16970 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 29, 1998 22 16971 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 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 16972 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 . 16973 1 2 INDEX OF PROCEEDINGS 3 4 VIVIAN CARLTON 5 Further Examination by Mr. Veis.........16974 6 . 7 . 8 . 9 . 10 . 11 . 12 . 13 . 14 . 15 . 16 . 17 . 18 . 19 . 20 . 21 . 22 . 16974 1 P-R-O-C-E-E-D-I-N-G-S 2 (9:00 a.m.) 3 THE COURT: Be seated, please. The 4 hearing will come to order. 5 Mr. Veis, you may continue with your 6 examination of the witness. 7 MR. VEIS: Thank you, Your Honor. 8 9 FURTHER EXAMINATION 10 11 Q. (BY MR. VEIS) Mrs. Carlton, when we 12 broke last evening, we were discussing 13 Exhibit A14019. I would request that you look at 14 that again. 15 A. (Witness reviews the document.) 16 Q. Directing your attention, please, to 17 the last page of the document -- I believe it's 18 Tab 1461. 19 Do you see the handwritten comment at 20 the bottom which reads, "The field work of the 21 examination is complete"? 22 A. Yes, I do. 16975 1 Q. Is that your handwriting? 2 A. Yes, it is. 3 Q. Could you explain how it is that the 4 examination came -- the field work of the 5 examination came to a close? 6 A. After we had completed most of the 7 asset quality review and the books and records and 8 we could not reconcile the books and records and 9 that we could not reach a conclusion as to the 10 identical losses held within the Couch portfolio, 11 we conducted a general summary of the subsidiaries 12 and was asked by our management to cease the exam, 13 finalize the report, because from all the 14 indication of all the problems, we would be going 15 back in within a short period of time to commence 16 the second exam and that they would like to just 17 get the final report in order to get it 18 Washington, D.C. 19 So, we did a summary of the activity in 20 the subsidiary to see if we could identify any 21 additional exposure; and the examination was 22 closed. 16976 1 Q. Did your examination team, then, in 2 fact, complete all the programs designated for 3 this institution? 4 A. No, we did not. 5 Q. That was as a result of supervision 6 telling you to leave the institution and finish 7 your report? 8 A. That's correct. 9 Q. Ms. Carlton, I'll show you a document 10 that's been marked as Exhibit A14020. 11 Do you recognize that document? 12 A. (Witness reviews the document.) This 13 is a copy of a supervisory letter that was sent to 14 the institution. Included in the package is the 15 rating form and, also, the final report as 16 generated to Washington, D.C. of the May '86 17 examination. 18 Q. That's your report of examination? 19 A. Yes, it is. 20 MR. VEIS: Your Honor, I move the 21 admission of Exhibit A14020. 22 MS. CLARK: No objection. 16977 1 THE COURT: Received. 2 Q. (BY MR. VEIS) Ms. Carlton, I draw your 3 attention first to the first page which is 4 identified as the supervisory letter? 5 A. Yes. 6 Q. Now, the first sentence indicates that 7 a copy of the examination had previously been sent 8 to the institution; is that correct? 9 A. Yes. 10 Q. So, that's sort of an advanced copy? 11 A. Yes, it was. 12 Q. Now, does -- let me direct your 13 attention to the third paragraph of the letter 14 which starts out, "The classifications are 15 detailed in Section 2 of the report." 16 A. Yes. 17 Q. Can you please explain the next 18 sentence relating to being directed to establish 19 required reserves? 20 A. Anytime an examination identifies 21 reserves that should be established, the 22 institution is required to, prior to the 16978 1 institution -- leaving that institution, providing 2 the examiners with a general entry showing -- that 3 shows reserves had been established as directed by 4 the examiners. 5 Q. I take it, then, that those reserves 6 were not on the books of United at the time that 7 the examination was conducted; is that correct? 8 A. That's correct. 9 Q. Now, directing your attention to the 10 next paragraph relating to failure to meet the net 11 worth requirement, could you please explain that 12 paragraph? 13 A. This paragraph is showing that we had 14 stated that they had failed to meet their net 15 worth requirement by 10.5 million and that that 16 amount did not include the reserve that was 17 requested by the examiners. 18 Therefore, the amount is much higher at 19 14.4 percent, which represents 6.3 percent of net 20 worth. 21 Q. Now, directing your attention to the 22 next paragraph, there's a reference to their 16979 1 disagreement with the calculation of the net worth 2 requirement. 3 Do you see that? 4 A. Yes. 5 Q. Can you explain that paragraph, please? 6 A. The institution had argued on the -- 7 the contingency factor, one being direct 8 investment, that some of the items that we had 9 included in that amount was inaccurate based on 10 what they had calculated of the assets they felt 11 should be included in that indirect investment. 12 They had also argued that to include 13 Couch at 140 million was inaccurate based on them 14 stating that the loans were -- the loans were 15 current. And they had argued on investment and 16 real estate on -- of not including that amount. 17 And we also had some nonconforming loans that they 18 were also arguing should not be included in the 19 net worth calculation due to well-defined 20 weaknesses. 21 Q. Was there any dispute about the 22 mathematical accuracy of your calculation? 16980 1 A. No. It was just disagreeing on the 2 actual loans and investments themselves, not on 3 the actual math calculation or the formula that 4 was used. 5 Q. Now, let me direct your attention to 6 the -- I believe it was the valuation form. It's 7 Bates No. OW078144. Let me direct your attention 8 to the -- the five columns which are MACRO. 9 Can you please explain what those are? 10 A. These are the individual items that 11 goes into the component of making an evaluation on 12 our different MACRO areas. The factors that are 13 addressed under those are items of consideration 14 that we come to the final conclusions of the 15 numeric number that's assigned to each MACRO 16 level. 17 Q. What does the "M" stand for? 18 A. "M" is management. 19 Q. And the "A"? 20 A. Asset quality. 21 Q. "C"? 22 A. Capital. 16981 1 Q. "R"? 2 A. Risk management. 3 Q. And "O"? 4 A. Operating results. 5 Q. Now, let me direct your attention to 6 the line across from "supervisory agent." 7 Do you see that line? 8 A. Yes. 9 Q. Does there appear to be some initials? 10 "NT," whose initials are those? 11 A. Neil Twomey. 12 Q. Who was Mr. Twomey? 13 A. He was a supervisory agent at the time 14 of this rating. 15 Q. Who assigns the final rating to the 16 institution? 17 A. The supervisory agent. 18 Q. So, what Mr. Twomey says is the final 19 rating, correct? 20 A. That's correct. 21 Q. Under "management," Mr. Twomey assigned 22 a 4? 16982 1 A. Yes. 2 Q. And asset quality, a 4? 3 A. Yes. 4 Q. Under capital, a 3? 5 A. Right. 6 Q. Under risk management, a 4? 7 A. Correct. 8 Q. A 3 under operating results? 9 A. Correct. 10 Q. And a composite of 4. Right? 11 A. That's correct. 12 Q. Now, is there an explanation of why 13 Mr. Twomey rated -- changed the rating of the 14 institution from the ratings above it on the form? 15 A. At the time that Mr. Twomey had 16 received the final report and provided the final 17 rating, we had reached the final conclusion on 18 the -- at least the Couch situation had exploded 19 into an industry problem in that we had over 15 20 institutions involved in the fraud. And it was 21 not only affecting United, but it was questioned 22 as to whether United would even collect on the 16983 1 loan due to the dual sales on those loans. 2 In addition to that, the loans were 3 brought current by management providing a note to 4 bring the loans current; and that was contrary to 5 which -- the information that management had 6 provided to Dallas and to the examiners. At that 7 point, we questioned the validity of the 8 transaction and said the whole amount should be 9 classified. 10 At that point, net worth was at 11 jeopardy because we felt loss was imminent within 12 that portfolio; and it reflected across the board 13 from asset quality to integrity of management and 14 to the losses of the institution. 15 Q. Now, in the section entitled 16 "Explanation of variance in ratings," do you see 17 that section at the bottom of the page? 18 A. Yes. 19 Q. It has a comment concerning management 20 factor being changed by the SA, which is the 21 supervisory agent, I assume? 22 A. Yes. 16984 1 Q. Is that Mr. Twomey's comment? 2 A. Yes. 3 Q. And what was his reason for changing 4 the management factor? 5 A. It was changed due to the condition of 6 books and records, misclassification of loans, 7 numerous loan deficiencies, and the general 8 capability of management in light of the increased 9 scheduled items and net operating losses. Due to 10 asset quality -- 11 Q. What about asset quality? 12 A. Asset quality is due to the volume of 13 scheduled items and classified assets and the 14 potential for loss in the Couch portfolio. 15 Q. That's Mr. Twomey's comment also; is 16 that correct? 17 A. That's his reason for changing the 18 rating different from the two prior ratings that 19 were assigned. 20 Q. And with respect to risk management, 21 there's a comment on why Mr. Twomey changed that. 22 A. That's due to the substantial negative 16985 1 gap and to the volume of high-risk investment in 2 high-yield bonds. 3 Q. Could you please explain what a "4" 4 means? 5 A. A "4" means that an institution is -- 6 exhibits a combination of unsafe and unsound 7 practices that immediate supervisory and 8 additional supervisory -- additional supervision 9 is required and the potential that a loss is 10 imminent with the institution and possibility the 11 viability of that institution is at jeopardy. 12 Q. Does that indicate there's serious 13 financial weaknesses? 14 A. Yes, it includes serious financial 15 weakness. It includes trends that can lead to 16 losses and upset a portfolio that is weak or major 17 deficiencies. 18 Q. Is a "4" a satisfactory rating? 19 A. No, it's not. 20 Q. Does it indicate that there's a risk to 21 the insurance fund? 22 A. Yes. To the point that although it may 16986 1 not be identifiable to the exact dollar amount, it 2 is at risk of being at jeopardy. 3 Q. And is there a potential for failure or 4 insolvency? 5 A. Usually when you rate a "4," you are to 6 the point that you can within, say, 12 to 18 7 months probably project based on the losses that 8 are taking place, hidden within a portfolio, 9 identify insolvency to some degree. 10 Q. Is it significantly below average, 11 then? 12 A. When you are rated a "4," yes, it is. 13 Q. Okay. Is there any consideration for 14 supervisory action when an institution is rated a 15 "4"? 16 A. Once an institution is rated "3" or 17 less, you are considered for supervisory action. 18 Q. And that would include, I take it, some 19 of the items we discussed yesterday regarding the 20 potential results of failing net worth 21 requirement? 22 A. Yes. There's a whole laundry list of 16987 1 things that could happen. 2 Q. And that would be to some extent at the 3 discretion of the supervisory personnel? 4 A. It's held at the discretion of the 5 supervisory agent, a combination with the 6 committees and other representatives at the higher 7 levels of the bank, including the president -- or 8 bank then would have been the bank of Dallas. 9 Q. Now, let me direct your attention to 10 Bates No. OW078149. 11 Do you see a block on that page 12 entitled "report summary"? 13 A. Yes. 14 Q. Can you please describe for us the 15 major findings of the report? 16 A. The major findings of the report was 17 that the institution had failed its minimum number 18 net worth requirement, that the scheduled items 19 had increased substantially, that you had major 20 loan deficiencies. And we addressed the Couch 21 situation and you had books and records problems 22 and the profitability of operation was based on 16988 1 non-operating items. 2 Q. Now, Ms. Carlton, I would also like to 3 ask you to take a look at Exhibit A14047. 4 What is that document? 5 A. This is a document that is labeled as 6 "privileged information section." It is a 7 document in which any comments that we use to make 8 against management we would not put in the 9 reports, either interim or regular report of 10 examination. We provide this. It is an in-house 11 document that's maintained by management. 12 Q. So, the institution doesn't see this? 13 A. No, they do not. 14 Q. Did you prepare this document? 15 A. Yes, I did. 16 Q. Did you give it to Mister -- to your 17 field manager? 18 A. Yes, I did. 19 MR. VEIS: Your Honor, I move the 20 admission of Exhibit A14047. 21 MS. CLARK: No objection. 22 THE COURT: Received. 16989 1 Q. (BY MR. VEIS) I would like to direct 2 your attention to Item 3 on the first page, which 3 is Bates OW122310. 4 Would you simply read that to yourself? 5 A. (Witness reviews the document.) Okay. 6 Q. Can you please explain the comment 7 under Item 3 regarding Mr. Gross, Mr. Williams, 8 and Mr. Munitz? 9 A. The question is asked: "Are the 10 directors persons of independent judgment who take 11 an active role in the guidance of the 12 association's affairs?" 13 And the answer was given, "No," that 14 the three directors, although they take an active 15 role in the institution, the meetings are held 16 quarterly and the minutes reflect general 17 meetings. You could not -- from what we could 18 read from the minutes and our observation, we did 19 not feel that the persons were of independent 20 judgment as far as operating the institution. 21 Q. What about the other directors? Were 22 they persons of independent judgment? 16990 1 A. The -- from what we could see, we felt 2 that you had outside influence taking place within 3 the institution. 4 Q. Did you have an observation about any 5 particular board members being dominant? 6 A. We had felt -- we had shown that 7 Mr. Hurwitz was one individual that was attending 8 the meeting and making comments or approvals in 9 the board meeting as was reflected in the minutes. 10 Q. Now, let me direct your attention to 11 Item 5. 12 Would you please read that to yourself? 13 A. (Witness reviews the document.) Okay. 14 Q. All right. Now, that question there 15 is: "Do you regard the management as trustworthy 16 and competent? If not, indicate and discuss any 17 unsatisfactory situation." 18 Your answer is, "No." 19 Can you explain that? 20 A. The answer was provided "no" because we 21 felt that if, indeed, the management was competent 22 and if, indeed, the management, indeed, had the 16991 1 experience level that they had purported with the 2 books and records being what they were, either 3 they were not aware of the situation or had 4 ignored the situation to the extent that you 5 received and could identify the problems that were 6 identified within the portfolio. 7 And when it came to the Couch 8 situation, we had requested the files -- the files 9 were not only missing, but they did not even have 10 the files within the institution. They had 11 written to Dallas and communicated to Dallas, 12 being the supervisory agent and the president of 13 the bank, that those loans were not delinquent. 14 It was proven that the note that they 15 granted to bring the loans current was done after 16 they had reported to Dallas that those loans were 17 current and that once the whole Couch situation 18 had exploded and other institutions had stepped 19 forward, it was identified that Mr. Couch had 20 stated that it was in bankruptcy and could not 21 only not pay United's loans back but possibly the 22 other institutions that were involved in the 16992 1 situation. 2 Q. So, this is a comment not only in 3 competence but trustworthiness, as well? 4 A. In our opinion, it was. 5 Q. Let me direct your attention to the 6 next page, OW122311, and, in particular, Item 11. 7 Do you see that relating to fees bonus 8 expense accounts? 9 A. Right. 10 Q. Would you please read that to yourself? 11 A. (Witness reviews the document.) 12 Q. Are you finished? 13 A. Yes. 14 Q. Would you please explain your response 15 to that item? 16 A. As part of our analysis of the -- of an 17 examination, we go through and analyze the salary 18 and compare the salary information of typical 19 institutions with like size assets and positions 20 with each other. 21 Based on that information, we found 22 that the -- that the institution's bonuses were in 16993 1 excess of the other institutions of like kind and, 2 even further, looking at those institutions in 3 that those institutions were in a better financial 4 condition. And once an institution is experienced 5 in net operating losses and failing their net 6 worth requirements and, in addition to that, the 7 institution was laying off individuals, we 8 questioned the management from that point for 9 providing bonuses when you're laying off 10 individuals and taking bonuses when you're having 11 operating losses and failing your net worth 12 requirement. 13 Q. Let me direct your attention back to 14 Exhibit 14020. On Page 4, which is Bates 15 No. OW078153, there's a comment regarding capital 16 adequacy. 17 Well, let me direct your attention 18 first to the Item B, net worth calculation. 19 A. (Witness reviews the document.) Okay. 20 Q. Now, where do the numbers come from to 21 make a net worth calculation? 22 A. The institution provides the numbers. 16994 1 Q. In what? 2 A. In the actual calculation and, in this 3 case, where we are calculating the base factors, 4 we go back and use the institution's numbers that 5 they have calculated as their final numbers for 6 that period. 7 Q. Do you check the institution's 8 calculation? 9 A. Yes. 10 Q. And I take it that you found an error; 11 is that correct? 12 A. That's correct. 13 Q. What was that related to? 14 A. That was related to one of the -- the 15 contingency factors when you have to go back and 16 you average four or five years of liabilities that 17 would have gone back to previous, say, '83, '84, 18 '85. 19 One of those year's numbers was 20 calculated and including in the base factor in 21 error and, therefore, had been carried forward in 22 all calculations that carried forward using that 16995 1 calculation. 2 Q. And based upon that recalculation, did 3 you find they were out of net worth compliance? 4 A. It just added -- the number just 5 increased from what we had previously calculated. 6 Q. Now, let me address next the asset 7 quality item. 8 Do you see that, where it's got a 9 summary of criticized assets on the lower portion 10 of the page? 11 A. Yes. 12 Q. Now, I would like to have you explain 13 briefly how -- well, first, let me ask you: Do 14 the numbers reflected here go into the calculation 15 of net worth in the -- based on the association's 16 numbers? 17 A. Those -- 18 Q. Or are they independent? 19 A. We have -- you do two calculations. 20 You review their numbers and reconcile -- or 21 determine if you can reconcile their numbers. 22 Then we generate our own set of numbers. And for 16996 1 the report purpose, because we are adding 2 additional classified items to those numbers, the 3 final numbers are our calculation as to what we 4 feel that calculation should be. 5 So, you would have a calculation 6 reflecting the institution's calculation and you 7 would have the regulator's calculation. 8 Q. Now, how does the addition of 9 classified assets or scheduled items affect the 10 net worth calculation? 11 A. One of the contingency factors that 12 goes into the calculation of net worth is that for 13 classified assets and scheduled items, you have to 14 take 20 percent of that total balance and reduce 15 your component in that calculation. So, you take 16 a 20 percent percentage of all classified assets 17 and reduce your requirement by that amount. 18 Q. Reduce which requirement? 19 A. Your net worth to determine your net 20 worth compliance. 21 Q. Where does it go into the calculation? 22 A. You have -- before you come down to 16997 1 your dollar minimum amount that you have as far as 2 meeting that requirement, there's only one of the 3 factors that are part of that calculation. 4 Q. You add 20 percent of the classified 5 items and scheduled items to which component? 6 A. You start off with your base factor. 7 Within the base factor, you have your scheduled 8 items as a factor. You have your direct 9 investment as a factor. Those numbers are added 10 together to come down to your minimum required 11 amount for net worth calculation, the amount that 12 you would need. You take that factor and go back 13 to your actual net worth amount that would be on 14 the TFR report and compared it to. That shows you 15 either the amount either you are short or over the 16 calculated amount. 17 Q. Let me show you two documents that have 18 been marked A14023 and A14024. Ms. Carlton, what 19 are exhibits -- what is Exhibit A14023? 20 A. This is the minimum net worth 21 calculation worksheet that is used in determining 22 capital compliance. 16998 1 Q. And what is A14024? 2 A. This document is back-up support to 3 show the numbers that are compiled and used as a 4 follow-up to support the numbers as you go through 5 the calculation of the actual net worth. 6 Q. Are these part of the work papers of 7 the examination? 8 A. Yes, they are. 9 MR. VEIS: Your Honor, I move the 10 admission of A14023. 11 MS. CLARK: Your Honor, we have no 12 objection to these exhibits, although I would note 13 again they seem to relate to something that is not 14 put in issue by the Notice of Charges. But with 15 that -- 16 THE COURT: All right. Received. 17 MR. VEIS: I also move the admission of 18 A14024, Your Honor. 19 MS. CLARK: Same response, Your Honor. 20 No objection although they are clearly not 21 relevant to the issue raised by the Notice of 22 Charges. 16999 1 THE COURT: Received. 2 Q. (BY MR. VEIS) Ms. Carlton, I would like 3 you to just briefly walk the Court through the 4 calculation of the minimum net worth requirement 5 and compliance, if you would, please. 6 I believe if you look at A14023, it's a 7 worksheet. 8 A. Yes. 9 Q. Would you explain where -- how the 10 numbers are derived that go into this calculation? 11 A. Okay. Your base factor calculation is 12 a cumulation of numbers that will go back, if you 13 look at -- it doesn't have a number, but the last 14 page on the page of the calculation, it will take 15 you back to the growth factors. And these numbers 16 where you go -- is the way that you use the 17 numbers of the institution -- shows where we use a 18 calculation per the institution and a calculation 19 per the examiners. It is a combination of using 20 growth factors, contingency factors, direct 21 investment. And you determine what your actual 22 requirement is per the institution. This is the 17000 1 amount that is actually then reported on the TFR 2 report by the institution as -- and sent to the 3 regulators as the actual net worth calculation. 4 For March of '86, they reported a net 5 worth of 190,173,000. 6 Q. Let me ask you, if I might -- let's go 7 to Line 1A on the first page of Exhibit A14023. 8 That's the base factor calculation. 9 Whose calculation of the minimum net 10 worth requirement is that? 11 A. The base factor is calculated by the 12 institution. 13 Q. Now, in the 1986 examination, was there 14 any dispute about the amount of the base factor 15 entered in Line 1A? 16 A. The dispute on that was that the number 17 they used had been one of the numbers, a part of 18 that number was calculated inaccurate by the 19 institution. 20 Q. Now, does this number in 1A on this 21 schedule include a correction or not? 22 A. No. 17001 1 Q. That's their number? 2 A. That's their number. 3 Q. And let's then address the growth 4 factor calculation, Item B, looking at Line 2. 5 A. Okay. 6 Q. The number under Item 2, can you tell 7 us where that comes from? 8 A. That number is the total of liabilities 9 at the end of the reporting period. That number 10 is also reflected from the institution's TFR 11 report and is a number that's generated by the 12 institution. 13 Q. Now, I notice there are some 14 adjustments that go into that factor. 15 What's the next step in calculating the 16 net worth requirement? 17 A. Once you have your base factor 18 calculation, you go through and you start -- you 19 pull your liability figures from the actual TFR 20 report. That one number would be 3D. That's a 21 carry-forward from that. And each line item then 22 walks you through -- you actually subtract one 17002 1 line, and it's a formula that's being calculated 2 as you move down the sheet with the factors in 3 Line 8 and 9, walking -- it's a calculation of -- 4 if it's a certain amount on one amount, you 5 analyze that number; and you move forward, still 6 checking if the assets are a certain size. You 7 would go to one line. If it's a different size, 8 you would go to another line item. 9 Q. Now, is there any dispute about the 10 growth factor calculation? 11 A. No. 12 Q. Let's go to Item D, the contingency 13 factor calculation, which is on Page K17 of the 14 worksheet or Page 6 at the top. It's K17 at the 15 bottom. 16 A. Okay. This is the calculation where 17 you actually get into the examiners going in and 18 actually having verified the numbers and including 19 our numbers and going through those calculations. 20 Anytime you have a difference between management 21 and institution and those numbers, we use our 22 calculation and go through those formulas. 17003 1 Q. Now, Item 23 relates to the scheduled 2 items component. 3 Do you see that? 4 A. Yes. 5 Q. Can you explain that, please? 6 A. That is the component in which it is 7 the requirement that 20 percent of scheduled items 8 is included on that line and added to the other 9 factors to come down to your minimum net worth 10 requirement amount. 11 Q. Now, is the entry on that line, 12 $65,597,139, 20 percent of the number immediately 13 to the left? 14 A. Yes, it is. 15 Q. Where does that number come from? 16 A. That number comes through your -- if 17 you're looking at the report, that number would 18 have come off the summary page of the scheduled 19 items that we had compiled for that period. 20 Q. So that -- could you please explain how 21 that is derived? 22 A. That number is derived by a combination 17004 1 of -- including your total classified asset 2 including your REO, your scheduled items which are 3 loans that are delinquent, and a combination of 4 any losses that are identified within the 5 portfolio and taking a 20 percent calculation of 6 that. 7 Q. Now, was there any dispute over the 8 mathematical accuracy of that figure in connection 9 with the 1986 examination? 10 MR. EISENHART: Your Honor, dispute 11 among whom? 12 Q. (BY MR. VEIS) Between the institution's 13 management and the regulators. 14 A. No, there was not. 15 Q. No dispute? 16 A. No, there was not. 17 Q. So, the institution accepted this 18 figure; is that right? 19 A. They accepted the calculation in that 20 the calculation -- they never questioned the 21 calculation itself. 22 MR. EISENHART: That was my point, 17005 1 Your Honor: The nature of the dispute here. I 2 think we've already seen that there were disputes 3 over the classification of the assets. 4 MS. CLARK: Just to clarify the 5 record -- I may have misunderstood the testimony, 6 but I understood that all of these numbers were 7 the institution's numbers. 8 Can we just have the witness clarify 9 whether the 327 is the institution's number or the 10 examiner's recalculation based on their own 11 opinions about the quality of the assets on the 12 books? 13 THE COURT: I think the witness stated 14 it, but let's make it clear. The 327 million was 15 your figure? 16 THE WITNESS: Yes, it is, as reflected 17 in the report. 18 Q. (BY MR. VEIS) Now, based upon the 19 numbers calculated under base factor, growth 20 factor, contingency factor, and amortization 21 factor, does the worksheet then reflect a minimum 22 net worth requirement? 17006 1 A. Yes, it does. 2 Q. What was that? 3 A. The minimum requirement was 204,555, 4 rounding. 5 Q. Now -- well, let's see. Where do you 6 get 204? 7 A. That's Line 32. 8 Q. I'm sorry. That's Line 32. What was 9 their actual net worth? 10 A. 190 million rounded. 11 Q. Where is that figure derived? 12 A. That was arrived from the thrift 13 financial reports. 14 Q. This is what the institution is 15 reporting? 16 A. That's correct. 17 Q. Does that include any loss reserves or 18 other items required by the regulators to be 19 deducted from net worth? 20 A. The 190 does not include that, no. 21 Q. So, then, additional scheduled items or 22 reserves would reduce that net worth further? 17007 1 A. That's correct. 2 Q. And would increase the net worth 3 deficiency? 4 A. That's correct. 5 Q. I take it that item -- or 6 Exhibit A14020 is the supporting documentation for 7 this calculation; is that correct? 8 A. That's correct. 9 Q. Ms. Carlton, let me show you a few more 10 documents marked Exhibit A14021 and 11 Exhibit A14022. 12 What are those documents? 13 A. These are the similar documents that we 14 just went through except these are for June 30th. 15 The other documentations were for March of '86, 16 March 31st. 17 Q. Now, this calculation is done 18 similarly? 19 A. It's the same. 20 Q. And directing -- 21 MR. VEIS: Your Honor, I move the 22 admission of A14021. 17008 1 MS. CLARK: Your Honor, this document 2 is not relevant to the Notice of Charges. This 3 entire line of questioning is not relevant to the 4 Notice of Charges. If it is -- there's nothing in 5 the Notice of Charges about miscalculating the net 6 worth requirement in the 1986 time period. It's 7 not there to be found. If it's not relevant, we 8 shouldn't be filling this record up with 9 information and evidence on that subject. 10 If it is relevant to something, then 11 the respondents should respond, should defend 12 against all of this. And what are we supposed to 13 do? Reopen discovery and start deposing the 14 low-level accounting people who were responsible 15 for filling out these forms? Should we bring back 16 Mr. Jim Wolfe? He was on the stand for two days. 17 They never asked him one question about this. 18 Should we bring back Bruce Williams and ask him 19 questions about how they filled out the TFRs? 20 Should we bring back the Peat Marwick accountants 21 who reviewed all these matters and start 22 litigating this issue? 17009 1 If it's relevant, then we should defend 2 against it, in which case we have to start all 3 over. We didn't review documents in light of 4 this. We didn't take depositions of people on 5 this subject. OTS brought people here and 6 examined them for days and didn't ask them these 7 questions. 8 We're just filling the record with a 9 bunch of stuff that's not relevant to the Notice 10 of Charges. There's no point to it. I think it's 11 prejudicial. I think we should not have it thrown 12 into the case on the 17th week of trial. So, we 13 object to this entire line of questioning. 14 MR. VEIS: Your Honor, I think the 15 financial condition of the institution is clearly 16 relevant to the net worth maintenance claim. It 17 also goes to the manner in which the institution 18 was run generally. I will represent that my line 19 of questioning on this is almost over, but I think 20 it is relevant to the issues in the case. 21 MS. CLARK: Your Honor, if it was 22 relevant to the way the institution was run, why 17010 1 they didn't they ask Mr. Wolfe who was the person 2 in charge of this department about this question 3 or Mr. Crow who was on the stand for ten days? 4 They didn't ask him a single question about this 5 subject matter. Now they try to get it in through 6 Ms. Carlton; and for what purpose, we don't know. 7 I think it's part of the same smoke screen we 8 talked about yesterday. You know, if he wants to 9 ask Ms. Carlton, "Was there some information that 10 you asked for about the Park 410 loan that they 11 didn't provide you? Was there some information 12 about the junk bond portfolios, the mortgage-backs 13 that they didn't provide you?" that would be 14 relevant. This information about problems with 15 books and record and low-level accounting is not 16 relevant, and it's prejudicial. 17 MR. EISENHART: Your Honor, I would add 18 that the asserted relevance of this is the net 19 worth maintenance claim. There were no demands 20 made based on any of these documents for net worth 21 contributions and OTS's net worth maintenance 22 claim in this case as they pleaded it as not based 17011 1 on these calculations or these numbers. 2 MR. VEIS: Well, with respect to 3 Mr. Eisenhart's claim, I think that it will be 4 developed here the way in which the ultimate net 5 worth maintenance demand was made and that 6 decision was made. It relates very directly to 7 these calculations and what was done at the 8 supervisory level with respect to it -- I don't 9 know what they are talking about, Your Honor. My 10 understanding is that Mr. Hargett, who was already 11 on and off the stand, is the witness who was 12 supposed to do the calculation to give the numbers 13 on which their net worth maintenance was based. 14 That's certainly the way the evidence has come in 15 to us. 16 THE COURT: Well, I think the net worth 17 maintenance figures are relevant. I'll receive 18 the documents. I agree that how the books were 19 kept may not be an issue in the case. It's not 20 raised by the Notice. But I think this does have 21 some relevance to issues that are recognized. 22 MR. VEIS: Thank you, Your Honor. I 17012 1 take that as a ruling that A14021 will be 2 received? 3 THE COURT: Received. 4 MR. VEIS: I also move the admission of 5 A14022. 6 THE COURT: Received. 7 Q. (BY MR. VEIS) I take it the figures in 8 A14021 were derived in the same fashion as those 9 in the prior exhibit, A14023: The minimum net 10 worth calculation worksheet for March 31st, 1986? 11 A. Yes, they were. 12 Q. In terms of the mathematical accuracy, 13 were there any disputes with the institution? 14 A. No, there was not. 15 Q. Now, what disputes were there with the 16 institution over the results of this examination? 17 A. The dispute in the examination, number 18 one, involved the classification of certain 19 assets, those being some of the loans within 20 themselves. They disagreed with our classifying 21 of those loans. If you had a disagreement on some 22 of the direct investments, direct investments or 17013 1 investments in which some of the properties were 2 instead of -- they were joint ventures, once an 3 institution contributes 100 percent or is actually 4 funding all the proceeds to those investments, 5 they are no longer ruled as a loan but, indeed, as 6 an investment by the institution. They questioned 7 us including those as investments. And there was 8 a disagreement that their books and records were 9 in a disarray to the tone at which they were, 10 although they could not provide sufficient 11 information as to why the errors were what they 12 were and they actually showed making corrections 13 although they stated there were no problems. 14 Q. Did they dispute the scheduling of any 15 assets? 16 A. Yes, they did. 17 Q. Did they dispute the classification of 18 any assets? 19 A. Yes, they did. 20 Q. Were those disputes resolved prior to 21 the 1987 examination? 22 A. No, they were not. 17014 1 Q. When did the 1987 examination begin? 2 A. In November of 1987. 3 Q. And this report was delivered to the 4 institution on or about April -- on or about 5 March 9th, 1987, if you would like at the 6 supervisory letter? The cover letter indicates in 7 the first paragraph of the -- 8 A. Yes. 9 Q. Is that common? 10 A. No, it's not. 11 Q. What normally happens when examiners 12 determine that items are to be scheduled or 13 classified? 14 A. Typically, when you classify assets, 15 you have loan discussions with management. They 16 are given the opportunity to provide additional 17 data as far as the reason why the disagreement is 18 between the examiners and the regulators. They 19 are asked to substantiate any unknown information 20 that we may not be aware of as regulators to be a 21 part of that analysis that goes into the final 22 classification. If that information is not 17015 1 provided or they do not provide the information or 2 substantiate the condition as being improved from 3 what we perceived it to be, those loans are then 4 classified -- management is directed to classify 5 those loans and reflect the changes in their 6 books. That's done prior to us leaving the 7 institution. 8 Q. Now, was the management of United 9 Savings Association of Texas given an opportunity 10 to submit information in response to your 11 examination on classification of assets? 12 A. Yes, sir, they were. 13 Q. Were they directed to classify those 14 assets subsequently? 15 A. Yes, they were. 16 Q. Did they do so? 17 A. No, they did not. 18 Q. How much money are we talking about, 19 Ms. Carlton? 20 A. If you're looking at 20 percent of 140 21 being a factor of net worth, it would make up over 22 one-fourth of their actual net worth number being 17016 1 included as a questionable amount. 2 Q. You mentioned 140. I take it that was 3 the Couch Mortgage number? 4 A. Yes, the -- 5 Q. What were the other numbers? 6 A. Other numbers would be -- if you go 7 through the report, you would see other 8 differences in the classification between the 9 examiners and the institution. And we reflect -- 10 if management disagreed, we reflect that in the 11 comments. Those numbers would also be a part of 12 that consideration. 13 Q. Now, let me direct your attention to 14 Page 4 which deals with asset quality. 15 Do you see that? 16 A. Page 4? 17 Q. I'm sorry. It's Bates No. OW078153. 18 THE COURT: That's Exhibit 14020? 19 MR. VEIS: Yes, Your Honor. I'm sorry. 20 Q. (BY MR. VEIS) Now, that is a summary of 21 the criticized assets in this report; is that 22 correct? 17017 1 A. That's correct. 2 Q. And do you know which of those -- what 3 segments of those were disputed by the 4 institution? 5 A. You would have to go through the 6 back-up support and actual accounts collections to 7 see that. 8 Q. Were there work papers that supported 9 the summary of criticized assets? 10 A. Yes, there was. 11 Q. Let me show you a document that's been 12 marked as A14025. What is Exhibit A14025? 13 A. This is the work paper support for 14 Page 4 showing the summary of criticized assets. 15 MR. VEIS: Your Honor, I move the 16 admission of A14025. 17 MS. CLARK: No objection. 18 THE COURT: Received. 19 Q. (BY MR. VEIS) Ms. Carlton, on the 20 right-hand column -- or beside the right-hand 21 column, do you see an item or a series of entries 22 that start with the letter "W"? 17018 1 A. Yes. 2 Q. What is that? 3 A. Those were the work paper references of 4 an additional sheet that supports those numbers. 5 Q. Are those included in this exhibit, 6 A14025? 7 A. All the numbers are not clear, but it 8 appears to be the majority of them are included. 9 Q. Let me address the item "portion 10 classified loss." 11 Do you see that? 12 A. Yes. 13 Q. Now, you talked about 20 percent 14 deductions. Now, does that apply to the portion 15 classified loss? 16 A. No. A loss classification requires 17 100 percent charge-off or 100 percent reduction of 18 your capital. 19 Q. Does that go right to the bottom line 20 then? 21 A. Yes, it does. 22 Q. So, that similarly reduces net worth by 17019 1 $3 million? 2 A. That's correct. 3 Q. Now, let me go back to the first page 4 of A14020 and ask you to read the paragraph at the 5 bottom of the page carrying over to the second 6 page. That's Bates No. OWO78142 and 78143. 7 MS. CLARK: Mr. Veis, I'm sorry. I 8 didn't hear the reference. 9 MR. VEIS: It's the first page of 10 Exhibit A14020. 11 MS. CLARK: Thank you. 12 A. (Witness reviews the document.) 13 Q. (BY MR. VEIS) Does that paragraph 14 summarize the items that management was disputing 15 with respect to the classification of assets? 16 A. That's correct. 17 Q. So, there was $140 million in Couch; is 18 that correct? 19 A. That's correct. 20 Q. $36.8 million of real estate owned? 21 A. That's correct. 22 Q. And 25.8 million in condominium loans? 17020 1 A. Yes. 2 Q. And $94.3 million in loans classified 3 because of well-defined weaknesses or because they 4 were slow? 5 A. That's correct. 6 Q. And those -- were those the items that 7 management did not enter into its books and 8 records even though directed to by the regulators? 9 A. That's correct. 10 Q. Let me now turn to Page 8 of the report 11 of examination, Exhibit A14020. That's Bates 12 No. OW078157. I would like to direct your 13 attention to the bottom entry. Could you describe 14 what this entry reflects? And I would point out 15 that this comes -- actually, you should probably 16 look at the preceding page because it seems to 17 have a heading that would explain part of that. 18 MR. BLANKENSTEIN: Excuse me, 19 Your Honor. If you could ask Mr. Veis to keep his 20 voice up. 21 THE COURT: Speak louder, please. 22 Q. (BY MR. VEIS) Item D, classified 17021 1 assets. Do you see that on Page 7. That's Bates 2 No. OWO78156. 3 A. Yes. 4 Q. Now, is that heading -- does that 5 heading relate to the following pages? 6 A. Yes, it does. 7 Q. Okay. And what are the following 8 pages? 9 A. The following pages are mortgage loans 10 classified primarily due to well-defined 11 weaknesses beyond delinquency. 12 Q. Let me direct your attention to, then, 13 the following page: OW078157. 14 A. Okay. 15 Q. There's an entry at the bottom of the 16 page for a loan, 14132732. 17 Do you see that? 18 A. That's correct. 19 Q. "Stephen M. Block, Trustee"? 20 A. Yes. 21 Q. Could you explain that entry, please? 22 A. This is one of the loans that is 17022 1 provided; and below it, in the narrative, are the 2 descriptions in which we identify the reason why 3 the loan is being scheduled as substandard under 4 the classification procedures. 5 Q. Is this section sort of a summary of 6 the classified loans? 7 A. Yes, it is. 8 Q. So, you said below it in the narrative? 9 A. Right. 10 Q. We will get to that in a moment. 11 The amount off to the right there is 12 $21,163,137. Isn't that next to the entry twice? 13 Can you please explain what that means? 14 A. The first amount would be the net book 15 value. That's the outstanding balance at the 16 time -- the date selected for the cut-off date. 17 The substandard amount -- if you look at the top, 18 you have three categories in which you can 19 classify an asset, one being substandard down for 20 a loss. The net book value can be broken down 21 into those three categories based on the 22 classifications that are assigned. And this -- in 17023 1 this instance here, we classify the full amount as 2 substandard for the 21 million. 3 Q. What does "substandard" mean? 4 A. Substandard means that you have 5 weaknesses within the loan that will identify the 6 possibility that repayment or the ability of the 7 borrower to service that debt or repay that debt 8 is questionable. It can be either the first line 9 of payment, being the note within itself, or 10 you'll question the value of the collateral, which 11 is the secondary course of repayment for the debt. 12 Q. You mentioned that there was a more 13 comprehensive discussion further on in the report; 14 is that correct? 15 A. Yes. 16 Q. Let me direct your attention to 17 Page 18, which is Bates OW078166. If you would, 18 please read to yourself the section dealing with 19 "Stephen M. Block, Trustee" which starts at the 20 bottom of that page and, I believe, carries over 21 to the next page. 22 A. (Witness reviews the document.) 17024 1 THE COURT: Is this a loan that's in 2 issue here? 3 MR. VEIS: Yes, Your Honor, it 4 certainly is. 5 THE COURT: All right. What page are 6 we on? 7 MR. VEIS: It's Page No. OW078166. 8 Beginning near the bottom of the page, there's an 9 entry, "Stephen M. Block, Trustee." 10 THE COURT: Thank you. 11 Q. (BY MR. VEIS) Have you finished that? 12 Could you please explain the reasons for the 13 classification of the loan to Stephen M. Block, 14 Trustee? 15 A. The reason for the classification of 16 this loan was due to appraisal deficiencies, the 17 inability of the borrower to service the debt, and 18 due to modification of the loan while it was four 19 months contractually delinquent. 20 Q. What does that mean? 21 A. It was a policy of the regulation 22 within this period of time that anytime a new loan 17025 1 was used to -- was granted in an effort to bring a 2 delinquent loan current, that loan itself was also 3 classified. 4 Q. To the same extent as the loan it 5 brought current? 6 A. That's correct. 7 Q. Now, let me direct your attention 8 specifically to the sixth paragraph on Page 19, 9 OW078167. It begins, "On July 29th, 1986." 10 A. Okay. 11 Q. Do you see that paragraph? 12 A. Yes. 13 Q. Now, does that paragraph discuss the 14 loan -- bringing the Block loan current? 15 A. Yes, it does. 16 Q. And who was that loan granted to? 17 A. This loan was granted to Norwood/United 18 Park, which is a joint venture partnership. 19 Q. Now, directing your attention to the 20 next two paragraphs, it discusses a Mr. Minch and 21 a Mr. Krasovec. 22 Do you see that? 17026 1 A. Yes, I do. 2 Q. Does it indicate Mr. Minch and 3 Mr. Krasovec were having financial difficulties? 4 A. In the final paragraph, it states that 5 management agrees that Mr. Block and Mr. Gordon 6 are having financial problems. 7 Q. Well, if a loan is delinquent and it's 8 brought current by another loan to someone who was 9 a guarantor of the first loan who has financial 10 problems, has the institution improved its 11 position by making that second loan? 12 A. Not in our analysis. We do an analysis 13 and consider those factors. And it is included as 14 another weakness to the credit. 15 Q. Now, it indicates that management 16 disagreed with the classification of -- it says 17 "these loans." I take it that refers to both the 18 Block loan and the Norwood/United Park loan? 19 A. Yes, they did. 20 Q. And were they directed to reflect the 21 classification of those loans on the books and 22 records? 17027 1 A. Yes, they were. 2 Q. Did they do so? 3 A. No, they did not. 4 Q. Let me direct your attention forward to 5 Page 23 of the examination: OW078171. 6 Do you see the Item 2, "Norwood"? 7 A. Yes. 8 Q. Would you please read that section? I 9 believe it carries over to the next page. 10 A. (Witness reviews the document.) Okay. 11 Q. Now, does this discuss weaknesses in 12 the Norwood loan? 13 A. Yes, it does. 14 Q. What weaknesses does it discuss? 15 A. Some of the weaknesses discussed were 16 the fact that the guarantors of this loan were the 17 same guarantors of the Block loan and that the 18 loan -- that loan was delinquent which shows that 19 the borrowers on it have financial difficulties. 20 Also, we questioned the value of the appraisal 21 that was prepared on the property. It shows an 22 increase of value in a declining real estate 17028 1 market; therefore, we reflected and asked them to 2 obtain a new appraisal that would be more in line 3 with what the -- that -- in which the assumptions 4 used would be more in line with the current real 5 estate market versus the appraisal that they had 6 presented. The loan also had a built-in interest 7 reserve within the loan that would carry the loan 8 for a certain period of time, and we also 9 addressed the stipulation made within the loan of 10 the joint venture agreement which showed sales 11 stipulation in which these individuals could be 12 released as guarantors from this loan. 13 Q. Is that a weakness? 14 A. It's just a factor to be measured in 15 the consideration as you go along and complete the 16 analysis of the loan and determine if those 17 factors are met in the future reviews of that 18 loan. 19 Q. Now, it indicates here that management 20 disagreed; is that correct? 21 A. Yes. 22 Q. Were they directed to schedule this 17029 1 loan? 2 A. Yes. 3 Q. Did they do so? 4 A. No. 5 Q. Let me direct your attention to the 6 section under "management" with respect to 7 records, systems, and controls. Same page. It's 8 Bates OW078172. 9 A. Okay. 10 Q. Would you just read that section to 11 yourself? I have a number of questions to ask. 12 A. (Witness reviews the document.) Okay. 13 Q. Is that your final report on the 14 condition of the books and records of the 15 institution? 16 A. That's correct. 17 Q. Were there work papers that supported 18 that report? 19 A. Yes, there was. 20 Q. Let me show you a document that's been 21 marked as Exhibit A14032. 22 THE COURT: Could I ask a question at 17030 1 this point? We're on III there on Page 24. The 2 next page starts Roman Numeral V. Is there a 3 Roman Numeral IV? 4 MR. VEIS: Apparently not, Your Honor. 5 This is a continuous pagination. 6 THE COURT: Back on Page 2 under the 7 report summary, there's a reference to Comment 4. 8 Is this -- would this be where that comment would 9 be, or is that somewhere else? 10 MR. VEIS: I think that the -- it 11 appears -- since the comment on Page 2 relates to 12 non-operating items and Item 5 is operating 13 results, I think what we see here is a 14 typographical error. That should be a Roman 15 numeral IV, but we can confirm that with 16 Ms. Carlton. 17 A. The operating results that you have, 18 the V, is really IV. 19 Q. (BY MR. VEIS) So, I take it that's just 20 a typographical error, Ms. Carlton? 21 A. Yes. 22 Q. Ms. Carlton, have you had a chance to 17031 1 review Exhibit A14032? 2 A. Yes, I did. 3 Q. And what is that? 4 A. This is the support for the comment 5 that you find within the report under 6 "management," and that identifies the books and 7 records problem and schedules to substantiate 8 those numbers. 9 MR. VEIS: I move the admission of 10 A14032. 11 MS. CLARK: Your Honor, if books and 12 records is going to be part of the case, then I 13 suppose we should have this document in the record 14 to show that the books and records that were at 15 issue have nothing to do with major loans, 16 mortgage-backed securities, junk bonds, and the 17 rest but, instead, have to do with miscoding 18 property types, classifications, and the like. 19 But I understood your ruling to be that these 20 issues are not in the case because they are not 21 relevant to anything in the Notice of Charges; 22 and, therefore, I would object to the admission of 17032 1 this document. 2 THE COURT: Well, I'm not sure to what 3 extent this is relevant to the issues in the case 4 if the respondents individually are not charged 5 with maintaining bad books and records. 6 MR. VEIS: No, Your Honor. But the 7 condition of the books and records goes a good 8 deal of the way toward explaining many of the 9 things that happened during that examination that 10 do relate to issues in the case. This is 11 background material. Ms. Clark is absolutely 12 correct. We have not based a claim against the 13 respondents based on the books and records, but it 14 does explain why the examinations were conducted 15 as they were. And that, I believe, is going to be 16 an issue based upon the defense as -- that is 17 going to be an issue based upon the manner in 18 which the defense has conducted its depositions. 19 They have certainly attempted to explore with 20 Ms. Carlton whether or not the examinations were 21 conducted in an appropriate manner, and explaining 22 how they were conducted and why they were 17033 1 conducted is certainly relevant to dealing with 2 that. 3 MS. CLARK: Your Honor, it's the 4 respondents' positions that Ms. Carlton's 5 examination was conducted in an appropriate 6 manner: Thoroughly, professionally, and so on. 7 What we have not heard one word about is how 8 miscoding property types has anything to do with 9 the fact that Ms. Carlton specifically reviewed 10 the provisions of the employment agreement that 11 are in the Notice of Charges and did not criticize 12 them, how miscoded property types have anything to 13 do with the fact that she specifically made the 14 decision to pass the Park 410 loan. 15 How she conducted the examination is 16 not at issue. Ms. Carlton is not on trial in this 17 case. We are not criticizing the way she 18 conducted this examination. What they are trying 19 to do is put up a smoke screen to say that she 20 didn't conduct a proper examination, and I don't 21 think that this is relevant to any of the issues 22 that she actually did look at. We should hear 17034 1 from her what information she had about the issues 2 in this case and what conclusions she drew about 3 that information. That's what's relevant, not a 4 bunch of books and records problems that they 5 didn't even bother to ask the people who could 6 give an explanation about them when they were 7 here. 8 MR. VEIS: Your Honor, I would note 9 that under "books and records," there's also a 10 reference to undeferred gains and mortgage-backed 11 securities which is one matter that I wanted to 12 get into shortly. 13 THE COURT: All right. I'll receive 14 the document. 15 MR. VEIS: Thank you, Your Honor. 16 Q. (BY MR. VEIS) Now, Ms. Carlton, A14032, 17 do you see that? 18 A. Yes. 19 Q. Is this a summary work paper 20 summarizing generally those matters that you found 21 to be issues in the books and records? 22 A. Yes. You have a whole folder that 17035 1 would include additional documentation on books 2 and records. 3 Q. Now, let me ask you about a couple of 4 items on A14032. 5 Item 3 refers to a restatement? 6 A. Yes. 7 Q. Do you know what that refers to? 8 A. That's the restatement of the actual 9 financial statements that the auditors would 10 prepare. 11 Q. And was that related to mortgage-backed 12 securities? 13 A. Yes, it was. 14 Q. We'll explore that later. 15 Now, in addition, there's an entry 16 indicating that financial subsidiaries are not 17 included. 18 Do you see that under Item 6? 19 A. That's correct. 20 Q. What does that refer to? 21 A. That means that at that time, we had -- 22 the financial analysis did not include the review 17036 1 of subsidiaries in her analysis that she was 2 conducting. 3 Q. And why was that? 4 A. Because we did not -- we closed the 5 exam out prior to going into any length of detail 6 in that category. 7 Q. Do you know whether investment 8 securities were held in any of those subsidiaries? 9 A. Yes, there was. 10 Q. Now, let me go back to the report of 11 examination. Paragraph 3 -- or the third 12 paragraph under Item A on Page OW078172 says, 13 "Furthermore, a 36,542,392-dollar unrecorded gains 14 booking on mortgage-backed securities resulted in 15 a restatement of the first and second quarter 16 earnings." 17 Do you see that? 18 A. Yes. 19 Q. Do you know what that related to? 20 A. That related to a -- a situation in 21 which the institution had been deferring their 22 gains and purported that the auditors had allowed 17037 1 them to do that. 2 During the examination, it was 3 purported that a change in that decision had been 4 made and the institution reversed their booking of 5 those transactions in that manner and recorded a 6 gain of $36 million. Because 36 million is a 7 significant and material amount, it caused the 8 institution to have to go back and the auditors to 9 restate the first and second quarter earnings to 10 reflect that amount. 11 Q. Now, let me direct your attention to a 12 document that's been previously admitted at 13 Tab 184. It's marked as Exhibit A10663. 14 Is that document identical to a -- with 15 the exception of the first page, which is a cover 16 memorandum, is that document the -- which is 17 titled "United Savings Association of Texas - 18 business plan, August 28th, 1986" included in the 19 work papers of the 1986 examination? 20 A. We had a business plan dated for this 21 period that is -- was like this, yes. 22 Q. Does it appear to be identical? 17038 1 A. It appeared to, yes. 2 Q. Granted that it's some significant 3 number of pages long. 4 A. It appeared to look like a business 5 plan that was a part of the work papers. 6 Q. Okay. Now, we were talking about a 7 36-million-dollar-plus gain on mortgage-backed 8 securities in 1986, do you recall, from our 9 discussion of the report of examination? 10 Do you recall that? 11 A. Yes, I do. 12 Q. Now, I would like to direct your 13 attention to Page 4 of the business plan, which 14 has an entry OW005471. 15 A. Okay. 16 Q. I would like to direct your attention 17 to the section entitled "Structured arbitrage 18 program." 19 A. Okay. 20 Q. In particular, the second paragraph of 21 that section, the one that starts, "While the 22 structured arbitrage program" -- 17039 1 A. Okay. 2 Q. -- would you please read that sentence 3 or paragraph to yourself? 4 A. (Witness reviews the document.) Okay. 5 Q. Now, that paragraph refers in a 6 sentence that begins six lines up from the 7 bottom -- begins, "Therefore, in 1986..." 8 Do you see that sentence? 9 A. Yes. 10 Q. "Therefore in 1986, the association 11 sold higher coupon mortgage-backed securities that 12 are more likely to prepay and purchased lower 13 coupon mortgage-backed securities. These 14 transactions produce ready gains on sales of 15 mortgage-backed securities during the first six 16 months of 1986, totaling $38.9 million." 17 Do you see that sentence? 18 A. Yes. 19 Q. Now, are the gains referenced in the 20 sentence I've just read you the same gains that 21 you were speaking about in the report of 22 examination where you refer to the restatement of 17040 1 first and second quarter earnings by the amount of 2 some $36 million with respect to unrecorded gains 3 booking on mortgage-backed securities? 4 A. This is the portfolio that's identified 5 in that, yes. 6 Q. So, the gains are the same gains; is 7 that right? 8 A. Yes. The dollar amount is different 9 here, but the portfolio -- you're talking of the 10 portfolio for that first six-month period. 11 Q. And were you given any other reason for 12 the association's having realized those gains 13 other than what's set forth in those sentences? 14 A. No. This was the reason that was 15 provided. 16 Q. Now, is there anything in those 17 sentences that indicates to you that USAT had sold 18 those securities out of the mortgage-backed 19 securities portfolio for the purpose of generating 20 a gain to bolster profits? 21 A. That's not stated here. 22 Q. Thank you. 17041 1 Let me go back to the report of 2 examination -- 3 THE COURT: We'll take a short recess. 4 5 (Whereupon, a short break was taken 6 from 10:31 a.m. to 10:54 a.m.) 7 8 THE COURT: Be seated, please. We'll 9 be back on the record. 10 Mr. Veis, you may continue with your 11 examination. 12 MR. VEIS: Thank you, Your Honor. 13 Q. (BY MR. VEIS) Before the break, I just 14 directed your attention, Ms. Carlton, to Page 28 15 of the report of examination, which is OW078174. 16 Do you -- I direct your attention in 17 particular to the last paragraph of -- 18 THE COURT: Did you say Page 28? 19 MR. VEIS: Page 26 of the report of 20 examination, which is OW078174. 21 THE COURT: Thank you. 22 A. Okay. 17042 1 Q. (BY MR. VEIS) I direct your attention 2 in particular to the final paragraph on that page. 3 Would you read that to yourself? I have some 4 questions about that. 5 A. (Witness reviews the document.) Okay. 6 Q. Have you read it? 7 A. Yes, I have. 8 Q. Ms. Carlton, it discusses exposure to 9 interest rate risk, correct? 10 A. Yes, it does. 11 Q. And it refers to there being, during 12 June 1986, $1.5 million more than assets repricing 13 in six months or less. Then it says, "It will 14 take from three to five years for the dollar value 15 of assets pre-pricing to exceed the dollar value 16 of liabilities pre-pricing." 17 Do you see that sentence? 18 A. Yes. 19 Q. What does that mean? 20 A. As a part of the analysis of an 21 institution, we do what you call risk management 22 analysis in which you look at the portfolio of 17043 1 assets and the maturity of those assets; and you 2 compare those to the maturities of the liabilities 3 of the bank. Typically, in institutions, you try 4 to match the maturities of your assets with your 5 liabilities in an effort to manage your liquidity 6 and your borrowing capabilities and your ability 7 to continue to fund additional lending and other 8 business activities that a bank may have. If you 9 have a mismatch in your liabilities, being that 10 you have assets with maturities that far exceed 11 your liability which would your ability to either 12 borrow or fund additional lending, it could lead 13 to a liquidity prices in which you would not have 14 the funds in order to pay those deposits or to 15 continue to conduct your business. 16 Q. Is that what's referred to as a gap? 17 A. Yes, it is. 18 Q. And is this the summary of what's 19 called a gap analysis? 20 A. It's a part of that analysis, yes. 21 Q. Does this indicate what's called a 22 negative gap? 17044 1 A. Yes, it is. 2 Q. And that's three to five years. What 3 does that mean? 4 A. It means that at the composition and 5 the way the portfolio is structured, based on 6 those assets and liabilities that are within that 7 portfolio at that time, it would take that length 8 of time in years before you could bring those to 9 yield matching back in sync in order that you 10 would not have that negative mismatch. 11 Q. So, here, it says three to five years 12 as of June 1986? 13 A. That's correct. 14 Q. So, we're looking at somewhere between 15 1989 and 1991. Is that what this leads to? 16 A. Yes, from '86 going forward. 17 Q. Then it says, "According to management 18 and USAT's business plan dated August 28th, 1986, 19 in order to reduce the negative gap position, USAT 20 has entered into interest rate exchange agreements 21 (swaps) as well as interest rate cap and collar 22 agreements. In 1985, USAT significantly increased 17045 1 its investment in long-term mortgage-backed 2 securities funded by short-term repurchase 3 agreements." 4 Were those management's representations 5 to the examination team? 6 A. That's correct. 7 Q. I would like to direct your attention 8 back to Exhibit 10663, the business plan, back to 9 Page 4, which is OW005471. 10 A. Okay. 11 Q. Now, I would like to direct your 12 attention to the first full paragraph on that 13 page. 14 MR. EISENHART: Your Honor, can we have 15 that page reference again, please? 16 MR. VEIS: OW045471. 17 Q. (BY MR. VEIS) Is that the source of the 18 representation reported in your report of 19 examination which we've discussed at 20 Page OW078174? 21 A. Yes, it is. 22 Q. Now, let me direct your attention to 17046 1 the next paragraph. It says, "The result of the 2 strategies described above has been to more 3 closely match the interest rate sensitivity of the 4 association's assets and liabilities. While this 5 strategy has resulted in the association not 6 obtaining the maximum benefit of recent declines 7 in interest rates, management believes that the 8 effect of more closely matching the interest rate 9 sensitivity of the association's assets and 10 liabilities will provide a significant long-term 11 benefit to the association." 12 Do you see that? 13 A. Yes. 14 Q. Are they talking about hedging? 15 A. Yes. That's part of the -- a part of 16 the consideration in engaging in hedging activity. 17 Q. Is there anything in that paragraph 18 that would indicate that USAT intended to make 19 sales out of the mortgage-backed securities 20 portfolio for the purpose of generating a gain to 21 bolster profits? 22 A. No. 17047 1 Q. Let me direct your attention to the 2 next paragraph under the heading "structured 3 arbitrage program." 4 A. Okay. 5 Q. Do you see the paragraph that starts 6 "In late 1984"? 7 A. Yes. 8 Q. Please read that to yourself. 9 A. (Witness reviews the document.) Okay. 10 Q. Is there anything in that paragraph 11 that would indicate to you that USAT had made 12 sales out of the mortgage-backed securities 13 portfolio for the purpose of generating a gain to 14 bolster profits? 15 A. No. 16 Q. I would like to direct your attention 17 to Page 32 of the business plan, OW005499. 18 A. Okay. 19 Q. Item 8, interest rate management. 20 A. Okay. 21 Q. I would like you to review that 22 section, please, which goes over to the following 17048 1 page. 2 A. (Witness reviews the document.) Okay. 3 Q. Is there anything in that section of 4 the business plan -- 5 MR. KEETON: Your Honor, we get this 6 question about 10,000 times. The record is not a 7 video record; so, we don't see the lost minutes 8 that add up to the lost hours, the lost days with 9 this kind of wasteful examination. I object to 10 the question. 11 THE COURT: Well, your question is? 12 MR. VEIS: My question is whether 13 anything in the section she just read on 14 Page OW05499 through OW05500 under Item 8, 15 "interest rate risk management," indicates to her 16 that USAT intended to make sales out of the 17 mortgage-backed securities portfolio for the 18 purpose of generating gains to bolster profits? 19 THE COURT: Is there any claim that it 20 does? 21 MR. VEIS: I'm trying to go through the 22 information she had. 17049 1 THE COURT: Can you answer the 2 question? 3 THE WITNESS: No. 4 Q. (BY MR. VEIS) No, you can't answer the 5 question? 6 A. "No" to your question. 7 MR. KEETON: It's this whole procedure, 8 Your Honor, that wastes days on end. Mr. Guido 9 adopted it. Now Mr. Veis is infected with it. 10 MR. VEIS: I don't believe it's an 11 illness, Your Honor. 12 MR. KEETON: I think it's more than an 13 illness. It's abusive to this trial. 14 THE COURT: Well, I would like to move 15 along. 16 MR. VEIS: Thank you, Your Honor. 17 Q. (BY MR. VEIS) Ms. Carlton, I would like 18 to show you now a document that's been marked 19 B4164A. 20 MR. VEIS: Let me explain to the Court, 21 because of the copying problems, a copy of this 22 document is in evidence at B4164. Because of the 17050 1 varying types of colors and writing on here, I 2 have -- I propose to introduce into evidence the 3 original document. I have made color copies for 4 the Court and have delivered color copies to the 5 respondents' counsel. These are the work papers 6 relating to the Park 410 West Joint Venture. 7 These are, I believe, the best copies that can be 8 made of this document. And since it appears to be 9 a document of considerable controversy in the 10 case, I believe it would be appropriate to move 11 into evidence at this time the original work 12 papers. 13 MS. CLARK: Your Honor, we're very 14 pleased to have the color copy of this document. 15 I would just correct the record in that these are 16 not the work papers. This is a portion of the 17 work papers relating to Park 410. With that 18 qualification, we're pleased to not object to this 19 document. 20 THE COURT: Received. 21 MR. EISENHART: The only other comment 22 I would make is, apparently, the colors have some 17051 1 significance. OTS has delivered, I gather, two 2 color copies to the respondents. There are five 3 of us over here. 4 MR. VEIS: I delivered to Ms. Clark 5 copies of my exhibits. The practice has been to 6 deliver one set to respondents' counsel of 7 exhibits where there is some advance notice. I 8 would be pleased to arrange for color copying for 9 Mr. Eisenhart. 10 THE COURT: I think we've discussed 11 this before. When you're offering an exhibit, you 12 should have a copy of it for all parties. 13 MS. CLARK: Your Honor, to be fair to 14 Mr. Veis, he did deliver a complete set of 15 exhibits to me last Tuesday. We are not 16 criticizing Mr. Veis. It's probably my fault for 17 not getting the copies made. What we have a 18 difficulty with is when we do not get the 19 documents in advance when they come up with new 20 documents. 21 THE COURT: So, the arrangements that 22 have been used are when an advance copy is made to 17052 1 one respondent, that respondent makes the copy? 2 MR. EISENHART: Your Honor, on this 3 occasion, I stand corrected. If they provide it 4 to us in advance, we make the copies. 5 MS. CLARK: That is the origin of the 6 entire system, that they didn't want to make five 7 copies. That is not a difficulty in this case. 8 THE COURT: Thank you. Mr. Veis, 9 you're cleared. 10 MR. VEIS: Thank you, Your Honor. 11 I'll attempt to find some antibiotics 12 to see if I can rid myself of illnesses, as well. 13 I don't believe I heard a ruling to the 14 admission of the document. 15 THE COURT: I received it. 16 Q. (BY MR. VEIS) Ms. Carlton, can you 17 explain what this exhibit is: B4164A? 18 A. This is a narrative write-up that was 19 prepared by the State of Texas examiner that 20 reviewed the Park 410 Joint Venture during the 21 1986 examination. 22 Q. Now, was a copy of it provided to the 17053 1 federal examiners? 2 A. Yes, it was. 3 Q. Now, there appear to be handwritten at 4 least two, perhaps more, persons on this 5 documents. Can you explain whose handwriting is 6 on the first page and, particularly, the body of 7 the document and the marginal comments? 8 A. The comments that are in red were 9 prepared and placed by myself. The other comments 10 are comments that were made by the State of Texas 11 examiners and their staff. 12 Q. Let me address in particular the top of 13 the page. On the upper right-hand corner -- 14 that's OW120007 -- the word "pass" appears. 15 Do you see that? 16 A. Yes. 17 Q. Who wrote that? 18 A. That's prepared by the State. 19 Q. And with respect to the comment on the 20 side of the document which reads, "(We will pass - 21 weakness not material to classify)," whose comment 22 was that? 17054 1 A. That's my comment. 2 Q. Let me then go to the next page, 3 OW120008. About halfway down the page under 4 Item 3, do you see an entry that says, quote, "Who 5 are the letters of credit with," close quote, 6 followed by some initials? 7 A. Yes. 8 Q. Who wrote that comment? 9 A. I did. 10 Q. Now -- 11 MS. CLARK: Excuse me, Your Honor. Is 12 that comment in red, as well? It seems to be in 13 black on mine. 14 MR. VEIS: I'm sorry. I think we 15 failed to color copy the second page. Ms. Clark 16 is absolutely right. That comment is in red. 17 THE COURT: It's not in red on the 18 copy. You're saying on the original, it is in 19 red? 20 MR. VEIS: Yes, Your Honor. 21 Apparently, in the copying process, the copy was 22 failed to be made. I can certainly substitute 17055 1 color copies. 2 THE COURT: Already. We've made a 3 record as to whose comment it is. Let's move on. 4 Q. (BY MR. VEIS) Now, let me address your 5 attention in particular to your entry in which you 6 state, "We will pass - weakness not material to 7 classify." 8 What does that mean? 9 A. It means that based on the data that 10 was provided in this comment by the state examiner 11 and the weaknesses noted at that time, that those 12 weaknesses were not material to the date of the 13 origination of this loan and its impact on the 14 institution for me to include it in the 15 classification of assets at that time. 16 Q. Well, let me explore this. 17 What do you need to show or to find in 18 order to classify a loan? 19 A. When we make classifications of a loan, 20 we identify weaknesses that demonstrate an 21 apparent loss in some form or that a loss and 22 adverse trend or adverse impact will be immediate 17056 1 to the institution within an immediate short 2 period of time or within a length of time prior to 3 us re-entering the institution. Typically, we do 4 an outlook, say, from 6 to 12 months which would 5 address the period in which the next examination 6 would take a place. If we feel, within that time 7 frame, that some adverse action will impact the 8 institution beyond the control that we would have 9 in taking an action on it, we then make a decision 10 to include it in that examination as a part of our 11 analysis. 12 Q. In fact, you made a decision not to 13 include it as a classified asset? 14 A. That's correct. 15 Q. Now, why did you believe there would be 16 no -- let me see if I get the words right. I hope 17 I do -- no adverse impact on the institution 18 within the next 6 to 12 months? 19 A. This loan, as a part of its original 20 terms in the governance of this loan, had a 21 built-in reserve which we describe as a 22 "no default" type loan, meaning that it had a 17057 1 reserve that -- until that reserve was exhausted, 2 this loan could not go delinquent because the 3 interest payments would be paid out of that 4 reserve within the period of time to us 5 re-entering the institution; no way this loan 6 could have gone delinquent. In addition to that, 7 they also had pledged a letter of credit of 8 $10 million that could also be used as a secondary 9 source of repayment in the event something did 10 happen with the reserve or it was depleted prior 11 to that time. So, the first and secondary source 12 of repayment was not in jeopardy; therefore, the 13 weaknesses, although noted, were not material 14 enough to classify as credit at that time. 15 Q. Are you familiar with the use of the 16 term "material" as it's used in the context of 17 accounting and auditing? 18 A. Yes, I am. 19 Q. Does the term "material" mean the same 20 thing in the context of examining savings and loan 21 associations as it does in the context of auditing 22 and accounting? 17058 1 A. No, it does not. We have our own 2 definition for what we rule as material. 3 Q. What does it mean to an examiner in 4 this context? 5 A. We rule -- as transactions or events 6 material, if it causes, as an example, a 7 restatement of your financial condition, if that 8 material would impact your regulatory capital 9 compliance in any matter, be it not meeting your 10 requirements or rule you insolvency or if it would 11 have any adverse operating trend that would cause 12 you to lose money or, for some reason, to cause 13 operational losses to the institution. 14 Q. Now, you used the word "pass" in your 15 note on the first page of Exhibit 4164A. 16 A. Right. 17 Q. What did that word mean? 18 A. That means not considered for 19 classification. 20 Q. Does it mean that the examiners somehow 21 approved the loan? 22 A. No, it does not. 17059 1 Q. Do examiners approve loans? 2 A. No, we do not. 3 Q. Did the decision to pass the loan, as 4 you have described it, mean that examiners in 5 future examinations would never look at that loan 6 again? 7 A. No, it does not. 8 Q. Can loans be re-examined at any time? 9 A. Yes. 10 Q. Would this loan, in particular, be 11 likely to be reviewed again at the next 12 examination? 13 A. Due to its size as far as 80 million, 14 it will be part of the next review. As we go in 15 and start our review of loans for the next 16 examination, the work papers from the prior 17 examination, including items -- classifications 18 and items passed are pulled and considered as a 19 part of that pre-exam analysis going into the next 20 examination. 21 Q. Is there a program in the examination 22 process to examine large loans? 17060 1 A. Yes. That's a part of the loan-to-one 2 borrower violation; and we look for concentration 3 of loans to one individual to determine if you may 4 have one large loan that could impact capital if 5 that borrower, for some reason, failed to service 6 that debt. 7 Q. Well, let's continue to go through the 8 document. Let me go to Page 3, which is OW120009. 9 There's a reference on that page in the sixth line 10 to a land flip. 11 A. Yes. 12 Q. Do you see that? 13 A. Yes. 14 Q. Did you form a conclusion as to whether 15 or not this loan involved a land flip? 16 A. Based on the information that was 17 provided in the review and the information at the 18 institution, what I had known for a land flip was 19 not exhibited in the documentation within this 20 loan review. 21 Q. So, this isn't a land flip? 22 A. No. 17061 1 Q. Let's move on to Page 8 of 2 Exhibit B4164A which is Bates No. OW120014. There 3 is a discussion through the next three pages of an 4 appraisal. 5 Would you please read that to yourself? 6 I have some questions to ask you about it. 7 A. (Witness reviews the document.) Okay. 8 Q. There is a discussion beginning in the 9 second -- what appears to be a paragraph that 10 starts "In arriving at his value." 11 Do you see that? 12 A. Yes. 13 Q. Which seems to talk about different 14 approaches to value and they are not being used in 15 the appraisal. 16 Do you see that? 17 A. Yes. 18 Q. Can you please explain that? 19 A. One of the requirements in preparing 20 real estate appraisals on large development type 21 loans is that all three of the approaches to 22 estimated value should be addressed in the report 17062 1 itself. If those -- if the other approaches are 2 not used, there should be an explanation provided 3 as to why those approaches were not used. 4 Q. Well, now, is the failure to use the 5 cost and the income approaches to value a 6 well-defined weakness in the loan? 7 A. It's a well -- not in the loan, no. 8 Q. What is it? 9 A. It's a weakness of the appraisal report 10 itself. 11 Q. Now, what is a well-defined weakness? 12 A. A weakness in the appraisal report 13 would be an item not meeting the requirements as 14 specified by the guidelines that was set forth for 15 appraisal reports at that time. 16 Q. Now, what is a well-defined weakness as 17 it relates to a loan? 18 A. A well-defined weakness in a loan would 19 be a criteria that is demonstrated that will 20 impact the repayment of the source of repayment of 21 that borrower in order to service the debt of that 22 loan or to be in compliance with different 17063 1 covenants that are made within the lending 2 arrangement by that institution. 3 Q. If I understand correctly, the failure 4 to use the cost and income approach was a weakness 5 in the appraisal but not in the loan; is that 6 correct? 7 A. Yes, yes. 8 Q. Now, does that mean it was a good 9 lending practice to use that kind of an appraisal? 10 A. No. 11 Q. So, can there be poor lending practices 12 that don't lead to well-defined weaknesses that 13 would lead to classification? 14 A. Yes, there can be. 15 Q. Now, could that weakness of that 16 appraisal, together with other factors, lead to 17 weaknesses in the loan in the future? 18 A. If appraisal deficiencies or 19 assumptions used in an appraisal report are not 20 met, as the time passed and by the time frames 21 established by that appraisal, then the appraisal 22 assumptions can be ruled as questionable; and 17064 1 their value in which those assumptions were used 2 would be questioned because those requirements in 3 which he established that value were not met. 4 Therefore, the value is questionable as to whether 5 the value stands as purported by that appraiser 6 that prepared that report. 7 Q. So, in other words, things could 8 change? 9 A. Correct. 10 Q. I would like to direct your attention 11 back to the first page of Exhibit B4164A, 12 particularly in the first line. Does it indicate 13 when the loan was made? 14 A. On April 8th, 1986. 15 Q. And approximately when was 16 Exhibit B4164A prepared, or can you tell? 17 A. I can't tell. 18 Q. Was it prepared during the time when 19 the examination team was on-site at USAT between 20 May 27, 1986, and sometime in September of 1986? 21 A. This document was prepared during the 22 1986 examination. 17065 1 Q. So -- 2 MS. CLARK: Objection. I thought the 3 exam was over in October. 4 MR. VEIS: Perhaps I was wrong. I 5 appreciate that. 6 Q. (BY MR. VEIS) Let's clarify that. 7 When did the examination team actually 8 leave the premises of USAT? 9 A. May I look at another exhibit? 10 Q. Certainly. What exhibit are you 11 looking at? 12 A. The actual report itself. 13 Q. If you could direct us to where that's 14 shown. That would be Exhibit A14020. 15 A. (Witness reviews the document.) The 16 Bates No. OW078146, at the top, "Field work was 17 completed October the 3rd, 1986." 18 Q. And what does that mean? 19 A. That's the date we left the 20 institution. 21 Q. So, how old was this loan at the 22 point -- roughly at the point that these work 17066 1 papers must have been prepared? 2 A. It was about five months old. 3 Q. And how long was the interest reserve 4 to last? 5 A. Five years. 6 Q. So, at that point, the loan was five 7 months old with a five-year interest reserve, 8 correct? 9 A. Yes. 10 Q. And when did the loan first become 11 delinquent? 12 A. After the exhaustion of that reserve. 13 Q. So, that would be 1991? 14 A. Yes, if you go out five years. 15 Q. Now, did you personally review the 16 appraisal that's referenced in Exhibit B4164A? 17 A. No, I did not. 18 Q. And why not? 19 A. Because it was reviewed by the state 20 examiners. 21 Q. And what procedures are generally 22 undertaken when state and federal exams are 17067 1 conducted simultaneously with respect to review of 2 a reliance on each other's work papers? 3 A. It's a combination of -- we try not to 4 duplicate the entire work of theirs, but we review 5 the information provided to the point that we feel 6 comfortable in order to make the decisions that we 7 have to use their information. If we find that we 8 would like to do additional reviews, we can 9 request additional information. So, it's a matter 10 of what the situation is, whether it's material or 11 not, whether we would take an extra step to go 12 beyond their review, or if it's material enough to 13 warrant that. In a case like this, even when you 14 talk about the land flip, if -- based on the 15 information, that would -- to prove that, you have 16 to go outside the source of the institution. We 17 didn't feel that at the time, the jeopardy of the 18 repayment of the debt was at question. Therefore, 19 we did not request an investigation to go beyond 20 to prove that. 21 Q. So, I take it, then, a federal examiner 22 exercises judgment with respect to the use of 17068 1 state examination work papers; is that correct? 2 A. Right. 3 Q. And that's part of the normal course of 4 conducting an examination? 5 A. Right. And they make their decisions 6 separate from the judgment we make. To the tune 7 they want to verify whatever decisions they want 8 to, they are free to do that. We use our judgment 9 and make our decisions on what we feel should go 10 in the report. 11 Q. So, essentially, does B4164A report the 12 facts upon which you based your decision? 13 A. It purports what the State had put 14 together from his analysis of those loan credits. 15 Q. Do you know whether there were any 16 other appraisals of this property? 17 A. It only addresses one here. I was not 18 aware of another. 19 Q. Would it have raised any questions in 20 your mind if you had been aware of any other 21 appraisals? 22 A. We review all appraisals that are 17069 1 presented to us in loan review. And if you have 2 two appraisals, if those values -- if the 3 assumptions are greatly different, we would then 4 question which appraisal fairly represented the 5 true value of the property. 6 Q. But you weren't aware of any other 7 appraisals in this case? 8 A. No, I was not. 9 Q. Were you generally aware in 1986 and 10 1987 of the size and complexity of securities 11 operations of savings associations in the Dallas 12 region? 13 A. Yes, I was. 14 Q. How did USAT's securities operations 15 compare to those of other institutions in the 16 region in terms of size and complexity? 17 A. Bank United was one of the largest 18 institutions that engaged in investment 19 securities. The majority of the institutions back 20 in the Eighties were dealing in single-family and 21 major development type lending and did not engage 22 in investment securities as a part of their 17070 1 portfolio or strategy. 2 Q. What about the variety of investments 3 securities in United Savings Association's 4 portfolio? How did that compare to other 5 institutions in the Dallas region? 6 A. United stood alone. When you looked at 7 the different instruments that it engaged in as a 8 part of this investment strategy, we did not have 9 other institutions that went to the extent that 10 United did investing in the different instruments 11 that you find listed in this report. 12 Q. What about the size of that investment 13 portfolio? 14 A. United was also, if not the largest, 15 one of the largest institutions in our region that 16 invested in investment securities to the size that 17 they had. 18 Q. Well, I'm sorry to change the subject; 19 but in terms of comparisons with other 20 institutions, I have another question. 21 There were comments in the examination 22 report regarding the books and records of United 17071 1 Savings Association. 2 Do you recall that? 3 A. That's right. 4 Q. We discussed that earlier. By 5 comparison to other institutions in the Dallas 6 region, can you indicate to me the relative 7 quality of books and records of United? 8 A. The books and records at United at that 9 time was one of the worst that we had seen and 10 encountered in that we could not even reconcile 11 one quarter's financial data less than the period 12 from three years in which you typically should 13 have reviewed for the exam. It was one of -- you 14 find smaller institutions that may have books and 15 records -- most of them were insolvent. But for 16 an ongoing institution, this was one of the worst 17 that we had seen. 18 Q. Thank you. 19 I would like to show you now a document 20 that has been marked A14033 and ask you if you 21 recognize A14033. 22 A. (Witness reviews the document.) It's a 17072 1 copy of the investment policies that were 2 retrieved from the examination work papers -- from 3 the examination work papers. 4 MR. VEIS: Your Honor, I would note for 5 the record that there is a copy of the investment 6 policy that -- of United Financial Group dated 7 May 27, 1986, in evidence at Tab 181. But that 8 version is, in fact, different in that there's 9 handwritten material on Page 2. I also note that 10 this is copied directly from the work papers of 11 the examination and represents what is, in fact, 12 in the examination work paper files. 13 It also has attachments which I'm 14 informed were not attached to Exhibit A -- I'm 15 sorry -- Tab 181, which is A10636. 16 Q. (BY MR. VEIS) Ms. Carlton, this was 17 contained in the examination work papers, correct? 18 A. Yes. 19 MR. VEIS: I move the admission of 20 A14033. 21 MS. CLARK: Your Honor, as you can see, 22 it's not a Bates-stamped document; but I do 17073 1 believe I have seen a copy of this investment 2 policy as part of work papers where the examiners 3 would read the minutes and summarize them and 4 often copy exhibits to -- sorry -- read investment 5 committee and other minutes and summarize them. 6 Is that the source of this document? 7 Q. (BY MR. VEIS) This is in, I believe, 8 the securities analysis, Ms. Carlton? 9 A. It's not indicated here, but it is a 10 part of the work papers. 11 MS. CLARK: In any event, I believe 12 it's part of their review of the investment 13 committee minutes; and with that understanding, I 14 have no objection to its admission. 15 THE COURT: All right. Received. 16 Q. (BY MR. VEIS) Now, Ms. Carlton, is this 17 the investment policy that was given to the 18 examination team during the 1986 examination? 19 A. Yes, it is. 20 Q. Was the examination team told that this 21 was the investment policy that was in effect 22 during the 1986 examination? 17074 1 A. Yes, it was. 2 Q. Were you given any other investment 3 policies during the 1986 examination? 4 A. This is the only one I'm aware of. 5 Q. Now, did the examination team do a 6 complete review of USAT's securities transactions 7 during the 1986 examination? 8 A. No, we did not. 9 Q. What did the examination team do? 10 A. We identified the subsidiaries that 11 engaged in different investment securities, noted 12 the dollar amount, determined if they had the 13 basic documentation like the registers or 14 identified the portfolios to the tune that we 15 could disclose whether the information was 16 reported on the TFR report. In some cases, the 17 report did not reflect some of the activity that 18 the subsidiaries were actually engaged in. 19 Q. Did you look to see whether policies 20 were in place? 21 A. Yes, we did. 22 Q. Now, were you a specialist in 17075 1 mortgage-backed securities? 2 A. No, I'm not. No, I was not. 3 Q. I take it you're still not? 4 A. No, I'm not. 5 Q. Are you a specialist in hedging? 6 A. No, I'm not. 7 Q. And you weren't back in 1986 either? 8 A. No. 9 Q. Did you have any examiners in the 10 examination team who were specialists in 11 mortgage-backed securities? 12 A. In '86, no. 13 Q. Ms. Carlton, I'm going to hand you a 14 number of documents now; and hopefully, we can go 15 through these very quickly. It's Exhibit A14034, 16 Exhibit A14035, A14036, A14037, A14038, A14039, 17 A14039A, A14040, A14041, A14042, A14044, and 18 A14045. 19 Could you please look through those 20 documents while I distribute them to the Court? 21 A. (Witness complies.) 22 17076 1 (Discussion held off the record.) 2 3 Q. (BY MR. VEIS) Ms. Carlton, have you had 4 a chance to peruse those documents briefly? 5 A. Yes, I have. 6 Q. And do you recognize them as documents 7 from the work papers of the examination? 8 A. Yes, they are. 9 Q. I would like to just go through them 10 each very briefly. I would like to direct your 11 attention first to A14034. 12 Now, can you tell the Court what this 13 two-page document, A14034, is? 14 A. This document is a draft summary of a 15 comment that was made on USAT's engagement in 16 mortgage-backed securities. It addressed the 17 issue of United restating its first and second 18 quarterly earnings; and it addresses that that 19 work was conducted by Peat, their auditors. 20 MR. VEIS: Your Honor, I move the 21 admission of A14034. 22 MS. CLARK: No objection. 17077 1 THE COURT: Received. 2 Q. (BY MR. VEIS) Ms. Carlton, would a 3 mortgage-backed securities portfolio not only have 4 a longer comment than this -- let me start that 5 question over. 6 Would a mortgage-backed securities 7 portfolio as large as USAT's normally have a more 8 comprehensive comment concerning mortgage-backed 9 securities than this exhibit represents? 10 A. Yes. 11 MR. EISENHART: I'm not sure what her 12 basis for that would be. I thought she testified 13 that USAT's investment activities were far beyond 14 anything she had ever seen. I'm not sure what the 15 basis for "typically" would be. 16 MR. VEIS: I used the word "formally." 17 Let me first ask about mortgage-backed securities 18 portfolios in general. 19 Q. (BY MR. VEIS) Would they normally have 20 a more comprehensive comment that is represented 21 there? 22 MR. EISENHART: I'm not sure that 17078 1 solves the problem. I'm not sure he's established 2 that there's any base from which she could work. 3 THE COURT: Well, regardless of size? 4 MR. VEIS: Yes, Your Honor. 5 A. The comments provided here are 6 basically information that we received from the 7 auditors. We did not ourselves research this at 8 this time and go into any length. We relied on 9 the information that was provided by the auditors, 10 and we conducted an interview with the auditors 11 and reviewed their work and used that as our 12 support that they had used in the restatement of 13 those earnings. 14 Q. (BY MR. VEIS) Well, in a -- generally 15 speaking, in an institution that had a 16 mortgage-backed securities portfolio, would there 17 normally be a more comprehensive comment? 18 MS. CLARK: Your Honor, objection. If 19 you look at the document, it's clear, as she just 20 testified, that this is a summary of what happened 21 when they restated their earnings to recognize 22 gains that the accountants required them to 17079 1 recognize in connection with the rolldown. 2 Is he asking her whether, when a 3 mortgage-backed securities portfolio is required 4 to be restated by the auditors to recognize gains 5 that had been deferred, you would expect a longer 6 explanation of that because that's the only thing 7 she could compare it to? 8 THE COURT: All right. I'll sustain 9 the objection. 10 Q. (BY MR. VEIS) Did you do anything 11 further -- strike that. 12 Let me now address Exhibit A14035. 13 What is A14035? 14 A. These are notes that were taken when we 15 requested the work papers of Peat, Marwick, 16 Mitchell; and we made notes and copied data in 17 which they documented -- the approach was taken to 18 support their position in restating the earnings 19 for that quarter in '86. 20 Q. Why didn't you just Xerox those? 21 A. As a rule, when we review auditors' 22 work papers, we are not allowed to copy their work 17080 1 papers. But we can make notes or rewrite the data 2 that they provide to us. 3 Q. Is that what you did in this case? 4 A. Yes, it is. 5 Q. So, this is essentially information 6 that the examiners copied from the Peat Marwick 7 work papers? 8 A. That we redrafted from their work 9 papers. 10 MR. VEIS: Your Honor, I move the 11 admission of Exhibit A14035. 12 MS. CLARK: No objection. 13 THE COURT: Received. 14 Q. (BY MR. VEIS) Let me address A14036. 15 MS. CLARK: I'm sorry, Your Honor. 16 Could she at least identify the handwriting, 17 please? 18 MR. VEIS: I have no -- 19 THE COURT: Ms. Carlton, do you know 20 who wrote this document: 14035? 21 THE WITNESS: The first two pages is my 22 handwriting. The second two pages is an auditor 17081 1 that was my assistant. I don't have -- the 2 initials are not provided; so, I don't know the 3 person. But it would have been an auditor that 4 was assisting me on the exam. 5 Q. (BY MR. VEIS) That was one of the 6 Coopers & Lybrand auditors? 7 A. Yes. 8 Q. Let me now address Exhibit A14036. 9 A. Okay. 10 Q. What is this? 11 A. This is a document showing the 12 adjustments that were made for the March '86 13 mortgage-backed securities. This document was 14 prepared by the association. 15 Q. How do you know that? 16 A. In the left-hand corner, we have "PBA." 17 Q. Which means? 18 A. Meaning prepared by the association. 19 Q. And there's a note at the bottom of the 20 page. 21 Do you see that? 22 A. Yes, I do. 17082 1 Q. What does that relate to? 2 A. This is a reference that was made by 3 the examiner providing the source of the 4 information provided here by giving an explanation 5 for this work paper. 6 MR. VEIS: I move the admission of 7 Exhibit A14036. 8 MS. CLARK: No objection. 9 THE COURT: Received. 10 Q. (BY MR. VEIS) What use, if any, was 11 made of the information in Exhibit A14036? 12 A. It was just made a part to document the 13 actual transactions that we would have in record, 14 the sales that took place that were the underlying 15 documentation that lists the actual 16 mortgage-backed securities for that transaction. 17 Q. And these were the transactions as to 18 which there was a -- a restatement of income? 19 A. Yes, it was. 20 Q. Thank you. 21 Let me now address Exhibit A14037. 22 MR. VEIS: I would note for the record, 17083 1 Your Honor, that, again, we have made a color copy 2 of those pages of this document which were 3 difficult to copy otherwise. That would be the 4 first and last. I believe that may be a copy in 5 the record at Exhibit -- at Tab 587. However, I 6 would introduce that exhibit because the regular 7 Xerox copying has been very difficult because of 8 the highlighting on several of these pages, 9 particularly the last page. This is copied 10 directly from the work papers -- from the work 11 paper file. 12 Q. (BY MR. VEIS) Ms. Carlton, what is this 13 document? 14 A. This document shows the mortgage-backed 15 trades that were taking place at USAT between 16 December of '85 until June of nineteen -- well, 17 July of 1986. 18 Q. I think, actually, July is referenced 19 on a separate exhibit, I believe. 20 I'm sorry. You're right. There is a 21 July trade on the bottom of that last page. Is 22 that what you're referring to? 17084 1 A. Yes, I am. 2 Q. Now, in addition, I would like you to 3 look at A14038? 4 MS. CLARK: Is 14037 admitted? 5 MR. VEIS: Not yet. I haven't moved it 6 yet. 7 THE COURT: Are you going to? 8 MS. CLARK: Are you going to? 9 MR. VEIS: Well, I will at this time if 10 it will speed it up. 11 MS. CLARK: No objection. 12 THE COURT: Received. 13 Q. (BY MR. VEIS) Let me now address 14 A14038. 15 Do you see that? 16 A. Yes, I do. 17 Q. And what is that? 18 A. It is the trades for -- mortgage-backed 19 securities trades for July of '86; and at the 20 bottom, you also have two August transactions 21 noted on here. 22 Q. Two what transactions? 17085 1 A. August transactions. 2 MR. VEIS: Move the admission of 3 A14038. 4 MS. CLARK: No objection. 5 THE COURT: Received. 6 Q. (BY MR. VEIS) Now, who prepared 7 Exhibit A14037? 8 MS. CLARK: 37? 9 MR. VEIS: 37. 10 A. The institution would have prepared 11 this document. 12 Q. (BY MR. VEIS) What about A14038? Who 13 prepared that? 14 A. The institution prepared this document. 15 Q. Now, is it your understanding that 16 these were trades related to the restatement of 17 income in the first and second quarters of 1986? 18 A. They were provided as such. 19 Q. And did you do anything with these 20 documents other than put them in the work paper 21 file? 22 A. We reviewed to determine who the sales 17086 1 were with and just went through a general -- 2 looking at the coupon rates, the buy/sell 3 arrangements and the data that's contained, the 4 percentages that are shown here on these reports. 5 Q. That is to verify that the transactions 6 were those they reported them to be? 7 A. Correct. 8 Q. Let me now address A14039. 9 Do you recognize that document? 10 A. It's a comment on the interest rate 11 risk management. 12 Q. Is it part of the work papers? 13 A. Yes, it is. 14 MR. VEIS: Move the admission of 15 A14039. 16 MS. CLARK: No objection. 17 THE COURT: Received. 18 Q. (BY MR. VEIS) Ms. Carlton -- 19 MS. CLARK: Could you just clarify? Is 20 this a one- or two-page document? We've had some 21 confusion about this exhibit. 22 MR. VEIS: By my copy, it should be a 17087 1 one-page document with an attachment to -- the 2 issue relates to a page that, by my copy, I 3 believe should be attached to A14039A. Perhaps we 4 can get Ms. Carlton to clarify that because there 5 has been confusion between counsel on my side of 6 the table. 7 MS. CLARK: Just to clarify the report, 8 if I might, the documents are not Bates stamped; 9 so, we can't really tell what was attached to 10 what. But the first page we have which has an 11 illegible sticker on it has the title "Memo, re: 12 purchases of MBS." The next page we have is 13 headed "situation" and there's a work paper 14 reference on the bottom which appears to be WI101 15 and then 11 something which presumably is the 16 particular number. 17 THE COURT: Well, the copy that's been 18 provided to me is only one sheet. 19 MR. VEIS: I believe that's the way 20 it's supposed to be. 21 Q. (BY MR. VEIS) Ms. Carlton, looking at 22 Exhibits A14039 and A14039A, Exhibit 14039 is a 17088 1 memo, re: Interest rate risk management. 2 Exhibit 14039A is a memo, re: Purchases of MBS. 3 Now, attached to my copy of A14039A is 4 a second page which starts out with the word 5 "situation." Now, the question Ms. Clark has 6 raised is whether that page is properly attached 7 to A14039A or whether it's properly attached to 8 A14039, I believe. 9 A. They appear to be separate documents. 10 Q. Which -- 11 A. The interest rate risk management is 12 one document, stand-alone. 13 Q. A one-page document? 14 A. A one-page document, stand-alone. And 15 the Bates stamp 39A that addresses purchases of 16 mortgage-backed securities, the situation side of 17 it appears to be a continuation discussion of the 18 purchase of mortgage-backed securities. 19 Q. So, it should be attached to the 20 document that's been marked A14039A; is that 21 correct? 22 A. Yes. 17089 1 MR. VEIS: Your Honor, I hope that 2 clears up the confusion. If Ms. Clark has 3 additional questions -- 4 MS. CLARK: No. Thank you. That 5 clarifies it for us. 6 THE COURT: Are you offering A14039A? 7 MR. VEIS: I will offer both: 14039 8 and 14039A. 9 MS. CLARK: No objection. 10 THE COURT: Received. 11 MR. VEIS: Thank you, Your Honor. 12 Q. (BY MR. VEIS) Now, with respect to 13 14039 relating to interest rate risk management, 14 did the examination team complete the examination 15 program with respect to interest rate risk 16 management? 17 A. No. They did a discussion with the 18 person that was responsible for that area and 19 documented what was purported in this memo. 20 Q. And was there any analysis of interest 21 rate risk management? 22 A. Not from this, no. 17090 1 Q. And why was that? 2 A. Because we did not -- at that time, we 3 did not take the time to complete the examination 4 for '86 and go into detailed reviews. 5 Q. This is because you had been told to 6 leave? 7 A. That's correct. 8 Q. Now, let's turn to 14039A. Did you 9 complete the program, examination program, with 10 respect to purchases of mortgage-backed 11 securities? 12 A. No, we did not. 13 Q. And why was that? 14 A. Because we had been asked to leave and 15 did not complete the work. 16 Q. It was going to be addressed in a 17 subsequent examination? 18 A. Yes. 19 Q. Let me direct your attention to A14040. 20 What is A14040? 21 A. This is a discussion with the auditor 22 with Mary Mims who was responsible for this area 17091 1 which they addressed how interest rate swaps were 2 handled at the institution. 3 Q. Did the examination team complete the 4 examination program with respect to interest rate 5 swaps? 6 A. No, we did not. 7 Q. Did the examination team do any 8 analysis of interest rate swaps in the 1986 9 examination? 10 A. Only a general swap of the basic 11 information type activity in our report. 12 Q. So, it was very limited? 13 A. Yes. 14 Q. Why was that? 15 A. Because we had been asked to leave the 16 institution. 17 Q. Now, did anyone at United Savings 18 Association of Texas ever tell you that the 19 interest rate swaps were $12 million under water 20 at that time? 21 A. No, not that is noted in this comment. 22 Q. Is that something you would have noted 17092 1 in the work papers? 2 A. It possibly could have been noted in 3 the work papers. 4 Q. If you had been told, would you have 5 noted it? 6 A. Typically, we note all losses in the 7 portfolio. 8 MR. VEIS: Your Honor, I move the 9 admission of A14040. 10 MS. CLARK: No objection. 11 THE COURT: Received. 12 Q. (BY MR. VEIS) Let me turn now to 13 A14041. 14 What is A14041, Ms. Carlton? 15 A. It demonstrates a discussion that the 16 auditors had with Mary Mims who was responsible 17 for reverse repurchase swaps in which she 18 explained how they were handled at the 19 institution. 20 Q. Let me first -- just a quick question. 21 You mentioned the auditors. When you use that 22 term, are you speaking of the Coopers & Lybrand 17093 1 auditors who were members of the examination team? 2 A. Yes, I am. 3 Q. So, you're not speaking of Peat, 4 Marwick, Mitchell? 5 A. No, I'm not. 6 Q. The institution's auditors? 7 A. No, I'm not. 8 Q. Now, this is a work paper that's 9 included in the examination work paper files? 10 A. Yes, it is. 11 MR. VEIS: Move the admission of 12 A14041, Your Honor. 13 MS. CLARK: No objection. 14 THE COURT: Received. 15 Q. (BY MR. VEIS) Now, Ms. Carlton, this 16 document, A14041, discusses relationships between 17 mortgage-backed securities, reverse repurchase 18 agreements, and interest rate swap agreements; is 19 that correct? 20 A. Yes, it does. 21 Q. Is there an examination program for 22 that subject area? 17094 1 MS. CLARK: Objection. Could you 2 clarify what time period you're talking about? 3 You're speaking in the present tense, and I think 4 the relevant question was whether there was an 5 examination program at the time of the 1986 exam. 6 Q. (BY MR. VEIS) Was there an examination 7 program at the time of the 1986 examination that 8 would have covered this area? 9 A. Yes, there was. 10 Q. Did the examination team complete that 11 program? 12 A. No, we did not. 13 Q. Did the examination team do any 14 analysis on the subject of mortgage-backed 15 securities, reverse repos, and swaps? 16 A. Not beyond what you see here. 17 Q. And why was that? 18 A. Because we had been asked to leave. 19 Q. Would that subject matter be covered in 20 another examination? 21 A. Yes, it will be. It was. 22 Q. Let me address now A14042. What is 17095 1 A14042? 2 A. This is a document prepared by the 3 institution that shows the swap instruments that 4 was in place at that time, and the additional 5 support behind it is the report that also 6 identified the swap party and the terms and 7 conditions of those agreements that were in place. 8 Q. Is it part of the work paper -- 9 examination work papers in the examination file? 10 A. Yes, it is. 11 MR. VEIS: I move the admission of 12 A14042. 13 MS. CLARK: No objection. 14 THE COURT: Received. 15 Q. (BY MR. VEIS) Now, what would the 16 examination team have used A14042 for? 17 A. It would just document the actual swaps 18 that were on the institution's books and provided 19 us a part of the work papers to support the 20 numbers that were reported at that time period. 21 Q. Did the examination team do anything 22 with this information? 17096 1 A. Beyond filing it, no. 2 Q. Why was that? 3 A. Because we had been asked to leave the 4 institution. We did not do a thorough analysis of 5 the securities area. 6 MR. VEIS: Might I have a moment, 7 Your Honor? 8 THE COURT: Yes. 9 10 (Discussion held off the record.) 11 12 Q. (BY MR. VEIS) Let me address A14044. 13 THE COURT: What's your question? 14 MR. VEIS: I was waiting for 15 Ms. Carlton to look at the document so we could 16 identify it, Your Honor. 17 A. I see it. 18 Q. (BY MR. VEIS) What is it? 19 A. It's a group of schedules that shows 20 the gains and sales and securities transactions 21 along with the accounting that was taken with 22 these transactions. 17097 1 Q. What securities does it address? 2 A. It addresses mortgage-backed 3 securities. 4 Q. And does it also address high-yield 5 bonds or any purchases of equities? 6 A. (Witness reviews the document.) 7 THE COURT: Are we looking at the same 8 exhibit? 9 MR. VEIS: A14044, Your Honor. 10 THE COURT: Doesn't seem to me like -- 11 A. It was just securities transactions. 12 Q. (BY MR. VEIS) Can you tell from any of 13 the entries whether they involve stock 14 transactions? Let me direct your attention to 15 Page 1 of a series of pages that are headed "USAT 16 securities transactions." 17 A. It does engage -- you have Union 18 Carbide stock and Eckerd's stock; so, you do have 19 stock references. 20 Q. So, does this relate to the equity 21 arbitrage portfolio, do you think; or do you know? 22 A. Yes, it -- it would -- that portfolio 17098 1 of investment did deal with arbitrage activity. 2 Q. And who prepared these? 3 A. The association. 4 Q. Was this included in the examination 5 work paper files? 6 A. Yes, it was. 7 MR. VEIS: Your Honor, I move the 8 admission of A14044. 9 MS. CLARK: No objection. 10 THE COURT: Received. 11 Q. (BY MR. VEIS) Now, directing your 12 attention to the page immediately following the 13 cover page, it says "sales transactions." It's 14 headed "USAT securities transactions gain/loss on 15 sale and purchase accounting." 16 A. That's under 044? 17 Q. That's under 044, yes. 18 A. And which page? 19 Q. The first page following the cover. 20 A. Okay. 21 Q. Now, does that relate to high-yield 22 bond activity? 17099 1 MR. EISENHART: I'm not sure I'm on the 2 same page. I've got 14044. The first page is, 3 more or less, blank. The second page is headed 4 "USAT securities transactions gain/loss on sale 5 and purchase accounting." 6 MR. VEIS: That's precisely what I'm 7 referring the witness to. 8 MR. EISENHART: That was also the page 9 you were on when you had her identify Union 10 Carbide a minute ago? 11 MR. VEIS: No. That's the following 12 one. 13 MR. EISENHART: Okay. We're now on the 14 same page. 15 MR. VEIS: I hope we're all on the same 16 page. 17 Q. (BY MR. VEIS) Ms. Carlton? 18 A. Yes. This appeared to be on the 19 high-yield bonds. 20 Q. And was there a program -- an 21 examination program relating to high-yield bonds? 22 A. Yes, we did have one. 17100 1 Q. Was it complete? 2 A. No, it was not. 3 Q. Why not? 4 A. Because we had been asked to leave the 5 institution. 6 Q. Let me address A14045. I'm sorry. 7 Ms. Carlton, do you see Exhibit A14045? 8 A. Yes, I do. 9 Q. And what is it? 10 A. It's a document prepared showing the 11 mortgage-backed trading activity at July of '86. 12 Q. Who prepared it? 13 A. This was prepared by the institution. 14 Q. Was it provided to you for inclusion in 15 the work paper files? 16 A. Yes, it is. 17 MR. VEIS: I move the admission of 18 A14045. 19 MS. CLARK: No objection. 20 THE COURT: Received. 21 Q. (BY MR. VEIS) This relates to 22 mortgage-backed securities, correct? 17101 1 A. Yes, it does. 2 Q. And you've previously testified you did 3 not complete the program on mortgage-backed 4 securities? 5 A. Right. 6 Q. Thank you. 7 THE COURT: We'll adjourn until 1:30. 8 9 (Whereupon, a lunch break was taken 10 from 12:12 p.m. to 1:34 p.m.) 11 12 THE COURT: Be seated, please. We'll 13 be back on the record. 14 Mr. Veis, you may continue. 15 MR. VEIS: Thank you, Your Honor. 16 During the break, Ms. Clark brought an issue of 17 terminology to my attention that I need to clarify 18 so that in the further examination of Ms. Carlton, 19 we know exactly what we're referring to. I had 20 asked Ms. Carlton about the completion of 21 examination programs in 1986. Ms. Clark brought 22 to my attention and Ms. Carlton confirmed that the 17102 1 word "programs" was not officially attached to the 2 activities that I was referring to; and I would 3 like to clarify exactly what it was we were 4 dealing with, if I may. 5 Q. (BY MR. VEIS) Ms. Carlton, I would like 6 to show you an exhibit that has been marked as 7 Exhibit A14098. 8 Can you please explain what that 9 exhibit is? 10 A. This is an exhibit that, in 1986, were 11 the guidelines for reviewing different areas of 12 the examination in which it provided space for you 13 to document your work paper references. And in 14 1986, it's called examination worksheet. 15 Q. Now, was it materials of this type you 16 were referring to when I asked you about programs? 17 A. That's correct. 18 MR. VEIS: Now -- Your Honor, I move 19 the admission of A14098. 20 MS. CLARK: No objection. 21 THE COURT: Received. 22 Q. (BY MR. VEIS) If you could, explain the 17103 1 use of A14098 and other examination worksheets. I 2 notice there is a section under the "topics" line 3 there. Please explain what those relate to. 4 A. These provide the minimum procedures 5 that should be followed just cursory in your 6 analysis of an area. The additional topics at the 7 bottom provide your specific regs and memorandums 8 that would provide you further guidance as far as 9 procedures to follow in review of the categories 10 that this worksheet addresses, and the topic for 11 this is -- "securities tradings" is the category. 12 Q. And for each examination topic, was 13 there a separate examination worksheet? 14 A. Yes, it is. 15 Q. Is that examination worksheet utilized 16 to index the work papers for the subject under 17 review? 18 A. Yes. If you noticed, the exhibits that 19 you were questioning prior to that, the 1A is in 20 reference to this index on this exhibit on 98. 21 Q. Let me just direct you particularly 22 to -- let's see -- Exhibit A14034 which we 17104 1 reviewed just prior to lunch. That would be the 2 memo, re: Mortgage-backed securities? 3 A. Yes. 4 Q. Now, at the bottom of that page, is 5 there a work paper number? 6 A. Yes. You have 101 -- you have WI1011A. 7 And if you look under the "topics" at 98, you have 8 the WI101 as an index reference. And if you look 9 at the bottom, the first one is 1A as the 10 reference. 11 Q. So, at the bottom, under the item "work 12 papers," under "title" where it says 13 "mortgage-backed securities," that would be a 14 reference to the work papers in Exhibit A14034? 15 A. That's correct. 16 MS. CLARK: On the actual copy, is the 17 "A" legible? 18 MR. VEIS: It is on my copy. 19 A. It's not exactly clear on mine. Looks 20 more like an "H" on the copy. It's an "A," but it 21 looks like an "H." 22 MS. CLARK: Thank you. 17105 1 Q. (BY MR. VEIS) Is it your testimony that 2 all work papers were indexed in this fashion? 3 A. Yes, in '86. 4 Q. In '87, was there a change in the 5 terminology employed with respect to -- was there 6 a document in the examination work papers in 1986 7 that was similar to the examination worksheet 8 that's A14098? 9 A. Yes, it is. But instead of it being 10 called examination worksheet, it was called 11 examination program. 12 Q. And did it set forth objectives and 13 standards, as well? 14 A. Yes. 15 Q. So, when I asked you about completing 16 programs with respect to 1986 work papers earlier 17 today, were you referring to a completion of the 18 examination objectives set forth on the 19 examination worksheet relating to each of the 20 areas that I asked about? 21 A. That's correct. 22 Q. Now, was there also something called an 17106 1 EOP manual in 1986? 2 A. Yes, it was. 3 Q. What was that? 4 A. That was the policies and procedures 5 manual for the examination of institutions. In 6 1987, we had a change in manual; and it was called 7 thrift activity manual versus EOP manual. 8 Q. And with respect to 1986, did the EOP 9 manual provide somewhat of a more detailed 10 guidance on the examination of particular areas 11 than the examination worksheets did? 12 A. The worksheet is just a limited 13 narrative of -- the policies and procedures is a 14 procedures draft-written manual that provides 15 procedures and guidelines to follow. 16 Q. It tells you exactly what to do? 17 A. Exactly. 18 Q. That's part of what we referred to 19 earlier as a program? 20 It's not part of the program; but it's 21 part of the procedures that you follow, correct? 22 A. Correct. 17107 1 MS. CLARK: Is she talking about the 2 EOP or the later version? 3 MR. VEIS: I was talking about 1986, 4 which was the EOP. 5 MS. CLARK: Thank you. 6 Q. (BY MR. VEIS) And in 1987, there was 7 the thrift activities manual; is that correct? 8 A. That's correct. That replaced the EOP 9 manual. 10 Q. And did it provide more detailed 11 procedures in 1987 -- that is, the thrift 12 activities manual, did it provide more detailed 13 procedures in 1987 than what was set forth on the 14 programs that are in the work papers? 15 A. Yes, it does. 16 Q. Thank you. 17 MR. VEIS: I hope that's clarified the 18 issue for Ms. Clark, and I appreciate her bringing 19 it to my attention. 20 Q. (BY MR. VEIS) Let me ask you about an 21 exhibit that's been marked A14046. What is 22 A14046? 17108 1 A. It's a summary comment on the equity 2 arbitrage of United and its investment and 3 securities for both UFG, the holding company, and 4 UFC, a subsidiary of United. 5 Q. This was with respect to the equity 6 arbitrage program? 7 A. Yes. 8 Q. Does it summarize the information that 9 was available to the examiners in the 1986 10 examination? 11 A. Yeah. It spells out the goal as 12 purported by the institution. 13 MR. VEIS: Now, Your Honor, I move the 14 admission of A14046. 15 MS. CLARK: No objection. 16 THE COURT: Received. 17 Q. (BY MR. VEIS) Now, did you complete the 18 examination objectives for the equity arbitrage 19 segment of the examination in 1986? 20 MS. CLARK: Your Honor, is he referring 21 to a document like the one he's just introduced? 22 Was there a sheet like this -- is that the 17109 1 question -- that governed the examination of the 2 arbitrage? 3 MR. VEIS: That's the question. 4 A. No, we didn't. 5 Q. (BY MR. VEIS) And why was that? 6 A. Because we were asked to leave. 7 Q. Ms. Carlton, I show you now a document 8 that's been marked A14054. 9 Could you tell the Court what A14054 10 is? 11 A. This is a summary of the review of 12 minutes from 1986 -- through 1986 for the board of 13 directors meetings at United. 14 Q. Do you know who prepared it? 15 A. I did. 16 MR. VEIS: Your Honor, I move the 17 admission of A14054. 18 MS. CLARK: No objection. 19 THE COURT: Received. 20 Q. (BY MR. VEIS) Ms. Carlton, I would like 21 to direct your attention -- well, first, let me 22 ask you a question. 17110 1 What does this actually represent? Did 2 you review all of the minutes? 3 A. Yes. We go through -- at the 4 commencement of an examination, you request all 5 minutes from the previous examination to the 6 current examination; and you review those minutes 7 in a highlighted summary portion. You first 8 identify what is called routine business. And 9 after that, you select items that you feel is 10 significant for the exam or should be covered in 11 other areas and highlight those points. 12 In some cases, instead of drafting a 13 narrative, you may copy a portion of those minutes 14 or copy the minutes themselves if you want to use 15 a certain attachment as a reference work paper to 16 be a part of that review. 17 Q. So, this represents your selection of 18 what appeared to be a significant deal at the time 19 you reviewed the board minutes. Is that what 20 you're saying? 21 A. That's correct. 22 Q. Let me address your attention to the 17111 1 Bates numbers -- they appear to be OW121042. It 2 appears the Bates number did not copy, but it's 3 between the Bates numbers ending 41 and 43. 4 A. Do you have a date? 5 Q. August 29, 1984. 6 A. Okay. 7 Q. Do you see in the middle of the page 8 under that date, August 29, 1984, a reference to 9 Weingarten Realty? 10 A. Yes. 11 Q. And could you explain what significance 12 that has for the examination? 13 A. Weingarten Realty was one of the -- UFC 14 is a subsidiary of USAT; and here, it is showing 15 the investment -- that they had purchased 16 36 percent of Weingarten Realty, a large shopping 17 development in Texas. And it shows that this 18 investment was accounted for on an equity basis in 19 the equity investment securities. 20 Q. Now, do you have questions about the 21 investment in Weingarten Realty as involving some 22 sort of conflict of interest or some sort of 17112 1 affiliated party transaction? Do you recall? 2 A. We looked at the ownership of 3 Weingarten Realty for possibly an area in which it 4 could have been indirectly or directly involved 5 with the owners of Weingarten Realty and officers 6 and directors of the institution. 7 Q. And that would be Mr. Hurwitz and 8 Mr. Gross? 9 A. Yes. 10 Q. Let me direct your attention forward to 11 the next page, OW121043. In particular, I would 12 be directing you to the entry under January 25th, 13 1984. It goes over to the following page. I 14 would like you to please review that and let me 15 know when you're finished. 16 A. (Witness reviews the document.) Okay. 17 Q. What's the general nature of the 18 discussion there of Castle & Cooke, Inc.? 19 A. It shows there are advances that had 20 been made to Castle & Cooke, Inc. -- 21 Q. Do you mean investments? 22 A. Advances to that subsidiary. 17113 1 Q. Oh, I'm sorry. 2 A. They had made advances to the 3 subsidiary of $59 million. 4 Q. That was used to invest in 5 Castle & Cooke. 6 Is that how you read that? 7 A. That was funds used as part of their 8 investment to purchase, yes. 9 Q. Now, directing your attention forward 10 to the next page, do you see a -- an entry there 11 that begins, "Recent annual reports and 10Ks of 12 Castle & Cooke"? 13 A. Yes. 14 Q. And then it discusses Mr. Hurwitz. 15 Do you see that? 16 A. Yes. 17 Q. Now, what did you understand that entry 18 to mean? 19 A. That Mr. Hurwitz was describing the 20 activities of Castle & Cooke to the board of 21 directors in which they were making decisions to 22 invest in. 17114 1 Q. And this was the board of directors of 2 United Savings Association of Texas? 3 A. Yes, it was. 4 Q. Do you know whether Mr. Hurwitz was a 5 member of the board of directors of United Savings 6 Association of Texas? 7 A. He was not. 8 Q. Do you know if he had an ownership 9 position in the holding company for United Savings 10 Association of Texas? 11 A. He did. 12 Q. Do you know whether he was in a 13 position to exercise influence over the affairs of 14 United Savings Association of Texas? 15 A. Based on his position of ownership, he 16 could have exerted either implied or unimplied 17 pressures or powers. 18 Q. Do you know at the time whether any 19 entity with which Mr. Hurwitz was affiliated owned 20 stock in Castle & Cooke? 21 A. Was I aware of -- 22 Q. Do you know at the time whether any 17115 1 entity with which Mr. Hurwitz was affiliated owned 2 stock in Castle & Cooke? 3 A. At the time of reviewing these minutes, 4 no. 5 Q. What about later? 6 A. We did an analysis of Mr. Hurwitz' 7 ownership as a part of the '87 examination. 8 Q. And what did you find? 9 A. It will be reflected in that report. I 10 don't know just -- 11 Q. You don't know? 12 A. No. 13 Q. Now, did you ascribe any significance 14 to this entry in the minutes? 15 A. It was highlighted as one item of 16 showing Mr. Hurwitz' involvement into the 17 transactions and affairs of the institution. 18 Q. Did you draw any final conclusions with 19 respect to Mr. Hurwitz' involvement? 20 A. It was just one note among a collection 21 that we maintained. 22 Q. So, there were no final conclusions? 17116 1 A. Not at this point, no. 2 Q. Well, when you note something, does 3 that mean you want to keep it in mind for the 4 future? 5 A. And pass it on to the individuals that 6 were assisting me that was part of their analysis 7 to also look for. 8 Q. Thank you. 9 Ms. Carlton, I'll show you now a 10 document that's been marked A14055A. Please take 11 just a moment to peruse that and see if you 12 recognize it. 13 A. (Witness reviews the document.) 14 MR. VEIS: Excuse me, Your Honor. Did 15 we admit the previous exhibit, 14054? 16 THE COURT: Yes, that's admitted. 17 MR. VEIS: Thank you. 18 A. This document represents a review of 19 investment committee minutes. In the middle of 20 the document you'll find where another person also 21 reviewed part of the minutes. So, it's a 22 combination of me reviewing investment committee 17117 1 minutes and another person reviewing minutes. And 2 you're using the same concept, that we go back 3 from the previous exam and come forward and review 4 all minutes maintained during that period of time. 5 Q. (BY MR. VEIS) So, it's the same process 6 as you used with respect to the board of directors 7 minutes? 8 A. To the board of directors minutes, 9 that's correct. 10 Q. Let me address -- 11 MS. CLARK: Excuse me. Before you 12 proceed, there are some problems with this 13 document. Do you want to move its admission? 14 MR. VEIS: I move the admission of 15 A14055A. 16 MS. CLARK: Your Honor, my copy of this 17 document is missing several pages based on the 18 Bates numbers; and it also bears highlighting that 19 was apparently put on the document by litigation 20 counsel. We have a copy of this that we made from 21 the work papers a year and a half ago which does 22 not bear the highlighting. 17118 1 MR. VEIS: Which highlighting are you 2 referring to? 3 MS. CLARK: It's been done sometime 4 recently. 5 MR. VEIS: Are you referring to the 6 second page? 7 MS. CLARK: Yes. 8 MR. VEIS: Let me clarify that with 9 Ms. Carlton. I believe -- it may not have come 10 through on whatever copy you had. It was 11 certainly not put on by us. 12 Q. (BY MR. VEIS) Ms. Carlton, is the 13 exhibit before you, 14055A, a copy of the work 14 papers as they were in their present condition in 15 the work paper files? 16 A. Yes, it is. 17 Q. And was the highlighting in the work 18 papers as they are currently in the work paper 19 files? 20 A. I don't know how you can tell the 21 difference without -- but we can -- 22 MR. VEIS: Well, Your Honor, in the 17119 1 first instance, I think the presence of that 2 highlighting on the second page is certainly 3 inconclusive. I would note for the record that 4 the work papers previously admitted as 5 Exhibit A14037 had highlighting and, indeed, were 6 copied in color for precisely that reason. These 7 are the work papers in the condition that they are 8 in the files of the OTS; and they certainly have 9 not been highlighted by anyone in the litigation 10 team, to my knowledge. I don't believe it's 11 material to the exhibit; and, indeed, I had no 12 intention of asking about the highlighted items in 13 any event. 14 MS. CLARK: Your Honor, I agree that 15 the highlighting is not material; and provided 16 that a -- that the copy that goes into the 17 official record has all the pages, I do not have 18 an objection. I would just request if I could be 19 provided with a copy with all the pages so that I 20 can follow along with the examination. 21 MR. VEIS: Which pages are missing? 22 MS. CLARK: My copy is missing 166 and 17120 1 176. 2 MR. VEIS: Okay. 3 MS. CLARK: It could well be the 4 problem's on our end. I just would like to be 5 able to follow along. 6 MR. VEIS: 166 and what? 7 THE WITNESS: It's the front and back 8 document. 9 THE COURT: What's the first page of 10 the document numbered? 11 MR. VEIS: The first page of the 12 document, I believe, is OW121166. 13 MS. CLARK: I'm informed that the first 14 page is 165 and that 166 is missing. 15 Q. (BY MR. VEIS) Ms. Carlton -- 16 A. It's on the back, and it's a front and 17 back situation. 18 MR. VEIS: I see the problem. We'll 19 address that. What about the other document? 20 THE WITNESS: What was the other 21 number? 22 MS. CLARK: The two that I saw were 17121 1 missing were 166 and 176 from my copy. 2 THE WITNESS: Again, it's on the back. 3 MS. CLARK: And the other thing about 4 the document that should be fixed is, I believe, 5 174 and 173 are reversed. 6 MR. VEIS: It would appear so. 7 THE COURT: You want to offer a 8 corrected exhibit at a later time? 9 MR. VEIS: Yes, Your Honor, I would. 10 Actually, since I don't have those pages either, I 11 don't intend to ask any questions about them. I 12 don't think it will affect the course of the 13 examination. Yes, I will offer a corrected 14 version. May we have this admitted tentatively 15 pending the receipt of the corrected version 16 later? 17 MS. CLARK: That's fine with us, 18 Your Honor. 19 THE COURT: All right. Received on 20 that condition. 21 MR. VEIS: Thank you, Your Honor. 22 We will retrieve the original exhibit 17122 1 and make appropriate copies of the pages that were 2 not copied in reverse and insert them in the 3 copies for counsel and the Court. 4 THE COURT: Thank you. 5 Q. (BY MR. VEIS) Directing your attention 6 to the entry on the first page of A14055A which is 7 dated April 24th, 1986, do you see that? 8 A. Yes. 9 Q. Now, I would like to ask you about that 10 first paragraph. It says, quote, "The association 11 established the following investment goals: (1) 12 protection of capital, (2) the spread between 13 interest to be received from the corporate debt 14 security and the association's cost of funds, and 15 (3) capital appreciation." 16 Do you see that entry? 17 A. Yes. 18 Q. Now, did anyone ever mention any other 19 investment goals with respect to corporate debt 20 securities? 21 A. You have this and what you have in the 22 business plan. 17123 1 Q. And by "corporate debt security," do 2 you take that to mean junk bonds? 3 A. Yes. 4 Q. Now, is there anything in that set of 5 investment goals that would indicate that United 6 Savings Association of Texas intended to make 7 sales out of the high-yield bond portfolio for the 8 purposes of generating a gain to bolster profits? 9 A. No. 10 Q. Now, let me take you forward to 11 Exhibit OW -- I'm sorry -- to Bates No. OW121181. 12 Actually, let me direct your attention 13 back two pages before that to OW121179A before we 14 go to that. 15 A. Okay. 16 Q. Now, do you see a discussion there of, 17 in the third paragraph, a memorandum concerning 18 the UFG and USAT investment policy? 19 A. Yes. 20 Q. Now, following that, it says it was 21 adopted after full discussion. 22 Do you see that? 17124 1 A. Yes. 2 Q. And the next paragraph asserts that the 3 investment policy memorandum concerning 4 mortgage-backed security prepayment speed 5 assumptions were attached to the minutes of the 6 investment committee meeting; is that correct? 7 A. That's correct. 8 Q. Now, the date on this, if you look at 9 the previous page, is what? 10 A. May 27th, '86. 11 Q. I believe that's -- is that the 28th? 12 I'm talking about the date of the meeting, not the 13 date of the investment policy. 14 A. May 28th, '86. 15 Q. Now, if you would turn forward to the 16 investment policy. 17 A. It has a date of May 27th, '86. 18 Q. Now, is this a copy of the policy that 19 was attached to the investment committee minutes? 20 A. Yes, it is. 21 Q. And is this -- does this appear to be 22 identical to the investment policy we discussed 17125 1 earlier which was Exhibit A14033? 2 A. It would be the same base data with the 3 one in the earlier exhibit having marks and 4 comments on it. 5 Q. But otherwise identical? 6 A. Otherwise, it's the -- basically 7 identical. 8 Q. Does that confirm that the May 27, 1986 9 investment policy was the policy that was in 10 effect at United Savings Association of Texas 11 during the time you were performing the field work 12 for the 1986 examination of the institution? 13 A. Yes, it does. 14 Q. Now, what happened after the 15 examination was completed? 16 A. After the examination was completed, I 17 went on to the next examination; and the report 18 was submitted to the field manager and transmitted 19 to Dallas and reviewed in Dallas and transmitted 20 on to Washington, D.C. for further considerations. 21 Q. Now, did there come a time when 22 independent third parties were asked to review 17126 1 aspects of the operations of United Savings 2 Association of Texas? 3 A. Yes, it was. 4 Q. Please tell us about that. 5 A. Sometime between the '86 examination 6 and the 1987 examination, the supervisory agent, 7 along with other individuals, made a decision that 8 a third-party review should be conducted on the 9 financial books and records of the institution and 10 the investment securities portfolio. For the 11 investment securities portfolio, they hired out a 12 securities firm, Prudential-Bache, in order to 13 conduct that review. For the review of the books 14 and records, they contracted out an audit firm in 15 order to conduct that examination in an effort to 16 clarify or to substantiate the findings of the '86 17 examination. 18 Q. Now, with respect to the findings of 19 the examination relating to the maintenance of 20 books and records, did the independent third-party 21 reviewer substantiate the examiner's findings? 22 MS. CLARK: Your Honor, may we find out 17127 1 if she had any contact with the people who 2 conducted it or if she was in any way involved in 3 it before she starts answering these questions? 4 Q. (BY MR. VEIS) Did you attend a meeting 5 with institution management and Mr. Twomey 6 concerning the third-party reviews? 7 A. Yes. Prior to the examination, a 8 meeting was held with the management of the 9 institution with certain regulators; and the 10 institution was informed that a third-party review 11 had been conducted. And I was called in at that 12 point and informed of the third-party review that 13 had taken place. 14 Q. This was while management was present; 15 is that correct? 16 A. That's correct. 17 Q. This was before the 1987 examination? 18 A. Yes. They were told of the findings of 19 that examination, was informed that I would also 20 be the next EIC of the next examination that would 21 take place. 22 Q. Now, what was the institution's 17128 1 management told concerning the results of the 2 review by the third parties of the maintenance of 3 the books and records? 4 MR. KEETON: Your Honor, that's 5 hearsay. I object. 6 THE COURT: Denied. 7 A. They were told, in essence, that the 8 findings of the '86 exam were substantiated and 9 that as we commenced the 1987, that the role I 10 would be playing as being the examiner-in-charge 11 was to make sure that those corrections had been 12 corrected and that conditions were improved and -- 13 either improved or corrected during the 1987 14 examination. 15 Q. (BY MR. VEIS) Ms. Carlton, I would now 16 like to show you a document that has been marked 17 A14058. 18 Ms. Carlton, what is Exhibit A14058? 19 A. This is a pre-examination analysis of 20 what we referred to as a scope memorandum. It 21 sets out the guidelines that should be followed in 22 conducting an examination. 17129 1 Q. Is this scope memorandum specifically 2 tailored to United Savings Association of Texas? 3 A. No, it's not. It's generic, and it's a 4 copy that is sent to all institutions. 5 Q. This doesn't have anything -- the areas 6 in particular are simply areas that would be 7 examined in any institution? 8 A. Yes, it is. 9 Q. But this scope memorandum has, as a 10 subject, United Savings Association of Texas, 11 correct? 12 A. Yes, it does. 13 Q. And it was addressed to you as 14 examiner-in-charge? 15 A. Yes, it was. 16 MR. VEIS: Your Honor, I move the 17 admission of A14058. 18 MS. CLARK: No objection. 19 THE COURT: Received. 20 Q. (BY MR. VEIS) Now, Ms. Carlton, I show 21 you an exhibit that's been marked A14059. 22 Do you know what A14059 is? 17130 1 A. This is a special scope memorandum that 2 was provided during the 1987 examination. This 3 scope was provided from the supervisory agent, 4 Neil Twomey, and Ginger Baugh, who was the analyst 5 at the time. And it was addressed to myself and 6 Joe Cooper who was the field manager at that time. 7 Q. Now, does this specifically identify 8 areas of concern at United Savings Association of 9 Texas? 10 A. Yes. This memo is bridging the gap 11 between the -- bringing forward issues that were 12 still outstanding from the previous 1986 exam with 13 additional concerns that was made by the 14 supervisory agent and making it a part of the 15 scope for the review for the 1987 examination. 16 Q. What specific areas were you told to 17 look into in 1987? 18 A. The first one is to complete the review 19 of the general and specific reserves. The second 20 one is to complete the review of Couch loans. The 21 third one is to review several classified loans in 22 which you had a dispute over the classification. 17131 1 The fourth one is to review investment securities. 2 And it states that an overall review was warranted 3 at that time, and it addresses the third-party 4 review. No. 5 addresses the ownership of the 5 institution, and we were -- they are specifically 6 interested in any ownership either directly or 7 indirectly owned by Mr. Hurwitz. The sixth one is 8 transactions with affiliates. We were directed to 9 review any interested loans or other transactions 10 between United, its holding company, its 11 subsidiaries, or any company owned or controlled 12 by Mr. Hurwitz. 13 Q. Let me go back up to Item 1. Perhaps 14 we have addressed this. But I notice the second 15 sentence under Item 1 says, "The subject of 16 United's reserves has not been resolved since the 17 examination as of May 27, 1986. Therefore, it has 18 not yet been determined whether the amount of 19 general loan loss reserves which has been included 20 in United's calculation of its minimum net worth 21 requirement is accurate." 22 Do you see that? 17132 1 A. Yes. 2 Q. Can you explain that? 3 A. On "2," the institution reports and 4 reflects in their books what has been directed by 5 the regulators as reserves to establish and 6 actually book those reserves. And until they 7 properly classify the assets as directed by the 8 regulators, then any calculations made off of 9 those numbers are -- are questionable or does not 10 reflect the actual condition of the institution as 11 directed by the regulators. Therefore, you cannot 12 assess whether those numbers are accurately 13 reflecting the true condition of that institution. 14 Q. Now, Item 3 talks about loans 15 classified or otherwise criticized in the 1986 16 examination. 17 Do you see that? 18 A. Yes. 19 Q. It indicates that some are still being 20 disputed by United's management? 21 A. That's correct. 22 Q. Now, perhaps we've addressed this 17133 1 before; but is it unusual to have a dispute last 2 until the next examination? 3 A. Yes, it is. 4 Q. One of those loans was the Stephen 5 Block loan? 6 A. Yes, it is. 7 Q. Ms. Carlton, I'd like to show you now a 8 document that's been marked as A14061. 9 MR. VEIS: I'm not sure I moved the 10 admission of A14059. 11 MS. CLARK: No objection. 12 THE COURT: Received. 13 MR. VEIS: Thank you, Your Honor. 14 For the record, Your Honor, I would 15 note that a portion of this exhibit apparently has 16 been introduced under Tab 980 as A12165. I note 17 that A14061 differs in that there are different 18 Bates numbers attached, there are different 19 marginal comments, and there are attachments that 20 are not in A12165. In addition, I'll represent 21 that this is the document that was contained in 22 the work paper files; and upon identification, 17134 1 I'll move its admission. 2 Q. (BY MR. VEIS) Ms. Carlton, do you 3 recognize this? 4 A. It is a -- the first portion of it is a 5 letter from the institution to L.L. Bowman which 6 is the Commissioner of Texas where they are 7 addressing the issues in the State of Texas 8 examination. 9 Q. And are there attachments to that 10 letter? 11 A. Yes. Then you have the attachments, 12 one being investment committee minutes, another 13 being a memo addressed to Gerald Williams, and 14 another one being some type of draft form. And 15 you have a decision or information flow summary, 16 and you have minutes from the executive committee 17 of the institution. 18 Q. Now, is this a document that's found in 19 the examination work paper files? 20 A. Yes, it was. 21 Q. Was it found in the correspondence or 22 reading file? 17135 1 A. It was -- it was found in what we call 2 a general file, which is a correspondence file. 3 MR. VEIS: Your Honor, I move the 4 admission of A14061. 5 MS. CLARK: No objection. 6 THE COURT: Received. 7 Q. (BY MR. VEIS) Now, I want to address 8 your attention, Ms. Carlton, to the second page of 9 Exhibit A14061 which has a Bates No. OW128871. I 10 would like you to look at the paragraph that 11 starts at the bottom of that page, and it carries 12 over to the following page. 13 A. (Witness reviews the document.) Okay. 14 Q. Now, I gather from the date of this 15 that the report of examination referred to in the 16 cover letter, April 30, 1986, is the State report 17 of examination which was the result of the work 18 that was conducted by the Texas examiners at the 19 same time as the federal examiners were conducting 20 the May 27, '86 examination; is that right? 21 A. That's correct. 22 Q. So, they would be examining these 17136 1 matters at the same time? 2 A. That's correct. 3 Q. Now, it says here that -- well, the 4 department states that -- under the section in the 5 report entitled "securities" and in the 6 November 19 letter -- that "There are no documents 7 setting forth management's investment strategy. 8 Attached as Exhibits A1 and A2 are strategy 9 formulations adopted by the board." 10 Do you see that? 11 A. Yes. 12 Q. If you can find Exhibit A, it would 13 appear to be, although it's very difficult to 14 tell -- but immediately following the end of the 15 letter which runs on for 13 pages and ends at 16 Bates OW128882, there is a -- a copy of what 17 appear to be a -- what appears to be a resolution 18 of the investment committee. 19 Do you see that? 20 A. Yes. 21 Q. Have you had a chance to review that 22 resolution? 17137 1 A. Yes. 2 Q. Do you know whether there are any 3 strategies set forth in that? 4 A. It just says they approve the 5 guidelines and committee responsibilities. No 6 strategies. 7 Q. Does it say anything about criteria for 8 investment? 9 A. It states that they shall establish 10 investment criteria, approve specific investments. 11 It doesn't say what that criteria is. 12 Q. It does have something on the next 13 page, another matter I would like to ask you 14 about. If you would like on Page OW12884 under 15 "committee responsibilities." 16 A. Okay. 17 Q. I would like you to take a look at 18 Item F which relates to maintaining investment 19 register. 20 A. Okay. 21 Q. Is a savings association required to 22 maintain an investment register under federal 17138 1 regulations? 2 A. Yes, it is. 3 Q. And did United Savings Association of 4 Texas maintain an investment register that met the 5 criteria prescribed by regulations in 1986? 6 A. We took exception to them not having 7 one in the '86 exam. 8 Q. Ms. Carlton, I show you now a document 9 that's been marked A14062. 10 What is A14062? 11 A. This is a letter from supervisory agent 12 Neil Twomey addressed to the institution's 13 attorney, Art Berner. 14 Q. Was it found in the work papers for the 15 1987 examination? 16 A. Yes, it was. 17 Q. Where was it? 18 A. In the general file, correspondence 19 file. 20 Q. And was it provided for your 21 information during the examination? 22 A. Yes, it was. 17139 1 MR. VEIS: Your Honor, I move the 2 admission of A14062. A similar document is 3 apparently in evidence at Tab 2503, Exhibit B1453. 4 I'm informed that a -- they differed by virtue of 5 the handwritten initials which, I believe, are 6 "RW" at the top of the page. I don't know if 7 that's a copying problem or if it's a different 8 document. But I believe that, if nothing else, 9 A14063 is a better copy. 10 MS. CLARK: Can you identify the 11 initials that were just referred to? 12 THE COURT: Whose initials are those? 13 THE WITNESS: Richard Ward. 14 Q. (BY MR. VEIS) Who was he? 15 A. He was the field manager in Houston. 16 Q. He was your supervisor? 17 A. Yes. 18 MS. CLARK: No objection. 19 MR. EISENHART: There's another set of 20 initials on the bottom of the page, as well, that 21 I think are not on the other document. 22 MR. VEIS: Which ones are you referring 17140 1 to? 2 Q. (BY MR. VEIS) As long as the -- we're 3 identifying initials, let me address your 4 attention to the initials at the bottom of the 5 page in the center. 6 Whose are those? 7 A. That's my initials. 8 Q. Now, let me just ask you about one 9 item. 10 THE COURT: Well, while we're on the 11 initials, what's the other one at the top, "A" 12 something? 13 A. That's a person out of Dallas. I don't 14 recognize the last one. I don't know who that is. 15 THE COURT: Okay. 16 Q. (BY MR. VEIS) You believe it's some 17 supervisory person? 18 A. Yes. It would have been in Dallas and 19 then transferred to -- the "RW" is a Dallas 20 initial. The other initial -- the "RW" is a 21 Houston person, and this is a routing that comes 22 down from Dallas through the reading events. 17141 1 MS. CLARK: Your Honor, I'm sorry. I'm 2 confused. I have understood that the legible 3 initials in the right corner were the initials of 4 Richard M. Ward. We've seen those initials on a 5 variety of documents that we have seen in this 6 case. I believe they have previously been 7 identified by him during his deposition. I don't 8 now know what you're talking about in terms of the 9 other initials. 10 THE COURT: Do you have an "A" under 11 that "RW"? 12 MS. CLARK: Your Honor, I'm sorry. The 13 initials at the very top, are those the ones 14 you're talking about? 15 THE COURT: Yes. 16 MS. CLARK: I can't read those, but I 17 have assumed those were "RW." That was the 18 routing to Mr. Ward, and right below that are the 19 "RW," which are Mr. Ward's initials which he 20 previously identified during his deposition. They 21 are both the same, Richard Ward and Richard Ward. 22 THE WITNESS: I don't think so. 17142 1 MR. VEIS: I don't intend to ask any 2 questions about those initials. Regardless, I 3 think we know that Mr. Ward received this 4 document; and I don't intend to follow with 5 anything on that. 6 Has the document been admitted? 7 THE COURT: I haven't -- 8 MR. VEIS: I move its admission, 9 Your Honor. 10 MS. CLARK: No objection. 11 THE COURT: Received. 12 Q. (BY MR. VEIS) I would like you to look 13 at the third paragraph on the first page, 14 Ms. Carlton. 15 A. Okay. 16 Q. The sixth line down is a sentence that 17 begins "further." 18 Do you see that? 19 A. Right. 20 Q. "Further, it is generally acknowledged 21 that successful management of a portfolio of 22 high-yield bonds is extremely difficult 17143 1 considering the volatility of the market. In past 2 meetings and correspondence, the expertise of Joe 3 Phillips as the key individual in charge of the 4 high-yield bond portfolio was represented as a 5 major factor in the success of the high-yield bond 6 investments." 7 Do you know whether that was what was 8 represented to the regulators? 9 A. Other than what I read here? 10 Q. That was sent to you for your 11 information, was it not? 12 A. That's correct. 13 Q. And it further goes on that, "We 14 understand now that Mr. Phillips is no longer with 15 United"? 16 A. Right. 17 Q. You had previously had dealings with 18 Mr. Phillips during the 1986 examination? 19 A. Yes, we did. 20 Q. Ms. Carlton, I now show you a document 21 that's been marked A14060. 22 MR. VEIS: First, I would like to 17144 1 indicate that this exhibit does not include all 2 the attachments to the letter which forms the 3 first two pages. It contains only selected 4 attachments. These are all Bates numbered and 5 have bar code numbers on them. Certainly, if 6 respondents believe that there are exhibits that 7 are germane to any subject in the case that are 8 attached to this memorandum in its original form, 9 I would have no objection to their bringing them 10 forward as exhibits. But in order to keep the 11 size of the document manageable, I have included 12 only those attachments that I was going to ask 13 questions about. Each of the attachments which 14 are at OW129046 -- that's a single-page document. 15 Following that is OW129724 through 48 which is a 16 two-page document which is complete, and 129061 17 and 062 which are also a two-page document which 18 is complete. 19 Now, what I would like to do is ask 20 Ms. Carlton if she recognizes A14060. 21 A. Yes. It is a memorandum that came from 22 Jenard Gross, the CEO of United, that was 17145 1 addressed to me in which he is responding to 2 outstanding issues that we had and providing 3 position papers on several of the loans that had 4 been subject to comment that have been provided by 5 him by the officers responsible for those credits. 6 MR. VEIS: Your Honor, I move the 7 admission of A14060. 8 MS. CLARK: No objection. 9 THE COURT: Received. 10 Q. (BY MR. VEIS) I would like to turn 11 first to the second page, OW129043. And you'll 12 see there in the first full paragraph a -- two 13 sentences that say, "Attached are specific 14 comments relating to exceptions United takes to 15 your classification of loans and real estate. 16 They relate to Chapel Creek, Block, Mustang 17 Island, Trail of Timbers Creek, Post Oak 18 Apartments, and Hunting Bayou." 19 Do you see those sentences? 20 A. Yes, I do. 21 Q. I would like to direct your attention 22 to Block. Do you take that to be a reference to 17146 1 the loan of Stephen Block, Trustee? 2 A. Yes, it is. 3 Q. Going forward in the exhibit two pages 4 to Bates No. OW129046, does that appear to be the 5 institution's response to the examiner's 6 classification of the loan to Stephen Block, 7 Trustee? 8 A. Yes, it is. 9 Q. Now, let me direct your attention to 10 the first paragraph which says, "This loan is 11 listed by the examiners under the section titled 12 'loan classifications due to well-defined 13 weakness.' However, I feel that since an 14 immediate repayment of this loan was scheduled 15 after June 30th, 1986, it is inappropriate for 16 this loan to be considered in this list." 17 Do you see that? 18 A. Yes. 19 Q. Now, is that response a basis for not 20 classifying the Block loan? 21 A. They were just reiterating what had 22 been presented to them. 17147 1 Q. Is that a basis for not classifying the 2 loan? 3 A. No, it's not. 4 Q. Was it any excuse at all? 5 A. No, it's not. 6 Q. Why not? 7 A. Because they did not provide any 8 additional information in that statement that 9 would have changed the classification and the 10 reason for which we had included it in the report. 11 Q. That was because it had been paid off 12 by another loan granted by the institution? 13 A. Yes. That's what they are referencing 14 here. 15 Q. The loan at that point was some four 16 months late? 17 A. Right. 18 Q. Now, if you would turn to the next 19 page. That appears to be on two pages: OW129047 20 and OW129048. That appears to be the examination 21 exceptions for the refinancing loan of 22 Norwood/United Park. 17148 1 Is that their response to those? 2 A. Yes, it is. 3 Q. Now, I would like you to read to 4 yourself the item under No. 4 which relates to the 5 exception. "Loan documents suggest that this loan 6 was granted to modify and refinance three loans 7 which were contractually delinquent." I would 8 like you to read their response to that exception 9 to yourself. 10 A. (Witness reviews the document.) Okay. 11 Q. Is there anything in this presentation 12 by the association that would change your views as 13 an examiner as to whether the loan was granted to 14 modify and refinance loans which were 15 contractually delinquent? 16 A. No, it's not. 17 Q. Is there anything in there that would 18 change your view that that loan should be 19 classified? 20 A. No, it's not. 21 Q. Did anything in this change the 22 supervisor's review as to whether the loan should 17149 1 be classified? 2 MS. CLARK: Objection, Your Honor. I 3 don't believe there's any testimony that 4 supervision had taken any position on that loan at 5 the time of this document. 6 MR. VEIS: I'll withdraw the question, 7 Your Honor. 8 Q. (BY MR. VEIS) I would like you to turn 9 now to the next item, which is "comments on 10 financial books and records." It begins at 11 OW129061 and carries through to 062. It refers to 12 attached calculation of investment in 13 subsidiaries. I would like you to look at 14 particularly the second page under "net worth 15 calculation." 16 A. Okay. 17 Q. Now, that relates to investments in 18 subsidiaries and the inclusion or exclusion of 19 finance subsidiaries from the calculation. 20 Is that what that refers to? 21 A. That's correct. 22 Q. Now, what is the issue there? 17150 1 A. On finance subsidiaries, you have an 2 option that you can either consolidate the 3 operations of that subsidiary and include it on a 4 consolidated basis of the institution or you can 5 choose to not include it on a consolidated basis 6 when reporting the financials of the institution. 7 Q. How does that affect United in its 8 calculation of net worth in 1986? 9 A. If they include it as a part of direct 10 investment, it would increase that number. 11 Q. And was that an issue that had been 12 referred to Dallas for decision? 13 A. Yes, it was. 14 Q. And had it been further referred to 15 Washington, D.C. for decision? 16 A. Yes, it was. It was no longer part of 17 the examination decision. 18 Q. Was that issue still unresolved at the 19 beginning of the 1987 examination? 20 A. Yes, it was. 21 Q. Ms. Carlton, I'll show you now a 22 document that's been marked A14063. 17151 1 Do you recognize A14063? 2 A. Yes. 3 Q. What is it? 4 A. It is correspondence, again, that was 5 passed down from supervision to the examination 6 staff to review and for information to inform us 7 of activity that had taken place during the -- 8 since the previous examination. 9 Q. Now, there's an attachment to the 10 letter. 11 Do you see that? 12 A. Yes. 13 Q. And what is that attachment? 14 A. This attachment is an application for 15 approval to exceed the direct investment 16 limitation. It's addressed from Neil Twomey to 17 Roy Green, the principal supervisory agent, 18 president of Federal Home Loan Bank of Dallas. 19 Q. And is this information that was in the 20 general file in the examination work papers for 21 the 1987 examination of United Savings? 22 A. Yes, it was. 17152 1 MR. VEIS: Your Honor, I move the 2 admission of A14063. 3 MS. CLARK: No objection. 4 THE COURT: Received. 5 Q. (BY MR. VEIS) Now, the cover letter is 6 dated May 11th, 1987; is that correct? 7 A. Yes, it is. 8 Q. Now, does the cover letter relate to 9 the denial of the request to exceed the direct 10 investment limitation? 11 A. What do you mean by that? 12 Q. Well, let's just -- does it -- you know 13 that there was an application to exceed the direct 14 investment limitation. You mentioned that with 15 respect to the attachment? 16 A. Yes. 17 Q. This letter informs United Savings 18 Association of Texas that that application has 19 been denied, doesn't it? 20 A. Yes, it does. 21 Q. And that's in the third paragraph of 22 the letter, the last sentence? 17153 1 A. Yes, it does. 2 Q. I would like you to look at that 3 sentence, and I'll read it. "During and since the 4 examination, we have" -- "we continued to have 5 concerns regarding the condition of United. These 6 concerns included numerous incidences of 7 improperly maintained books and records, routinely 8 amended financial reports to FHLBB-Dallas, a 9 history of net operating losses, an increasing 10 involvement in high-risk investments, and 11 increased scheduled items. Limitation is hereby 12 denied." 13 Do you see that? 14 A. Yes. 15 Q. Those are all issues that were raised 16 in the 1986 examination, correct? 17 A. That's correct. 18 Q. Was this a supervisory response to 19 information contained in the 1986 examination? 20 A. Yes, it is. 21 Q. Now, I would like to turn to 22 Mr. Twomey's memo when apparently -- particularly 17154 1 the last page, 128998. Now, if you could take a 2 look at the last -- I'm sorry. Take a look at the 3 first paragraph on the page. 4 A. (Witness complies.) Okay. 5 Q. Now, the last sentence says, if I might 6 summarize the paragraph -- it seems to summarize 7 some of the findings of your examination. Right? 8 A. That's correct. 9 Q. The last sentence says, in short, "It 10 appears that United may be misstating financial 11 statements and circumventing supervisory 12 regulations." 13 Do you see that? 14 A. Yes, I do. 15 Q. Did you ever have any discussions with 16 Mr. Twomey concerning the possibility of 17 misstating financial statements for circumventing 18 regulations? 19 A. Yes, I did. 20 Q. What were those conversations? 21 A. We had conversations concerning the 22 number of violations that were reported, the 17155 1 numerous books and records problems that we had, 2 the numerous disagreements that you have on 3 classification of assets. 4 Basically, any other during the 5 examination that either had an impact on income or 6 impact on net worth, management disagreed, whether 7 it was either substantiated or not substantiated. 8 The books and records were such that we felt, in 9 one sense, you had a management that purported to 10 be such experts that they could invest in 11 investment securities which required a great deal 12 of competency and a great deal of experience; yet, 13 on the lower side of that picture, you had a -- 14 the same management team that could not and did 15 not have its books and records in order and to 16 the -- even to the lower level of records not be 17 correct as far as junk entries and basic 18 accounting was not in order. 19 And we concluded that based on that, 20 that it appeared to be an effort on the part of 21 management to allow this to take place in an 22 effort to circumvent the regs and by not taking 17156 1 the action that we had directed, it prolonged the 2 examination process to the point that based on 3 where, traditionally, regulators would account on 4 an examination reportings, the facts and some 5 issues remained outstanding that decisions were 6 not made that was by the management more time 7 before proper recognizing and identifying the fact 8 that they had, indeed, failed their minimum net 9 worth requirement and possibly other actions that 10 would have taken place with the institution if 11 they had recognized the losses as required by the 12 regulators. 13 The net worth would have been reduced 14 to a substantially lower level, and they would 15 have possibly maybe not only failed the minimum 16 but not even met the requirement in general. 17 MR. KEETON: Your Honor, I move to 18 strike the narrative answer. It's neither 19 responsive, and a bunch of it is sheer 20 speculation. 21 THE COURT: Denied. We'll take a short 22 recess. 17157 1 2 (Whereupon, a short break was taken 3 from 2:47 p.m. to 3:04 p.m.) 4 5 THE COURT: Be seated, please. We'll 6 be back on the record. 7 Mr. Veis, you may continue with your 8 examination. 9 MR. VEIS: Thank you, Your Honor. 10 Q. (BY MR. VEIS) Before the break, we were 11 looking at Exhibit A14063. I would like to turn 12 back that to exhibit, if I may. 13 Directing your attention back to 14 OW128998, do you -- would you please look at the 15 third paragraph on that page, the one that begins 16 "of additional concern"? 17 A. Okay. 18 Q. And it says, "Of additional concern is 19 United's investments in subinvestment grade 20 high-yield bonds. While the examiner did a 21 cursory review of the investments of the 22 association, her resources and time were not 17158 1 sufficient to allow a full review of this area." 2 Do you see that sentence? 3 A. Yes, I do. 4 Q. Does that accurately summarize the 5 extent of the review of securities investments by 6 your examination team in 1986? 7 A. Yes, it does. 8 Q. And does that state the reasons for 9 that extent? 10 A. Yes, it does. 11 Q. Let me direct your attention to A14065. 12 Have you seen A14065 before? 13 A. Yes, I have. 14 Q. And where? 15 A. In the work papers. 16 Q. And what is it? 17 A. This is a memorandum from Art Berner 18 sent to Neil that addresses the high-yield bond 19 portfolio. United is purporting the expertise of 20 its staff and wants to make that staff available 21 to other smaller institutions who can neither 22 afford our staff retention as an effort to our 17159 1 sole engagement in investment type security 2 activities. 3 MR. VEIS: Your Honor, I move the 4 admission of A14065. 5 MS. CLARK: No objection. 6 THE COURT: Received. 7 Q. (BY MR. VEIS) I believe you said they 8 were describing their expertise; is that correct? 9 A. They were purporting, in summary, that 10 to make their staff available. 11 Q. That they were experts? 12 A. That's correct. 13 Q. Now, at the same time, the regulators 14 had questions about their securities activities; 15 is that correct? 16 A. That's correct. 17 Q. And, indeed, in your last examination, 18 you hadn't been able to make any determination 19 concerning the securities investments; is that 20 correct? 21 A. That's correct. 22 Q. Ms. Carlton, let me show you A14066. 17160 1 A. Okay. 2 Q. What is A14066? 3 A. This is a memorandum dated 4 September the 9th, 1987, from Neil Twomey, the 5 supervisory agent, to Art Berner, the attorney at 6 United Savings, in which Neil is discussing the 7 institution's ability to hire someone to come in 8 and do a third-party review of their securities. 9 And the bottom five items document the 10 requirements that -- the scope for that minimum 11 review that should take place. 12 Q. Was this found in the work papers of 13 the examination? 14 A. Yes, it was. 15 Q. Where? 16 A. In the general file. 17 MR. VEIS: Your Honor, I move the 18 admission of A14066. 19 MS. CLARK: No objection, Your Honor. 20 THE COURT: Received. 21 Q. (BY MR. VEIS) Now, you earlier 22 mentioned in your testimony, Ms. Carlton, that 17161 1 there was to be a third -- you knew there was to 2 be a third-party review of the securities 3 activities. 4 Do you recall that? 5 A. Yes. 6 Q. Did you take this to be the 7 third-party -- this to be discussing the proposal 8 for the third-party review? 9 MS. CLARK: Your Honor, there's no 10 indication on the document of Ms. Carlton's 11 initials. Perhaps she could identify the other 12 initials on the document. I think we lack a 13 foundation as to whether she took this to be 14 anything at this point. 15 THE COURT: Did you see the document? 16 THE WITNESS: The "GF5" -- the 17 reference in the bottom corner is my writing. I 18 did see the document. 19 Q. (BY MR. VEIS) And "GF" is the file it 20 was sent to; is that correct? 21 A. Yes, it is. 22 Q. Is this referring to the third-party 17162 1 review of that -- that you had previously 2 testified about? 3 A. Yes, it is. 4 Q. I want to now show you A14069. 5 A. (Witness reviews the document.) Okay. 6 Q. Ms. Carlton, can you explain what 7 A14069 is? 8 A. This is an interim report that was 9 prepared dated January 15th, 1988; and it's a part 10 of the 1987 examination. 11 Q. Is this the first interim report that 12 was prepared? 13 A. Yes, it is. 14 MR. VEIS: Your Honor, I moved the 15 admission of A14069? 16 MS. CLARK: No objection. 17 THE COURT: Received. 18 Q. (BY MR. VEIS) Now, the first thing I 19 would like to ask you about is the figures at the 20 top of the page. 21 Do you see those? 22 A. Yes. 17163 1 Q. Now, where are those numbers derived 2 from? 3 A. From the thrift financial reports. 4 Q. These are the association's numbers? 5 A. Yes, it is. 6 Q. Now, do they include any of the 7 adjustments to financial records of the 8 institution that had been directed to have been 9 made by the examiners following the 1986 10 examination? 11 MS. CLARK: Objection, Your Honor. 12 They were not directed by the examiners to make 13 anything. I think Mr. Veis is misspeaking. 14 Q. (BY MR. VEIS) Were they directed by the 15 supervisory authority to make adjustments to the 16 books and records with respect to certain reserves 17 and classified assets? 18 MS. CLARK: As of the date of this 19 report? 20 MR. VEIS: In the 1986 -- at the end of 21 the 1986 examination. 22 A. They had been directed during that 1986 17164 1 examination, and that examination took place prior 2 to this interim report. 3 Q. (BY MR. VEIS) And were the -- were 4 those adjustments included in the figures derived 5 from the thrift financial reports that are 6 reflected in the interim examination report? 7 A. No. 8 Q. So, they hadn't made those adjustments 9 yet, had they? 10 A. No. 11 Q. There's no inclusion of specific loss 12 reserves? 13 A. No. 14 Q. There's no inclusion of Couch Mortgage? 15 A. No. 16 Q. What about reserves on REO? 17 A. I don't know to the extent those were. 18 They had made some adjustments on REO. 19 Q. Let me direct your attention further 20 down the page to the section entitled "regulatory 21 capital compliance." 22 A. Okay. 17165 1 Q. In the first place -- let's look at the 2 first paragraph. Would you read that to yourself, 3 please? 4 A. (Witness reviews the document.) Okay. 5 Q. Now, it reports that USAT once again 6 failed to meet its minimum regulatory capital, 7 correct? 8 A. That's correct. 9 Q. And as of what date? 10 A. As of September the 30th, 1987. 11 Q. September or November? 12 A. September. Oh, ended November the 30th 13 of 1987. 14 Q. Thank you. 15 Now, what was the -- what was that 16 failure due to? 17 A. It was due to the increase in scheduled 18 items, classification -- classified assets, the 19 inclusion of -- 26 million of Couch not included, 20 and 37 million in other loans. 21 Q. The institution wasn't including those 22 adjustments on its books; is that correct? 17166 1 A. Right. 2 Q. Now, what about the next paragraph? It 3 relates to specific reserves on real estate owned? 4 A. Yes. It states that they had not 5 established for appraised losses 35.5 million at 6 September 30th. 7 Q. Now, there's a -- that wasn't included 8 on the books, correct? 9 A. Right. 10 Q. Now, the next page deals with 11 criticized assets. 12 Do you see that? 13 A. Yes. 14 Q. Now, what were the total criticized 15 assets as of September 30th? 16 A. 497 million. 17 Q. Were some of those $497 million in 18 assets classified? 19 A. Yes. 20 Q. Were some scheduled? 21 A. Yes. 22 Q. Let me direct your attention to Bates 17167 1 No. OW128895, the section entitled "operations" 2 under "financial analysis." Please read that 3 section. It's only two paragraphs. Just read it 4 to yourself. 5 A. (Witness reviews the document.) Okay. 6 Q. Can you please explain what those 7 paragraphs mean? 8 A. It deals with the earnings for the 9 institution for a period from July 1, 1986, to 10 September the 30th, 1987, which they state they 11 had earnings of $3 million. It goes on to break 12 down the major composition of that earnings. 13 97 percent of it was from non-earning income for 14 the past five quarters; and they identified that 15 income as coming in from gains on the sale of 16 mortgage-backed securities, gains on the sale of 17 investment securities, and gains on the sale of 18 futures contracts and loan sales. 19 Q. That's all non-operating income? 20 A. Yes, it is. 21 Q. What's the difference between operating 22 income and non-operating income? 17168 1 A. Non-operating income is traditionally 2 income that you may experience maybe once in an 3 event or once in a financial period. It's not 4 considered your normal operating income that you 5 would record on, say, a monthly basis as coming 6 from your normal operations from the institution. 7 Q. Kind of like interest income, for 8 example? 9 A. Yes. That you receive off of mortgage 10 loans, yes. 11 Q. Now, you note in there that there's 12 some risk to the association. 13 Would you please explain that? 14 A. It goes on to state that continuing to 15 rely on current income places additional risk to 16 the institution in that USAT had experienced a 17 50-million-dollar loss and that loss was due to 18 the stock market crash. 19 Q. Was that an equity arbitrage portfolio, 20 if you know? 21 A. It was a combination of several things. 22 Q. Let me direct your attention to the 17169 1 next page, OW128896. That deals with high-yield 2 corporate bonds. 3 Do you see that, "risk management"? 4 A. Yes. 5 Q. Please read that to yourself. I have a 6 couple of questions about that. 7 A. (Witness reviews the document.) Okay. 8 Q. Directing your attention to the last 9 paragraph there, it talks about risk. 10 Do you see that? 11 A. Yes. 12 Q. Now, is that related only to the 13 high-yield bonds in this particular paragraph? 14 A. Yes, it is. 15 Q. And that indicates a 50-million-dollar 16 negative net income in October? 17 A. That's correct. 18 Q. And that's in high-yield bonds? 19 A. That's correct. 20 Q. Now, directing your attention to the 21 following page, OW128897, do you see a section 22 down there concerning Drexel Burnham Lambert? 17170 1 A. Yes. 2 Q. Now, read that to yourself. 3 A. (Witness reviews the document.) Okay. 4 Q. It indicates there that Drexel owns 5 9.7 percent of the stock of United Financial Group 6 as of the date of whatever information is current 7 in the examination? 8 A. That's correct. 9 Q. That's more than it owned at the last 10 exam? 11 A. Yes. 12 Q. Now, you indicate that Drexel Burnham 13 Lambert was the major underwriter for the majority 14 of USAT's and its subsidiaries' corporate bonds 15 and equity securities. 16 Do you see that? 17 A. Yes. 18 Q. When referring to corporate bonds, are 19 you referring to the high-yield bond portfolio? 20 A. Yes, we are. 21 Q. When you refer to the equity 22 securities, are you referring to the equity 17171 1 arbitrage portfolio? 2 A. Yes. That was one of the subsidiaries. 3 Q. Now, let me direct your attention to 4 the last page of A14069. If you could take a look 5 at the conclusion. 6 A. (Witness reviews the document.) Okay. 7 Q. What was your initial conclusion with 8 respect to the financial condition of United 9 Savings Association of Texas as of the date of 10 your interim report of January 15th, 1988? 11 A. That the condition of the institution 12 continues to deteriorate and that they were not 13 meeting a minimum regulatory requirement and that, 14 furthermore, within these service corps and these 15 securities areas, that it was possible -- 16 disclosed other items of material interest. 17 Q. So, they were already failing their net 18 worth requirement? 19 A. Correct. 20 Q. And you hadn't finished reviewing all 21 the areas? 22 A. Correct. 17172 1 Q. Ms. Carlton, I'll show you now a 2 document that's been marked A14070. 3 What is A14070? 4 A. It is the second interim report that 5 was prepared on United and sent to supervisory 6 agent Neil Twomey during the 1987 examination. 7 Q. And that was prepared by you and your 8 staff -- 9 A. Yes, it was. 10 Q. -- dated March 10, 1988? 11 A. Yes, it is. 12 MR. VEIS: Your Honor, I move the 13 admission of A14070. 14 MS. CLARK: No objection. 15 THE COURT: Received. 16 Q. (BY MR. VEIS) Ms. Carlton, I would like 17 you to look at the first section, the numerical 18 section describing total assets, regulatory 19 capital, and net income. 20 A. Yes. 21 Q. And where are those figures derived 22 from? 17173 1 A. From the TFR report. 2 Q. So, by -- these are United Savings 3 Association's own figures; is that correct? 4 A. Right. 5 Q. And these are quarterly figures for 6 December and September 1987? 7 A. Yes, it is. 8 Q. Now, I take it there was a substantial 9 loss in the last quarter of 1987? 10 A. Yes, there was. 11 Q. Do you know what that's related to? 12 A. It was, in part, to the stock market 13 crash that had occurred. 14 Q. Were there any other components? 15 A. You had an increase in scheduled items, 16 also. 17 Q. Now, let's look at regulatory capital 18 compliance. 19 By the way, that net loss was 20 $183 million; is that correct? 21 A. That's correct. 22 Q. Let's look at regulatory capital 17174 1 compliance. Go ahead and read that to yourself, 2 and then we'll discuss it. 3 A. (Witness reviews the document.) Okay. 4 Q. What's the -- what's the regulatory 5 capital deficiency as of December 31, 1987? 6 A. 110 million. 7 Q. And that's up from November 30th of 8 7 million; is that correct? 9 A. Yes, it is. 10 Q. And it indicates here that there's a 11 classification of $157 million in other loans 12 reviewed. That's in the Interim Examination 13 Report No. 2, March 10, 1988. 14 Do you see that? 15 A. Yes. 16 Q. Now, in a previous interim report, if 17 you look, it was 37 million; is that correct? 18 A. That's correct. 19 Q. Are we to infer that the examiners have 20 found another $120 million approximately in loans 21 to classify in the interim? 22 A. Right. 17175 1 Q. Now, let me ask you about the next 2 paragraph which relates to the regulatory capital 3 calculation. 4 Now, the second sentence states, quote, 5 "The examiner's review of this report disclosed 6 several material errors"; is that correct? 7 A. Yes. 8 Q. Do you have any recollection of what 9 those were? 10 A. Some of them, again, were the -- the 11 component -- information used in the component 12 factors that were being used. 13 Q. Now, this is a similar problem to what 14 you found in the 1986 examination? 15 A. Part of it, yes. 16 Q. Let me address, then, Page 2, which is 17 Bates OW128900. 18 A. Okay. 19 Q. Now, it says here, "For the quarter 20 ending December 31, 1987, the association reported 21 a loss of $183.8 million. This amount increased 22 the net loss for the year to $185.7 million. The 17176 1 two primary reasons for this loss: (1) the 2 recording of general valuation allowance per 3 quarterly report of $136,778,000, and (2) the 4 adverse mark-to-market adjustment on equity 5 arbitrage of approximately $50 million for the 6 month of October." 7 Do you see those sentences? 8 A. Yes. 9 Q. What is that $136 million? 10 A. Part of that is the reserve used to 11 establish the classification of assets in order to 12 make sure that they had the proper 20 percent 13 reserve established. 14 Q. Does that include the Couch loans or 15 not? Can you tell from this document? 16 A. I can't tell just looking at those 17 numbers. 18 Q. All right. Well, let me go to the next 19 page, OW128901. Let me ask you to read the 20 section entitled "investment securities" down 21 through the first three paragraphs. 22 A. (Witness reviews the document.) Okay. 17177 1 Q. Would you please explain what that -- 2 those three paragraphs are telling the supervisory 3 personnel back in Dallas? 4 A. This comment is telling Dallas that as 5 we entered into our review of their investment 6 securities activities, we again encountered books 7 and records problems. The basic register which is 8 the first item that should be documented, the 9 actual trades and sales of securities, was not 10 maintained. So, from a third-party review, not 11 knowing all the -- not having a record of the 12 actual sales and purchases and transactions that 13 had taken place, it made it nearly impossible to 14 know how to evaluate and analyze the different 15 portfolios that the institution was maintaining. 16 It sets out the deficiencies that we had noted at 17 that time. And although the institution had -- 18 could generate any document through the computer, 19 it was not provided, the one document that had the 20 information that was required by the regulators, 21 and that they were in the process of going back 22 and establishing the historical data that was 17178 1 required by the regulation and then they would 2 make that available with us. 3 Q. But they weren't maintaining it 4 current? 5 A. Right. 6 Q. That was a violation of regulations? 7 A. Yes, it was. 8 Q. Was it also a violation of the books 9 and records regulations? 10 A. Yes, it was. 11 Q. Was that a problem that had been noted 12 in the 1986 examination? 13 A. Yes, it was. 14 MR. EISENHART: I'm afraid Mr. Veis may 15 have cut Ms. Carlton off before she finished her 16 answer. He had asked about the three paragraphs 17 under the "investment securities," and she had 18 only talked about the first two. 19 MR. VEIS: Well, I'm satisfied with her 20 answer at this point; but I may come back to the 21 third. 22 Q. (BY MR. VEIS) Ms. Carlton, the subject 17179 1 of the investment register, contract register, is 2 that what it's called? 3 A. Yes. 4 Q. I would like to direct your attention 5 to A14061, which is the letter to L.L. Bowman 6 which is, I believe, the response to the Texas 7 Board of Examination. 8 May I help you? (Indicating) 9 A. Okay. 10 Q. I would like to direct your attention 11 to -- that letter is dated January 9th, 1987? 12 A. That's correct. 13 Q. And that's a little over -- a little 14 more than a year prior to the date of this report, 15 correct? 16 A. That's correct. 17 Q. Now, I would like to direct your 18 attention back to OW128884, which is the second 19 page of the investment committee or the resolution 20 of the board of directors of United Savings with 21 respect to the investment committee. 22 A. Okay. 17180 1 Q. Take a look at F, if you would, please. 2 A. (Witness reviews the document.) Okay. 3 Q. Now, if I read that correctly, that 4 resolution makes it the investment committee's 5 responsibility to maintain the investment 6 register, correct? 7 A. Correct. 8 Q. And was the investment committee doing 9 that? 10 A. No, it was not. 11 Q. And that's a resolution of the board of 12 directors of United Savings, correct? 13 A. Correct. 14 Q. So, they weren't following their own 15 procedures? 16 A. Correct. 17 Q. Now, I would like to talk to you about 18 the third paragraph -- well, before I get to that, 19 you said they made it nearly impossible, I 20 believe -- was that your words -- to conduct your 21 examination? 22 A. In the investment -- in the review of 17181 1 investment securities, you have to rely on the 2 institution to provide you all the trades, and 3 there can be numerous and numerous trades. So, 4 there's no way we can go in and compile a history 5 of that type of data to conduct an analysis. 6 Q. Let me direct your attention to the 7 last sentence of the second paragraph on OW128901 8 in Exhibit A14070. That says, "Furthermore, the 9 lack of such documentation creates an undue burden 10 on examination efforts to discern clearly the 11 difference between legitimate or possible 12 speculative transactions in this market." 13 Do you see that? 14 A. Yes. 15 Q. Is that what you were referring to when 16 you said it was nearly impossible to conduct the 17 examination activities? 18 A. Right. 19 Q. Let me ask you about the third 20 paragraph immediately below that. It discusses 21 consultations with the association's independent 22 auditors: Peat, Marwick, Mitchell? 17182 1 A. Right. 2 Q. What did that consultation reveal? 3 A. Because we had had difficulties in 4 reconciling their books and records, the second 5 source of policing of an institution is their 6 independent auditors. So, our question was did 7 they know and what was provided to them as far as 8 books and records and how much of the work of the 9 auditors was prepared by the institution and 10 wanted to know what the -- did they feel the 11 investments were properly accounted for. And we 12 made -- included a statement here concerning that 13 meeting we had had with them. 14 Q. And Peat Marwick's position was that 15 the association had properly accounted for its 16 investment securities -- 17 A. That's correct. 18 Q. -- and had properly accounted for its 19 hedging account activities? 20 A. That's correct. 21 Q. Now, do you know what the auditors 22 relied on? 17183 1 A. They relied on information from the 2 institution. 3 Q. Let me direct your attention further 4 down the page to an item entitled "sale of CMO 5 residuals to Drexel Burnham." 6 A. Okay. 7 Q. Just read that briefly, and then I'll 8 ask you some questions. 9 A. (Witness reviews the document.) Okay. 10 Q. Were you looking at this transaction as 11 some sort of affiliated party transaction or 12 possible conflict of interest? 13 MR. EISENHART: Your Honor, I object to 14 the leading nature of the question. Ms. Carlton 15 can say why she was looking at it. 16 THE COURT: Sustained. 17 Q. (BY MR. VEIS) Why were you looking at 18 this transaction? 19 A. It was presented to show the 20 relationship with Drexel in that it owned 21 9.7 percent ownership of UFG. We had a regulation 22 back then that if you owned 10 percent of an 17184 1 institution, it sets forth control. And with 2 this -- this is showing a loss to the institution. 3 We also wanted to demonstrate that a loss had been 4 experienced through these sales that had been 5 initiated through Drexel and to show their 6 affiliation that it had. 7 Q. Let's talk about what you knew about 8 Drexel at that point. Apparently, you knew they 9 owned 9.7 percent of United Financial Group. 10 Right? 11 A. That's correct. 12 Q. And I think you said in your previous 13 testimony that they had sold high-yield bonds to 14 USAT or one of its subsidiaries. 15 Am I correct about that? 16 A. That's correct. 17 Q. Now, do you know -- did you know at 18 that point whether or not Drexel underwrote 19 securities for any entities affiliated with 20 Mr. Charles Hurwitz? 21 A. We did not know at that time. 22 Q. Were you ever told that Drexel owned 17185 1 stock in MCO Holdings? 2 A. No, we were not. 3 Q. Were you ever told that -- well, do you 4 know who Michael Milken is? 5 A. Yes, I do. 6 Q. Do you know whether he was affiliated 7 with Drexel Burnham Lambert? 8 A. Not to my knowledge. 9 Q. You don't know? 10 A. No, I don't. 11 Q. Did you ever hear that Michael Milken 12 owned stock in MCO Holdings? 13 A. No. We have no record of that. 14 Q. Let me address your attention to the 15 next page, OW128902, the section there entitled 16 "conflict of interest." 17 Do you see that? 18 A. Yes. 19 Q. It goes on for several pages. If you 20 would take just a moment and briefly review the 21 next five pages relating to conflict of interest. 22 A. (Witness reviews the document.) Okay. 17186 1 Q. Now, if you would, please explain the 2 concerns you had with respect to conflicts of 3 interest, particularly with respect to Mr. Stanley 4 Rosenburg. 5 A. Mr. Rosenburg was a borrower of the 6 institution. He was also a shareholder of UFG and 7 a director of MCO Holdings, which owned 13 percent 8 of UFG, which is the parent of United Savings, the 9 institution. 10 Our concern was that it had the 11 appearance of a conflict of interest in that he 12 had used his position to obtain credit and 13 participate in joint ventures with the institution 14 and that as a result of his involvement with these 15 loans, that he had not performed his fiduciary 16 duties of responsibilities in that position and 17 this practice was ruled as unsafe and unsound. 18 These loans had been classified as 19 substandard, and this provided several of the 20 loans -- this writing is a combination of several 21 of the loans. And based on that, it had -- at 22 that point, had an adverse impact on the 17187 1 institution. 2 Q. And the four loans at issue totaled 3 over $96 million; is that correct? 4 A. Four loans? 5 Q. I think if you look at the first 6 page -- 7 A. Yes. 8 Q. Now, it appears that the major 9 component of that is the Park 410 project. 10 Do you see that? 11 A. That's correct. 12 Q. Now, that was the one you had looked at 13 in 1986 and decided it was -- you had written the 14 words "pass - weakness not material to classify," 15 I believe, were the words on the exhibit. 16 Do you recall that? 17 A. That's correct. 18 Q. Now, in 1987, you went into the 19 examination and found that you wanted to classify 20 it? 21 A. Correct. 22 Q. Can you explain why it was classified 17188 1 during the 1987 examination? 2 A. In this write-up in 1987, you had the 3 point where the institution had not reported any 4 sales on the properties since its inception and 5 the interest reserve would be depleted in 1989 and 6 that the borrower had come in and petitioned to 7 extend -- restructure the debt and extend the 8 credit now, asking for another ten years on the 9 note in addition to the already interest reserve 10 that was built into the loan. 11 This had been demonstrated with no 12 sales and with the borrower admitting that they 13 were having financial difficulties, the 14 well-defined weakness had surfaced and was 15 apparent at this time. Therefore, we classified 16 the loan. 17 Q. Did you do a property inspection in 18 connection with classifying that loan? 19 A. Yes, we did. 20 Q. Now, I would like to review for just a 21 moment the time frames for classification. 22 You're writing this in March of 1988; 17189 1 is that correct? 2 A. Right. 3 Q. And I believe that you said that the 4 standard for classifying was the eminence of loss 5 within 6 to 12 months; is that correct? 6 A. Correct. 7 Q. Now, 1986, was there an eminent loss 8 within a 6- to 12-month time frame? 9 A. No, it was not. 10 Q. And in 1987, I take it there was? 11 A. Yes, it was. 12 Q. And that was because the interest 13 reserve was being depleted? 14 A. Correct. And the borrower had admitted 15 that they were having financial conditions. So, 16 you knew at that point, once that reserve was 17 depleted, that the capabilities of the borrower to 18 service that debt was not there. 19 Q. Couldn't make the payments? 20 A. Or wouldn't have. 21 Q. Now, let me ask you to address your 22 attention now to OW128908. It says -- it's the 17190 1 second-to-last page of Exhibit 14070. 2 A. Okay. 3 Q. I would like to particularly direct 4 your attention to the section entitled "United MBS 5 Corporation." 6 A. Okay. 7 Q. Read that to yourself, and then I'll 8 have some questions for you. 9 A. (Witness reviews the document.) Okay. 10 Q. Now, it indicates there, does it not, 11 that the United MBS portfolio was a 12 1.6-billion-dollar portfolio? 13 A. Yes. 14 Q. And it was funded by reverse repurchase 15 obligations and dollar rolls? 16 A. Right. 17 Q. Now, let me read you the second 18 paragraph under there. It says, "UMBS generates 19 income by entering into reverse repo and dollar 20 roll contracts collateralized by their FNMA, GNMA, 21 and FHLMC mortgage-backed securities. The 22 'spread,' income, the difference between the 17191 1 proceeds received and the repurchase value on 2 these MBS security contracts is predetermined and 3 it appears no speculation is involved. UMBS is 4 operating profitably at December 31, 1987, with a 5 year-to-date net income of $37,479,000." 6 Do you see that? 7 A. Yes. 8 Q. Now, with respect to the first 9 sentence, the one that talks about generating 10 income by entering into reverse repos -- 11 A. Right. 12 Q. -- is that what United Savings 13 Association of Texas told you they did? 14 A. Yes. 15 Q. And with respect to the statement 16 regarding spread income being predetermined, do 17 you see that? 18 A. Yes. 19 Q. Did management of United Savings 20 Association of Texas tell you that the spread 21 income was predetermined? 22 A. Right. 17192 1 Q. Now, based on the information that was 2 available to you concerning the documentation in 3 the securities portfolio -- first, let me -- see 4 the section that talks about year-to-date net 5 income at December 31 of $37 plus million? 6 A. Okay. 7 Q. Now, based on the available 8 documentation of the securities portfolio, could 9 you tell whether or not the gains -- that is, the 10 $37 million -- were the result of the sale of 11 mortgage-backed securities to generate gains to 12 bolster quarterly and year-end profits? 13 A. No. 14 Q. Could you tell whether they were the 15 result of sales to rebalance the portfolio? 16 A. No. 17 Q. Could you tell whether they were the 18 result of sales to enhance the spread? 19 A. No. 20 Q. Could you tell whether they were the 21 result of sales to improve asset quality? 22 A. No. 17193 1 Q. So, when you saw there were gains in 2 the portfolio, could you tell what the 3 institution's purpose was in taking those gains? 4 A. We could only -- no. We could only see 5 that they were gains and noted the percentage that 6 they made up of the income number. 7 Q. Let me direct you to the conclusion of 8 Exhibit A14070 on Page OW128909. 9 A. Okay. 10 Q. Please read it, and then I'll ask you 11 some questions. 12 A. (Witness reviews the document.) Okay. 13 Q. Well, I'm particularly interested in 14 the second paragraph. It indicates that there 15 were still items in dispute? 16 A. Right. 17 Q. What were those? 18 A. Regulatory capital requirement 19 computation, investment securities, hedging 20 activities -- and hedging activity. 21 Q. I want to show you a document that's 22 been marked A14052. 17194 1 Have you seen Exhibit A14052 before? 2 A. Yes, I have. 3 MS. CLARK: Your Honor, we can't locate 4 our copies of this. Could we hold on for one 5 second? 6 MR. VEIS: Certainly. I would be happy 7 to slow down. 8 THE COURT: We'll take a short recess. 9 10 (Whereupon, a short break was taken 11 from 3:56 p.m. to 4:12 p.m.) 12 13 THE COURT: Be seated, please. We'll 14 be back on the record. 15 Mr. Veis, you may continue. 16 MR. VEIS: Thank you, Your Honor. 17 Before I turn to the document I put 18 before Ms. Carlton, A14052, we realized during the 19 break that there was a document relating to the 20 1986 examination that we hadn't put in the record. 21 It's A14043, and it's in the sequence of documents 22 that we introduced right before the noon break. I 17195 1 would like to just ask Ms. Carlton to identify it 2 and move its admission at this point and take care 3 of that problem. 4 Q. (BY MR. VEIS) Ms. Carlton, do you 5 recognize A14043? 6 A. Yes. 7 Q. Is that one of the documents relating 8 to securities that you were supplied during the 9 1986 examination by the association? 10 A. Yes. 11 Q. And how do you know it was supplied by 12 the association? 13 A. At the top is "PBA"; and at the bottom, 14 you have an '86 work paper reference. 15 Q. And is that a listing of -- of 16 securities purchased by the association? 17 A. Right. 18 Q. And it is also -- does it list 19 securities sold, as well; or is that something 20 else? Can you explain the document? 21 A. They list the broker, the security 22 type, the date that they were purchased, and the 17196 1 principal premium and discount amount as of 2 April 30th, 1986. 3 Q. And this was provided you by the 4 association in conjunction with your examination 5 of securities activities in 1986, correct? 6 A. Correct. 7 MR. VEIS: Your Honor, I move the 8 admission of A14043. 9 MS. CLARK: No objection. 10 THE COURT: Received. 11 MR. VEIS: Thank you, Your Honor. 12 Q. (BY MR. VEIS) I placed before you 13 before we went on break, Ms. Carlton, A14052. 14 A. Okay. 15 Q. I would like to turn your attention 16 back to that, if you would, please. 17 A. (Witness reviews the document.) 18 Q. What is that exhibit? 19 A. This is management's response to a 20 classification of assets. 21 Q. Now, they indicate that -- in the 22 first -- I'm sorry. 17197 1 Who is it written by? 2 A. Art Berner. 3 Q. And to whom is it addressed? 4 A. To me. 5 Q. And was this found in the work papers 6 relating to the 1987 examination? 7 A. Yes, it was. 8 MR. VEIS: Your Honor, I move the 9 admission of A14052. 10 MS. CLARK: No objection. 11 THE COURT: Received. 12 MR. VEIS: Thank you, Your Honor. 13 Q. (BY MR. VEIS) Now, let me ask you about 14 this response to the examiner's exceptions. The 15 first paragraph indicates that the association is 16 setting forth its disagreement in the memo; is 17 that correct? 18 A. That's correct. 19 Q. Now, they refer to fundamental 20 differences in the third line of the first 21 paragraph. 22 Do you see that? 17198 1 A. Yes. 2 Q. Now, let me ask you -- with respect to 3 that first item, it talks about differences with 4 respect to classifying appraisal deficiencies as 5 loss assets. 6 A. Right. 7 Q. Is that something that's a matter of 8 discretion? 9 A. No, it's not. 10 Q. Why not? 11 A. Anytime an identified appraised loss 12 was identified, it required an automatic 13 charge-off of 100 percent reserve. Appraised 14 losses were never in a substandard. They are 15 always loss. 16 Q. That's just automatic by regulation? 17 A. Right. 18 Q. Is there anything to agree or disagree 19 about? 20 A. They can, but it made no difference as 21 far as the category it would be placed in. 22 Q. Now, turning your attention to the 17199 1 second page of A14052, it indicates that -- 2 that -- in the second paragraph, it indicates, 3 "With respect to individuals' exceptions noticed, 4 you have asked us to agree or disagree with the 5 classifications indicated and management's 6 response is as follows." 7 Do you see that paragraph? 8 A. Yes. 9 Q. Is there an item there for the Norwood 10 loan? 11 A. Yes. 12 Q. What does that say? 13 A. It's substandard for 30.9, and 14 management disagrees. 15 Q. Is that the same loan that was 16 substandard in the 1986 examination? 17 A. Right. 18 MS. CLARK: Objection, Your Honor. 19 There was no evidence it was substandard in the 20 '86 exam. 21 MR. VEIS: We can go back to that. 22 Q. (BY MR. VEIS) Was it substandard in the 17200 1 '86 exam, Ms. Carlton? 2 A. We can go back and look. 3 Q. I think we should. That would be 4 Exhibit A14020. 5 I want to direct your attention to -- 6 to Page 23 which discusses the Norwood loan. 7 A. Yes. A -- the portion of the Norwood 8 loan that would cover the balance of the Block 9 loan was classified substandard with the rest of 10 the loan being subject to special mention. 11 Q. Thank you. 12 So, some portion, that which would be 13 necessary to pay off the Block loan or is 14 attributable to pay off the Block loan was 15 substandard, correct? 16 A. Correct. 17 Q. How much was the Block loan? 18 A. I think it was 21 million. 20 19 something million. 20 Q. That was the one they disagreed with in 21 1986, correct? 22 A. That's correct. 17201 1 Q. And now in 1987, you have found 2 $30 million of the Norwood loan to be substandard, 3 which is 9 million more; is that correct? 4 A. That's correct. 5 Q. And they disagree? 6 A. Right. 7 Q. So, they continued to disagree on the 8 $21 million; and they disagree on an additional 9 9 in 1987? 10 A. Correct. 11 Q. So, this has been going on since 12 sometime in 1986? 13 A. Correct. 14 Q. And it's now 1988? 15 A. Correct. 16 Q. You'll note the next item, Couch 17 Mortgage, they also disagree; is that correct? 18 A. Right. 19 Q. That's been going on since 1986, as 20 well? 21 A. Correct. 22 Q. Now, I would direct your attention to 17202 1 Park 410 in the following section under "current 2 year exceptions." 3 Do you see that? 4 A. Right. 5 Q. And what does that indicate with 6 respect to Park 410? 7 A. 49 million is being classified -- 49 of 8 the 80 million is being classified substandard, 9 and management agrees with the classification. 10 Q. Thank you. 11 Ms. Carlton, I would like to show you 12 now a document that's been marked A14071. What is 13 Exhibit A14071? 14 A. This is a copy of the agenda for the 15 exit management meeting of the 1987 examination 16 with attachments. 17 Q. Is it something that was included in 18 the work paper files? 19 A. Yes, it was. 20 MR. VEIS: Your Honor, I move the 21 admission of A14071. 22 MS. CLARK: No objection. 17203 1 THE COURT: Received. 2 Q. (BY MR. VEIS) Ms. Carlton, what exactly 3 is an exit management meeting? 4 A. After an examination, we conduct a 5 meeting with the management office of the 6 institution along with the departmental heads and 7 disclose to them the subject matter of the 8 violations that were noted in each area of the 9 bank that they are responsible for and provide 10 them our conclusions and results and identify to 11 them, in summary form, the deficiencies that were 12 noted during the examination. 13 Q. Is this to give them sort of a preview 14 of the examination report that you intend to send 15 to Dallas? 16 A. Yes, it is. 17 Q. Look at the first two pages. It's sort 18 of an outline? 19 A. Yes, it is. 20 Q. Is that an outline of what the 21 presentation was to be? 22 A. Correct. 17204 1 Q. Now, under Item 2, "capital adequacy," 2 there's an item "regulatory capital requirement." 3 Do you see that? 4 A. Right. 5 Q. And it indicates that failed 6 requirement by 112,553 on 12/31/1987 and refers to 7 Attachment 1. 8 Do you see that? 9 A. Right. 10 Q. Now, is that 112,000 or is that just 11 omitting zeros? 12 A. That's 112,000. 13 Q. 112,000 or 112 million? 14 A. It's 112 million. 15 Q. Thank you. 16 Now, I would like to direct your 17 attention to Attachment 1. Can you please explain 18 what Attachment 1 is? 19 A. Attachment 1 is the analysis of the 20 regulatory capital showing the association numbers 21 and also showing the examiner's numbers by 22 comparison. 17205 1 Q. I would like to go through this, if we 2 could. Now, the first item there on OW128928 is 3 "reconciliation of capital." 4 Do you see that? 5 A. Right. 6 Q. Now, the first entry is "GAAP capital." 7 Do you see that? 8 A. Right. 9 Q. What's the entry there? 10 A. On the "GAAP capital," you have 11 16 million 64 in both categories: Association and 12 examination. 13 Q. Is this based on the association's 14 books and records? 15 A. Right. 16 Q. Now, do you recall the approximate 17 asset size of USAT at this time? 18 A. They were approximately 4.5 billion 19 about that time. 20 Q. Now, lower there, it indicates they 21 have a larger regulatory capital. 22 Do you see that? I think $63 million. 17206 1 A. Right. 2 Q. Can you explain how that number relates 3 to the GAAP capital? 4 A. Under "goodwill," it's -- it's not 5 included in GAAP capital, but goodwill is a 6 regulatory mechanism that is allowed to be 7 considered as a part of capital from a regulatory 8 standpoint. So, if you look from your GAAP basis, 9 you would have less capital. Our books, if you 10 review it from a regulatory standpoint, you have 11 included in it appraised equity capital and 12 several other numbers that will make the 13 difference in that calculation. 14 Q. What is appraised equity capital? 15 A. That was where an institution was 16 allowed to appraise its office building and assess 17 the value of that property and make it part of the 18 calculation. 19 Q. So, the components, then, of USAT's 20 regulatory capital at December 31st, 1987, were 21 $16 million in GAAP capital, $45 million in 22 goodwill, $17 million in appraised equity capital, 17207 1 and other items for $142 million; is that correct? 2 A. That's correct. 3 Q. Let's go down to the Footnote 2 at the 4 bottom of the page which seems do be a 5 calculation -- is that of loss reserves or 6 specific reserves? Can you explain that? It 7 starts "total specific for examiners." 8 A. It says, "Total specific per examiners 9 - plus association's specific (32 million minus 10 3 million) which is allocated for general 11 reserves." Once we do the reserve analysis, if we 12 find that you don't need all the reserves for a 13 specific reserve, you can release that amount; and 14 then it can then be used as general reserves by 15 the institution. 16 Q. Okay. So, if you -- let me see if I 17 understand this calculation. The examiners found 18 $62 million of those -- are those new specific 19 reserves that have not previously been booked? 20 A. The examiners had -- this would include 21 all reserves, be it booked or not. 22 Q. But the association has specific 17208 1 reserves of 32 million, it says down here. Right? 2 A. Right. 3 Q. And the examiners are realizing 4 3 million of that? 5 A. Right. 6 Q. And that's the 29-million-dollar figure 7 to the right? 8 A. Exactly. 9 Q. What's the $62 million above that? 10 A. That would be our analysis based on the 11 classification of what we need as specific reserve 12 based on the indicated losses that had been 13 identified plus any specific asset loss that we 14 could tie to a specific asset that had been 15 identified. 16 Q. And you come up with specific reserves 17 required of $91,129,000; is that correct? 18 A. That's correct. 19 Q. And is that the figure under 20 reallocation of loan loss reserves sort of between 21 the "examiners" and "association" columns? 22 A. That's correct. 17209 1 Q. Now, what difference does it make in 2 the calculation of regulatory capital compliance 3 whether reserves are specific or general? 4 A. Specific reserves have a direct impact, 5 100 percent on -- in your capital as far as 6 reserves. Your general reserves does not have a 7 direct impact on your capital calculation. 8 Q. So, the $62 million goes right to the 9 bottom line? 10 A. Correct. 11 Q. Thank you. 12 Now, let's go through this reallocation 13 of loan loss reserves. If you would explain, 14 please, what you did in making that calculation. 15 A. What we start off with is you start 16 with the calculation that has been prepared by the 17 institution. They will provide you with a list of 18 loans, and attached to each asset will be their 19 schedule identifying reserves that are 20 specifically with an asset. In addition to that, 21 you have, like, a bucket reserve wherein certain 22 portfolios, based on historical loss, you expect 17210 1 to experience a certain percentage of loss with 2 that portfolio. That loss is a general reserve to 3 be allocated as desired or as needed as that 4 portfolio indicates any type of losses. 5 We then take our classification of 6 assets, and prior to asking an institution to 7 establish specific reserves, we will also pull 8 from that bucket of general reserves what we need 9 to establish the specific reserves that we have. 10 If we exhaust all the general reserve category, 11 then we would ask the institution to then identify 12 additional specific reserves plus establish 13 additional general bucket reserves for the 14 portfolio based on what they would need as far as 15 historical losses. 16 Q. Now, you say you pull from the general 17 reserves some amount of money that's needed to 18 establish specific reserves. Right? 19 A. Right. 20 Q. And that ultimately is what the 21 91-million-dollar figure represents; is that 22 correct? 17211 1 A. Right. 2 Q. And then the $74 million in general 3 reserves under the examiner's call, that is what 4 the examiners believe is necessary as general 5 reserves at that point? 6 A. That should be transferred, right. 7 Q. So, under the examiner's calculation, 8 the total regulatory capital was only 9 $138 million; is that correct? 10 A. Right. 11 Q. And the association and the examiners 12 both agreed on what the capital requirement was, 13 though, didn't they? 14 A. Correct. 15 Q. And what was the ultimate -- the 16 final -- final calculation of the deficit of 17 regulatory capital? 18 A. For the institution, they had 53.6 19 million. For the examiners, we had 112.5. 20 Q. Now, how do you reserve for substandard 21 assets? 22 A. You establish a 20 percent reserve. 17212 1 Q. And how did that impact the minimum net 2 worth calculation? 3 A. That contingency factor, you would have 4 your total classified and criticized assets. You 5 would take 20 percent of that amount, and that 6 20 percent would be included in that contingency 7 line in the net worth calculation. 8 Q. And does that increase the net worth 9 requirement? 10 A. Yes. 11 Q. Let me direct your attention, then, to 12 the following page, OW128929, where it says 13 "summary of criticized assets." 14 A. Okay. 15 Q. Now, under there, you have a "portion 16 classified substandard"? 17 A. Right. 18 Q. Is that $381 million? 19 A. That's correct. 20 Q. Now, directing your attention to the -- 21 the following page, OW128930, it indicates "action 22 required by criticized assets." Can you explain 17213 1 how those numbers are derived? 2 A. (Witness reviews the document.) This 3 is just a follow -- additional breakout in which 4 we determine what is specific reserve and those 5 with unreserved losses and show the percentage, 6 the composition of those might make a net worth. 7 Q. 20 percent of substandard which is 8 $76 million, is that 20 percent of the 9 $381 million on the previous page? 10 A. Yes. 11 Q. Yes. And with respect to the loss 12 items? 13 A. That would be the full amount. 14 Q. Okay. So, the -- you've also got an 15 entry there for 20 percent of scheduled items. 16 Right? 17 A. Right. 18 Q. Does that also go to increase the net 19 worth requirement? 20 A. Correct. 21 Q. So, what was the total increase to the 22 net worth requirement as a result of the 17214 1 classification of scheduling of assets? 2 A. 134 million. 3 Q. Now, did you also make an insolvency 4 projection at that meeting? I direct your 5 attention to -- 6 A. Yes, we did. 7 Q. And what projection was that? 8 A. What we would do is take the income 9 losses for the year and look at the monthly losses 10 that the institution had experienced. And, based 11 on that, we would average and determine if those 12 losses continued going forward in the same manner 13 in which they have. With dividing the months out, 14 we would determine how many months we project the 15 institution to insolvency. 16 Q. Do you recall what the projection was 17 with respect to USAT? 18 A. I think looking at it from 190 is 19 probably eight to nine months, I think, at the 20 time, just doing a quick analysis. It was in the 21 work papers. 22 Q. We'll look at those work papers 17215 1 subsequently. 2 Now, this exhibit is an agenda for a 3 meeting with management. Right? 4 A. That's correct. 5 Q. Do examiners also meet with the board 6 of directors of the institution? 7 A. Yes, sir, we do. 8 Q. Did you prepare an agenda for that 9 meeting? 10 A. Yes, we did. 11 MR. VEIS: Your Honor, I'm about to go 12 into this; but I notice that we're getting close 13 to 5:00. I suspect I would go well beyond 5:00 if 14 I began asking questions about that. 15 THE COURT: How much more are you going 16 to have? 17 MR. VEIS: I should be done not much 18 later than the lunch break tomorrow. 19 THE COURT: All right. We'll adjourn 20 until 9:00. 21 (Whereupon at 4:44 p.m. 22 the proceedings were recessed.) 17216 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 29th 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 . 17217 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 29th 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