I was aware of that, yes, sir. 12 Q. Now, take a look at the memorandum that 13 I was showing you: A13408. It's a discussion of 14 interest rate cap usage. 15 Have you ever seen that memo before? 16 A. I don't believe I've ever seen this 17 memo, no, sir. 18 Q. Okay. 19 A. I don't remember it. 20 Q. Can you tell us what your understanding 21 of an interest rate cap is? 22 A. My understanding of an interest rate 15435 1 cap is where a fee is paid, and the contract will 2 have a -- a time period. Let's just say five 3 years. And there will be a strike price. And if 4 interest rates go above that strike price, then 5 you, as the owner of the cap, would receive a 6 payment -- 7 Q. You mean the purchaser of the cap? 8 A. The purchaser of the cap, yes, sir. 9 Q. I'm sorry. Go on. 10 A. Let's just assume United Savings buys 11 the cap. A fee would be paid. And if interest 12 rates rose to such a level that the strike price 13 was exceeded, then United Savings would receive 14 the difference between the strike price and 15 whatever the actual probable LIBOR rate was on a 16 periodic basis, monthly or quarterly. And then if 17 interest rates fell back below the strike price, 18 United Savings would receive no payment. 19 So, it was kind of an interest rate 20 protection device. 21 Q. To protect against rising interest 22 rates? 15436 1 A. Against rising interest rates. 2 Q. Now, do you recall any discussions 3 prior to the creation of the USAT Mortgage Finance 4 portfolio in November of '85 on the use of caps as 5 a vehicle to protect against rising interest rates 6 as opposed to swaps? 7 A. I really do not. There may have been 8 discussions, but I just don't remember them. 9 Q. What are the differences between using 10 a swap and using a cap to protect against rising 11 interest rates? 12 A. Well, a swap would be -- you don't 13 have -- you don't pay a fee up front. So, it's 14 not -- I don't think it's booked as an asset. 15 It's kind of an off-balance sheet type affair. 16 And it does have a turn just like a cap; so, it 17 could be five years. And it's an agreement to 18 exchange interest payments with another party. 19 For example, United Savings would typically want 20 to pay a fixed rate and receive a variable rate to 21 offset some type of interest rate risk. 22 And a cap is, you know, kind of like I 15437 1 tried to describe. So, they are different; but 2 they are both, you know, cousins. 3 Q. Well, with a cap, you pay a fee; and 4 you don't for a swap. Right? 5 A. That is correct. The thing that I left 6 out about a swap is that since an interest rate 7 swap is a contract to exchange interest rate 8 payments, the -- typically, the weaker credit 9 company has to put up collateral. For example, 10 most of our interest rate swaps -- or many of our 11 interest rate swaps were with Federal Home Loan 12 Bank, which is a government agency type credit; 13 and, obviously, United Savings was not. So, 14 United Savings would have to post collateral to 15 make sure we were able to meet our obligations. 16 And so, that has a cost to it. 17 Q. What's the cost associated with posting 18 collateral? Does the person on the other side of 19 the transaction get to keep the interest off of 20 that collateral? 21 A. No, sir. 22 Q. Okay. The interest -- 15438 1 A. Not to my -- no, sir, he does not. 2 Q. That's not a cost? 3 A. Right. 4 Q. What are the costs? 5 A. Well, I guess at the ultimate extreme, 6 if all of your collateral became encumbered by 7 some events, then in order to, you know, enter 8 into new interest rate swaps, United Savings 9 literally would have to go out and buy some type 10 of collateral. 11 Q. But it's some sort of an uncertainty or 12 contingency? 13 A. Well, collateral cost is -- is a real 14 cost in my mind. It's a real -- 15 Q. When you put on the swaps at USAT 16 Mortgage Finance, did you do a calculation of what 17 the implied cost of the swaps would be? 18 A. I don't remember specifically doing 19 that, no, sir. 20 Q. Well, did you yourself do it? 21 A. I just don't remember exactly what 22 calculations I would have done or whether I would 15439 1 have known exactly what Mr. Phillips was doing in 2 terms of the specific interest rate swaps he was 3 putting on. 4 Q. So, you don't remember? 5 A. No, sir, I don't remember. 6 Q. Now, with regard to the difference 7 between swaps and caps, did you know what the 8 effect was or the different effect was between a 9 swap and a cap in a declining interest rate 10 environment? 11 A. I can't say -- I guess the factual 12 answer is I don't remember whether I would have 13 known that at the time or not. 14 Q. Do you know it now? 15 A. I think so. 16 Q. What do you think the answer to the 17 question is? 18 A. I believe that if you had a declining 19 interest rate environment, it would be better to 20 not have either one; but that -- I mean, in a 21 declining interest rate environment, both 22 instruments would be not helpful. 15440 1 Q. Well, take the cap, for example. 2 A. Okay. 3 Q. You pay a premium for the company. 4 Right? 5 A. Paid a premium and it's on the books as 6 an asset, yes, sir. 7 Q. And interest rates go down? 8 A. Right. 9 Q. Do you lose anything more than your 10 premium? 11 A. Anything more than your premium? No, I 12 don't believe you would. If I'm -- I don't think 13 you would. 14 Q. Swaps are on the books and you have a 15 declining interest rate and you are the payor of a 16 fixed rate interest and you're receiving a 17 variable interest rate. 18 Do your losses increase if interest 19 rates go down? 20 A. If interest rates go down, you would be 21 in a -- just looking strictly at the swap, 22 ignoring all other factors, you would be in a 15441 1 disadvantageous position because the institution 2 would be paying a fixed rate and interest rates 3 would be declining. 4 So, in a perfect world, you would hope 5 that -- you know, you would rather be paying that 6 lower interest rate. 7 Q. Do you recall seeing a memorandum that 8 Bruce Williams wrote where he quantified what the 9 effect was on the swaps toward the end of 1986 10 after interest rates had declined from the spring 11 of 1985? 12 A. I don't -- I remember Bruce writing 13 memos, and I remember Bruce and others. The 14 interest rate swaps were a common topic of 15 discussion, but I don't remember specific memos. 16 He probably -- I feel pretty confident that he did 17 do such an analysis. 18 Q. Do you recall a negative number of 19 $122 million being attributable to the swaps in 20 1986? 21 A. No, sir, I don't recall that. 22 Q. I was just trying to use that to 15442 1 clarify the magnitude. 2 A. Sure. 3 Q. So, when you put on the USAT Mortgage 4 Finance, did you attempt to ascertain what the 5 spread would be between the cost of funds adjusted 6 for the swaps and the mortgage-backed security 7 portfolio? 8 A. Well, as -- I guess the best answer to 9 that is I attended the Salomon Brothers 10 presentation, and I'm sure I was involved in some 11 subsequent discussions of that. I don't remember 12 what those discussions were. But in terms of what 13 the assets were and what the hedges were going to 14 be, to the best of my memory, that was 15 Mr. Phillips and his mentors. 16 Q. Who were his mentors? 17 A. Well, by "mentors," I would mean 18 Mr. Huebsch, which was his direct supervisor, and 19 whoever was the -- the person that said, "Go do 20 this," or the body that said, "Go do this." And 21 this morning, I speculated that that was probably 22 the executive committee. But I -- factually, I 15443 1 don't know because as I tried to explain during -- 2 and in this time period, Gerry Williams would go 3 to these meetings and come back and kind of give 4 me my marching orders. He tried to keep me 5 informed of what was going on. 6 Q. Who was the executive committee at that 7 time? We're talking the spring of '85 through 8 December of '85. 9 A. As best I remember, it was Gerry 10 Williams. If Mr. Gross was there -- I'm a bit 11 confused as to when he came. But if he were 12 there, certainly Mr. Gross would have been on the 13 executive committee. If we're talking UFG, 14 certainly Mr. Hurwitz, Dr. Munitz. And then there 15 would have been a secretary typically. And as to 16 whether they would have been an official member or 17 not, I don't know. And that would have been 18 either Jim Pledger or Art Berner. 19 Q. Okay. Let's go back to your 20 October 24th memorandum, back to USAT Mortgage 21 Finance again, its creation. It's Exhibit A10574 22 at Tab 570. 15444 1 A. Okay. 2 Q. Now, after the paragraph where you set 3 out the alternatives, on the second page, it says, 4 "A final direction determination will be 5 determined at the next asset/liability committee 6 meeting on October 25th." It says, "There is 7 absolutely no assurance that this transaction will 8 be exempt from consolidation with the parent." 9 Do you see that? 10 A. I see that. 11 Q. "It is possible the only CMO 12 confirmation will meet the new requirements." 13 Do you see that? 14 A. Yes. 15 Q. It says, "Additionally, the definition 16 of a reverse repurchase agreement as a security is 17 an aggressive interpretation according to our 18 legal staff." 19 Do you recall that? 20 A. I don't recall that, but I remember -- 21 I remember the -- at the time of the formation of 22 this subsidiary, that it was done in anticipation 15445 1 of a proposed regulation coming out that would not 2 require consolidation for liability growth 3 purposes. And I remember that there was no 4 assurance that -- you know, as to how the 5 regulation is going to come out. 6 Q. Do you remember my question at the 7 outset when I pointed you to Paragraph 1, Point 1, 8 that says the securities are issued from the 9 financing sub -- 10 A. I do. 11 Q. -- and I asked you what securities you 12 referred to there? 13 A. I remember that. 14 Q. Now, does this refresh your 15 recollection that reverse repurchase agreements 16 was, in the mind of your counsel anyway, an 17 aggressive interpretation of that term 18 "securities"? 19 A. No, sir. I really don't remember. I 20 certainly see what the sentence says, but I 21 don't -- don't remember. 22 Q. What, in your understanding, does a 15446 1 lawyer say to a client when he says that that's an 2 aggressive interpretation? 3 A. Well, in my mind, if we're dealing with 4 a proposed regulation and we're talking about an 5 aggressive interpretation, it means that that 6 interpretation isn't a slam dunk. That's what it 7 means to me. 8 Q. So, it means there's a risk to that 9 interpretation? 10 A. It means that -- to me, it means 11 that -- just from reading this document and what 12 these words mean to me is that there is a risk 13 whenever you're dealing with a proposed regulation 14 that the interpretation that we used here may not 15 be how the final regulation comes out. 16 Q. Now, let's go to the next paragraph on 17 the last page. It says, "Assume this transaction 18 does not work and that the new regulations would 19 require consolidation with the parent. It would 20 be our intent to place the mortgage-backed 21 securities and the associated repurchase 22 agreements back into USAT. However, this would be 15447 1 consistent with our overall business plan." 2 Do you see that? 3 A. I do see that. 4 Q. So, as of October 24th, 1985, this 5 document indicates that it was at least your 6 intention to place the mortgage-backed securities 7 and their associated repurchase agreements back 8 into USAT if the subsidiary didn't qualify as a 9 financing subsidiary? 10 A. As of this date, I would agree with 11 your statement. 12 Q. Now, let's go to Exhibit A1619, which 13 is Tab 501. 14 A. (Witness reviews the document.) 15 Q. These are the minutes of the 16 asset/liability committee meeting of October 25th, 17 1985, which you make reference to in your 18 October 24th, 1985 memorandum which was 19 Exhibit A10574; is that correct? 20 A. Yes, sir. 21 Q. Okay. Then it says under the creation 22 of the financing subsidiary -- it says, "Creation 15448 1 of financing subsidiary. It was agreed it would 2 be in our best interest to move ahead with 3 establishing a new finance subsidiary. The 4 mortgage-backed securities would be purchased in 5 USAT and passed to the new subsidiary. The MBS 6 would be funded with reverse repos and hedged with 7 swaps, caps, and/or collars." 8 Do you see that? 9 A. Yes. 10 Q. It says, "An initial application to the 11 Federal Home Loan Bank would request permission 12 for up to 500 million in securities. A final 13 decision as to the security volume to be placed in 14 the subsidiary and actual hedging device used was 15 to be determined Monday, October 28th, at the 16 scheduled executive committee meeting." 17 Do you see that? 18 A. I do see that. 19 Q. Does that refresh your recollection 20 that there were discussions about what hedging 21 device to use -- swaps, caps, or collars -- for 22 USAT Mortgage Finance? 15449 1 A. No, sir, it really does not. We 2 certainly may have discussed it, but I just don't 3 remember. 4 Q. Do you recall having conversations in 5 which you discussed the significance of the 6 premium as a cost to USAT than using caps to hedge 7 the interest rate risk with the mortgage-backed 8 securities portfolio funded with reverse 9 repurchase agreements? 10 A. I don't ever remember us discussing 11 that. I didn't think -- I didn't -- I don't 12 remember us feeling the premium was a big deal, 13 but I just don't remember. 14 Q. But you don't recall it being a major 15 issue? 16 A. No, sir. 17 Q. Now, I would like to direct your 18 attention to a document that's not in the record. 19 It's A1216, which are the minutes of an executive 20 committee of the board of directors of United 21 Savings Association of Texas. 22 Do you see that? 15450 1 A. I do see this. 2 MR. GUIDO: I would like to move the 3 admission of A1216, Your Honor, which are the 4 minutes of the executive committee of the board of 5 directors of United Savings Association dated 6 November 7th, 1985. 7 MR. VILLA: No objection. 8 THE COURT: Received. 9 Q. (BY MR. GUIDO) Now, do you see the 10 "whereas" paragraph there? 11 A. I do. 12 Q. Is that making reference to the 13 subsidiary USAT Mortgage Finance that was created 14 and collapsed in November or December of 1985? 15 A. I believe it is. 16 Q. Now, I want to direct your attention to 17 A1108, which is Tab 131. These are the minutes of 18 the meeting of the board of directors of United 19 Savings Association dated November 14th, 1985. 20 MR. VILLA: Could you give us the 21 number again? 22 MR. GUIDO: 1108, Tab 131. 15451 1 MR. VILLA: Thank you. 2 Q. (BY MR. GUIDO) This says, "The regular 3 meeting of the board of directors of United 4 Savings Association of Texas was held at 5 10:00 o'clock a.m. on November 14th, 1985, on the 6 sixth floor conference room" -- 7 THE COURT: Mr. Guido, I don't think 8 it's necessary to read that. 9 MR. GUIDO: Okay, Your Honor. 10 Q. (BY MR. GUIDO) Do you see all members 11 of the board were present when the meeting was 12 called to order except for Dr. Kozmetsky? 13 A. Yes, sir, I see that. 14 Q. Do you see where it says also present 15 were Charles Hurwitz, Burton Borman, Michael Crow, 16 and Jim Pledger? 17 A. Yes, sir, I see that. 18 Q. Take a look at Page 2 of the document. 19 See the motion -- the third paragraph down, 20 "Motion: The following resolutions were 21 unanimously adopted"? 22 A. Yes, sir. 15452 1 Q. You see where that approves the 2 creation of United Mortgage Finance, the 3 subsidiary that was created and collapsed in 4 November of 1985? 5 A. Yes, sir, I see that. 6 Q. The date of that is November 14th, 7 1985, correct? 8 A. Yes, sir. 9 Q. Now, I would like to direct your 10 attention to A1622 which is Tab 504. Do you have 11 that in front of you? These are the minutes of 12 the asset/liability committee of the next day, 13 November 15th, 1985. 14 Do you see the reference to the 15 financing sub? 16 A. I do. 17 Q. It says, "The securities in USAT 18 Mortgage Finance were expected to be settled 19 today." 20 Does that refresh your recollection 21 that the USAT Mortgage Finance securities were 22 purchased on or about November 15th, 1985? 15453 1 A. I don't really remember, but I 2 certainly don't have any reason to dispute what 3 these minutes say. 4 Q. Now, I would like to direct your 5 attention to A1620. I may have had you look at 6 that once before. 7 Do you have that in front of you? 8 A. I do. 9 Q. Do you see mention to a report by you 10 in those minutes? 11 A. About the -- a discussion of Mr. Crow's 12 short-term tactical planning memo? 13 Q. Uh-huh. 14 A. Yes, I see that. 15 Q. And the date of this asset/liability 16 committee is what? November 1st, 1985? 17 A. Yes, sir, it is. 18 Q. Okay. Can you read into the record 19 that paragraph about your tactical planning 20 report? 21 A. "A discussion of Mister -- of M. 22 Crow's, quote, 'short-term tactical planning,' end 15454 1 quote, memo concluded that we need to stay 2 flexible in terms of year-end planning. We have 3 an opportunity to add up to 400 million in 4 liability growth by 12/31/85, but this needs to be 5 managed closely given the current unknown status 6 of the branch sales and financing subsidiary." 7 Q. Now, I would like to direct your 8 attention to Tab 1131, which is A10582. It's a 9 memorandum from Jim Wolfe to you dated 10 November 8th, 1985. 11 Who was Jim Wolfe? 12 A. Jim Wolfe was senior vice president and 13 controller of United Savings. 14 Q. And do you recall receiving this 15 memorandum? 16 A. No, sir, I do not. I remember 17 liability growth during this time period was a big 18 deal. 19 Q. Was that because the regulators, prior 20 to the date of this memorandum, had written and 21 told you that there was a problem with USAT's 22 liability growth? 15455 1 A. I'm not sure of the details, but it was 2 communicated to me that -- well, I think the board 3 of directors had passed a resolution that 4 liability growth would not exceed some certain 5 number, $4 and a half billion or some such number; 6 and I knew that we better not exceed that 7 number -- 8 Q. Take a look at -- 9 A. -- under any circumstance. 10 Q. Look at Footnote 4 under 12/30/85 on 11 the bottom of the first page. Do you see that? 12 The maximum allowed growth. 13 Do you see that? 14 A. Yes, sir. 15 Q. It says $4,680,000,000? 16 A. I see that. 17 Q. Take a look at Footnote 4 on the second 18 page. It says, "As permitted in the November 1, 19 1985 Federal Home Loan Bank Board letter, 20 Exhibit C" -- do you see that? 21 A. Yes, sir, I do. 22 Q. And then there's a letter attached to 15456 1 that. Right? 2 A. Yes, sir. 3 Q. It is a letter from the Federal Home 4 Loan Bank Board to Gerald Williams, board of 5 directors? 6 A. I see that. 7 Q. And it sets a limit for the liability 8 growth at 12/31/85 of 4.68 billion. Look at the 9 very last paragraph. 10 A. I do see that, yes, sir. 11 Q. Now, you had a limit of 4.680. Right? 12 A. Yes, sir. 13 Q. And you wrote a planning memorandum, a 14 short-term planning memorandum, indicating that as 15 of the date of that memorandum, that you had 16 $400 million worth of leeway. Right? 17 A. That's what I think that last memo 18 said, yes, sir. 19 Q. Okay. And so, would it be fair to 20 conclude from that that the liabilities at the 21 time that you wrote the memorandum were 22 4.280 million? 15457 1 A. Well, I don't know because we had a lot 2 of -- I remember this tactical planning sheet that 3 I had to try to communicate with Gerald Williams. 4 We had a lot of things going on during this time, 5 like a proposed branch sale and, you know, maybe 6 buying more high-yield bonds. And the financing 7 sub had grown from -- I think back in my original 8 memo, I was talking about 150 or 250 million and 9 now we were at 500 million; and I'm a bit -- I'm 10 not quite sure of the facts. But I do remember 11 one thing for absolute certainty, that I wasn't 12 going to below that growth limit. It was going to 13 come in at -- it wasn't going to come in close to 14 4.68 billion. It was going to come in under that 15 if I had anything to do with it. 16 Q. At the time that you wrote your 17 memorandum indicating that there was $400 million 18 worth of room, what was the contemplated size of 19 USAT Mortgage Finance? 20 A. Which memorandum was that, please? 21 Q. That was the 1620 memorandum, A1620. 22 A. Okay. Well, help me out here. Where 15458 1 does it say the contemplated size? 2 Q. I just asked you the date of that 3 memorandum. I just gave you the date of the 4 memorandum. 5 A. The date of this memorandum is 6 November 6th, and it reflects the asset/liability 7 committee of November 1st. 8 Q. And do you recall what the contemplated 9 size of USAT Mortgage Finance was at that time? 10 A. It's probably in these papers you've 11 shown me. I remember that the first memo you 12 showed me was -- the contemplated size was 13 150 million in new securities, and then it grew to 14 500 million at some point or the contemplated 15 size. 16 Q. Do you have A1620 in front of you? 17 A. I do. 18 Q. What's the date of that meeting? 19 A. That is an asset/liability committee 20 meeting of November 1st. 21 Q. Okay. And that's the date that you 22 talked about $400 million capacity being under the 15459 1 liability growth regulation, isn't it? 2 A. It is, yes, sir. 3 Q. And does that show what the size of 4 USAT Mortgage Finance was contemplated to be at 5 the time? 6 A. Well, in Item No. 4, it says, "Creation 7 of finance subsidiary. The new finance subsidiary 8 USAT Mortgage Finance was expected to be finalized 9 by early next week with assets of about 100 plus 10 million." Then it goes on to say it was agreed 11 that even if the subsidiary is later disapproved, 12 that USAT should purchase up to an additional 13 300 million. 14 Q. Okay. All right. So, at that time, 15 you at least assumed you had a 300-million-dollar 16 leeway to absorb USAT Mortgage Finance back into 17 USAT? 18 A. Ignoring all of these -- ignoring all 19 of the other factors, you know, when I quote -- 20 whenever the minutes quote the 400 million in 21 liability growth, it goes on to say "But this 22 needs to be managed closely given the unknown 15460 1 current status of the branch sales and financing 2 subsidiary." And I remember, also, some idea of 3 investing in junk bonds during this -- this 4 quarter. 5 Q. Well, were the commitments already made 6 in this quarter to purchase the junk bonds? 7 A. I don't -- I don't remember. 8 Q. Okay. Was it something that was being 9 discussed? 10 A. I think it was a discussion. As to 11 whether anything was actually done about it, I 12 don't know. 13 Q. Okay. And the branch sales -- do you 14 recall what the deposits were on the branch sales? 15 A. No, sir, I do not. 16 Q. Were they about $93 million? 17 A. I don't know. 18 Q. Okay. Now, let's go to Tab 503, back 19 to Tab 503, which is A1621, which is November 7th, 20 1985. It's the executive committee minutes. 21 MR. VILLA: Can you give us that tab 22 again? 15461 1 MR. GUIDO: I'm sorry. It's A1216. 2 MR. VILLA: 1216. 3 MR. GUIDO: It's the November 7th 4 executive committee minutes which I just 5 introduced into the record. 6 Q. (BY MR. GUIDO) Do you see that? 7 A. Yes, sir, I do. 8 Q. That makes mention of $500 million in 9 mortgage-backed securities -- 10 MR. VILLA: I believe it's up to 11 500 million. 12 Q. (BY MR. GUIDO) Up to $500 million? 13 A. Yes. That's the authorization to 14 create the sub. 15 Q. Now, this is the sub that you had been 16 advised by your counsel that the interpretation 17 you were putting on reverse repurchase agreements 18 as being securities was aggressive. 19 Do you recall that? 20 A. I remember using that language in a 21 memo to Mr. Gerry Williams. 22 Q. Now, as of November 7, 1985, was it 15462 1 your contemplation to create an entity with assets 2 that would take you over the liability growth 3 limitation if you were required to consolidate 4 them as of that date? 5 A. Could you repeat that, please? 6 Q. As of November 7th, the date of the 7 resolution which authorizes up to $500 million to 8 be purchased in that subsidiary, was it your 9 intention to purchase something that your counsel 10 had advised you was based on an aggressive 11 interpretation that would end up with the result 12 of you violating the liability growth regulations? 13 MR. VILLA: Objection, Your Honor. He 14 missread the document. It says for the 15 association to transfer up to $500 million of 16 mortgage-backed securities to the finance 17 subsidiary, and now he's asking about a purchase 18 of $500 million. It has an obvious indication on 19 that question he's asking to transfer from the 20 parent to the sub as opposed to buying 500 new 21 ones. 22 THE COURT: All right. Can you 15463 1 clarify? 2 Q. (BY MR. GUIDO) Were the assets, the 3 mortgage-backed securities that were placed into 4 USAT Mortgage Finance, owned by USAT prior to 5 November 7th, 1985? 6 A. I don't know. They could have been, or 7 we could have purchased new ones. I just don't 8 remember. 9 Q. If they were in USAT as of 10 November 7th, 1985, they would have already been 11 included -- the financing for them would have 12 already been included in USAT's liability figures, 13 would it not? 14 A. If they had been in USAT already, I 15 would think they would already be in the -- the 16 associated liabilities would already be in the 17 liability totals. 18 Q. All right. So that USAT Mortgage 19 Finance wouldn't raise up the liabilities, would 20 it? 21 A. If it were a mere transfer, if I'm 22 thinking correctly. 15464 1 Q. Okay. So that you would have had 2 4.280 billion -- let's just go down Mr. Villa's 3 path here. 4.280 billion. Right? 4 A. Where did -- you're asking me -- 5 Q. They have transferred -- 6 A. You're asking me to just assume we had 7 4.280 billion. 8 Q. Well, you indicated in the memorandum 9 that you had $400 million worth of room in the 10 liability growth. Do you remember that memo? 11 A. Well, I'd better go back and look at 12 it. Which memo is it? 13 Q. I think it's the A1620 memorandum. 14 A. Okay. 15 Q. Okay? 16 A. Well, in order to really answer your 17 question, I would probably need to look at this, 18 quote, "short-term tactical planning memo" because 19 I remember we had a lot of other stuff going on at 20 the time. 21 Q. It says, "We are not" -- 22 A. I certainly see where it says 15465 1 400 million. 2 Q. "We have an opportunity to add 3 400 million in liability growth." Right? 4 A. But this needs to be managed closely 5 given the current unknown status of the branch 6 sales and we had junk bonds sales or junk bond 7 purchases floating around. 8 Q. It doesn't say anything about junk 9 bonds in that memorandum, does it? 10 A. It does not. 11 Q. And you've already testified that the 12 junk bonds were a discussion point. There had 13 been no previous commitment to purchase them? 14 A. I believe what I tried to say is that I 15 don't -- I remember them being discussed. As to 16 whether there were any purchases or not, I don't 17 remember. 18 Q. Well, were there commitments to 19 purchase them? 20 A. I don't remember. 21 Q. Okay. Well, if there had been 22 commitments, as of November 1, 1985, would you 15466 1 have told anybody that you had $400 million worth 2 of room to grow if those commitments had absorbed 3 that portion of that $400 million? 4 A. Well, I guess as of -- the purchases as 5 of that date, I guess not. But I would want -- 6 again, it would seem to answer your questions, I 7 would need to look at this short-term tactical 8 planning memo. 9 Q. I understand what you just said. I'm 10 still asking you my question. My question is: As 11 of November 1st, 1985, if there had been 12 commitments, legally enforceable commitments to 13 buy high-yield bonds funded with some sort of a 14 source, a commitment for that funding, that 15 wouldn't have given you -- if it had eaten into 16 the $400 million, you wouldn't have written the 17 $400 million as being room, would you? 18 A. For any contemplated junk or high-yield 19 bonds up to November 1st, I guess I would have 20 considered that in the 400 million. 21 Q. But if it had been a commitment, you 22 wouldn't have had $400 million of room. Right? 15467 1 A. Well, sir, I see the 400 million. I'm 2 sure I knew what it meant at the time. But in the 3 detail you're asking me to reconstruct it, I -- I 4 can't. 5 Q. Well, it says, "We have an opportunity 6 to add up to 500 million in liability growth by 7 1985." 8 Do you see that? 9 A. I see that. 10 Q. That's talking about prospective 11 activity, isn't it? 12 A. That's the way I would read it. 13 Q. Okay. So, is it fair to assume that 14 that didn't include -- the $400 million didn't 15 include previously contractual obligated 16 purchases? 17 A. I think that's fair to assume. 18 Q. Now, let's take -- 19 A. It might not include planned purchases. 20 But anything that had been purchased up to that 21 point, I would assume I would have known about it 22 when I wrote the 400 million. 15468 1 Q. Thank you. 2 Now, let's take Mr. Villa's point. 3 Let's assume that all $500 million of the 4 mortgage-backed securities financed with swaps, 5 okay -- I mean, financed with reverse repurchase 6 agreements were transferred from USAT to USAT 7 Mortgage Finance. 8 A. Okay. 9 Q. Would that transaction have created a 10 liability growth problem as of December 31, 1985? 11 A. Under the assumption that they are 12 simply transfers of -- from the parent to the sub 13 and then the treatment of the sub is consolidated, 14 I don't think it would have any effect. 15 Q. Okay. All right. So, if those facts 16 were correct, the liability growth regulation were 17 not the reason to dissolve USAT Mortgage Finance? 18 A. Could you re-ask that? I'm lost. 19 Q. I said that if there was a transfer of 20 all of the assets, the $500 million worth of 21 mortgage-backed securities financed with reverse 22 repos to USAT Mortgage Finance, that there would 15469 1 be no impact on the liability growth. Right? 2 A. Agreed. 3 Q. If that's the case, then isn't it true 4 that the liability growth regulations would not 5 have been violated as of December 31 because of 6 that transfer? 7 A. If they were all transferred from the 8 parent into the sub and they were consolidated, I 9 think I would agree with you, if I'm understanding 10 the process. 11 Q. Okay. And does it not follow, then, 12 that the sale of the assets of mortgage-backed 13 securities of USAT Mortgage Finance, would it not 14 have been in order to avoid violating the 15 liability growth regulation? 16 A. If all of the -- well, under your 17 scenario, I think we probably would have just 18 shoved everything back up into the parent because 19 the -- the sub at this point was a -- it didn't 20 meet our business objective; so, it was kind of a 21 pain in the neck. 22 Q. That wasn't my question. My question 15470 1 was: If it's true, as has been suggested, that 2 the mortgage-backed securities were already in 3 USAT funded with reverse repos and they were moved 4 down -- I'm saying let's just assume all of them 5 were moved down -- to USAT Mortgage Finance -- 6 MR. VILLA: Your Honor, just so it's 7 clear, I wasn't suggesting that as a matter of 8 fact. He was simply reading a document to him, 9 and he wasn't reading the words of the document. 10 Whatever the facts are we'll be able to prove 11 separately. When you read a document to a 12 witness, you ought to read it accurately. 13 THE COURT: Well, we have now a 14 hypothetical question; so, let's have the answer. 15 MR. VILLA: I'm not suggesting that as 16 a father of fact, and I never did. 17 MR. GUIDO: I took it as a suggestion 18 of a matter of fact, Your Honor. I would like to 19 finish the hypothetical, if I might. 20 A. Could you repeat the question, please? 21 Q. (BY MR. GUIDO) If the mortgage-backed 22 securities were already in USAT funded with 15471 1 reverse repos and they had been moved to the 2 subsidiary -- and you indicated that that wouldn't 3 have any impact one way or another on liability 4 growth. Right? 5 A. If nothing else happened, I don't think 6 so. 7 Q. Then doesn't it follow that the sale of 8 the mortgage-backed securities out of the USAT 9 Mortgage Finance subsidiary were not to avoid 10 violating the liability growth rate regulations? 11 A. Under the scenario you've constructed, 12 assuming nothing else is happening, assuming no 13 branch sales, no purchases of high-yield bonds, 14 none of these other things floating around, I 15 don't see how -- you know, if you already met your 16 growth limitation and you were meeting it, yeah, I 17 don't -- I don't see -- 18 Q. Okay. Now, I'm sorry for the 19 diversion. Let me go back to my question, okay, 20 which is: If you take Exhibit 16 -- I'm sorry -- 21 A10582 -- 22 A. Let's see. 15472 1 Q. It's Tab 1131. Excuse me. This is the 2 Jim Wolfe memo of November 8th, 1985. 3 A. Okay. (Witness reviews the document.) 4 Q. See where it says, "Maximum allowed 5 growth, 4.68 billion"? 6 A. I do. 7 Q. If you take the $400 million which you 8 discussed in the short-term tactical planning memo 9 that's referred to in A1620, Tab 502, all right, 10 and subtract the 400 million from the 4.68, end up 11 with 4.280 billion. Right? 12 A. I agree if you subtract those two 13 numbers, that's what you end up with, yes, sir. 14 Q. If you look at the liability growth at 15 3/31/86, what's that show? 16 A. 3/31/86 is 4.752 billion. 17 Q. If you subtract the 4.28 billion from 18 the 4.752 billion, what do you end up with? 19 472 million? 20 A. I'll take your word for it, Mr. Guido. 21 Q. Assuming that the mathematics are 22 correct? 15473 1 A. Yes. 2 Q. You also mentioned in your memo, A1620, 3 the branch sales. 4 Do you see that? 5 A. Well, I do see that. 6 Q. Okay. And do you recall the -- what 7 the size of the branch sales were? 8 A. I do not, no, sir. 9 Q. I would like to direct your attention 10 to A5010 at Tab 557. That is the performance 11 report for the fourth quarter in 1985 total dated 12 February 7th, 1986. 13 A. (Witness reviews the document.) 14 Q. Do you see that? 15 A. I do see that. 16 Q. I would like to direct your attention 17 to Bates stamp US 1116. What does that show? 18 A. 1116? 19 Q. Uh-huh. At the top of the page -- take 20 a look at the first paragraph. It says, "The 21 year-end sale of six branches in the San Antonio 22 region with deposits of 93 million produced a gain 15474 1 of 7 .2 million after a 2 million goodwill 2 write-off." 3 Do you see that? 4 A. I do see that. 5 Q. Okay. Does that refresh your 6 recollection that the liabilities that were 7 disposed of with the branch sale at year-end were 8 $93 million? 9 A. Well, yes, sir, I see the 93 million. 10 The thing that I'm a bit hesitant on is how we -- 11 how United paid for that branch sale, and I just 12 don't remember. 13 Q. What do you mean how it paid for the 14 branch sale? 15 A. Well, in the Independent American 16 branch sale that occurred at the end of 1984, it 17 was kind of a liability for liability swap, if I 18 remember correctly. 19 Q. Well, what was the liability that was 20 swapped for the sale of these Austin branches? 21 A. I don't remember. Of the San Antonio 22 region? 15475 1 Q. The San Antonio region. 2 A. Yes, sir. I don't remember. 3 Q. And the branch sale that you just gave 4 me an example of, what was swapped for what again? 5 A. The Independent American branch sale, 6 there was a big cash flow bond that was issued to 7 pay for that branch sale. 8 Q. Why did you have to pay for a branch 9 sale? 10 A. Because that's what happens when you 11 sell branches. You've got to pay -- it's a weird 12 transaction that whenever you sell something -- 13 whenever you're selling branches, you're selling 14 deposit liabilities. And, obviously, the entity 15 that's going to assume those liabilities is going 16 to have to be paid for that. 17 Q. So, they are going to have to get 18 something in exchange for those liabilities? 19 A. Yes, sir. So, it can be thought of as 20 a liability for liability swap. And the whole or 21 one of the main purposes of the branch sale is the 22 liabilities that you sell, you have to pay less. 15476 1 In other words, if -- just in a simple example, if 2 Mr. Guido had a deposit of $1,000 and United sold 3 that deposit in the case of Independent American, 4 we got a 15 percent premium. So, we paid 5 Independent American $850. 6 Q. For them to take it off your hands? 7 A. For them to assume Mr. Guido's deposit 8 liability. And instead of paying cash, we used 9 a -- another liability. We used the cash flow 10 bond, and the difference is a gain. 11 Q. Now, Independent American, was that 12 referred to as the Olney bond, O-L-N-E-Y bond? 13 A. I think the Olney bond was separate. I 14 think that was a -- I may be -- my memory is the 15 Olney bond was a branch sale from before I got 16 there, before I arrived at United. 17 Q. Okay. 18 A. The cash flow bond I'm speaking of was 19 a -- was a big cash flow bond that was structured 20 by Salomon Brothers. 21 Q. Okay. For the sale of a different 22 group of branches other than that's being referred 15477 1 to in this exhibit? 2 A. I believe so, yes. 3 Q. And what were the deposits on those? 4 Do you recall? 5 A. It was big. It was 5 to 600 or -- you 6 know, in the neighborhood of half a billion 7 dollars. 8 Q. So, what you're saying is that the full 9 $93 million of deposit might not have been a full 10 deduction in the liabilities of USAT at that time? 11 A. Oh, exactly because whoever bought 12 these -- these deposits, we had to pay them 13 something. And, you know, we would have had to 14 use some liability to raise the money. 15 Q. Now, I would like to show you a 16 document which I've marked as A1114A, which is an 17 excerpt from a portion of the investment committee 18 minutes which are A1114. 19 MR. VILLA: Do you have a tab number? 20 MR. GUIDO: This has not been 21 introduced. I don't have the tab number for 22 A1114. 15478 1 MR. VILLA: Tab 1047. 2 MR. GUIDO: Tab 1047? 3 MR. VILLA: Yes. 4 MR. GUIDO: 1114. What tab number is 5 it? 6 MR. VILLA: Tab 1047. 7 MR. GUIDO: A? 8 MR. VILLA: A. 9 MR. GUIDO: There is no such document 10 in the file. Has it been given to him already? 11 THE WITNESS: I don't see it. 12 13 (Discussion held off the record.) 14 15 THE COURT: What exhibit is that? 16 MR. GUIDO: It's A1114, Your Honor. 17 It's the May 8th, 1986 board of directors minutes. 18 MR. VILLA: Your Honor, I'm informed 19 that it was entered erroneously as A114. Check 20 under A114. 21 MR. GUIDO: I'm sorry. I missed what 22 you had to say, Mr. Villa. 15479 1 MR. VILLA: It was entered erroneously 2 as A114, and I think now the Court can find it. 3 THE COURT: Well, it's marked as A114. 4 MR. GUIDO: What I would like to do 5 is -- I gather this is Exhibit A114 in the record, 6 Your Honor? 7 THE COURT: Yes, it is. 8 Q. (BY MR. GUIDO) And this is the minutes 9 of March -- May 8th, 1986, of the board meeting. 10 And it starts with Bates stamp K4664. I would 11 like to direct your attention -- 12 THE COURT: Wait a minute. It starts 13 at -- okay. K4664, that's the cover sheet? 14 MR. GUIDO: The cover, right. K4664 is 15 the first page of the exhibit, Your Honor. 16 THE COURT: Okay. 17 Q. (BY MR. GUIDO) I would like to direct 18 your attention to K4678, Mr. Crow. And this is 19 the first quarter 1986 performance report of 20 May 2nd, 1986. I would like to direct your 21 attention to Page 4 of the performance report, 22 which is K4681. And I direct your attention to 15480 1 the second paragraph. Under "non-interest 2 income" -- do you see that? 3 A. I do, yes, sir. 4 Q. "Gains on the sale of corporate 5 securities totaling 8.8 million net of a 6 2 million-dollar provision for possible future 7 losses." 8 Do you see that? 9 A. Yes, sir, I do. 10 Q. It goes on, "Large gains were 11 recognized during the quarter on the sale of SCI 12 holding debentures, 2.2 million gain." 13 Do you see that? 14 A. I do. 15 Q. "And the retirement of the Series D 16 cash flow bond collateralized with Ginnie Mae 17 securities which provided a 1.9 million net gain"? 18 A. Yes. 19 Q. Do you recall what the size of the cash 20 flow bond was that's referred to there? 21 A. Not specifically because these -- this, 22 I think, had to do with the Independent American 15481 1 branch sale; and there were various series: 2 Series A, B, C, D. And there were quite a few 3 series of bonds. And as to the size of the 4 specific Series D, I don't remember. 5 Q. Well, do you recall the sale of the 6 Series D bond? 7 A. I do not, no, sir. 8 Q. I would like to show you a document 9 which has been marked as A13 -- 10 THE COURT: We'll take a short break. 11 12 (Whereupon, a short break was taken 13 from 3:14 p.m. to 3:36 p.m.) 14 15 THE COURT: We'll be back on the 16 record. 17 Mr. Guido, you may continue. 18 MR. GUIDO: Thank you, Your Honor. 19 Q. (BY MR. GUIDO) Do you see the mention 20 to the sale of the cash flow bond that's referred 21 to there? 22 THE COURT: Where are we now, 15482 1 Mr. Guido? 2 MR. GUIDO: Your Honor, we're in A114 3 at K4681. 4 THE COURT: Okay. Thank you. 5 A. I do -- 6 Q. (BY MR. GUIDO) Do you see the Series D 7 cash flow bond that's mentioned there? 8 A. Yes, sir, I do see that. 9 Q. Now, were those cash flow bonds that 10 you testified to, including the Series D, were 11 they held by USAT? 12 A. I think they were a liability on USAT's 13 books. 14 Q. Okay. Now, if they showed a liability 15 of $200 million for that cash flow bond, what 16 would that have done to the liability growth 17 figure which we have been discussing which I 18 think, in terms of room, was up to about 19 $472 million? Would that have taken it up to 20 about $672 million? 21 A. I can't be sure, but I don't think so. 22 Q. Why not? Assume that the cash flow 15483 1 bond that's referred to there was sold, 2 approximately $200 million. 3 A. Okay. 4 Q. Let's make that assumption. 5 A. I will assume that. 6 Q. That gives you about $672 million of 7 room between November 1, 1985, and March 31st, 8 1986, does it not? 9 A. Well, the way I remember, the cash flow 10 bond was a liability; and we have assumed that it 11 was a 200-million-dollar liability. And so, USAT 12 would have had to have come up with the cash to 13 retire that. You know, we've got to write a check 14 to the cash flow bond holders. So, I would assume 15 we would have had to have issued another liability 16 to raise the cash to pay the Series D holders; but 17 I can't reconstruct it from this. 18 But I know that whenever we retired 19 debt or retired liabilities, we -- we didn't have 20 a lot of excess cash. We usually, you know, 21 issued another liability to pay off something like 22 the cash flow bond. 15484 1 Q. So, what you're saying here, if I look 2 at this exhibit and I look at the sale of the cash 3 flow bonds which provided a 1.9 million net gain, 4 you're saying you essentially just shifted one set 5 of liabilities for another set of liabilities and 6 recorded an accounting gain? 7 A. Well, sir, it's not a sale. It's a 8 retirement of a liability; and it's very, very 9 similar to that branch sale we were speaking of. 10 If I can retire or extinguish a liability for a 11 discount, then that is, in fact, a real gain by my 12 reckoning, both accounting and economic. 13 Q. Take a look at Page 4 of the 14 performance report, which is K4681. 15 A. (Witness complies.) Okay. 16 Q. What does that show -- do you see where 17 it says "liability growth" under "regulatory 18 compliance"? 19 A. I do. 20 Q. Do you see where it shows a 3/31/86 21 liability of $456 million? 22 A. Yes, sir. 15485 1 Q. Does that show that there's about 2 $100 million excess as of that date? 3 A. It does. 4 Q. Now, let me show you another document 5 which is A13008, which is at Tab 1133. 6 THE COURT: Would you state that 7 exhibit number again, Mr. Guido? 8 MR. GUIDO: Your Honor, it's A13008. 9 It's at Tab 1133. It's a memo from Mr. Creel 10 dated 4/16/1986. 11 Q. (BY MR. GUIDO) Do you see that 12 memorandum, Mr. Crow? 13 A. Yes, sir. I've got that in front of 14 me. 15 Q. Does that show you as a recipient of 16 that memorandum? 17 A. It does. 18 Q. What does that show the room in the 19 liability growth was at April 11th, 1986? 20 A. As of this date -- I guess we're doing 21 it as of April 11th, 1986 -- 22 Q. That's correct. 15486 1 A. -- it shows the liability growth, that 2 we have room to grow by 389,518,000 is the way I 3 read this report. 4 Q. Now, I would like to direct your 5 attention to B690, which is at Tab 585. That is a 6 memorandum dated December 11th, 1985, from 7 Mr. Pledger. 8 Have you ever seen this memorandum 9 before? 10 A. I don't remember it from the time. 11 I've seen this memorandum in the last few days. 12 Q. Does it show you receiving a copy of 13 that memorandum? 14 A. It does. 15 Q. Do you have any reason to dispute the 16 fact that you received a copy of the memorandum? 17 A. No, sir. 18 Q. Now, this is the Jim Pledger that you 19 said was the regulatory counsel. Right? 20 A. Yes, he is, or was. 21 Q. He was the person that you said 22 reported to Art Berner? 15487 1 A. That's my recollection. 2 Q. Okay. I would like to direct your 3 attention to the first page of the memorandum. 4 And I direct your attention to the second 5 paragraph. "Pursuant to the new regulations, the 6 proceeds from the issuance of securities which are 7 issued after the effective date of the regulation 8 (the date the regulations are published in the 9 Federal Register), are included in the 10 association's total liabilities for purposes of 11 net worth and liability growth calculations unless 12 two things happen." 13 Do you see those -- do you see that? 14 A. Yes, sir, I see that. 15 Q. And the first one is "The securities 16 are collateralized by assets that have 17 substantially the same duration as the securities 18 issued." 19 Do you see that? 20 A. I do. 21 Q. What's your understanding of the term 22 "duration" there? 15488 1 A. I can't say what Mr. Pledger meant. I 2 think we discussed this morning what -- what I 3 understand duration to be. But in this context, I 4 don't know. 5 Q. Does duration in this context mean time 6 period? Expected life? 7 A. I don't know. 8 Q. Do you recall what it was that made 9 USAT Mortgage Finance not qualify as a financing 10 subsidiary? 11 A. In terms of my memory, no, sir, I 12 don't. 13 Q. Okay. Well, let's take a look at 14 Page 2. Do you see USAT Mortgage Finance, Inc.? 15 A. Yes, sir. 16 Q. Now, did you say you had seen this 17 memorandum in the last few days? 18 A. Yes, sir. 19 Q. And it was provided to you by counsel? 20 A. Yes, sir. 21 Q. Do you see where it says, "The 22 500 million reverse repurchase issuance made by 15489 1 USAT Mortgage Finance, Inc."? 2 Do you see that? 3 A. Under Point No. 2? 4 Q. Uh-huh. 5 A. Yes, sir. 6 Q. I'm sorry. I was looking at the last 7 paragraph, which is an elaboration on Point No. 2? 8 A. I'm sorry. 9 Q. Do you see USAT Mortgage Finance, Inc.? 10 A. I do. 11 Q. "The 500 million reverse repurchase 12 issuance made by USAT Mortgage Finance, Inc. was 13 completed" -- 14 A. I see that. 15 Q. Does that clarify the record that it 16 was USAT Mortgage Finance that issued the reverse 17 repos that were used to finance the purchase of 18 the securities and not USAT that subsequently 19 transferred them to USAT Mortgage Finance? 20 A. Let's see. Could you repeat that, 21 please? 22 Q. Does that clarify that it was USAT 15490 1 Mortgage Finance that issued the reverse 2 repurchase agreements that were used to fund the 3 mortgage-backed securities and not USAT? 4 A. Well, I guess it does. I'm a little 5 unsure, but I'll accept that. 6 Q. Then it says, "The securities issued in 7 this subsidiary were reverse repurchase 8 agreements, and these agreements have a maturity 9 of 60 to 90 days." 10 Do you see that? 11 A. I do. 12 Q. Do you have any reason to dispute the 13 accuracy of that statement? 14 A. No, sir. 15 Q. Is that your recollection of the facts? 16 A. I just don't remember; so, I don't -- I 17 don't know. 18 Q. What was it about USAT Mortgage Finance 19 that resulted in not qualifying under the finance 20 regs as a financing subsidiary? 21 A. I think that -- and I get a bit muddled 22 up here. But I think that as the reverse repos 15491 1 rolled over, then that was construed to be a new 2 liability and would no longer qualify. But I may 3 have that botched up. 4 Q. Let's put the grandfathering issues 5 aside, which I think you're addressing. 6 The question is: What in the first 7 instance made USAT Mortgage Finance as 8 structured -- 9 THE COURT: Would you speak a little 10 louder? 11 MR. GUIDO: I'm sorry, Your Honor. 12 Q. (BY MR. GUIDO) What in the first 13 instance made USAT Mortgage Finance not qualify as 14 a financing subsidiary? 15 A. I don't really remember. 16 Q. Was it that the swaps did not qualify 17 as duration matching of the assets and 18 liabilities? 19 A. You'll have to -- I don't know. You'll 20 have to help me with some documents or something. 21 Q. Take a look at that paragraph again, 22 that last part of the paragraph. It says, "The 15492 1 two tests are the duration match test without 2 regard to swaps or hedges." 3 Do you see that? 4 MR. NICKENS: Your Honor, if we are 5 going to read this, we ought to read the two 6 sentences that he didn't read into the record 7 which clarify this issue. 8 Q. (BY MR. GUIDO) "This renewal or 9 rollover will cause the issuance to be treated as 10 a new issuance under Section 563.13-2(b)(2). 11 After such a renewal, the issuance will be tested 12 for inclusion as part of net worth under 13 Section 563.13-2(c)." Then it goes on and talks 14 about the two tests. "The two tests are: (1), 15 the duration match test (without regard to swaps 16 or hedges) discussed previously, and (2), whether 17 the proceeds were remitted in exchange for a 18 liability issued by the association (which would 19 be included in the association's total 20 liabilities)." 21 Do you see that? 22 A. I do. 15493 1 Q. Then it says, "The duration match test 2 which is discussed above." Okay? 3 A. In the next paragraph? 4 Q. Okay. No, I'm not going to the next 5 paragraph. I want you to move back to the 6 paragraph that makes reference to "without regard 7 to swaps or hedges discussed previously." 8 Do you see that? 9 A. No, sir, I'm lost. 10 Q. Look at the second-to-the-last line on 11 Page 2 of the memorandum. 12 A. Okay. 13 Q. Do you see the reference to the two 14 tests? 15 A. I do. 16 Q. "One is the duration match test without 17 regard to swaps or hedges discussed previously." 18 Do you see that? 19 A. I do. 20 Q. Let's go to the discussed previously 21 which is on the first page. Look at the third 22 paragraph down after the two bullet points of the 15494 1 second paragraph. It says, "This provision has 2 the effect of restricting the types of securities 3 that may be excluded from the association's net 4 worth requirements to CMOs, pass-through bonds, 5 and other pass-through types of financing. 6 Although not defined in the regulation, the pre-am 7 balance to the regulation explains that the 8 duration test measures the weighted average 9 maturity or repricing period of a stream of 10 payments." 11 Do you see that? 12 A. I do. 13 Q. "This duration matching test is not 14 affected by the use of interest rate risk 15 management techniques such as swaps, options, or 16 futures." 17 Okay? Do you see that? 18 A. I do. 19 Q. Now, does that refresh your 20 recollection of the reason why USAT Mortgage 21 Finance did not qualify as a financing sub under 22 the regulations? 15495 1 A. No, sir. 2 Q. Do you understand what that paragraph I 3 just read you means? 4 A. No, sir. 5 Q. Did you at any time understand what 6 that meant? 7 A. I don't know. I suspect that I did, 8 but I -- I just don't know. 9 Q. Now, do you see the reference to the 10 duration tests in that paragraph, what it 11 measures? 12 A. I do. 13 Q. It says it measures the weighted 14 average maturity or repricing period of a stream 15 of payments. 16 Do you see that? 17 A. I do. 18 Q. Is that how you've been using the term 19 "duration"? 20 A. No, sir. 21 Q. How does your use differ from this 22 definition? 15496 1 A. Well, this appears to me to be talking 2 about -- my memory is -- is that this -- the, 3 quote, "weighted average maturity" would be more 4 average life. You know, I think I've got a fairly 5 good understanding of what duration means; and I 6 think that's different than weighted average 7 maturity. 8 Q. Your definition of duration that you've 9 been testifying to? 10 A. That is correct. 11 Q. Now, tell us what your definition of 12 duration is again. 13 A. My definition -- or the definition that 14 I believe is commonly used in the investment 15 committee -- community is that it is a measurement 16 of the price sensitivity of a security given a 17 change in interest rates, and it is expressed in 18 years. So, that's my definition. It measures 19 price volatility. 20 Q. Now -- it measures volatility? 21 A. Price volatility of the security. 22 Q. Price volatility. 15497 1 Now, do you remember I asked you about 2 the Black-Schoels model, the option pricing model? 3 A. Yes, sir. 4 Q. Was that -- the outcome of -- the 5 Black-Schoels model gives you what should be the 6 expected price of the premium for an options 7 contract, does it not? 8 A. I don't know. 9 Q. You don't know what it gives you? 10 A. Not really. I've heard the term 11 "Black-Schoels model." I could be mistaken. I 12 thought it was an option adjusted type model; but, 13 sir, I don't know what the Black-Schoels model 14 really shows. 15 Q. And you're saying volatility is a 16 measure of price sensitivity? 17 A. What I've -- well, I believe I said 18 that duration was a measurement of the price 19 sensitivity of a security or financial instruments 20 given a certain change in interest rates. 21 Q. I thought that that was prepayment 22 rates. 15498 1 A. No. 2 Q. No? 3 A. No. 4 Q. So -- what is your understanding of the 5 definition of the term "volatility"? 6 A. Volatility in this context would be -- 7 Q. No. I just mean the term "volatility," 8 period. 9 A. Dynamite would be volatile. 10 Q. Volatility measures the degree to which 11 something moves? 12 A. That is a fair characterization. 13 Q. How about -- does it measure the 14 frequency with which it might move when you're 15 making reference to financial instruments? 16 A. I don't -- oh, I don't think so. 17 Q. If duration is measured in years, what 18 does that tell you about how extreme a move will 19 be based on interest rates? 20 A. Well, if duration were measured in 21 years, it would give you a very good indication 22 that if you had one security that had a duration 15499 1 of 15 or 15 years and you had another security 2 that had a duration of two, then you could 3 conclude that if rates went up by 200 basis 4 points, the 15 duration is going to go down in 5 price dramatically more than the duration of two. 6 Q. But it doesn't tell you how far, does 7 it? It only tells you it will be greater? 8 A. I think that duration, if you get into 9 the guts of it, will give you an indication of how 10 far that price movement would be. But I can't 11 here -- sitting here today, you know, tell you 12 what the price movement of the duration of five 13 versus ten would be. I simply can't do that. 14 Q. If you had the same duration to couple 15 the relationship between a two-year and a 15-year, 16 that price change, with a four and a 17-year, 17 would you end up with the same result? 18 A. The 17 would have a much more -- much 19 bigger price movement than the four-year. 20 Q. Does it tell you anything about the 21 magnitude of the change, the term "duration"? 22 A. Duration is used, I believe -- I 15500 1 believe if you get into the guts of these 2 calculations, that, yes, it does give you an 3 indication of how far that price movement will 4 change. 5 Q. If you just know the years. We're only 6 talking about just knowing the years. That's all 7 you're telling me. 8 A. No, no, no, no. 9 Q. Something more? 10 A. We're talking about the duration 11 number, which is expressed in terms of years. 12 Q. You don't think that's weighted average 13 maturity? 14 A. No, sir, I do not. 15 Q. Now, let's go to the third page of the 16 document, which is the second full paragraph. It 17 says, "If the issuance fails to meet the duration 18 matching test, the proceeds of the issuance will 19 be counted in the association's calculation of 20 total liabilities." 21 Do you see that? 22 A. I do. 15501 1 Q. And then it says, "Since the duration 2 matching test does not permit the consideration of 3 hedges or swaps, it appears there will be a 4 significant difference between the maturities of 5 the repurchase agreements and the mortgage 6 securities and would, therefore, be included in 7 the association's total liabilities." 8 Do you see that? 9 A. I do. 10 Q. Does that refresh your recollection of 11 why USAT Mortgage Finance did not qualify as a 12 financing sub? 13 A. No, sir. I really don't remember the 14 reason. I do not. 15 Q. Then it says, "An increase in total 16 liabilities could have a significant impact on the 17 association's net worth requirements and on its 18 liability growth." 19 Do you see that? 20 A. I do. 21 Q. "Note also that the association's board 22 adopted a resolution to limit liability growth to 15502 1 4.68 billion by year end. The effective date of 2 these regulations is almost certainly going to be 3 before year end." 4 Do you see that? 5 A. I do. 6 Q. Then it says, "Therefore, the actual 7 rollover dates of the reverse repurchase 8 agreements will be very important. If they occur 9 after January 1, 1986, then the impact on 10 liability growth can be much more easily managed; 11 and the association will be able to meet its 12 4.68 billion liability target." 13 Do you see that? 14 A. I do. 15 Q. Now, did the reverse repos roll after 16 January 1st, 1988? 17 A. I don't know. 18 Q. If they did, what would have been the 19 impact on USAT's ability to meet its liability 20 growth limitation? 21 A. If they did and management had decided, 22 clearly, the sub didn't meet its initial 15503 1 objectives -- but if the reverse repos rolled over 2 after January 1st, then I think we could have 3 gotten past the end of the year and could have 4 worried about it in the first quarter, I guess -- 5 Q. Okay. 6 A. -- as I understand what's being written 7 here. 8 Q. Okay. Now, take a look at 9 Exhibit B697, which is a memorandum dated 10 December 17th, 1985, from Jenard Gross to 11 distribution, including yourself. 12 MR. GUIDO: What tab number is that? 13 MR. NICKENS: 1310. 14 Q. (BY MR. GUIDO) This is a memorandum 15 dated December 17th, 1985, from Mr. Gross to you 16 and to others. 17 Have you seen this document before? 18 A. That appears to be my writing on it, 19 so -- I don't remember it, but it looks like my 20 scribbling on it. 21 Q. Take a look at the first entry. See 22 the 11-million-dollar figure and then a line and 15504 1 then it says, "About 9 million now according to 2 Phillips"? 3 Do you see that? 4 A. I do see that. 5 Q. And then it says -- there's a 6 400-million-dollar figure and it's underlined and 7 then there's a line down and it says, "Will take 8 more." 9 Do you see that? 10 A. Yes, sir. 11 MR. NICKENS: Is that 400 million? 12 A. It must be 4 million. 13 Q. (BY MR. GUIDO) Do you see that? 14 A. I do. 15 Q. Both of those entries are in your 16 handwriting? 17 A. Yes, they are. 18 Q. Okay. Now, let's go back to the 19 beginning. It says, "Based on my conversations 20 with Ron Huebsch and Joe Phillips today, I think 21 where we have finally wound up on this 22 5-million-dollar sub is as follows. They are 15505 1 going to end up retaining the Salomon swaps, the 2 Morgan assets, and the Drexel flex repos to the 3 extent of about 150 million." 4 Do you see that? 5 A. I do. 6 Q. Does that comport with your 7 recollection about what happened with USAT 8 Mortgage Finance? 9 A. My recollection is that -- I guess it 10 does. My recollection is that we -- that United 11 collapsed the sub, put roughly 150 million into 12 a -- into United Savings, and sold roughly 13 350 million in securities. 14 Q. What did it do with the $500 million 15 worth of swaps? 16 A. My recollection is we put some of the 17 hedges up into USAT, or maybe they were there to 18 start with. Anyway, they just stayed. And I 19 think we -- this is where the birth of the mirror 20 swap occurred, if I'm not mistaken. 21 Q. What do you mean the mirror swap? 22 A. I believe there was an interest rate 15506 1 swap that was on the books. As to what -- 2 probably on the books of USAT. And, in essence, 3 an offsetting swap was entered into -- 4 Q. Well -- 5 A. -- with -- I think -- I think the 6 counterparties were the Federal Home Loan Bank. 7 Q. Well, let's first start with -- you 8 said that the swaps were probably on the books of 9 USAT. 10 I thought that you testified earlier 11 that USAT Mortgage Finance had $500 million worth 12 of assets, mortgage-backed securities funded with 13 reverse repos that were hedged with swaps. 14 What were they doing on the books of 15 USAT if they were hedging a transaction at USAT 16 Mortgage Finance? 17 A. Well, I don't -- I don't necessarily -- 18 we didn't always have the assets and liabilities 19 or -- excuse me -- the assets and the hedges in 20 the same place. For whatever reason, they could 21 be -- it could be just more convenient to have a 22 hedge at a certain corporate level, USAT, and have 15507 1 the assets in the sub. But I -- I mean, if you 2 can show me the documents, I'll try to remember. 3 But I'm a bit foggy in terms of the details. 4 Q. Are the reasons you're foggy on the 5 details that USAT wasn't very clear about where it 6 kept instruments on its books and records? 7 A. No, sir. I don't think that's a fair 8 characterization. I think we were pretty clear in 9 our books and records. 10 Q. Well, you just testified -- and let's 11 assume that it's accurate -- that these swaps that 12 were hedging transactions that were on the books 13 of USAT Mortgage Finance for convenience purposes 14 were put on at the USAT level. 15 Is that what you just testified to? 16 A. I better read this memo. 17 Q. All right. 18 A. (Witness reviews the document.) What I 19 was trying to convey is I'm not sure where the 20 swaps were. 21 Q. So, it could be that USAT Mortgage 22 Finance never had any swaps on its books. 15508 1 Is that what you're testifying? 2 A. I'm not sure. It's possible. But I 3 just don't know. 4 Q. And it could be that if there were any 5 swaps to hedge the interest rate risk between the 6 reverse repos and the mortgage-backed securities 7 at USAT Mortgage Finance, that they could have 8 been on the books of USAT? 9 A. Well, I'm a bit confused here now 10 but -- please repeat that last question. 11 Q. It could be that the swaps that were 12 hedging the interest rate risk between the reverse 13 repos and the mortgage-backed securities that were 14 on the books of USAT Mortgage Finance were 15 actually held at the USAT level? 16 A. I remember other hedges in other subs 17 where that was done. As to what exactly was done 18 on this sub, I don't remember. 19 Q. But you're saying it was done? 20 A. No, sir. 21 Q. Not in this situation, but in at least 22 a situation you know of where it was done? 15509 1 A. Yes, sir. 2 Q. Did you ever read the regulations that 3 directed USAT on how to maintain its books and 4 records vis-a-vis its subsidiaries and affiliated 5 entities? 6 A. I'm not sure. I probably did. I can't 7 be sure. I think Mr. Wolfe and Mr. Doolittle and 8 certainly our legal staff would have been up to 9 speed. But in -- if you're asking me, in fact, do 10 I have an independent memory of sitting down and 11 reading those, no, sir, I do not. 12 Q. You were the chief financial officer 13 for both UFG, USAT, and USAT's subsidiaries, were 14 you not? 15 A. That is correct. I think in terms of 16 the subsidiaries, I was probably chief financial 17 officer of most of them, if not all of them. 18 Q. What, in your understanding, is the 19 responsibility of a chief financial officer of an 20 entity? 21 A. Well, the chief financial officer of an 22 entity would come in; and if there was a material 15510 1 weakness in the internal control, he would correct 2 it or make it -- establish procedures and systems 3 and processes where that condition would be 4 corrected. A CFO would be responsible for 5 maintaining a competent staff to make sure that 6 you have adequate controls, that you can produce 7 timely and relatively accurate financial 8 information. And it would be the responsibility 9 of the chief financial officer to establish 10 systems and procedures so that -- we were wiring 11 large sums of money as we've discussed. These 12 securities transactions, you're talking about big 13 bulks -- and to make sure that somebody doesn't 14 walk out with $20 million. So, in capsule form, 15 that's what I would say is the CFO's 16 responsibility. And it's -- I would add one 17 other. To keep the CEO and the board and other 18 appropriate management apprised of what's going on 19 in terms of financial trends, that sort of thing. 20 Q. Was one of the responsibilities of the 21 CFO at USAT the responsibility to make sure that 22 the books and records were kept in conformity with 15511 1 applicable regulations? 2 A. Yes. 3 Q. Was that a responsibility that you were 4 aware of at the time? 5 A. Sure. 6 Q. Were you aware of the regulations that 7 required the operations of subsidiaries of USAT to 8 be kept distinct from the operations of USAT 9 itself? 10 A. I remember, Mr. Guido, that we 11 certainly had separate general ledgers; and we had 12 separate records for the various subsidiaries. As 13 to -- again, as to -- if you're asking me do I 14 remember sitting down and getting the book out and 15 personally reading the regulations, I simply don't 16 remember. 17 Q. Why do you think you kept separate 18 general ledgers for separate entities? 19 A. Well, they had separate tax ID numbers. 20 They had separate -- they were separate corporate 21 entities. 22 Q. And they had separate regulations that 15512 1 applied to them, did they not? 2 A. I think certainly the two that I can 3 think of -- one entity, United Financial Group, 4 certainly had certain regulations such as SEC 5 reporting and that sort of thing. And United 6 Savings had a different set of regulations. And 7 I'm quite sure that some of the subs had 8 specialized regulations. 9 But as I sit here today, I can't -- I 10 can't quote you chapter and verse at all. 11 Q. USAT Mortgage Finance was a financing 12 subsidiary, was it not -- 13 A. I don't. 14 Q. -- or attempted to be a financing 15 subsidiary? 16 A. It was a subsidiary. As to what type 17 of -- exactly what type of subsidiary, I just 18 don't remember. 19 Q. All right. But there was the hope at 20 USAT that it would qualify as a financing 21 subsidiary? 22 A. Well, I'll put it like this. There was 15513 1 the hope that the subsidiary would be established 2 and that it would not be consolidated for purposes 3 of liability growth, yes, sir. 4 Q. All right. And was the 5 non-consolidation provision applicable to finance 6 subsidiaries that you were looking at at the time 7 to ascertain whether or not consolidation would be 8 required? 9 A. Could you repeat that last question, 10 please? 11 Q. Was it the finance regulations that was 12 being looked to to ascertain whether or not USAT 13 Mortgage Finance would have to be consolidated or 14 not for purposes of net worth and liability 15 growth? 16 A. I don't know. In terms of the specific 17 regulations, I would have deferred probably to 18 Mr. Pledger and Mister -- Mr. Berner or one of 19 their people. 20 Q. Well, let's go back to the memoranda. 21 Let's just take your memoranda, A10574, the first 22 document that we looked to in this packet. 15514 1 A. Okay. (Witness reviews the document.) 2 Q. See the first sentence? It says, 3 "Among other things, the following items are key 4 elements of qualifying financing subs"? 5 A. Yes, sir, I do. 6 Q. Does that refresh your recollection 7 that when you were looking at USAT Mortgage 8 Finance, you were looking to ascertain whether or 9 not it qualified as a financing sub? 10 A. Yes. From looking at this, I guess I 11 must have been looking at either a proposed 12 regulation or a summary of a proposed regulation 13 or talking with Mr. Pledger. I mean, I can't be 14 sure; but that would be safe assumptions. 15 Q. Were you aware that there were 16 regulations in effect about -- that affected the 17 operations of financing subs? 18 A. I just -- I don't remember what I was 19 aware of in mid-1985 or late 1985. 20 Q. All right. Let's go -- 21 A. But I don't have any doubt, sir, 22 that -- you know, we certainly had Mr. Pledger 15515 1 there. We had lawyers crawling all over us. 2 So -- and I paid attention to the attorneys. 3 Q. Well, let's take a look back at B697, 4 that one-page memorandum which is at Tab 1310. 5 This is the collapse of USAT Mortgage Finance? 6 A. Mr. Gross' memo? 7 Q. Yeah. 8 A. Yes, sir. 9 Q. Anywhere in that memorandum, do you see 10 mention of liability growth as a factor in 11 determining how to structure the collapse of USAT 12 Mortgage Finance? 13 A. (Witness reviews the document.) No, 14 sir, I don't see it anywhere in this memo. 15 Q. Do you see a discussion about the net 16 effect on the profit and net worth of USAT by the 17 structure that was proposed by Ron Huebsch and Joe 18 Phillips to collapse USAT Mortgage Finance? 19 MR. VILLA: I'll object to the 20 characterization of the document. 21 THE COURT: What's your objection? 22 MR. VILLA: Your Honor, it doesn't say 15516 1 that this was a proposal by Mr. Huebsch and 2 Mr. Phillips; and we've had testimony on this 3 issue. Mischaracterizes the document. 4 MR. GUIDO: Your Honor, I'll just have 5 to walk through the document then. 6 THE COURT: All right. Let's do that. 7 Q. (BY MR. GUIDO) Let's start at the 8 beginning, Mr. Crow. 9 A. Okay. 10 Q. "Based on my conversations with Ron 11 Huebsch and Joe Phillips today, I think where we 12 finally wound up on this 500-million-dollar sub is 13 as follows: They are going to end up retaining 14 the Salomon swaps, the Morgan asset, and the 15 Drexel flex repos to the extent of about 16 $150 million. They are going to end up 17 liquidating the remaining assets which is going to 18 generate an income of about $11 million." That's 19 talking about generating a gain. Right? 20 A. That is the way I would interpret that, 21 yes, sir. 22 Q. "They are going to reverse the swaps 15517 1 and keep them intact and let them run off over the 2 period that they currently show, which is up from 3 87 to 91." 4 Do you see that? 5 A. I do. 6 Q. "Which should end up having a net 7 result of spreading the loss over the five- to 8 seven-year period of about the same amount of 9 money," referring back to the $11 million. Right? 10 A. Well, I don't know that it refers back 11 to the 11 million; but I certainly see the 12 sentence that you read. 13 Q. Okay. Now, it indicates that the loss 14 on the swaps was approximately the same as the 15 income on the mortgage-backed securities. Right? 16 A. (Witness reviews the document.) I 17 don't know exactly what it means. I can certainly 18 see why you would read it that way, and that 19 certainly may be the case. I just don't know. 20 Q. Well, you testified that there was a 21 mirror swap that was put in place. 22 Do you recall that testimony? 15518 1 A. Yes, sir. I think that's what this 2 refers to. 3 Q. Of about $350 million. Right? 4 A. I don't remember what the size was, but 5 I remember the mirror swap. 6 Q. Okay. And the mirror swaps had the 7 effect, did it not, accountingwise, of amortizing 8 the loss of the swaps over a period of years? 9 A. It -- I think the -- I think because of 10 the transaction costs and that sort of thing, you 11 would have a loss going forward, yes, of a stream 12 over a period of years. 13 Q. Okay. And, in fact, isn't that what 14 the last sentence of this paragraph says: "The 15 end result of that will be that we will be writing 16 off these swaps over that period of time which 17 will result in losses of roughly the 18 11-million-dollar spread out over those years"? 19 A. That's what this sentence says. 20 Q. So, is the net effect of the 21 transaction that's described here is a recognition 22 of an accounting gain of $11 million at the date 15519 1 the transaction was put on in December of 1985 and 2 deferring the losses on the swaps over a five- to 3 seven-year period? 4 A. Assuming all these numbers are right, I 5 would agree with that. 6 Q. Okay. Do you have any reason to 7 dispute the accuracy of the numbers? 8 A. Well, yes, sir. 9 Q. And that's your handwritten note. 10 Right? 11 A. Yes, sir. And I would say that -- that 12 Mr. Gross, while an exceedingly intelligent man 13 and a careful CEO, kept a tape-recorder; and he -- 14 I don't think he always edited his memorandum 15 carefully. But, sir, I don't -- I'm just 16 cautioning that I wouldn't take this to the bank. 17 Q. What? The 11- versus 9-million-dollar 18 figure? 19 A. Yeah, the exact numbers. 20 Q. Okay. Fine. But in terms of the 21 essence of the transaction, the recognition of the 22 gain on the mortgage-backed securities and the 15520 1 deferral of the losses on the swaps, you wouldn't 2 dispute that, would you? 3 A. I recall that there was a gain to the 4 mortgage-backed securities; and as I've indicated 5 here, I guess, you know, if I'm correct, it was 6 about 9 million bucks and that you would spread 7 the so-called loss on the swaps over a period of 8 time. And I guess I'm questioning as to what that 9 loss is. I don't know. 10 Q. All right. Now, let's go on. So, if 11 we take the $11 million which you say -- about 12 9 million now according to Phillips of income this 13 year, figure the branch sale goes through which 14 gives us about 7 .5 million, that is about 15 eighteen five. Right? 16 A. I do see that. 17 Q. That's looking at the gain on the sale 18 as how it affects the income in that time period. 19 Right? 20 A. That would be my interpretation, yes, 21 sir. 22 Q. Then it says, "If we have lost 15521 1 4.5 million in October and November and lose 2 another 2.5 in December, that would be a total of 3 7 million." 4 Do you see that? 5 A. I see that. 6 Q. And that includes no loan loss for the 7 quarter. So, let's say that is another 4 million 8 which would be about 11 million. Okay? 9 A. Yes, sir. 10 Q. Then suppose we brought the loan loss 11 reserve back up to where it was at the end of the 12 year. That would be another 4. Okay? 13 A. Okay. 14 Q. That gets you up to 15 million. 15 Do you see that? 16 A. I see that. 17 Q. "That would, then, put us in the 18 situation of having about 2.0 or 2.5 profit in the 19 fourth quarter, which is about where we would like 20 to be." 21 Do you see that? 22 A. I do see that. 15522 1 Q. Okay. Now, does that paragraph 2 indicate that the collapse of USAT Mortgage 3 Finance was being assessed in light of its impact 4 on the profits of the association in the fourth 5 quarter of 1985? 6 A. Could you repeat that question, please? 7 Q. Does that indicate to you that what was 8 being evaluated in this memorandum was the impact 9 of the collapse of USAT Mortgage Finance as it was 10 structured on the profit of USAT for the fourth 11 quarter of 1985? 12 A. Well, it appears to me that Mr. Gross 13 is writing a memo to a number of individuals; and 14 he is talking about the collapse of this finance 15 sub and other income statement type items: Loan 16 loss reserves, that sort of thing. So, we're 17 getting -- we're getting certainly into quarterly 18 profits here. 19 Q. And he's discussing the impact that 20 this sale has on -- or that this collapse of USAT 21 Mortgage Finance has on quarterly profits. Right? 22 A. Yes, sir. That's certainly one of the 15523 1 elements, absolutely. 2 Q. Is liability growth -- the impact of 3 the liability growth anywhere one of the elements 4 in this memorandum? 5 A. In this memorandum, I don't see 6 liability growth mentioned at all. It looks like 7 Mr. Gross is talking about quarterly profits. 8 Q. All right. Let's take a look at two 9 documents: A1218 and A1220, the executive 10 committee meetings of December 22nd, 1985, and the 11 notes that were attached to it. 12 A. What were those again, please? 13 Q. You don't have them. I do. It's A1218 14 and A1220. 15 MR. GUIDO: This is December 12th, 16 1985, Your Honor. I misspoke myself and said it 17 was December 22nd. I would like to move the 18 admission of A1218, Your Honor, and A1220. 19 MR. RINALDI: 1218 is in. 20 MR. GUIDO: A1220? 21 MR. VILLA: Your Honor, we don't show 22 1218 as being in. 15524 1 2 (Discussion held off the record.) 3 4 MR. VILLA: A1218 is not in, correct. 5 No objection. 6 THE COURT: A1218 is received. 7 MR. GUIDO: And A1220, which is the -- 8 MR. VILLA: No objection to 1220. 9 THE COURT: Received. 10 Q. (BY MR. GUIDO) Now, A1218 in the second 11 paragraph says, "The committee discussed the new 12 financing subsidiary regulations and possible 13 alternatives. After full discussion, it was 14 decided that Mr. Berner should keep in daily 15 contact with Washington representatives to 16 determine the status of the effective date of such 17 regulations and a decision on the next course of 18 action would be made by the executive committee as 19 soon as possible." 20 And then 1220, A1220, says "Financing 21 subsidiary." 22 Do you see that? 15525 1 A. I do. 2 Q. "A, regulatory update, and B, 3 alternatives options." 4 Do you see that? 5 A. I do. 6 Q. "Option No. 1 was roll transactions 7 into first quarter of 1986 and defer a decision." 8 Do you see that? 9 A. I do see that. 10 Q. Did that happen? 11 A. Well, this appears to be an agenda to 12 the meeting; and I wasn't at the meeting. But 13 from the documents we've looked at, if you're 14 asking me is it rolling the -- could you ask that 15 question again, please? 16 Q. I asked you whether or not Item No. 1 17 actually occurred. 18 A. I don't believe it did. 19 Q. Okay. Then (2), it says, "Sell the MBS 20 for a gain of about 15 million. This would reduce 21 reliance to the branch sale to report fourth 22 quarter earnings and provide a cushion for lost 15526 1 reserves." 2 Do you see that? 3 A. I do. 4 Q. Were MBSs sold for a gain? 5 A. My -- yes. We've seen that 6 mortgage-backed securities -- and my memory is 7 consistent with we sold roughly 350 million -- the 8 numbers may be off a bit in terms of the gain; 9 but, yes, sir. 10 Q. Then Item 3 says, "Sell or maintain the 11 400-million-dollar interest rate swaps. A 12 December sale would reduce the 15 million MBS 13 sales gains. Swaps sales could be delayed until 14 1986 and offset by gains on sales of servicing, 15 real estate, branches, et cetera." 16 Do you see that? 17 A. I do see that. 18 Q. Were the interest rate swaps sold or 19 maintained? 20 A. I'm quite sure they went extinguished 21 or sold as we were terming them, and the only 22 exception to that is we did the mirror swap. 15527 1 Q. Okay. Then look at the next 2 subparagraph. It says, "If the swaps are not 3 sold, they could be used as a general hedge to 4 close the association's gap or to hedge junk bond 5 purchases funding with money and deposits." 6 Do you see that? 7 A. I see that. 8 Q. Do any one of those three items that we 9 have just read make mention of the liability 10 growth regulation? 11 A. I don't see any such mention, no, sir. 12 Q. Do those paragraphs make mention of the 13 impact that the sale of the mortgage-backed 14 securities would have on the fourth quarter 15 profits of USAT? 16 A. Yes, sir. In Item No. 2, it -- my 17 interpretation is that that's what is being talked 18 about there as an agenda item to discuss at the 19 executive committee. 20 Q. Okay. Does the sale or the maintenance 21 of the swap agreements make reference to the 22 impact that the sale would have on the profit, the 15528 1 net profit that would be reported on the sales of 2 the MBSs? 3 A. I think that would be what's referred 4 to in Item No. 3. 5 Q. Okay. Now, are you aware -- or were 6 you aware, I guess, at the time that USAT Mortgage 7 Finance was collapsed of how hedges were to be 8 accounted for? 9 A. Yes, sir. 10 Q. Okay. What is your understanding of 11 how hedges were to be accounted for? 12 A. I believe we accounted for our 13 hedges -- and this is prior to Sandy's sub. We 14 accounted for our hedges on a macro basis, and 15 they were not to be marked to market. And a gain 16 or loss would be recognized if the interest rate 17 swap or whatever were extinguished. 18 Q. I didn't ask you how you accounted for 19 things, Mr. Crow. I asked you whether or not you 20 knew -- what your understanding was of the 21 applicable regulations that controlled accounting 22 for hedges? 15529 1 MR. NICKENS: Your Honor, the 2 witness -- he's just arguing with the witness. 3 The witness' answer was fully responsive to the 4 question. 5 THE COURT: All right. Do you want to 6 ask this question? 7 MR. GUIDO: I'll rephrase the question, 8 Your Honor. 9 Q. (BY MR. GUIDO) At the time -- I'm 10 talking about December 1985. At the time, were 11 you aware of what the requirements were on how to 12 account for hedge transactions? Yes or no? 13 A. I have no doubt that I was aware of the 14 accounting rules having to do with hedge 15 transactions. 16 Q. Okay. Was the guidance for accounting 17 for hedge transactions contained in any 18 publications of the Financial Accounting Standards 19 Board? 20 A. I can't quote chapter and verse where I 21 got my guidance. I guess the simple answer to 22 your question is: I don't know. I suspect so, 15530 1 but I don't know. 2 Q. Have you ever heard of something called 3 FAS 80? 4 A. Yes, sir. 5 Q. What does FAS 80 deal with? 6 A. FASB 80 covers, to the best of my 7 recollection, exchanged/traded futures contracts. 8 Q. Okay. So, were you aware of FAS 80 at 9 the time of the transactions at USAT Mortgage 10 Finance? 11 A. I tried to stay up on the accounting 12 rules. I can't remember -- or I can't recall as I 13 sit here today what I knew about FASB 80 at this 14 time, but I -- seemed to me FASB 80 covered a 15 different subject. 16 Q. Well, did it deal with futures 17 contracts as hedging instruments? 18 A. Yes, sir. 19 Q. Okay. And do you recall that to 20 qualify as a hedge for accounting, for a futures 21 contract to qualify as a hedge, it had to be a 22 micro hedge, not a macro hedge? 15531 1 A. Under FASB 80, if you wanted to hedge 2 accounting, yes, I think you had to have a micro 3 hedge and you had to do correlation analyses and 4 this sort of thing. In fact, we did that later on 5 in my tenure at United in Sandy's sub. 6 Q. But prior to the creation of Sandy's 7 sub, did you do any such correlations? 8 A. I don't believe that we treated 9 anything as a micro hedge. 10 Q. When you say "micro," you're saying 11 M-I-C-R-O. Right? 12 A. That's correct. 13 Q. And the hedges accounting for the swaps 14 and any hedging instruments is macro hedges, 15 M-A-C-R-O. Right? 16 A. That's correct. 17 Q. Prior to the Sandy Laurenson sub? 18 A. That is correct. 19 Q. With regard to swaps, what is your 20 understanding of the source of guidance for 21 accounting for swaps at the time USAT Mortgage 22 Finance was collapsed? 15532 1 A. Well, the source for guidance, you 2 know, were the AICPA bank and thrift audit guides. 3 If there were any FASB statements on point, that 4 would certainly be guidance. If there were -- 5 there may be -- I get confused as to when all of 6 this came into effect, but there were exposure 7 drafts by various AICPA/FASB research groups. 8 And, you know, that is an area that gets -- when 9 you're talking about accounting rules, 10 specifically on point, if we had any questions -- 11 we had a lot of CPAs on our staff. But if we had 12 any questions, we checked them with Peat Marwick; 13 and, from time to time, I would call Arthur 14 Anderson. 15 Q. Well, let's stick to this question 16 about swaps. 17 A. Okay. 18 THE COURT: Mr. Guido, this might be a 19 good time to recess. We'll adjourn until 20 9:00 o'clock tomorrow morning. 21 22 (Whereupon at 4:48 p.m. 15533 1 the proceedings were recessed.) 2 . 3 . 4 . 5 . 6 . 7 . 8 . 9 . 10 . 11 . 12 . 13 . 14 . 15 . 16 . 17 . 18 . 19 . 20 . 21 . 22 . 15534 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 20th day of July, 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 . 15535 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 20th day of July, 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