22306 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 SEPTEMBER 2, 1998 22 22307 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 22308 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 . 22309 1 2 INDEX OF PROCEEDINGS 3 Page 4 KEVIN O'CONNELL 5 Continued Examination by Mr. Leiman.....22310 6 Further Examination by Mr. Dueffert.....22330 7 Further Examination by Mr. Leiman.......22349 8 LEONARD LAPIDUS 9 Examination by Mr. Veis.................22359 10 . 11 . 12 . 13 . 14 . 15 . 16 . 17 . 18 . 19 . 20 . 21 . 22 . 22310 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. Leiman, you have some more 6 redirect? 7 MR. LEIMAN: Yes, Your Honor. I have a 8 short period of redirect. 9 10 CONTINUED EXAMINATION 11 12 Q. (BY MR. LEIMAN) Good morning, 13 Mr. O'Connell. 14 A. Good morning. 15 Q. At the end of the day yesterday, we 16 were talking about the formal Home Loan Bank Board 17 Memorandum R-62. 18 A. That is correct. 19 Q. I read to you the following sentence: 20 "Directors who willingly allow others to make 21 major decisions affecting the future of the 22 corporation wholly without supervision or 22311 1 oversight may not depend on their lack of 2 knowledge for that ignorance itself is a breach of 3 fiduciary duty." 4 Do you remember that? 5 A. Yes. 6 Q. In your review of the exhibits and 7 testimony in this matter, did you reach an opinion 8 as to whether the senior loan committee and/or the 9 board of directors willingly allowed others to 10 make major decisions affecting the future of USAT 11 without supervision or oversight? 12 A. Yes. 13 Q. To whom did the SLC or the board of 14 directors give that power? 15 MR. DUEFFERT: Your Honor, objection to 16 the SLC. I don't think R-62 applies to the senior 17 loan committee. 18 MR. LEIMAN: Your Honor, it's a 19 delegation that -- respondents have argued that 20 the delegation seems to flow in several 21 directions. I think that what happened in this 22 case was -- and in fact, that was part of their 22312 1 cross-examination -- that the SLC somehow was 2 acting as an arm of the board of directors, if I 3 understand their argument. 4 THE COURT: All right. What's your 5 question again? 6 MR. LEIMAN: To whom did the SLC or the 7 board of directors give the power? 8 MR. DUEFFERT: What power are we 9 talking about, and for what purpose? I object. 10 THE COURT: I think you'd better take 11 one at a time. The board of directors -- 12 MR. LEIMAN: All right. I'll take them 13 separately. Fair enough, Your Honor. 14 A. The board of directors, through its 15 formal delegation, delegated major decision-making 16 power to the senior loan committee. 17 Q. (BY MR. LEIMAN) And to whom was the 18 power delegated by the senior loan committee? 19 A. Testimony of Messrs. Gross, Crow, 20 Williams indicated that they delegated to David 21 Graham almost all the important decision-making 22 duties in terms of underwriting, in terms of 22313 1 gathering the documents, in terms of reviewing the 2 overall underwriting documents, and preparation of 3 the underwriting documents. 4 Q. Would that have been contrary to R-62? 5 A. In my view, yes. 6 Q. Let's move on to something else. 7 We've talked about the board of 8 directors. Let's talk about underwriting. 9 Do you remember Mr. Dueffert asking you 10 about whether an appraisal that failed R-41B could 11 be relied upon by management? 12 A. Yes, I do. 13 Q. You responded, "It would have been 14 useful for management to have reviewed the 15 appraisal." 16 Now I'm going to ask you a follow-up 17 question to that. Okay? 18 A. Okay. 19 Q. Would it have been essential for USAT 20 management to have reviewed a copy of the 21 Love & Dugger 46-and-a-half-million-dollar 22 appraisal as of December 31, 1985 -- that's 22314 1 Tab 711 -- and maintained a copy of it in the 2 institution's files? 3 MR. DUEFFERT: Point of clarification. 4 Essential for what purpose? 5 MR. LEIMAN: Whether it would have been 6 essential in conformity with regulations in safe 7 and unsound practices, Your Honor. 8 THE COURT: All right. 9 A. Yes, absolutely. 10 Q. (BY MR. LEIMAN) Also, regarding 11 appraisals, did you see any evidence or testimony 12 that indicated that the Schulz 88-million-dollar 13 appraisal should not -- that's T7084 -- should not 14 have been relied upon? 15 A. For purposes of actually approving an 16 actual loan amount, yes, I saw ample evidence that 17 the Schulz appraisal should not have been relied 18 upon. 19 Q. What did you see, Mr. O'Connell? 20 A. If you'll recall, Mr. Leiman, on 21 Monday, we went through in some detail some of the 22 specific line items of the Schulz appraisal that 22315 1 indicate that -- above and beyond the fact that it 2 was an as-developed appraisal, that it took 3 essentially a future value of the property, and 4 based its valuation on this projected future 5 value. I believe we went through some specific 6 line items to indicate that the comparables in the 7 Schulz appraisal simply were not comparables. 8 Q. Did you read any testimony that would 9 have suggested that the Schulz appraisal should 10 not have been relied upon? 11 A. Yes. In addition to the actual 12 documents, there was some extensive testimony by 13 Mr. Charles White in terms of the manner in which 14 the joint venture dealt with Mr. Schulz, 15 Mr. White's understanding of how Mr. Schulz was 16 retained, and ultimately how Mr. Schulz came to 17 the numbers that he came to in the appraisal 18 report. 19 Q. Let me show you a portion of 20 Mr. White's testimony. 21 A. Okay. 22 Q. Mr. O'Connell, would you please turn to 22316 1 Page 7635? 2 A. 35? Okay. 3 Q. I'm going to ask you to read a couple 4 of paragraphs here. Would you please read 5 starting on 7365, Line 22 and read through Line 5 6 of 7636? 7 A. Okay. Line 22 is a -- is a second 8 paragraph of a question. Quote, "Why did 9 Mr. Graham want you to drop Love & Dugger?" 10 Answer, "Well, it was real clear by 11 this point that there would be -- United would be 12 unable to make the loan with an R-41B appraisal 13 from Love & Dugger." 14 Q. All right, sir. Now, would you please 15 skip down to Line 16 and read the question and 16 answer? 17 A. Okay. Question, "And what was the 18 desired result that is referred to here?" 19 Answer, "That would be the magic number 20 of the R-41B appraisal in that 90-million-dollar 21 range." 22 Q. All right, sir. Now, would you please 22317 1 read on Page 7637 Mr. Schwartz' question and the 2 answer to it by Mr. white? 3 A. Okay. Question, "(By Mr. Schwartz) 4 Mr. white, first of all, what was the number that 5 Mr. Graham told you that you would have to hit for 6 Mr. Schulz to reach an appraised value for the 7 property as developed in the 87 to 8 90-million-dollar range?" 9 Answer, "Well, I would need to push the 10 gross revenues to the 124-, 125-million-dollar 11 range." 12 Q. Mr. O'Connell, was that among the 13 testimony that you read that was instrumental in 14 forming your opinion? 15 A. In this courtroom, yes, that is 16 correct. 17 Q. All right. Let's move on. You said 18 something in your testimony to Mr. Dueffert I 19 wanted to clarify. 20 MR. LEIMAN: For reference to counsel, 21 I'm referring to Page 22205 starting at Line 9. 22 Q. (BY MR. LEIMAN) And this is what you 22318 1 stated. "Management of USAT itself kept using 2 as-is appraisals in their underwriting documents." 3 Is that what you meant to say? 4 A. No, it was not. 5 Q. What did you mean to say? 6 A. They actually were referencing as-is 7 appraisals in their underwriting document. 8 Q. Mr. O'Connell, in your testimony during 9 cross-examination, you talked to Mr. Dueffert 10 about the Love & Dugger 11 46-and-a-half-million-dollar appraisal as of 12 December '85. That's at T7143. 13 Do you remember that? 14 A. I don't remember the exhibit number 15 offhand; but yes, I do remember the question and 16 answer session, yes. 17 Q. I think you said that that 18 Love & Dugger appraisal failed to meet R-41B 19 requirements, and I believe you also said it was 20 not an appraisal that USAT should rely upon in 21 underwriting the 80-million-dollar Park 410 ADC 22 transaction? 22319 1 A. That is correct. 2 Q. Were you saying, Mr. O'Connell, that 3 the Love & Dugger appraisal did not need to be in 4 USAT's files? 5 A. No, not at all. I didn't say that at 6 all. 7 Q. Tell me what you were saying, what you 8 meant. 9 A. The Love & Dugger appraisal was made 10 for the joint venture. It was -- and the joint 11 venture, of course, was a partner of the 12 institution. 13 The Love & Dugger appraisal, made for 14 the joint venture and ordered on the basis by the 15 joint venture evidently for some business purpose, 16 indicated that the 80-million-dollar deal wasn't 17 doable. The joint venture appraisal said the 18 value wasn't there. We have a 47-million-dollar 19 appraised value. That is something that has to be 20 in the books and records. That is something that 21 the examiners have a right to see. That is 22 something, frankly, the auditors have a right to 22320 1 see. That is something that would be required for 2 an association to have a complete books and 3 records in their files. 4 Q. Is there a regulation that required 5 USAT to maintain complete records? 6 A. Well, it's actually within the books 7 and records regulation, yes. The 563.17 series. 8 Q. Let me show you the regulation. Is 9 this the one you're referring to, Mr. O'Connell, 10 here on paragraph -- Subparagraph C in 563.17-1? 11 A. Yes, that is correct. 12 MR. BLANKENSTEIN: Your Honor, does 13 Mr. Leiman have copies to share with us of the 14 regulation he's showing him? 15 MR. LEIMAN: I should think that by 16 this time -- I don't, but could I have him read 17 it? Would that be satisfactory, Your Honor, if he 18 reads that portion? It's only a paragraph of the 19 regulation. 20 MR. DUEFFERT: I think it would be 21 helpful for us to see context. 22 THE COURT: You don't have a copy? 22321 1 MR. LEIMAN: I think it's right there. 2 Isn't that that gray book, Mr. Dueffert? Why 3 don't you read the portion of the regulation -- 4 MR. DUEFFERT: If we could just have an 5 exhibit number, we could probably find the copies. 6 I believe it's an admitted exhibit. 7 MR. LEIMAN: Your Honor, I would submit 8 we should take judicial notice of the regulations 9 in this case. 10 THE COURT: Well, we just need a 11 number. It may be in as Exhibit B87. 12 MR. SCHWARTZ: I think, Your Honor, 13 that that is the 1987 -- that's the 1987 edition, 14 although the history does not indicate that it was 15 amended. 16 17 (Discussion held off the record.) 18 19 Q. (BY MR. LEIMAN) Mr. O'Connell, we'll 20 come back to that particular regulation. Okay? 21 A. Okay. 22 Q. All right. Let's move on. 22322 1 Was the 1986 80-million-dollar Park 410 2 transaction structured as an ADC loan? 3 A. Yes. That was how it was structured on 4 the association's books, yes. 5 Q. All right. Was the 1986 6 39.4-million-dollar Norwood transaction structured 7 as an ADC loan? 8 A. In part. As I recollect, the structure 9 was a 30-million-dollar ADC loan and a 10 9.4-million-dollar equity infusion from an 11 association affiliate. 12 Q. Were ADC loans permitted by the Federal 13 Home Loan Bank Board regulations in 1986? 14 A. Oh, sure. 15 Q. Were ADC loans encouraged by the 16 Federal Home Loan Bank Board in 1986? 17 A. No. 18 Q. Let me show you what's previously been 19 marked as Exhibit B3969. 20 MR. SCHWARTZ: Tab 1541. 21 MR. LEIMAN: For the record, Your 22 Honor, we think it's Tab 1541. 22323 1 Q. (BY MR. LEIMAN) Do you have a copy of 2 that in front of you? 3 A. I'm not -- 4 Q. I'll provide you a copy of that 5 exhibit, Mr. O'Connell. 6 Would you please turn to Page 3 of the 7 exhibit? And what I'd like you to do -- 8 A. Okay. That is -- you're talking about 9 at the top, Page 53277? Is that what you're 10 referring to? 11 Q. Yes. That's the third page, 12 Mr. O'Connell. I'd like you to start reading -- 13 in the first full paragraph, please read down 14 about -- 15 A. Of which column? 16 Q. Sorry. The second column. I'd like 17 you to read down about six or seven sentences. 18 Read that for us, please. 19 MR. KEETON: Your Honor, could we ask 20 the witness to cut out the commas and the periods 21 and the question marks? It's making a very 22 strange record. The ladies don't know whether to 22324 1 write that in or out. No other witness I've ever 2 been in in any other trial has ever done it that 3 way. Could he please read what he's been asked to 4 read? 5 THE COURT: Could you do that? 6 THE WITNESS: Certainly. I apologize. 7 That may make it easier. 8 A. The first paragraph talking about where 9 it says "the board"? 10 Q. (BY MR. LEIMAN) Yes, sir. 11 A. Okay. "The board believes the current 12 procedures are demonstrably inadequate for certain 13 assets. ADC loans and similar loans and 14 investments have long been recognized as 15 relatively risky assets. These assets are often 16 characterized by very low or nonexistent borrower 17 equity in the project, high fee income, the 18 payment of interest through an interest reserve, 19 and equity kickers that give the lender a 20 percentage of any profit. Many problem ADC loans 21 are improperly reported by thrifts to the board as 22 loans when, under proper accounting principles, 22325 1 they are, in economic substance, direct 2 investments. Because of the absence of any 3 substantial borrower equity, the lender must 4 generally depend upon the success of the 5 underlying project to receive payment of the 6 principal and interest on an ADC loan. The 7 absence of borrower equity also increases the 8 incentive for a borrower to walk away from a 9 failing project absent a firm personal guarantee 10 backed by significant assets. All of these 11 factors make ADC loans and similar investments far 12 riskier than conventional thrift investments." 13 Q. Thank you, Mr. O'Connell. I have a 14 question for you now. 15 What are the key safety factors in safe 16 and sound underwriting with regard to ADC 17 transactions? 18 A. Well, principally -- in fact, if you 19 want to review the entire preamble of this, you'd 20 be talking about valuation of the property. You 21 have to make sure there is a valuation of the 22 underlying property since that is the first and 22326 1 primary source of repayment for the loan. 2 You would also be looking for borrower 3 equity because to the extent that there is equity 4 in the project, you have a buffer between the 5 potential loss of the institution and any market 6 decline or any adverse conditions that might 7 result. 8 And the third is a question of debt 9 service. To the extent that a borrower can 10 actually show an independent source of cash flow 11 to make debt service, then that's an indication of 12 borrower strength. It shows again that the 13 property has an independent source of funds to 14 support the loan. 15 Q. You mentioned the term -- the first 16 factor, No. 1, was valuation. Right? 17 A. That is correct. 18 Q. Is that like an appraisal? Is that a 19 form of valuation? 20 A. Yes. That is -- what we required for 21 ADC loans is an appraisal, yes. 22 Q. All right. First, was there a useful 22327 1 appraisal relied upon in underwriting the Park 410 2 transaction? 3 A. No, there was not. 4 Q. Okay. That's the first fact that was 5 not. 6 Second, was interest on the 1986 7 Park 410 transaction paid automatically by USAT 8 through an interest reserve, or was it paid from a 9 source outside the thrift? 10 A. It was paid entirely through the 11 interest reserve on the -- from the thrift itself. 12 Q. All right. Third factor you mentioned 13 was debt service. I'm sorry. Equity. 14 Did the borrowers in the Park 410 15 transaction have an equity interest in the 16 property? 17 A. No. They had no actual equity in the 18 original document. They had an equity interest. 19 They actually owned the actual joint venture. But 20 they had no initial equity in the project, no. 21 Q. Let's look at whether the three 22 underwriting safety factors were present regarding 22328 1 the 1986 Norwood transaction. Okay? 2 A. Okay. 3 Q. Norwood. First, was there a useful 4 appraisal relied upon in underwriting the Norwood 5 transaction? 6 A. No, there was not. 7 Q. Do you say that for the reasons that we 8 discussed during your direct-examination by me? 9 A. Yes. Again, as you may recall, we went 10 through some specific line items with the Bolin 11 appraisal to indicate why the valuation could not 12 be relied upon. 13 Q. The second factor was: Was interest on 14 the 1986 Norwood transaction paid automatically by 15 USAT through an interest reserve, or was it paid 16 from a source outside the thrift? 17 A. Again, all funds for the interest 18 payments came from inside the thrift. 19 Q. Third factor. Was there borrower 20 equity in the Norwood project? 21 A. Yes, as a matter of fact. 22 Q. Did that equity come from a source 22329 1 outside the thrift? 2 A. No. It was actually provided by a 3 thrift affiliate. I believe it was United 4 Financial Corporation. 5 Q. Based upon your answers and what you've 6 just said, do you have an opinion as to whether 7 the underwriting for the 1986 Park 410 ADC loan 8 met reasonable standards of safety and soundness? 9 A. Yes, I do have an opinion. 10 Q. What is that opinion? 11 A. That the underwriting of that 12 transaction recklessly violated safe and sound 13 lending principles and was in violation of 14 applicable regulations regarding loan 15 underwriting. 16 Q. All right. Based on your testimony 17 this morning, do you have an opinion as to whether 18 the underwriting of the 1986 Norwood ADC loan met 19 reasonable standards of safety and soundness? 20 A. Again, yes, I have an opinion. 21 Q. Do you have such an opinion? 22 A. Yes. 22330 1 Q. What's your opinion? 2 A. Again, that the underwriting of that 3 transaction recklessly disregarded safe and sound 4 investment principles and violated underwriting 5 regulations as laid out in the books and records 6 of the regulations. 7 MR. LEIMAN: Your Honor, I have no 8 additional questions at this time for the witness. 9 Thank you, Mr. O'Connell. 10 THE COURT: Is there any recross? 11 MR. DUEFFERT: A little bit, Your 12 Honor. Not much. 13 THE COURT: All right. 14 MR. LEIMAN: I'm sorry. I didn't hear. 15 MR. DUEFFERT: I said a little bit. 16 17 FURTHER EXAMINATION 18 19 Q. (BY MR. DUEFFERT) Let's talk about 20 three things. No. 1, Charles White. 21 A. Okay. 22 Q. You've cited some testimony by 22331 1 Mr. white regarding moving numbers around on a pro 2 forma. Right? 3 A. That is correct, yes. 4 Q. Did you do anything to verify his 5 claims, the fact that they made sense, before 6 accepting them as being credible? 7 A. Well, yes. As a matter of fact, I 8 double checked on the Schulz appraisal, checked 9 the undiscounted numbers, and they were, in fact, 10 in the 120-million-dollar range. In fact, I think 11 something over $120 million. 12 Q. Did you -- Mr. white said that he was 13 moving numbers into subsequent periods, correct, 14 on the pro formas? 15 A. I don't recall him using that exact 16 phrase; but yes, that is what he would have to do 17 on a Lotus spreadsheet, yes. 18 Q. Have you run the numbers to see what 19 difference the changes identified by Mr. white 20 actually made on the pro formas? 21 A. You mean have I independently tested it 22 on my own Lotus or Excel spreadsheet, no, I have 22332 1 not. 2 Q. Whether or not on a Lotus or Excel 3 spreadsheet, have you run the numbers? 4 A. No, I have not. 5 Q. Have you determined if any of the 6 changes determined by Mr. White were even material 7 to the outcome? 8 A. Actually, yes. They would be for the 9 very simple reason that to the extent you change 10 the overall gross numbers, that changes the 11 overall base from which you then discount to 12 present value. So, yes, of course they would be 13 material. 14 Q. Schulz' appraisal used a 12 or 15 13 percent discount factor, correct? 16 A. That is correct, yes. 17 Q. You haven't checked to see if moving 18 sales to subsequent periods would make an 19 appraisal value, based on a 12 or 13 percent 20 discount factor, go up or down, have you? 21 A. Oh, I don't need to. It's 22 self-obvious. It's part of basic mathematics. 22333 1 It's part of basic present value analysis. 2 Q. If the appreciation factor is less than 3 12 percent in the pro forma, postponing sales into 4 subsequent periods would make the discounted 5 present value go down rather than up. Right? 6 A. That is correct, yes. 7 Q. Assume that you do what Mr. White says 8 he does, shifting the periods of projected sales 9 into the future. Assume that would make the net 10 present value of the gross sell-out go down by 11 more than $2 million. 12 Would that make any difference to your 13 analysis? 14 MR. LEIMAN: Your Honor, could I have a 15 reference to the transcript page that Mr. Dueffert 16 is referring to and what he's reading from? 17 MR. DUEFFERT: I'm not reading from 18 anything, but I'm referring to Mr. White's 19 description of what he did at transcript 20 Page 7644. 21 MR. LEIMAN: Okay. 22 A. Right. 22334 1 Q. (BY MR. DUEFFERT) Assume with me, 2 Mr. O'Connell, that because Schulz used a 12 and a 3 half or 13 percent discount factor in his 4 appraisal -- 5 A. Okay. 6 Q. -- that Mr. White's pushing of 7 numbers, as he alleges, into subsequent periods 8 makes the discounted present value of the gross 9 sell-out go down by $2 million. 10 A. If that is all he did. But as 7644 11 notes, Counselor, you're forgetting the fact that 12 he has, as I believe the phrase is, we have the 13 increased bump. The fact of the matter is he was 14 increasing the sales price, the projected sales 15 prices, for the purpose of offsetting the 16 discounted value. 17 But you're right. In and of itself, 18 without that, quote, "bump," if he did nothing 19 more than take the exact same number and spread it 20 out to subsequent periods, you're right. That 21 would lead to a lesser value when you present 22 value it. 22335 1 Q. You don't have an analysis to offer, do 2 you, of the mathematical effects of doing what 3 Mr. White says he did? 4 MR. LEIMAN: Asked and answered, Your 5 Honor. 6 THE COURT: Denied. 7 A. I was going to say I think I answered 8 that. 9 THE COURT: Could you answer it? 10 THE WITNESS: The answer is "no." 11 Q. (BY MR. DUEFFERT) Could we take another 12 look at the Federal Register page you just read? 13 It's B3969 at Tab 1541. 14 A. Okay. I've got it in front of me. 15 Q. First, this statement was not 16 reproduced in the Code of Federal Regulations as 17 the official policy statement of the Federal Home 18 Loan Bank Board with regard to ADC loans, was it? 19 A. That is my understanding, that in 20 general, the preambles are not made part of the 21 actual regulation book, yes, that is correct. 22 Q. And one wouldn't look to 12 CFR 22336 1 Section 371.17 for that, correct? 2 MR. SCHWARTZ: 371? 3 Q. (BY MR. DUEFFERT) I'm sorry. 571.17. 4 A. Back up. Actually, there are three 5 sections here that are addressed in the -- in the 6 final rule. It would be 561, 563, and 571. I'm 7 just reading from the first page. So, there would 8 be three sections that the changes in the 9 regulations here would affect. 10 Q. Once again, however, what we're looking 11 at now is not the official policy statement of the 12 Federal Home Loan Bank Board, correct? 13 A. Frankly, I would disagree with that. I 14 would think that the preamble to a regulation that 15 is about to be in effect is a clear policy 16 statement by the Bank Board indicating "Here's the 17 policy. This is why we're doing it, and here's 18 the formal regulation." I mean, that's -- if you 19 have a different interpretation, fine. But that's 20 the way I've always interpreted it. 21 Q. Well, let's take a look at this first. 22 A. Okay. 22337 1 Q. Page 27 -- 53277. There is a 2 discussion of a troubled thrift and its 3 skyrocketing assets. 4 A. Is that the very last -- 5 Q. I believe in the third column is a 6 discussion of Empire, I believe. Right? 7 A. Right. It starts with the phrase "In 8 one case, the institution's assets skyrocketed"? 9 Q. Right. 10 A. Okay. 11 Q. It says, "By December 1983, its 12 construction loans were over 80 percent of its 13 total loan portfolio." 14 A. Correct. 15 Q. In the center column, it talks about 16 the absence of borrower equity. 17 A. That is correct. 18 Q. Increasing the incentive for borrowers 19 to walk away. 20 A. Also correct. 21 Q. Also in that column, there is a quote, 22 "Many problem ADC loans are improperly reported by 22338 1 thrifts to the board as loans when, under proper 2 accounting principles, they are in economic 3 substance direct investments," correct? 4 A. That is correct. 5 Q. With United yesterday, we saw, did we 6 not, that United had a small portfolio relatively 7 of ADC loans, correct? 8 A. Relative to the thrifts. I would say 9 overall, 4 percent is a moderate amount. But 10 relative to those Texas thrifts, certainly it was 11 small. 12 Q. We also saw that with regard to 13 Park 410, United required $10 million in letters 14 of credit as collateral, correct? 15 A. That is correct, yes. 16 Q. And we also saw yesterday that with 17 regard to Norwood and with regard to certain loan 18 fees, United chose to defer rather than 19 immediately recognize fees and interest and chose 20 to record Norwood as a direct investment. Right? 21 A. That is the record that you showed us, 22 although I don't recall us discussing specifically 22339 1 about the fees. If we did, we did. But I don't 2 specifically recall addressing that. I thought we 3 primarily had addressed the issue of the direct 4 investment reporting. 5 Q. United deferred the 900,000-dollar fee 6 on the Norwood loan, did it not? 7 A. I believe so, yes. But I should note, 8 Counselor, that it is only self-evident because if 9 they had booked the fees, they would have charged 10 themselves. Remember, United as the joint venture 11 paid the fees. So, any fees they paid, they would 12 have had to bill their affiliate, which is one 13 reason I didn't criticize the fees in my opinion 14 because I knew it was a wash transaction. 15 Q. You're saying -- you implied about a 16 minute ago that United was trying to maximize the 17 amount of immediate fees it would recognize for 18 purposes of interest income, did you not? 19 A. When did I imply that a minute ago or a 20 few minutes ago? I specifically -- forget what 21 you think I'm implying, Counselor. What I said 22 was -- and what's in the opinion -- is that I very 22340 1 much criticized the 1984 transaction in which they 2 did, indeed, book fees. And I did, indeed, 3 criticize the Park 410. But because of the 4 structure of the 1986 transaction where UFC put up 5 9 and a half million, I did not criticize the fee 6 structure in that because, as I say, it would have 7 been a wash. United was effectively paying 8 itself. 9 Q. Mr. O'Connell, you're familiar with 12 10 CFR 371 -- 12 CFR 371.17? 11 MR. BLANKENSTEIN: 571. 12 MR. DUEFFERT: Thank you. 13 Q. (BY MR. DUEFFERT) 571.17? 14 A. Yes. 15 Q. And it presents a list of factors for 16 deciding how to book or record an ADC transaction 17 as a loan versus an investment. Right? 18 A. That is correct, yes. 19 Q. And this is Exhibit B4117, correct? 20 A. Yes, that is correct. 21 Q. Located at Tab 1048A. And you have 22 just criticized United's accounting or recording 22341 1 of the 1984 Block loan, correct? 2 A. That is correct, yes. 3 Q. And did I hear you also just now 4 criticized United's recording of the Park 410 loan 5 in 1986? 6 A. Well, yes. That's also stated in the 7 opinion, yes. 8 Q. You are saying that as part of your 9 report, that you are saying that the Park 410 loan 10 in 1986 was incorrectly recorded? 11 A. As an ADC loan as opposed to what it 12 was in substance, a direct investment, yes. 13 Q. Under this policy statement which was 14 in the Code of Federal Regulations, the Federal 15 Home Loan Bank Board presented, did it not, a list 16 of factors that should be weighed in determining 17 whether an ADC transaction should be recorded as a 18 loan or as an investment. Right? 19 A. That is correct, yes. 20 Q. And this is the regulation that you -- 21 or policy statement that you purport to have 22 relied upon for purposes of your evaluation? 22342 1 A. Yes. 2 Q. As I read it, there's only one hard 3 figure in this policy statement. If you look at 4 the bottom of the second column, Page 2 of the 5 exhibit, it says, "If, after considering all of 6 the factors associated with a particular 7 arrangement, the risks and rewards are deemed to 8 be similar to those of an investment in real 9 estate, the following guidance is to be followed." 10 A. Okay. 11 Q. It goes on to the next column. "One, 12 if the lender will receive a majority of the 13 expected residual profit from the project." It 14 goes on to suggest that the project should be 15 booked in accordance with various policy 16 statements. 17 A. That is correct. 18 Q. "Two, if the lender has less than a 19 majority participation in the expected residual 20 profit, t entire arrangement may be, in essence, a 21 real estate joint venture." 22 Then it refers to another FASB 22343 1 statement or several of them, correct? 2 A. Correct. 3 Q. Finally, "If the risks and rewards are 4 deemed to be similar to those of a loan, interest 5 should be recognized as income as specified in the 6 loan agreement," correct? 7 A. That is correct. 8 Q. As I read those factors, the key 9 determination is whether the lender will receive a 10 majority of the expected residual profit from the 11 project, correct? 12 A. That is your interpretation. But, in 13 fact, if you look at the preceding -- if you look 14 at the preceding paragraph on the second page when 15 it says, quote, "If after considering all of the 16 factors associated with a particular 17 arrangement" -- and my reading is you have to go 18 and look at the, roughly, six factors that are 19 stated -- that are stated ahead of that. 20 Q. Sir, would you read that entire 21 paragraph that you just referred to into the 22 record? 22344 1 A. Sure. "If, after considering all of 2 the factors associated with a particular 3 arrangement, the risks and rewards are deemed to 4 be similar to those of an investment in real 5 estate, the following guidance is to be followed." 6 Q. The word "investment," is there 7 significance to that word in that paragraph in 8 your mind, sir? 9 A. Yes. 10 Q. So, even if, on the basis of the 11 preceding factors, you believe it looks like an 12 investment, you still have to go to the next list 13 of factors, correct? 14 A. That is correct. 15 Q. And the single hard test is whether the 16 lender will receive a majority of the expected 17 residual profit from the project. Right? 18 A. That is one of the hard tests. 19 Q. What other hard test is in that second 20 column I just pointed you to? 21 A. Well, the second column is "If a lender 22 has less than a majority participation, the 22345 1 expected residual profit, the entire arrangement 2 may be, in essence, a real estate joint venture." 3 Q. But the hard trigger is whether or not 4 the lender has a majority or not of the residual 5 profit participation. Right? 6 A. For that one paragraph, yes. 7 Q. Right? 8 A. Right. 9 Q. 50 percent. Right? 10 A. That is correct. 11 Q. Mr. O'Connell, what was United's profit 12 participation or participation in the expected 13 residual profits of the 1984 Block loan? 14 A. My recollection is it was 15 approximately -- it was less than 50 percent. I 16 shouldn't really guess. 17 Q. You don't know, do you? 18 A. Not offhand. I'd rather look at the 19 actual document. 20 Q. It's not in your report, is it? 21 A. No, it is not. 22 Q. Would it refresh your memory if I 22346 1 suggested to you that their expected residual 2 profit participation in the 1984 Block loan was 3 zero? 4 MR. LEIMAN: Your Honor, I'm going to 5 object to the entire line of questioning. It's 6 well beyond the scope of my very brief 7 redirect-examination. We're going back to the 8 cross-examination that Mr. Dueffert did yesterday. 9 We're wasting time. 10 MR. DUEFFERT: Your Honor, I have three 11 more questions. 12 THE COURT: All right. Denied. 13 Q. (BY MR. DUEFFERT) Will you dispute, as 14 you sit here today, that United had no profit 15 participation in the 1984 Block loan? 16 A. That's my current recollection, yes. 17 Q. Now, let's move on to the Park 410 loan 18 of 1986. 19 A. Okay. 20 Q. What was United's profit participation, 21 also sometimes called an equity kicker, in the 22 1986 Park 410 loan? 22347 1 A. Again, my recollection is it was less 2 than 50 percent. 3 Q. You can't tell me? 4 A. Again, instead of relying on 5 recollection, I'd rather go to the actual 6 document. 7 Q. You can't tell me? 8 A. No. 9 Q. Would it refresh your recollection if I 10 told you their profit participation was 11 25 percent? 12 A. That sounds about right, yes. 13 Q. Two more questions, sir. 14 A. Okay. 15 Q. First, looking at your report, can you 16 point me anywhere in it where you discuss the fact 17 that the contemporaneous regulation of the Federal 18 Home Loan Bank Board or policy statement that 19 governed this area had a trigger based on the 20 majority of the expected profit -- residual profit 21 from the project? Try it again. 22 A. Okay. Right. 22348 1 Q. Do you disclose anywhere in your 2 report -- 3 A. Oh, I see. Okay. 4 Q. -- that this is a factor? 5 A. No, I did not. 6 Q. Last question. 7 Can you point me to anywhere in your 8 report where you advise me and the Court of the 9 simple fact that United had a 25 percent profit 10 participation in the Park 410 loan? 11 A. Again, no, that is not in the report. 12 MR. DUEFFERT: No further questions. 13 THE COURT: Any other respondents have 14 recross? 15 MR. BLANKENSTEIN: None. 16 MR. EISENHART: I have none, Your 17 Honor. 18 THE COURT: Redirect? 19 MR. LEIMAN: I just have one question, 20 Your Honor, a single question. 21 . 22 . 22349 1 2 FURTHER EXAMINATION 3 4 Q. (BY MR. LEIMAN) Are the factors that 5 Mr. Dueffert referred to in the exhibit you have 6 in front of you, B4171, are they meant to be 7 applied mechanically or are they meant to be 8 applied in good faith by the thrift and its 9 management? 10 A. Obviously, they are to be applied in 11 total by the thrift and its management. And 12 particularly, if you recall, Mr. Leiman, in 13 yesterday's redirect, we discussed a document in 14 which there was a checklist for the Norwood 15 transaction of 1984 in which either Peat Marwick 16 or the internal auditors or the internal staff 17 actually had a checklist of six out of the seven 18 categories where it actually indicated that the 19 property was a direct investment. 20 So, it is supposed to be applied in 21 good faith and exercise good and fair judgment on 22 the part of the management. 22350 1 MR. LEIMAN: Nothing further. 2 THE COURT: Thank you, Mr. O'Connell. 3 You may step down. We'll take a short recess. 4 5 (Whereupon, a short break was taken 6 from 9:46 a.m. to 10:10 a.m.) 7 8 THE COURT: Be seated, please. We'll 9 be back on the record. 10 MR. NICKENS: Your Honor, before we 11 begin Mr. Lapidus' testimony, there are a couple 12 of issues we'd like to discuss with the Court. 13 Last week, we had a discussion about 14 scheduling, and you asked us to confer and report 15 to you before the recess as to where we stood on 16 the overall scheduling issue. 17 We have had some discussions, but we 18 have not been able to reach any accommodation or 19 agreement between our two respective positions 20 with regard to scheduling. 21 The respondents are -- have all 22 individually made both personal and professional 22351 1 plans based upon the assumption that this 2 proceeding would be -- this part of the proceeding 3 anyway would be concluded on the October 16th date 4 or thereabouts. And we simply can't move those in 5 such a way that we could conclude the proceeding 6 on any schedule that does not include a recess. 7 We are prepared -- we've checked with 8 everybody's schedules -- prepared to come back -- 9 to recess and come back in February for the final 10 session which, including rebuttal, we believe 11 should not be more than ten weeks. We are 12 estimating eight to ten weeks, but ten weeks on 13 the safe side. 14 My understanding of the OTS's position 15 is that we should simply continue. And we are not 16 in a position to do that in such a way that we 17 could complete the case. 18 The first direct conflict, although it 19 is one that I have where a case was set on 20 December 2nd based upon the representation that I 21 would be given approximately a month to prepare 22 for that case. Now, I could do it in something 22352 1 shorter than that, but I can't do anything that 2 would make this thing work. 3 That's where we are on that issue. 4 MR. GUIDO: I think that Mr. Nickens 5 has correctly indicated where we stand on that 6 issue. We tried to figure out a way of adjusting 7 witnesses and doing various things, Your Honor, to 8 abbreviate it. And we wouldn't come to a mutually 9 agreeable format on how to go forward with regard 10 to the witnesses, Your Honor. 11 For that reason, the OTS will complete 12 its direct testimony by the 16th, the way we 13 project it at the present time. And we believe 14 that we should continue and finish it, given 15 breaks for the holidays, Your Honor. 16 I have discussed this matter with my 17 colleagues in Washington, and our position is that 18 we should just press ahead and get the testimony 19 portion of this proceeding over and start focusing 20 on the briefing part and the proposed findings of 21 fact, Your Honor. 22 And as a consequence, we could not come 22353 1 to an understanding with the respondents on how we 2 should proceed. They take the position that for 3 scheduling reasons they can't start again until 4 February, Your Honor. We take the position that 5 we believe we should press on and complete this 6 matter, Your Honor. 7 THE COURT: Well, it seems to me we do 8 need some recess. And then there is the matter of 9 the holidays. I -- my view is that February -- if 10 we can start in February and complete it, that 11 that's what we should do. I have other matters I 12 also have to take care of, proceedings I have to 13 complete and so on, and I'd like to do that before 14 the end of the year. And I just think that's 15 probably the best solution. 16 MR. NICKENS: Thank you, Your Honor. 17 THE COURT: Do you have a date in 18 February? 19 MR. NICKENS: We will come up with one, 20 Your Honor. It will be the early part of 21 February. Mr. Villa has a trial and 22 Mr. Blankenstein has a trial in February, but we 22354 1 will give you a schedule that completes this thing 2 in February and into the early part of March. We 3 can do that during the recess. 4 MR. GUIDO: Your Honor, the second 5 matter pertains to the motion that was filed by 6 the respondents with regard to documents that the 7 FDIC -- we had sent to the FDIC and they claimed 8 privilege over. We have a letter that we received 9 from the FDIC this morning which I'd like to pass 10 up to the Court. I've already given that to 11 Mr. Nickens. 12 Apparently, the respondents had also 13 filed a motion to compel those documents before 14 Judge Hughes and the FDIC enforcement action. 15 THE COURT: Does that embrace all of 16 them that are at issue here? 17 MR. GUIDO: Your Honor -- 18 MR. NICKENS: This did, Your Honor. It 19 was all the same documents. 20 MR. GUIDO: And, Your Honor, the court 21 has ruled on those documents. And the FDIC has 22 asked me to present to the Court its views with 22355 1 regard to that. And that is that it will not be 2 taking any locutory appeal with regard to the 3 documents that Judge Hughes ordered to be 4 produced, and it will be producing those documents 5 to Mr. Nickens today according to the schedule. 6 And I think that the letter indicates they will 7 try to get to them -- the materials to them this 8 morning, Your Honor. 9 And then with regard to notes that they 10 took, discussions that they had had with 11 Mr. Lapidus, Judge Hughes ruled that those 12 documents not be produced. And they told me that 13 it's their view that that issue has now been 14 mooted by that -- the judge's order in that case. 15 And I said that I would present their views to 16 Your Honor and Mister -- 17 THE COURT: You're saying "they" now. 18 Is that the respondents here or -- 19 MR. GUIDO: They, the FDIC. I don't 20 know what the respondents' views are on that, Your 21 Honor. I have had discussions with them, but I 22 would rather Mr. Nickens express the respondents' 22356 1 views to the Court. 2 MR. NICKENS: Your Honor, we're 3 studying the effect of the judge's order. And for 4 purposes of this proceeding, if we feel like we 5 are legally entitled to the documents in light of 6 that ruling, we will file a new motion or 7 otherwise not file a motion. 8 So, for purposes of briefing and your 9 consideration, the motion that we filed with you 10 is either moot or withdrawn; and we will file a 11 new motion after considering the effect of this 12 and after having had a chance to see the documents 13 that have been ordered to be produced which we 14 have not yet seen. 15 And that raises the somewhat broader 16 issue of Mr. Lapidus' testimony and our schedule 17 for today, if I could raise that with you. We 18 will not be able to complete -- apart from these 19 document issues, not be able to complete 20 Mr. Lapidus' testimony today. We had 21 originally -- I had originally estimated that it 22 would be about two days. I think we could do 22357 1 somewhat less than that, but we're not going to be 2 able to complete him today, particularly in light 3 of the fact that I will, at lunch, presumably see 4 some more documents that might go to his 5 testimony. That's further reason why we will not 6 be able to finish today. 7 Mr. Veis has indicated that his direct 8 testimony will take approximately three to four 9 hours, and my cross an equal amount, possibly a 10 bit more in light of the nature of his testimony. 11 What we're asking the Court to do is to 12 go ahead and have his direct and then go ahead and 13 do our recess. There is also a personal element 14 to this. You probably have witnessed the fact 15 that I have been having some respiratory problems 16 of some nature or another. I have been assured by 17 the doctor that I will not make anyone else sick 18 by my presence, but I am not sure that I can 19 comfortably talk for extended periods of time. 20 And so, all of that together comes 21 to -- I'm asking and the respondents are asking 22 that we go ahead and get Mr. Lapidus' direct 22358 1 finished and then resume after the recess and 2 complete his testimony thereafter. 3 THE COURT: I gather there is no 4 opposition to that? 5 MR. GUIDO: Your Honor, we don't -- 6 we've said that we should just press ahead. And 7 we are not in a position to object to it, although 8 we do think that breaking up direct and 9 cross-examination creates problems. We understand 10 the scheduling problem, Your Honor. 11 THE COURT: All right. We'll adjourn 12 when Mr. Veis is through. 13 Sir, would you take the oath, please? 14 15 LEONARD LAPIDUS, 16 17 called as a witness and having been first duly 18 sworn, testified as follows: 19 20 THE COURT: Be seated, please. 21 Mr. Veis. 22 MR. VEIS: Good morning, Your Honor. 22359 1 Thank you. 2 3 EXAMINATION 4 5 Q. (BY MR. VEIS) Would you please state 6 your name for the record? 7 A. My name is Leonard Nathan Lapidus. 8 Q. And who is your employer, Mr. Lapidus? 9 A. I work for the Office of Thrift 10 Supervision and Department of the Treasury. 11 Q. And what is your position with the 12 Office of Thrift Supervision? 13 A. I am a field examiner. 14 Q. Now, if you would, please, can you 15 describe briefly your educational background for 16 the Court? 17 A. I graduated in 1979 from Ohio State 18 with a major in finance and marketing and a minor 19 in accounting. 20 Q. Did you seek employment after your 21 graduation from college? 22 A. Yes, I did. I held several jobs. 22360 1 Q. Why don't we start with the first one. 2 You graduated in 1979. 3 Where did you go to work then? 4 A. I went to work at -- it was kind of a 5 retail store, department store as a manager 6 trainee for a couple of months. 7 And after that, I went to work for 8 Leader Mortgage in their mortgage loan collection 9 department. 10 Q. And how long did you work at Leader 11 Mortgage? 12 A. About eight months or so. 13 Q. So, I take it in 1980? 14 A. Roughly. I then tried a brief stint as 15 an insurance salesman, and I went to work for 16 National City. It's a large bank in Cleveland. 17 Q. I'm sorry? 18 A. National City. 19 Q. Is that a bank? 20 A. It's a large bank in Cleveland. 21 Q. And what did you do for National City 22 Bank? 22361 1 A. I was working in their installment loan 2 collection department, and I was trying to apply 3 to get into their management trainee program. 4 Q. Now, did there come a time when you 5 left National City Bank? 6 A. Yes. I had taken the civil service 7 test and had received several forms from different 8 government agencies and one of them was the 9 Federal Home Loan Bank Board, which was the 10 predecessor to the OTS. 11 Q. And did you then go to work for the 12 Federal Home Loan Bank Board? 13 A. Yes. I believe in May of '81, I began 14 working for the Federal Home Loan Bank Board. And 15 I worked for -- basically, I've worked for them 16 since. There's been -- the OTS is the third name 17 change or second name change. 18 Q. Now, was there a particular place that 19 you -- a particular district of the Federal Home 20 Loan Bank Board that you went to work for? 21 A. Yes. I worked in the Chicago district. 22 Q. And have you always worked in the 22362 1 Chicago district? 2 A. I -- 3 Q. Barring name changes. 4 A. Well, I worked in the Chicago district 5 until it became the central region. And then I 6 moved from Chicago back to Cleveland, which is 7 where I was raised. 8 Q. And you now work for -- do you now work 9 for the OTS in Cleveland? 10 A. Right. Central region. 11 Q. Now, if you would, please, describe the 12 training that you received as an examiner. 13 A. Well, in addition to being trained in 14 the field basically, we -- there's -- you are 15 required to take one or two courses a year in 16 various areas. 17 Q. Now, is there a school called new 18 examiner school? 19 A. Yes. That's usually the first one you 20 take. Then after that, there's an intermediate 21 examiners school. 22 Q. Have you taken the intermediate 22363 1 examiners school? 2 A. Yes, I have. 3 Q. Have you taken any other courses in 4 connection with your work as an examiner? 5 A. I've taken a variety of courses. I've 6 taken appraisal and -- two different appraisal 7 courses. I've taken a course called FIFO, 8 financial instruments, futures, and options. 9 Q. Now, when did you take the FIFO course? 10 A. I'm not sure. I think in '83 or '84. 11 Q. Was there any particular effect on your 12 job responsibilities after you took the FIFO 13 course? 14 A. Well, sometime in there -- I'm not sure 15 if it was even before or after I took the 16 course -- I had been approached by Larry Kenney. 17 Q. And who is Larry Kenney? 18 A. He is now the Chicago regional capital 19 market specialist. 20 Q. And what did Mr. Kenney approach you 21 about? 22 A. And he asked me if I wanted to 22364 1 specialize in capital markets and that, in 2 addition to training me in the field, I would -- 3 you know, he would help me in those areas where I 4 needed help. 5 Q. So, Mr. Kenney was sort of a mentor? 6 A. Yes, he was. 7 Q. Now, what did being a capital markets 8 specialist involve? 9 A. Well, basically, from an examination 10 standpoint, we specialize in the examination of 11 institutions where they had investments or -- in 12 mortgage-backed securities, treasuries, junk 13 bonds, agency securities, a variety of hedging. 14 In the early years, options were a really big 15 issue and eventually swaps and the other types of 16 derivative securities became an issue as time went 17 on in the institution. 18 Q. Did the FIFO district also have other 19 kinds of specialists during the 1980s? 20 A. Yes, we did. We had trust specialists. 21 We had white collar crime specialists. We had a 22 commercial real estate specialist. I was an 22365 1 alternative for commercial real estate, but that 2 was not my main area of work. My main area was in 3 capital markets. 4 Q. Well, now, let's talk a little bit 5 about capital markets. Were there any other 6 courses that you took that would relate to your 7 responsibilities in dealing with capital markets 8 or financial instruments? 9 A. Well, I took a course outside the 10 regular system at the Chicago -- I think it was 11 the Chicago Option Exchange is where it was given. 12 Q. What was that course on? 13 A. It was a course on -- on options, 14 mainly on calls and puts. And they had -- one of 15 the people from one of the houses came in and 16 taught the course. 17 Q. Have you taken any courses on 18 securities? 19 A. I took a course from the National 20 Securities Examiners -- I can't remember the 21 exact -- 22 Q. National Association of Securities 22366 1 Dealers, the NASD? 2 A. Yeah. I took that for a couple days. 3 I've taken an advanced capital markets class, 4 emerging issues which dealt mainly with capital 5 market issues. And I also taught with Larry 6 Kenney. We taught a district-wide class and 7 basically an advanced FIFO class. 8 Q. FIFO being the -- 9 A. FIFO, financial instruments, futures, 10 and options. And my area was the nuts and bolts 11 of the examination process, and he dealt with the 12 more esoteric concepts. 13 Q. Are you talking about the nuts and 14 bolts of examining financial instruments? 15 A. Yes. And futures and options. We -- I 16 created a number of work papers for the course, 17 and those were to the examiners trying to give 18 them a basic understanding of what to look for. 19 And the idea was that they would -- with this 20 training, they would be able to handle the more -- 21 the simpler problems and they would be able to 22 recognize when the problems were beyond their 22367 1 scope and then they would call in myself or one of 2 the other people that specialized in that area. 3 Q. Now, have you taken any courses in 4 asset/liability management? 5 A. Yes, I did. I took an asset/liability 6 management class. I also took kind of related for 7 interest rate risk analysis for sensitivity and 8 such. I've taken classes basically from Sendero 9 when Sendero -- when the Federal Home Loan Bank 10 used Sendero as a model for measuring interest 11 rate risk. 12 Q. Now, you started, I take it, as a field 13 examiner. Right? 14 A. Yes. 15 Q. Now, did there come a time when you had 16 another position with the OTS? 17 A. Yes. At the end of I think 1989, 18 November or December '89, I had applied for a 19 position as a case manager. 20 Q. What's a case manager? 21 A. They replaced supervisory agents as -- 22 it was basically a name change. And I had been 22368 1 given that position or won that position, however 2 you want to call it, and I was a case manager for 3 over a year. 4 Q. Well, what were your responsibilities 5 as a case manager? 6 A. I had about 35 institutions that I 7 was -- that I was in charge of. I spent probably 8 the first five or six months working almost 9 exclusively on capital plans because of the FIREA 10 legislation. And during that time, I guess I 11 would say I handed several institutions over to 12 the RTC because they were unable to meet the 13 requirements. 14 Q. I think you said that you -- well, did 15 there come a time when you were no longer a case 16 manager? 17 A. Yes. They were downsizing. And 18 basically, I believe there were about 20 or so 19 case managers and field managers, and there were 20 only going to be 12 positions. And we heard there 21 were rumors there were going to be less than that. 22 And as a new case manager, I felt my 22369 1 odds of maintaining a position were slim. 2 Q. Were you the most junior or among the 3 most junior? 4 A. I probably was the most junior. And 5 there was -- because they had merged the districts 6 into regions, Cleveland was now in the central 7 region and there was an opportunity -- when I was 8 moving back into the field, instead of just going 9 into the field in Chicago, I went to the field in 10 Cleveland -- 11 Q. Now, Cleveland is your hometown. 12 Right? 13 A. Yes. That's where I was born and 14 raised, and I took advantage of that opportunity. 15 Q. So, in 1981, you moved back to 16 Cleveland and went back into the field? 17 A. Yes, I did. 18 Q. And you continue to be a field examiner 19 today? 20 A. Yes, I am. 21 Q. And do you have any professional 22 certifications? 22370 1 A. I'm -- I have a certification as an 2 FTR, federal thrift regulator. 3 Q. Now, I would like to go back to 1988, 4 if I could, and the work that you were doing at 5 that point. I gather that at that point, you had 6 been working as a specialist in capital markets 7 and financial instruments as an examiner for some 8 period of time; is that correct? 9 A. For about five or six years at that 10 point, I think. 11 Q. Now, if you would, just tell us again 12 what exactly that entailed in terms of your work 13 and your responsibility with respect to 14 examinations. 15 A. Well, while I was in charge on a number 16 of jobs, a lot of times my position was as an 17 assistant working on that particular area. If an 18 examiner or a supervisory personnel determined 19 there was a situation where they needed a 20 specialist, I would be called in; and I would 21 probably work -- sometimes I spent 50, 60, 22 70 percent of my time working on that, exclusively 22371 1 on reviewing financial instruments and different 2 types of hedging activities that institutions were 3 involved in. 4 Q. Would that include reviews of funding 5 mechanisms? 6 A. Yes. Oh, sorry. The -- all sides of 7 the balance sheet: The assets, the liabilities, 8 and the off balance sheet items. 9 Q. So, you would review, for example, 10 reverse repurchase agreements? 11 A. Yes, I would. And dollar rolls and 12 whatever other type of funding source that the 13 institution was using to finance their activities. 14 Q. Now, prior to 1988, had you done any 15 work in the Dallas region or district? 16 A. I had been in Dallas on -- I had been 17 in the Dallas district in '86 -- 18 Q. What was that? 19 A. -- in New Orleans doing an examination 20 of -- it's funny. I can remember the name of the 21 president, but I can't remember the name of the 22 institution. 22372 1 Q. But it was an institution in 2 New Orleans? 3 A. Yes, it was. We were there for about 4 three months. 5 And then in '88, I had been requested 6 to be the examiner-in-charge for a place called 7 AmeriCity. They had -- in Dallas. 8 Q. Do you recall what months of 1988 that 9 was? 10 A. I think July, August, September. 11 Probably July, August, September, October, 12 somewhere in that area. 13 Q. What was AmeriCity? 14 A. Well, there was a holding company. 15 There was two -- there were two thrifts. One was 16 in Dallas. The other was in New Mexico. There 17 were several service corporations. Some of them 18 were jointly owned by the two institutions. They 19 were involved in extremely sophisticated 20 activities regarding financial instruments. 21 Mainly, they had a variety of mortgage-backs and 22 derivative mortgage-backed securities. 22373 1 Q. And you were asked to be the 2 examiner-in-charge, correct? 3 A. Yes. 4 Q. Who asked you to be the 5 examiner-in-charge? 6 A. I believe it was Chet Biedron, who was 7 the -- and Larry Kenney. Chet Biedron I think at 8 the time was our head supervisory agent on the 9 supervision side of the Federal Home Loan Bank of 10 Chicago. 11 Q. Now, did they tell you why you were 12 being requested to be the examiner-in-charge for 13 AmeriCity? 14 A. They said that the institution was 15 heavily involved in securities transactions. They 16 had a very sophisticated program, and they needed 17 someone to be able to really look at it and 18 determine whether or not what they were doing was 19 within reasonable standards. 20 However, I told them that I did not 21 think it would be a good idea for me to be the EIC 22 of two jobs and to do that review. And I 22374 1 requested that they select two other people to be 2 the examiner-in-charge for those two jobs. And I 3 had a hand in selecting one of the EICs. The 4 other one, they turned down my request. 5 Q. Now, did you, in fact, go to AmeriCity 6 to work in the examination as an assistant? 7 A. Yes, I did. 8 Q. What did you do as an assistant? 9 A. I reviewed all the activities of the 10 institutions and their subsidiaries. I had a 11 number of conferences with the president and 12 the -- I think he was an executive vice president 13 who were involved with these transactions. 14 Q. And by "these transactions," are you 15 referring to the securities transactions? 16 A. Yes. They were buying and selling 17 mortgage-backed securities. They had purchased a 18 number of derivative mortgage-backed securities in 19 terms of having purchased interest-only securities 20 and principal-only securities. They had some 21 hedging, I believe, that they did. But for the 22 most part, they had a -- essentially a trading 22375 1 portfolio which they managed. 2 Q. And was this a safety and soundness 3 examination? 4 A. Yes. It was a safety and soundness 5 examination, but it was also tied into the 6 Southwest Plan, I think, because they were a 7 potential acquirer. 8 Q. And what did you determine with respect 9 to AmeriCity's management of its securities 10 portfolios? 11 MR. NICKENS: Your Honor, I don't 12 understand the relevance of AmeriCity's situation. 13 The background that he went there, made an 14 examination perhaps could be relevant; but the 15 results, you know, what was -- I just don't 16 understand the relevancy. 17 MR. VEIS: I was just trying to 18 complete the description of events. 19 THE COURT: Let's move on. 20 Q. (BY MR. VEIS) You finished the 21 AmeriCity examination? 22 A. Yes, I did. 22376 1 Q. In about August or September, I think 2 it was? 3 A. Probably sometime in September. 4 Q. And what then? Did you go home? 5 A. Yeah. I went back to Chicago. 6 Q. Now, did there come a time when you 7 were told you were going back to Texas? 8 A. Yes. I received a call from Larry 9 Kenney, I believe, telling me that there had been 10 a request that I go down to Houston to assist in 11 the examination of an institution. 12 Q. What institution was that? 13 A. United Savings Association of Texas. 14 Q. And approximately when was that? Do 15 you recall? 16 A. When was I told? 17 Q. When were you told that? 18 A. Sometime in November. 19 Q. Of 1988? 20 A. Of '88. 21 Q. Now -- and did you go then directly to 22 Houston from Chicago? 22377 1 A. After the Thanksgiving Day -- after 2 Thanksgiving weekend, I flew from Chicago to 3 Houston and went to USAT. 4 Q. Now, before we get to your arrival at 5 USAT, I'd like to go back to your conversation 6 with Larry Kenney. 7 What were you asked to do at USAT? 8 A. They -- I was told that they did not -- 9 that the Federal Home Loan Bank of Dallas did not 10 have a good handle on what the institution had 11 been doing in terms of its securities activities 12 and hedging and their risk-controlled arbitrage 13 and that I was -- they were asking that I go back, 14 instead of just looking for the review period, 15 which is basically from when the last exam was, I 16 was to go back as far as I could to track the 17 activity and review the minutes of the institution 18 to determine how the activities had been 19 established and who had -- who had approved these 20 activities. 21 Q. Now, were you told anything about prior 22 examinations? 22378 1 A. Just that the -- they did not have the 2 people who were specialists in that area to look 3 at it and that I should just look at it as an 4 independent review. 5 Q. Now, did you review prior examination 6 reports? 7 A. No, I did not. 8 Q. Now -- so, you flew to Houston. I take 9 it then you went to the institution? 10 A. Yes. I was -- I went to the 11 institution. I met the examiner-in-charge, Brenda 12 Bese. And I think she introduced me to whoever 13 was in the room with her at the time. And then 14 she took me upstairs and introduced me to Dominic 15 Bruno, and I was given a place to work on that 16 floor. 17 Q. After your arrival, what did you do to 18 begin your assignment? 19 A. Well, I started requesting information. 20 I had been told that I needed to go to this woman 21 to request board minutes and other committee 22 and -- other committee minutes. And I requested 22379 1 the information, and I was given board minutes to 2 review and executive committee minutes and 3 investment committee minutes. 4 Q. Were your requests written or oral? 5 A. As far as I know, remember, they were 6 oral. There may have been some written requests 7 along the way. 8 Q. Was the staff cooperative? 9 A. Yes, they were. What I asked for, I 10 was given. 11 Q. Were there any individuals who were 12 particularly cooperative? 13 A. Dominic Bruno was very helpful. He was 14 able to answer questions for the most part that I 15 had and was able to -- when I needed specific 16 information, he was able to get that rather 17 quickly for me. 18 Q. Did you ever speak with Michael Crow? 19 A. Yes. I met with him, I think, several 20 times. 21 Q. What about Bruce Williams? 22 A. I also met with him several times. 22380 1 Q. Did you meet more frequently with 2 Mr. Bruno than with Mr. Crow and Mr. Williams? 3 A. Yes. I probably talked to him at least 4 once a day, if not more. 5 Q. Now, did you attend any investment 6 committee meetings during the time you were at 7 USAT? 8 A. One that I remember. They invited me 9 to attend a meeting so that I could see how the 10 investment committee operated. 11 Q. Do you have any recollection of the 12 events at that meeting? 13 A. I don't -- the only thing I really 14 remember about that meeting is that they had some 15 kind of proposal to sell off a really large chunk 16 of their -- I don't know if it was securities or 17 hedging. But basically, they would have -- they 18 wanted to sell this off, and they would have taken 19 some losses. But they wanted me to approve what 20 they were doing, and I told -- 21 Q. I'm sorry. What did you say? 22 A. I told them that I am not authorized to 22381 1 approve their activities and that if they -- they 2 needed to make that decision, whether or not they 3 wanted to sell those securities. 4 Q. Now, is it within an examiner's 5 authority generally to approve transactions by an 6 institution that it's examining? 7 A. No. In fact, I don't think that would 8 ever be considered by any examiner, that they 9 would do that. 10 Q. Now, this was while you were at USAT. 11 Do you recall approximately when that 12 investment committee meeting was held? 13 A. Sometime in December. I think the 14 earlier part of the month. 15 Q. The earlier part? 16 A. Yeah. 17 Q. Now, do you know whether there had been 18 a prior detailed comprehensive review of the USAT 19 mortgage-backed securities portfolios? 20 A. I don't know if there was one prior to 21 mine. 22 Q. You're not aware of one, though, are 22382 1 you? 2 A. No. 3 Q. Your review was limited, I take it, to 4 the mortgage-backed securities portfolio? 5 A. I looked at the mortgage-backed 6 securities portfolio, the financing for that 7 portfolio, and the hedges that the institution 8 indicated were -- the off balance sheet hedges 9 that the institution indicated were hedges against 10 that portfolio. 11 Q. Did you review any other securities 12 activities? 13 A. No, I did not. 14 Q. Now, I'd like to talk specifically 15 about the areas that you reviewed. 16 Did you review asset/liability 17 activities? 18 A. As in interest rate risk management? 19 Q. Yes. 20 A. No, I did not. 21 Q. Did you review the management of 22 mortgage-backed securities and derivatives? 22383 1 A. Yes, I did. 2 Q. And did you review the liabilities that 3 financed the acquisition of those mortgage-backed 4 securities and derivatives? 5 A. Yes, I did. 6 Q. What kind of liabilities were those? 7 A. Well, the institution -- in addition to 8 the deposit base which funded a portion of it, the 9 institution used reverse repos and dollar rolls, 10 which are basically a short-term investment 11 product that -- where the broker will lend money 12 to the institution in exchange for holding the 13 asset -- the institution's assets as collateral. 14 In this case, the mortgage-backed securities. 15 Q. And I believe you just said a few 16 minutes ago that you also reviewed the hedging and 17 off balance sheet activities? 18 A. Yes, I did. 19 Q. In particular, what instruments are 20 involved in the activities that you reviewed? 21 A. Well, for the most part, the 22 institution used -- had swaps; but they also 22384 1 had -- they also had some calls and a collar and 2 some options, I think. 3 Q. Did they have futures? 4 A. Yeah. I think they had futures, too. 5 But they were mostly minor. 6 Q. I'm sorry. Did you mention caps? 7 MR. NICKENS: Your Honor, did he say 8 "calls"? 9 THE COURT: That's what I heard. I'm 10 not sure I understand that. 11 Q. (BY MR. VEIS) As in call options? 12 A. I'm sorry. I meant call options. 13 THE COURT: Thank you. 14 A. I think they had call options. 15 Q. (BY MR. VEIS) What about interest rate 16 caps? 17 A. Yes. I believe they did have an 18 interest rate cap. I think they also had an 19 interest rate collar. 20 Q. Now, I believe you also said you 21 reviewed -- you requested minutes of the board of 22 directors, the executive committee, and the 22385 1 investment committee; is that correct? 2 A. Yes, that's right. 3 Q. And did you review those documents, as 4 well? 5 A. Yes, I did. And for the investment 6 committee minutes where -- since they were weekly 7 meetings, I basically made copies of those minutes 8 I thought were appropriate rather than trying to 9 write down each item. 10 Q. You didn't copy all of them, did you? 11 A. No. I just copied parts. 12 Q. Now, I'd like to go back to your 13 request for information. 14 When you requested minutes, did you 15 specifically -- did you specify the committees 16 that you wanted to review? 17 A. I don't really recall if I did. I 18 probably would have asked them to give me those 19 minutes that were -- that applied to their 20 activities, which is why I ended up looking at 21 some of the executive committee minutes, because 22 either the board or the executive committee made 22386 1 those decisions before the investment committee 2 was formed. 3 Q. Did you ask them for any materials that 4 were relevant to your review of the 5 mortgage-backed securities activities? 6 A. I would have asked them. 7 Q. And that would include any minutes; is 8 that correct? 9 MR. NICKENS: Your Honor, I object to 10 the leading. The witness has indicated clearly he 11 doesn't remember. 12 Q. (BY MR. VEIS) Well, I notice you 13 haven't mentioned anything about asset/liability 14 committee minutes. 15 Did you receive any asset/liability 16 committee minutes? 17 A. No, I did not. 18 Q. Did anyone tell you that the 19 asset/liability committee minutes would be 20 relevant to your review of mortgage-backed 21 securities activities? 22 A. No, they did not. 22387 1 Q. Now, let me ask just how you went about 2 this review. You got all these materials. 3 What did you do next? 4 A. Well, I was actually doing several 5 things at once. In addition to reading through 6 the institution's minutes, I was also looking 7 through their monthly or their records, whatever 8 they had. They had records that showed what their 9 average balance and yields were on their 10 securities during the month. They had monthly 11 records on their various off balance sheet 12 activities, and they had the repurchase agreements 13 and dollar rolls. And I was looking at them -- as 14 I went along, looking at different aspects of the 15 institution trying to get a solid handle on what 16 they had done and when they had done it and how 17 they had progressed from the beginning which, I 18 think, was sometime in '85 until the present time 19 which -- at that time, the present time -- I cut 20 it off at September 30th because the 21 examination -- the financial information that they 22 were using for the report, as I understood it, was 22388 1 to be as of September 30th. 2 Q. Did anyone assist you in your review? 3 A. I had two assistants. I don't think 4 they were there the whole time. There was Randy 5 Kiner who was -- 6 Q. Who was Randy Kiner? 7 A. He is a Chicago examiner who was down 8 in Houston on another job. And I kind of borrowed 9 him for a couple weeks. And then the Dallas 10 people also sent me an examiner who they had hired 11 to be a securities specialist, and he worked with 12 me for a week or two, as well. 13 Q. Do you recall his name? 14 A. No, I don't. 15 Q. Mr. Lapidus, did you create any work 16 papers in connection with your review? 17 A. Yes, I did. 18 Q. I'd like you to look to your right at 19 that stack of trial exhibits and look at those. 20 They are Exhibits A14101, A141022, A14103, A14104, 21 and A14105. 22 Can you identify those exhibits as your 22389 1 work papers? 2 A. Yes. They are -- to the best of my 3 knowledge, they are my work papers from that 4 examination. 5 Q. And you have -- have you had an 6 opportunity to review those prior to testifying 7 today? 8 A. Yes, I have. 9 Q. Were those work papers prepared by you 10 or under your supervision in connection with your 11 responsibilities in examining the mortgage-backed 12 securities activities at United Savings 13 Association of Texas? 14 A. Yes, they were. 15 MR. VEIS: Your Honor, I move the 16 admission of Exhibits A14101, A14102, A14103, 17 A14104, and A14105. 18 MR. NICKENS: No objection, Your Honor. 19 THE COURT: Received. 20 Q. (BY MR. VEIS) Now, Mr. Lapidus, I'd 21 like to first direct your attention to 22 Exhibit A14102. 22390 1 Would you pull that, please? Now, you 2 have explained to us what these documents are. I 3 would like to very briefly run through this and 4 explain what the contents are without getting into 5 detail as to what you did with them. 6 Can you do that, please? If you would 7 start, say, at OW182409. Let me -- let me ask you 8 a question before we do that. 9 Would you take a look, please, at 10 OW182402 and OW -- well, just look at that one. 11 A. Okay. 12 Q. What is that? 13 A. That is a note that Brenda sent me. 14 Q. Brenda Bese? 15 A. Yes. 16 Q. Why did she send you that note? 17 A. The -- when I had returned to Chicago, 18 I had not yet completed writing the comments. In 19 fact, I had basically barely begun on them. And 20 it was anticipated that I would return to Houston 21 or Dallas to write those comments. However, it 22 was decided that I would write those comments in 22391 1 Chicago. And there were basically three packages 2 which were these work papers that were sent to my 3 house, and I worked on the comment at my house. 4 Q. Now, it also refers in this note from 5 Ms. Bese to time sheets at the bottom. 6 Do you see the bottom of Page 182402? 7 A. Yes. It says, "Please send time sheets 8 to the proper people." This might be my writing. 9 Q. There are some documents that relate 10 to -- that seem to be time sheets. 11 Do you see those? 12 A. Yes. 13 Q. Do they reflect work that you did at 14 USAT and also Mr. Kenney? 15 A. They are the time sheets from January 16 when I worked at my house or my condo, rather, and 17 then there is four hours in February, which I'm 18 not sure what I did then. And then the others -- 19 the one for Larry Kenney is for Friday, which was 20 January 20th, which is when he reviewed my 21 comments and -- through the E-mail and sent me 22 suggestions. 22392 1 Q. Now, while these documents are in the 2 work paper folder, they are not actually in the 3 work papers; is that right? 4 A. No, they are not. 5 Q. Now, the work papers start at OW182409? 6 A. Yes, they do. 7 Q. All right. Starting from there, would 8 you please explain just what it was that you put 9 into your work papers? 10 A. Well, the first sheet of paper is 11 basically just an index. And the next sheet is a 12 general index for this particular work paper 13 folder. And the first group of work papers was 14 the mortgage-backed securities consolidated 15 monthly spread analysis, and then there were swaps 16 and cost recaps, mortgage-backed security dollar 17 rolls for -- mortgage-backed securities purchased 18 by UMBS and USAT including trade tickets, and 19 examiners notes, investment committee minutes. 20 Q. Moving to the next page, USAT/UMBS 21 consolidated monthly spread. 22 Is that a document you prepared? 22393 1 A. Yes. 2 Q. How did you go about preparing that? 3 A. Well, I took the institution's monthly 4 reports that they had which had the average 5 balance for the month and the average -- and the 6 yield. And I took the information on the reverse 7 repos and the dollar rolls. And basically, what I 8 did is for each month when the information was 9 available, I put down the dollar amount and the 10 yields and the cost of the borrowings and 11 basically ran a -- did the total every month and 12 calculated the basis point spread for the reverse 13 repos and the dollar rolls to the mortgage-backed 14 securities. 15 Q. Now, does that continue through 16 OW182414? 17 A. Yes, it does. 18 Q. What is the next page, OW182415? 19 A. This is the institution's quarterly 20 cost of funds. As you can see by the -- for 21 example, like OW182414, for September, there were 22 $2.8 billion of mortgage-backed securities and 22394 1 about $2.1 billion in reverse repos and dollar 2 rolls. Obviously, they needed the deposit base of 3 the institution to fund the remainder of the 4 assets. 5 Q. Is that quarterly cost of funds -- I'm 6 sorry. 7 Does the quarterly cost of funds 8 reflected cost of funds from the deposit basis? 9 A. Yes, it does. And I can't remember 10 why, but I couldn't get anything better than 11 quarterly information on their cost of funds. 12 Q. And did you create -- did you prepare 13 OW182415 based on information the association 14 provided you? 15 A. Yes, I did. 16 Q. Let's move to OW182416, which is headed 17 "Average MBS held by month - USAT." It appears to 18 run through OW182424; is that correct? 19 A. Well, the -- actually, the monthly 20 average mortgage-backed securities and repos for 21 USAT runs through OW182419. And then there's 22 OW182420 is the monthly spreads for the three 22395 1 finance subs. And then OW182421 through 424 is 2 the basically similar run for United Mortgage-back 3 Security, which was USAT's service corporation. 4 Q. Now, did you prepare those pages based 5 on information provided by the association? 6 A. Yes, I did. 7 Q. Moving to OW182425 through, I believe, 8 OW182430, can you explain what those are, please? 9 A. This is a sheet prepared by the 10 institution. It's just a sample of one of 11 their -- of one of their reports. And it breaks 12 down the -- and has their GL account numbers. 13 Q. By that, you mean general ledger? 14 A. Yes. And they have dollar roll 15 reconciliations included in here and the 16 mortgage-backed security reconciliation for USAT. 17 And then it goes on to UMBS. I think it also 18 includes UMBS, too. 19 Q. Moving then to OW182431, what is 20 OW182431? 21 A. This is a sensitivity -- I wrote down 22 "9/30/88 sensitivity to rate changes." The date 22396 1 on the top of this sheet is October 3rd. This is 2 when they ran the September 30 information for me, 3 or that's when they ran the September 30 4 information. 5 It's basically the market value of the 6 mortgage-backed securities and derivatives and the 7 hedges. And the -- for the unchanged or basically 8 the current market value, it shows a total of 9 200 -- a total loss of 213.7 million. 10 Q. Now, is this a sensitivity analysis? 11 A. Yes, it is. It shows the sensitivity 12 to changes in rates for plus or minus 50 and 100 13 basis points. 14 Q. And in particular, what does it show 15 about the sensitivity of the mortgage-backed 16 securities portfolio as a whole, including hedges, 17 to changes in interest rates? 18 A. Well, basically, that the -- it shows a 19 couple things. First of all, as is typical with 20 mortgage-backed securities, there is an obvious 21 sensitivity to changes in interest rates. 22 Q. What do you mean by that? 22397 1 A. Well -- 2 MR. NICKENS: Your Honor, the 3 representation was made that this witness was not 4 going to testify as an expert in the case but to 5 testify about his findings as to the 1988 6 examination. I can't tell from the current 7 question and answer whether he is expressing some 8 current opinion or some opinion that he formed 9 back in 1988. 10 It's been expressly represented in two 11 different forms that he was not going to go beyond 12 what he had done in 1988 as reflected in his 13 report. And I -- I don't believe this sort of 14 thing we're just getting into is reflected in his 15 report. And so, I have an objection if we're 16 going beyond those parameters. 17 MR. VEIS: Your Honor, I'll move on. I 18 certainly agree that we have made representations 19 along the lines Mr. Nickens has stated, that he's 20 going to testify about what he did at USAT. 21 THE COURT: Would you speak a little 22 louder, Mr. Veis? 22398 1 MR. VEIS: I'm sorry. We have indeed 2 stated that he will testify about what he did at 3 USAT, and I will move on. 4 Q. (BY MR. VEIS) This is a work paper or 5 document included in your work papers, correct? 6 A. Yes. 7 Q. Now, moving to the next page, OW182432, 8 what does that note represent? 9 A. It's -- the little top section is a 10 summary of the daily mark-to-market and shows 11 unrealized gains and losses which -- of course, it 12 equals -- if you look at the prior sheet, it shows 13 that it equals the 184861 and -- 086. Sorry -- in 14 unrealized losses on the assets. And it also 15 shows a weekly trend summary running from December 16 of '87 through October 3rd of '88. And it shows 17 unrealized asset -- unrealized gains and losses on 18 assets/hedges, the book value for UMBS, USAT, and 19 other book value and total book value. 20 Q. And was this prepared by the 21 association? 22 A. Yes, it was. 22399 1 Q. Let me move to the next one. This is 2 OW182433. 3 What is this document? 4 A. This is a list of the finance sub 5 mortgage-backed securities that they held. It's 6 divided by coupon and by type in terms of the fact 7 that it's the various agencies: Freddie Mac, 8 Ginnie Mae, and Fannie Mae. 9 Q. Is this a document you prepared? 10 A. Yes, it is. 11 Q. What is the source of your information? 12 A. The institution's records. 13 Q. Directing your attention to the next 14 page, OW182434, is that the source of any 15 information you derived concerning the finance 16 sub's MBS portfolio? 17 A. Yes. I would say it is. 18 Q. Is that correct continuing on to 19 OW182440? 20 A. Well, this has the other assets of USAT 21 and UMBS probably. I'm sorry. How far did you 22 say to go? 22400 1 Q. Let's take it -- does this discuss the 2 assets of the -- of United MBS and USAT, as well? 3 A. It looks like it -- this may only be -- 4 this looks like it may only be USAT. 5 Q. Well, let's move then to the following 6 page which by the index you prepared which is at 7 OW182410, I believe it indicates the swap cost 8 recap is Work Paper No. WI100-1. Now, I direct 9 your attention to Bates No. OW182441. Now, it 10 appears -- and I'd just like you to verify -- that 11 the work paper segment, WI100-1, carries through 12 from OW182441 through OW182567. 13 And my question to you is: Are these 14 pages all included in the segment of your work 15 papers relating to the swap cost recap? 16 A. Yes, it is. Yes, they are. 17 Q. Is this information that was provided 18 to you by the institution? 19 A. Yes, it was. This is their monthly 20 reports on their -- basically recaps on their 21 interest rate swaps and -- let's see. There is 22 also a collar and a cap in here. 22401 1 Q. Now, moving then to the segment that is 2 titled in the index "MBS dollar roll - USAT 3 Finance, Inc." which is work paper segment 4 WI100-2, it appears to start on Page OW182568. 5 Do you see that? 6 A. Yes. 7 Q. It bears at the bottom a notation, 8 "1 of 6." No. I'm sorry. 1 of 60. 9 It appears that that segment then 10 continues through OW182635; is that correct? 11 A. Yes. 12 Q. Now, what is the first page of this 13 segment which is OW182568? 14 A. This is a copy of a discussion sheet I 15 gave to Bruce Williams regarding some 16 discrepancies that I found between what the 17 institution had on their books and what the broker 18 advice had indicated in terms of the cost of 19 principal-only securities. 20 Q. And approximately how much was that 21 difference? 22 A. About 10 million. 22402 1 Q. Okay. We'll be returning to that 2 later. 3 Now, if you would move then to the 4 following section starting at OW182636, which is 5 work paper segment WI100-3. It indicates it's 6 Page 1 of 60. And it's called "MBS purchased by 7 UMBS and USAT including trade tickets." 8 Do you have that? 9 MR. NICKENS: Your Honor, Mr. Veis said 10 636. 11 MR. VEIS: 182636. 12 Q. (BY MR. VEIS) Now, that's denominated 13 or numbered 1 of 60 and -- 14 MR. NICKENS: My question, Your Honor, 15 is he said "the next section." In my book, the 16 next section is at OW182569. Did I miss 17 something? 18 MR. VEIS: Well, we identified -- 19 that's a section that I think I just was just 20 looking at. This is all part of 100-2. 21 MR. NICKENS: Okay. I thought the 22 witness had just identified that single page, but 22403 1 maybe I was mistaken. This whole area -- 2 MR. VEIS: Well, let's just go back to 3 make sure that the record is clear. 4 Q. (BY MR. VEIS) There was the memorandum 5 you identified as being one to Mr. Williams. 6 A. Yes. 7 Q. And the following page, OW182569, is a 8 numerical schedule of some sort. 9 Do you see that? 10 A. Yes. That's -- it says on the bottom 11 it's the mortgage-backed security portfolio as of 12 September 30, '88, for the USAT portion only. 13 Q. And how far does that work paper go? 14 Just the first page or -- 15 A. Well, it goes to OW182571. 16 Q. Now, where does the USAT portfolio 17 stop? 18 A. On OW182570. 19 Q. And below that there is an entry for 20 DARTs? 21 A. And AMPs. 22 Q. And what are those or what are those 22404 1 portfolios? 2 A. That's the finance subs. 3 Q. And does that continue through 4 Page 571? 5 A. Yes. 6 Q. Now, following that -- I don't want to 7 burden the record or bog us down in identifying 8 each of the documents. 9 But there appear to be some trade 10 tickets and some various sorts of schedules of -- 11 that are referred to as option adjusted spreads. 12 Then moving to Page 577, there are what appears to 13 be another worksheet. 14 Let me first ask you: With respect to 15 the USAT portfolios that start at OW182569, is 16 that a schedule that you prepared? 17 A. No. I don't think so. This looks like 18 something the institution prepared. 19 Q. All right. Thank you. 20 Now, what about -- moving to 577, here 21 we have what appears to be a listing of various 22 securities. 22405 1 A. Yes. It's kind of hard to read, but it 2 looks like a work paper that was prepared from one 3 of my programs. It shows the trade ticket, has 4 something about dollar rolls in there, settlement 5 dates, maturity dates, coupons, purchase price, 6 et cetera. 7 Q. If you look over at the next page, 8 OW182578, is that -- is that a copy of a longer 9 page? Do these two pages belong together? 10 A. Yes, they do. 11 Q. So, in the original, was this one long 12 page? 13 A. It would have been simply a computer 14 printout. It would have been folded over and 15 attached. 16 Q. So, this was copied onto two pages, 17 although it was not a two-page document 18 originally? 19 A. That's correct. 20 Q. So, if I put these side by side and 21 line up the lines, I can read straight across from 22 trade ticket on the far left to unrealized gain or 22406 1 loss on the far right? 2 A. That's correct. 3 Q. Moving then to Page OW182583, was that 4 prepared by the association? 5 A. Yes, it was. 6 Q. And was that provided to you as a part 7 of your review? 8 A. Yes, it was. 9 Q. That particular document appears to go 10 through 182585. 11 What is the following document headed 12 "USAT Finance I"? It's at 182586. 13 A. It is probably a reverse repo list. 14 Q. Was this prepared by the association? 15 A. Yes, it was. 16 Q. Let me direct your attention now to 17 OW182595. 18 What is OW182595? 19 A. It's a listing of the UMBS 20 mortgage-backed security holdings as of 21 September '88. 22 Q. Now, that's similar in nature to the 22407 1 first document we look at in this segment, I 2 believe. I'd like to ask you a question about 3 that. 4 If you'd compare that to OW182569. The 5 format appears the same; is that correct? 6 A. Yes, it does. 7 Q. And I take it then that -- is this 8 simply a similar format listing of securities for 9 a different entity? 10 A. Yes. It's basically the same type of 11 preparation. It's just that this is for the 12 service corporation of United Mortgage-backed 13 Security, while the other one was for the 14 institution. 15 Q. Now, were the materials we just 16 reviewed following the schedule at 182569 that 17 started with the trade tickets on 182572 going 18 through 182594, did they constitute the source 19 materials for the schedule you prepared of the 20 securities of United Savings Association? 21 A. They would probably be tied into -- as 22 a source material for the -- for the institution's 22408 1 work papers and for mine. 2 Q. Let me move then to the UMBS schedule 3 which is at 182595. 4 Again, in the interest of time, I'd 5 like you to briefly look through the following 6 documents, through 182635. You will notice that 7 182636 is a schedule, again, that I want to ask 8 you about. 9 But does it appear to you, based on 10 your review, that the documents following 182596 11 are source material for the information in the 12 schedule that you prepared: 182595 through 13 182596? 14 A. Yes, it does. Again, there is another 15 one of -- there is an institution schedule at the 16 beginning. There is a schedule prepared either by 17 myself or one of my assistants that's within the 18 work papers. 19 Q. And then beginning at 182636, it 20 appears to be a new segment of the work papers, 21 WI100-3, which is titled, according to the index, 22 "MBS purchased by UMBS and USAT including trade 22409 1 tickets." 2 Do you see that? 3 A. Yes. 4 Q. That indicates at the bottom it's 5 Page 1 of 60, correct? 6 A. Yes, it does. 7 Q. Did you prepare the schedules that are 8 set forth at OW182636 through OW182638? 9 A. I think they may have been prepared by 10 one of the two examiners that were assisting me. 11 Q. That would be Mr. Kiner or the examiner 12 whose name you can't remember? 13 A. Yes. And since Randy didn't put his 14 name on here, it might be that other person. 15 Q. Let me -- there is a schedule following 16 that beginning at 182639. I'm sorry. 182640, 17 which begins -- which is titled "MBS purchased by 18 USAT," and that continues to 182643. 19 The format is similar. Right? 20 A. Yes, it is. It's probably done by the 21 same person. 22 Q. Now, following that, there is a series 22410 1 of documents with a lot of handwritten notes on 2 them. It begins at 182644 and continues through 3 182653, I believe. 4 Do you know what those documents are? 5 A. They look like more reviews that were 6 done. Again, they have the trade ticket and they 7 have writing down here. Probably taken from the 8 various trade tickets and summarized on these 9 sheets. Again, this would have probably have been 10 done by one of my assistants. 11 Q. Now, I'd like to direct your attention 12 back to OW182636 and just direct your attention to 13 the first entry on 182636 under "Fannie Maes held 14 by UMBS," which indicates trade ticket number of 15 182637. 16 Do you see that? 17 A. Yes, I do. 18 Q. I'd like you to look across at OW182644 19 under the entry "Fannie Maes held by UMBS." 20 It's the identical trade ticket number 21 there, correct? 22 A. Yes. It looks to be the same thing. 22411 1 It looks like they simply printed out the 2 settlement date and the trade ticket date and then 3 they used -- they simply wrote in the information. 4 Q. Would then the schedules beginning at 5 OW182644 be schedules that were prepared by 6 examiners during their reviews? 7 A. I think so. 8 Q. And would they be essentially the 9 precursor of the schedules that begin at OW182636? 10 A. Probably. Since there is more 11 information on the handwritten information, 12 there's probably value to both of them in terms of 13 analysis. 14 Q. Continuing with WI100-3, looking -- 15 beginning at OW182654, there are indicated to be 16 another 60 pages of documents. Some of them are 17 trade tickets, and some of them are schedules. 18 Just review those very quickly and tell 19 me whether these are documents that were supplied 20 to the examiners by the institution. 21 A. As far as I can tell, these are all 22 copies of institution work papers. 22412 1 Q. And following that -- we're very close 2 to the end of this exhibit -- there is an entry 3 here for notes from minutes of the investment 4 committee beginning at OW1828699. 5 A. Yes. 6 Q. Is that something that was prepared by 7 one of the examiners who worked for you? 8 A. I'm not sure. It could have been 9 prepared by one of the examiners that worked for 10 me. It also could be a copy of something that was 11 prepared by someone else during the examination. 12 Q. But these are notes from the investment 13 committee minutes that reflect a review of the 14 minutes, correct? 15 A. Yes, it does. 16 Q. Directing your attention to the top, do 17 you see the initials under the date 9/6/88 of JPJ? 18 A. Yes. 19 Q. Is that the initials of the examiner 20 whose name you couldn't recall? Do you recall the 21 name John P. Janitor? 22 A. That sounds familiar. 22413 1 Q. Do you know whether he was an examiner 2 at USAT during the 1988 examination? 3 A. I think so. I think that name sounds 4 familiar. 5 Q. But you don't recall whether he's the 6 one that assisted you? 7 A. No. 8 Q. I'd like to take a, look hopefully 9 briefly, at A14103 and ask you what these are. In 10 particular, I'd direct your attention to 11 Page OW182744. 12 A. Okay. 13 Q. Is that an index or work paper? 14 A. Yes, it is. Similar to the one in the 15 last one we looked at. And this shows 16 mortgage-backed security activity, 1986, interest 17 rate caps and swaps, mortgage-backed security 18 dollar rolls cost analysis, residuals, IOs and POs 19 at 3/31/86. Futures and options hedge. 20 Investment policy and procedure updates summary. 21 Mortgage-backed security and hedge policies, 22 internal audit report, resumes, investment 22414 1 officers, and Federal Home Loan Bank periodic 2 reports. 3 Q. Now, let's begin -- I'd like to just 4 identify these very briefly so that we know what 5 they are so we know what is in the work papers and 6 can move on. 7 Let's look at WI101-1 which appears to 8 start at OW182752. 9 Do you see that? 10 A. Yes, I do. It's handwritten, and it's 11 my writing. 12 Q. And that indicates it's a partial list 13 of MBS activity in 1986? 14 A. It says, "Attached is a partial list of 15 MBS activity in '86. It indicates management was 16 very active in 1986. In addition to the various 17 swaps of securities, i.e., sale of one security 18 and purchase of another of a different coupon or 19 issuer. Purchases were also noted. Many of the 20 swaps of the security was for profit on a sale, 21 improved yields, or both." 22 Q. And this indicates at the bottom -- 22415 1 it's Page 2 of 6 or is that 1 of 6? I can't read 2 that. Can you tell? I guess the next page 3 indicates it's 2 of 6. 4 A. I guess that must be a 1 then. 5 Q. Let me direct you to continue your 6 attention through OW182757 which is -- indicates 7 it's 6 of 6. 8 Do you see that? 9 A. Yes. 10 Q. Now, the pages following the memorandum 11 you just read from, the note you just read from, 12 appear to be some sort of listing of securities 13 transactions. 14 Is that essentially correct? 15 A. Yes. It's a list I made. 16 Q. How do you know you made it? 17 A. It's my writing. 18 Q. Does it have your initials at the top? 19 A. Well, that, too. But, yeah, it has my 20 initials and my handwriting. 21 Q. And let's move to the next page, 22 OW182756 which, according to your index, indicates 22416 1 it's interest rate caps and swaps and it's Segment 2 101-2. 3 A. I think that's 182758. 4 Q. I'm sorry. You're right. It is. I 5 apologize. 6 A. This is -- it's cost of swaps and caps 7 year to date. Basically, it's a quarterly run on 8 how much the -- it cost the institution to have 9 the swaps and the caps and the collars. 10 Q. And what are the materials that are 11 behind OW182758 which run through 182785 which 12 is -- indicates it's Page 25 of 25 under segment 13 WI101-2? 14 A. It's the institution's work papers. It 15 has -- there is -- I have a work paper on 182760, 16 and then there is back up for it. "United MBS 17 interest rate caps, United MBS interest rate 18 collar." I'm sorry. How far? 19 Q. 182785. 20 A. There is a summary of the interest rate 21 caps in effect. Looks like one of -- a monthly 22 summary for November 30, '88. There is a work 22417 1 paper on swaps that's in here. 2 Q. Are all of these materials that were 3 considered by you in conducting the examination, 4 particularly as it related to swaps and caps at 5 USAT and its subsidiaries? 6 A. Yes, it is. 7 Q. Let's move then to OW182786, which 8 according to your index is MBS dollar roll cost 9 analysis. It's work paper segment WI101-3. It 10 appears by the notations at the bottom that it's 11 approximately a 50-page segment ending at 12 OW182836. 13 A. I would agree with that. It looks like 14 Randy's work that he did on the dollar rolls. 15 Q. Randy Kiner? 16 A. Randy Kiner. Sorry. 17 Q. And there is a handwritten memorandum 18 or work paper. It's the first page. 19 Is that a work paper that was prepared 20 by Mr. Kiner? 21 A. Yes. This would be a summary of his 22 findings. He looked at 13 transactions at United 22418 1 Savings and 11 at UMBS. This is basically a 2 sample. 3 Q. I'm sorry. That was a sample? 4 A. Yes. 5 Q. So, it was not a compete review of all 6 dollar roll transactions? 7 A. No, it wasn't. 8 Q. Now, are the materials following 9 Mr. Kiner's work paper, which appears to run 10 through OW182787, the materials that he reviewed 11 in connection with his dollar roll work? 12 A. For the most part, it's copies of 13 various institution work papers and sheets. The 14 back part looks like a shrunken copy of a work 15 paper that Mr. Kiner did. 16 Q. Now, when you refer to the back part, 17 can you give me a Bates number, please? 18 A. I'm sorry. 182833 through 182836. 19 Those four sheets appear to be work papers that 20 Mr. Kiner did from which he drew his conclusions 21 that were on the first page, 182786. 22 Q. Now, let's move then to work paper 22419 1 segment WI101-4. According to the index, that is 2 residuals, IOs, and POs. It says 3/31/86. 3 Do you see that? 4 A. Yes. 5 Q. Now, at the bottom of the page, 6 OW182837, it appears to say 3/31/88 which -- 7 A. It says "CMO residuals/IOs/POs at 8 3/31/88." 9 Q. So, again, this is just a typographical 10 error in the index? 11 A. Yes. I would say that was just a 12 typographical error in the index. 13 Q. Well, now, if you would, please, look 14 through the pages running from OW182837 through 15 OW182887. The first page indicates it's 1 of 48. 16 The last page that I mentioned indicates it's 48 17 of 48. 18 Can you describe briefly what these 19 documents represent? 20 A. The first is an institution work paper 21 that's a trend analysis that runs from 22 January 31st, '87, to March 31st, '88. That 22420 1 covers two pages. 2 Let's see. Then there is a work paper 3 on CMO residuals that I did. My initials are on 4 the top. Basically, this is what -- I think this 5 is what they had left that were not sold as of 6 10 -- 10/'88. That's what it looks like. The 7 next is an institution work paper that some 8 information has been written on. It's USAT CMO 9 residuals, and it has -- looks like I wrote the 10 date sold on the left-hand side for those that 11 were sold. 12 Q. And that's Bates No. 182840? 13 A. OW182840. It's a list of CMO residuals 14 as of June 30, '88. And I have the -- I wrote in 15 the date sold, most of which were in October. 16 Q. What are the following pages? 17 A. Institution sheets, trade tickets. 18 Then on OW182844, there is the Dominic Bruno memo 19 to the investment committee on the sale of 20 residuals. 21 Q. Then how far does that -- are there 22 attachments to that? Can you tell? 22421 1 A. Yes. I think it goes through OW182849. 2 Q. And following OW182849, what's the next 3 page? 4 A. The next page is OW182850, which is a 5 work paper that the institution prepared on its 6 IOs and POs as of September 30th. And you can see 7 where on the sheet I wrote in "purchase dates" and 8 "market prices per Bear Sterns as of September 30, 9 '88." And I don't know for sure where I got that 10 information from. I may have requested it from 11 the institution. I may have gotten it from some 12 other source. 13 Q. Let's move on. The next page, OW182851 14 indicates at the bottom it's IOs' history. 15 Do you see that? 16 A. Yes. This is the first of a series of 17 papers on the histories of the institution's IOs 18 and POs. 19 Q. How far do those run? 20 A. Okay. The IOs run through 182854. And 21 then the next ticket, 182855, is the beginning of 22 the POs. And that runs through 182861. Then 22422 1 there is -- I don't know what. Looks like someone 2 copied the bottom of the -- I'm not really sure 3 what this is. Just says "IOs and POs" on it. It 4 must be the back of a piece of paper or something. 5 I'm not really sure. 6 Q. Moving then to OW1826 -- I'm sorry -- 7 182863, there are a number of documents that are 8 somewhat difficult to read. 9 Can you tell what those are? 10 A. Well, as far as I can tell, these work 11 papers appear to be three copies of essentially 12 the same thing. And they look to be a work paper 13 that I did on their IOs and POs. It looks like I 14 took the purchase information. I put the par as 15 of September 30th. The book value as of 16 September 30th. The prices that I got from -- the 17 prices I got from Bear Sterns, and the 18 institution's market price, which these were for 19 September 30th. But as I said before, they made 20 these runs as of October 4th and there was a 21 difference. 22 On OW182867, I have a note written 22423 1 saying that "Based on the trade tickets made 2 available, there are some major discrepancies 3 between the book and the price per the broker 4 advices." 5 Q. Now -- we'll return to that. 6 THE COURT: Mr. Veis, we'll take a 7 short recess. 8 9 (Whereupon, a short break was taken 10 from 11:40 a.m. to 12:00 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 Q. (BY MR. VEIS) Mr. Lapidus, we were 17 discussing, before we broke, the work paper 18 segment related to IOs and POs, WI101-4. You had, 19 I believe, just indicated what OW182867 was. 20 Could you please continue through the 21 segment and identify the remainder of the 22 documents? 22424 1 A. Okay. After that, there's broker's 2 advice. 182868 is a Goldman Sachs confirmation on 3 an IO No. 1. 4 Q. I take it that broker's advice is 5 continued then through 182872; is that correct? 6 A. Yes. And that includes the POs as well 7 as the IOs. 8 Q. Now, then at 182873, there appear to be 9 a number that -- at the beginning, there appear to 10 be a number of schedules describing date and price 11 information on MBS POs and IOs; is that correct? 12 A. Yes, it is. It's -- there's a variety 13 of prices. It's not really a daily quote, but it 14 looks like to be a weekly price quote and a 15 measure of the change in the price. And it has 16 the prepayment assumptions and the yield based on 17 the price and then the spread off of treasury. 18 Q. And that continues through OW182887; is 19 that correct? 20 A. That's correct. 21 Q. Now, let's move on to the next segment 22 of the work papers which, according to the index, 22425 1 would be futures and options hedged, WI101-5. 2 A. Yes. 3 Q. Now, that indicates at the bottom of 4 the first page, which is OW182889, that it's 5 Page 1 of 33. 6 Do you see that? 7 A. Yes. 8 Q. Let me -- let's just address those 33 9 pages which end at Bates OW182922. 10 Now, do you recognize the first page 11 ending in 889? 12 A. It looks like the draft of part of the 13 comment, and it basically deals with futures and 14 options. 15 Q. All right. Then let's look at the next 16 page. Can you explain what that page summarizes? 17 A. UMBS hedging amortization schedule. 18 Just a monthly schedule and shows the deferred 19 gain or loss. 20 Q. And that's for the months January '88 21 through, what, June 1989? 22 A. Yes. 22426 1 Q. From where is that information derived, 2 or can you tell? 3 A. It looks like it was a projection of 4 when these amounts would be deferred or written 5 off or -- I'm not really sure. 6 Q. Let's -- 7 THE COURT: I assume these are 8 thousands; is that right? 9 THE WITNESS: They appear to be. They 10 usually are. I can't guarantee that -- if they 11 are thousands or if those are actually just in 12 dollars. 13 Q. (BY MR. VEIS) Now, following that page, 14 on Bates number ending 891, there is a little 15 table referring to Hedge 1, Hedge 2, and some 16 other columns. 17 Can you explain what that is, please? 18 A. Looks like it shows the quantity of the 19 hedges. It shows T note futures. It has 20 mark-to-market gains or losses, changes. And it 21 has total futures -- I assume it's the total 22 mark-to-market losses, which is 2.6 million. 22427 1 Q. Now, was this prepared by the 2 association? 3 A. Yes. 4 Q. Directing your attention to the next 5 page, I believe it's titled "Inventory." It's the 6 page ending in 892. 7 A. Yes. 8 Q. Is that an association record, as well? 9 A. Yes, it is. 10 Q. And with respect to the next pages of 11 this document or this segment running from Bates 12 893 through 898, is that information regarding 13 futures that is provided by the association? 14 A. Yes, it is. 15 Q. And then looking at Bates number ending 16 in 899, what is that? 17 A. Okay. It says "USAT Hedge 1, 213." T 18 note futures. It has the daily and cumulative 19 gains and losses. It is a comparison of the 20 Freddie Mac 8 percent to the treasury note 21 futures, and there is a regression analysis on it. 22 Looks like it's not too bad. Correlation is 22428 1 pretty high. 2 Q. Now, were the remainder of the 3 materials running from the page you just looked at 4 through the end to Bates number ending 292 5 materials that were provided to the examiners by 6 the association? 7 A. I'm sorry. Ending 29 what? 8 Q. 292 -- or I'm sorry -- 922. It's 9 marked at the bottom "33 of 33." 10 A. This all looks like institution's -- 11 the institution's work papers and memos. 12 Q. Let's look at the next segment of your 13 work papers, 101-6, which appears to begin at the 14 next Bates number, OW182923. 15 Do you see that? 16 A. Yes, I do. 17 Q. Let me suggest that perhaps there's an 18 error in the index because the entry indicates 19 that this is investment policies. I notice that 20 this appears to be a schedule relating to options, 21 at least the first page. 22 Let me then direct your attention to 22429 1 OW182920, which indicates it's WI101-6 and 2 indicates at the top it's an update of investment 3 policies and procedures. 4 Do you see that? 5 A. Yes. It's from the August 31st, '88 6 minutes, Exhibit A to those minutes. And it's an 7 update of their policies and procedures for 8 mortgage-backed securities and hedging. 9 Q. Now, behind that -- and this is -- I'm 10 afraid the number is a little confusing because 11 you will see that it goes through 4 of 4 and then 12 becomes 5 of 26. And then -- these pages are all 13 numbered sequentially; but at Page 27, it becomes 14 27 of 81. 15 My question to you is simply this: Is 16 this the investment policy and procedures manual 17 that was provided to you by the institution? 18 A. Yes, it is. 19 Q. Okay. And that runs through OW183010, 20 correct? 21 A. Yes. 22 Q. All right. Let's move to the next 22430 1 segment of the work papers. See the internal 2 audit report? Let me just ask you to briefly look 3 at the internal audit report segment beginning at 4 Bates number ending -- it's OW183011. It 5 indicates it's 3 of 15. And 15 of 15 is 183025. 6 Do you see that? 7 A. Yes, I do. 8 Q. Was this provided to the examiners by 9 the association? 10 A. Yes, it was. 11 Q. Now let me direct your attention to the 12 next segment, which is WI101-8. It's noted in the 13 index as "resumes-investment officers." It starts 14 at OW183026. It indicates at the bottom it's 15 Page 1 of 25. The 25th page runs to -- or is 16 OW183050. 17 Do you see that? 18 A. Yes, I do. 19 Q. Are those resumes of the investment 20 officers of United Savings Association of Texas 21 that were provided to the examiners by the 22 association? 22431 1 A. Yes, it is. It has -- 2 Q. Now, if you would -- 3 A. -- a number of people in here. 4 Q. If you would look then at the next and 5 last segment of this work paper file, it indicates 6 it's the FHLB periodic reports. That starts at 7 Bates No. OW183051. At the bottom, it appears to 8 be Page 1 of 62. 9 A. The first part is the -- is schedule -- 10 Section H, which is -- 11 Q. That's Section H of what? 12 A. Section H of the quarterly report which 13 was used to calculate the institution's interest 14 rate risk using the Sendero model I believe we 15 used at the time. 16 Q. And I take it that the information was 17 provided to the Federal Home Loan Bank in order to 18 make those calculations? 19 A. Yes. The institution had to prepare 20 the information on the sheets and then the various 21 Federal Home Loan Banks would run the calculations 22 and, I believe, usually give the institutions a 22432 1 copy of the results. 2 Q. Now, is it correct that the various 3 segments of the reports to the Federal Home Loan 4 Bank run through the page that's Bates numbered 5 OW183109? 6 A. Yes. That's a blank page. At least, 7 on this copy it's a blank page basically. It 8 looks like the back of a page. 9 Q. Okay. Set that exhibit aside, 10 Mr. Lapidus. I think we've sufficiently 11 identified all of the materials. 12 Now, if you would look at the remaining 13 three exhibits before you, which are A14101, 14 A14104, and A14105. 15 Do you have those in front of you, sir? 16 A. Yes, I do. 17 Q. I just have a very brief series of 18 questions on these. 19 Can you tell me what these are? And 20 I'm asking you about all of them together. 21 A. Basically, it comprises a review of and 22 copies of the institution's minutes that were made 22433 1 during the examination. 2 Q. Now, Exhibit A14101, which begins at 3 Bates No. OW181917 with a cover sheet, if you will 4 look at the last page of that document which is 5 OW182141 -- 6 A. That's correct. 7 Q. -- it has at the bottom "IC" and then 8 it has what appears to be a date of 5/27/87? 9 A. Right. That would be the investment 10 committee as of that date. 11 Q. That's 5/27/87? 12 A. Right. 13 Q. Now, if you then look at 14 Exhibit A14104, if you look at the bottom, it does 15 have, does it not, the next sequential Bates 16 number, OW182142? 17 A. Yes, it does. 18 Q. And at the bottom, it says "IC" again 19 followed by 6/3/87? 20 A. That's right. 21 Q. And if you look then at the bottom of 22 the last page of Exhibit A14104, it bears the 22434 1 Bates No. OW182223 and has the notation "IC" 2 12/30/87. 3 Do you see that? 4 A. Yes, I do. 5 Q. Now, while these are introduced as 6 separate exhibits, are they, in fact, a continuous 7 sequence of investment committee and other 8 minutes? 9 A. Yes, they are. 10 Q. And were all part of the work papers in 11 one segment? 12 A. Yes, they were. 13 Q. Let me then look at -- ask you to look 14 at A14105. If you look at the Bates number on the 15 bottom of the first page of A14105, do you see it 16 says OW182224? 17 A. Yes. 18 Q. And isn't that the next sequential 19 number after the last page of the previous 20 exhibit, A14104, which was OW182223? 21 A. Yes, it is. 22 Q. And the date of the -- this appears to 22435 1 be minutes of the investment committee dated 2 January 6th, 1988, correct? 3 A. Yes, they are or they appear to be. 4 Q. Now, the prior meeting in the previous 5 exhibit was dated 12/30/87, correct? 6 A. Yes. This would be about a week later. 7 Q. Now, moving to the back of this 8 exhibit -- I'm not sure I can find a date. Well, 9 the remainder -- the last page of this exhibit is 10 OW182399. 11 Do you see that? 12 A. Yes, I do. 13 Q. Now, was Exhibit A14105 also part of 14 the same sequence of committee minutes that you 15 previously testified included A14101 and A14104? 16 A. Yes. 17 Q. So, in the records of the examination, 18 then, the investment committee minutes all 19 comprised a single package; is that correct? 20 A. I believe they did. 21 Q. And you would have reviewed them that 22 way; is that correct? 22436 1 A. Yes. 2 Q. All right. Well, I believe you said a 3 little earlier that -- 4 MR. NICKENS: Your Honor, could we 5 establish at what point in time? The reason for 6 that is that Mr. Veis -- two of these exhibits 7 were ones that I provided at the time of the 8 deposition and Mr. Veis indicated had been lost 9 from the files of the OTS. 10 MR. VEIS: I can address that, Your 11 Honor, and explain the OTS's position. 12 THE COURT: Let's hear one at a time. 13 MR. NICKENS: Your Honor, the reason is 14 that there was uncertainty as to whether these had 15 been reviewed, the last two, at the time the 16 comment was written. And so, the question of 17 when -- 18 THE COURT: What comment are we talking 19 about? 20 MR. NICKENS: The comment that we're 21 going to eventually get to that was a part of the 22 examination that was prepared by Mr. Lapidus. 22437 1 MR. VEIS: Your Honor -- 2 MR. NICKENS: I just would like for the 3 witness to say one way or another when it was that 4 he reviewed these last two portions which were not 5 a part of the records of the OTS at the time of 6 his deposition. 7 THE COURT: Can you answer that? 8 THE WITNESS: I looked at them during 9 the examination, and I had them and I used them 10 when I was writing my comment. However, when I 11 went to Washington for the first time this year to 12 discuss it, these papers were missing. They were 13 not there. I don't know when they disappeared. 14 Obviously, they disappeared after these "OW" 15 numbers were put on, which was sometime after I 16 had returned the work papers to Brenda Bese, that 17 I mailed them to her in Dallas. 18 THE COURT: Mr. Veis. 19 MR. VEIS: I believe what seems to have 20 happened -- and this is not in any way casting 21 aspersions on anyone -- as Your Honor knows during 22 discovery in this case, we were ordered and 22438 1 complied with that order to provide access to all 2 of the OTS records involving USAT to the 3 respondents. 4 The respondents arranged with a 5 contractor to image the documents that they were 6 provided access to. And the bar codes with the 7 "OW" numbers on them are the result of that 8 process. As I understand it, the original 9 documents have stickers with the bar codes and 10 these have been copied. 11 The apparent problem was that it seems 12 that by -- for some reason -- and no one knows why 13 and certainly given the volume of the production, 14 we can understand how things could be misplaced. 15 But the fact of the matter is that when 16 Mr. Lapidus came to Washington, the two exhibits 17 that are now A14104 and A14105 were not in the 18 work paper files. They had obviously been imaged 19 by respondents' contractors. For whatever reason, 20 they were not there. Mr. Lapidus did not review 21 them when he was in Washington because he couldn't 22 find them. He has previously testified in his 22439 1 deposition that he believed there were documents 2 missing, but he wasn't sure what they were. And 3 it wasn't until he attended his deposition and 4 Mr. Nickens introduced those two exhibits to his 5 deposition that he saw them again after -- it was 6 the first time since 1988 that he had seen them. 7 He testified at some length concerning 8 that. He has certainly identified that these 9 are -- testified that these are documents that he 10 did, in fact, review during the examination. I 11 don't think that there's really an issue about -- 12 of this at this point in terms of when he saw 13 them. 14 MR. NICKENS: The only question -- and 15 the reason I ask the question -- is whether or not 16 he had them at the time that he wrote his comment, 17 which occurred after he had returned home and 18 additional exhibits were sent to him as indicated 19 by other records. 20 Now, the witness has testified that he 21 had them. There's some deposition testimony that 22 I may be able to bring out on cross, but we at 22440 1 least have the record of where we are at this 2 point. 3 THE COURT: You may proceed. 4 MR. VEIS: Thank you, Your Honor. 5 Q. (BY MR. VEIS) Now, Mr. Lapidus, earlier 6 you stated that Dominic Bruno was particularly 7 helpful to you. 8 Do you recall that? 9 A. Yes, I do. 10 Q. Now, did you have any conversations 11 with Mr. Bruno concerning the mortgage-backed 12 securities activity at USAT? 13 A. Well, we probably talked about them 14 every single day but -- 15 Q. Well, did he -- were any of your 16 conversations helpful to you in analyzing the 17 activity at USAT? 18 A. Mr. Bruno was very helpful. At one 19 point in our discussions, he indicated that the 20 prior activities before he got there, they had 21 been basically selling off the mortgage-backed 22 securities and buying -- for a profit and buying 22441 1 the lower coupons which basically concurred with 2 my beliefs that the institution had been actively 3 trading its mortgage-backed securities to generate 4 accounting income. 5 Q. And what was that accounting income 6 used for? No. Let me ask you first: Did 7 Mr. Bruno say anything about what that accounting 8 income was used for? 9 A. I believe that he indicated that they 10 needed the money to shore up their capital so that 11 they could meet capital requirements and basically 12 continue to operate the institution. 13 Q. Now, Mr. Bruno said this to you while 14 you were at USAT in November/December of 1988? Is 15 that when? 16 A. Yes. 17 Q. Now, is that conversation with 18 Mr. Bruno -- we've discussed a comment which we 19 will be introducing shortly. 20 Is that comment from Mr. Bruno 21 concerning the selling of securities to generate 22 income and using that income to shore up capital 22442 1 or meet capital requirements specifically 2 indicated in your comment? 3 A. No, it is not. 4 Q. Why not? 5 A. Well, Mr. Bruno's statements -- and 6 actually, in fact, some of my own conclusions in 7 those areas -- were there were no support. I 8 didn't have any memos from the investment 9 committee or members of the committee stating that 10 they were doing this. I didn't have any real 11 documentation to support these conclusions. The 12 conclusions that I have in there are the ones that 13 I could support from my review. 14 Q. Now, did Mr. Bruno tell you whether 15 there had been a conscious decision by management 16 to sell off securities to generate income and use 17 that income to shore up capital or meet capital 18 requirements? 19 MR. NICKENS: Your Honor, this is 20 leading. I object. 21 THE COURT: It seems to me that was his 22 prior testimony. What's this question? 22443 1 MR. VEIS: The question is -- his prior 2 testimony was that, in fact, it had been done. My 3 question is whether or not Mr. Bruno told him that 4 this had been a conscious decision by management 5 to engage in that. 6 MR. NICKENS: He's just putting words 7 in the mouth of the witness. 8 THE COURT: Well, I'll deny your 9 objection. 10 A. I'm not sure I understand the question. 11 As far as I know, it was their intent to do so. 12 It was not something they did, I mean, by 13 accident. Their goal was to generate income. 14 Q. (BY MR. VEIS) Thank you. Now, did 15 Mr. Bruno tell you who was responsible for the 16 trading activity in mortgage-backed securities 17 that was conducted to generate gains to shore up 18 capital or meet capital requirements? 19 A. Well, basically, he had indicated that 20 Mr. Crow and Mr. Williams and basically the 21 members of the investment committee -- I can't 22 remember if it was as a whole, but they were the 22444 1 ones that were directing the activities. 2 Q. Did Mr. Bruno describe to you the 3 nature of his position at USAT? 4 A. Well, basically, he considered himself 5 a custodian. He had to clean up -- basically, not 6 only did he have to take care of the existing 7 portfolio, he had to basically clean up other 8 people's messes. He had very little control over 9 what went on. He basically followed orders. His 10 recommendations were not really listened to. He 11 just was there to take care of business and, like 12 I said, clean up other people's messes. 13 Q. Now, was Mr. Bruno involved in 14 supplying you with things like investment 15 committee minutes? 16 A. The investment committee minutes came 17 from another person. 18 Q. Well, did Mr. Bruno provide you with 19 any documents that were not included in the 20 minutes of the investment committee? 21 A. Yes, he did. He provided me several 22 documents. Basically, memos that he had 22445 1 written -- I think they were all that he had 2 written -- to various executives in the 3 institution. And these memos had not been made 4 part of the investment committee minutes, and he 5 felt that I should at least be aware of these. 6 Q. Well, let me direct your attention to 7 Exhibit A14105. And specifically, could you turn 8 to OW182275? 9 THE COURT: Could you repeat the 10 number? 11 MR. VEIS: OW 182275. 12 Q. (BY MR. VEIS) Are you there, 13 Mr. Lapidus? 14 A. Yes, I am. 15 Q. Now, is that one of the memorandum that 16 Mr. Bruno provided to you? 17 A. Yes, it is. It has my notation on it. 18 Q. What notation is that? 19 A. Well, essentially, there's two 20 notations. One is I wrote "Memo to Mike Crow to 21 the made part of the investment committee 22 minutes." And the other I wrote was 22446 1 "Confidential. Examiners received from D. Bruno." 2 Q. Can you explain why those notations 3 were made? 4 A. Basically, Dominic knew -- or Mr. Bruno 5 knew that these memorandums that he had sent to, 6 in this case, Mister -- 7 MR. NICKENS: Your Honor, I object to 8 the witness testifying as to what Mr. Bruno knew. 9 He can testify as to what he had been told, 10 although I do think it's strange that Mr. Bruno 11 was brought here with the knowledge of this 12 witness' testimony and not asked these questions. 13 But for him to speculate as to what he knew and 14 not tell us what was said, I object to. 15 THE COURT: All right. Sustained. 16 MR. VEIS: Your Honor, I think in the 17 first place, Mr. Nickens' objection contains at 18 least one misleading fact. As we have previously 19 stated, we didn't have these documents until 20 Mr. Lapidus' deposition. 21 So, if the implication is that 22 Mr. Bruno should have been asked about this 22447 1 because this is in the investment -- or in the 2 work papers, the simple answer is we didn't have 3 the documents or those work papers at the time. 4 So, I think this -- this is certainly a 5 misleading -- if Mr. Nickens would like me to ask 6 him what he was told, then I'm happy to do so. 7 But I certainly -- the section of the objection 8 dealing with Mr. Bruno's testimony in this case is 9 simply not germane to Mr. Lapidus' testimony. 10 MR. NICKENS: The evidence will be that 11 this witness was interviewed by the FDIC in 1992, 12 that he was interviewed twice by the OTS earlier 13 this spring, all prior to Mr. Bruno's testimony, 14 and the -- and of course, Mr. Bruno wasn't asked 15 these questions. That's the basis for my comment. 16 My objection is that he shouldn't be 17 allowed to testify as to what Mr. Bruno believed 18 without telling us what he said or heard. 19 THE COURT: All right. Can he tell us 20 what he was told by Mister -- 21 THE WITNESS: I'm sorry. Your Honor, 22 if I had been allowed to finish my sentence, all I 22448 1 was trying to say was that Mr. Bruno knew that 2 this memo was not part of the investment committee 3 minutes which was obvious because he had access to 4 the investment committee minutes. I'm sorry. I 5 know I'm probably talking out of order, but that's 6 all I'm trying to say. 7 Q. (BY MR. VEIS) Did Mr. Bruno tell you 8 that these were not part of the investment 9 committee minutes? 10 A. Well, he knew they weren't part of it. 11 He had access to them, and I had access. I had 12 reviewed the investment committee minutes. This 13 memo was not in there. 14 Q. All right. Let me move to OW182335. 15 THE COURT: Mr. Veis, how much more are 16 you going to have? 17 MR. VEIS: Well, Your Honor, I have one 18 more of these memoranda. I could finish this 19 subject in about two or three minutes if you're 20 looking for the lunch break, which I assume you 21 are. 22 THE COURT: All right. 22449 1 Q. (BY MR. VEIS) Are you at 182335? 2 A. Yes. 3 Q. Is that another memorandum that was 4 given to you by Dominic Bruno? 5 A. Yes, it is. 6 Q. And was it made -- given to you under 7 the same circumstances as OW182275? 8 A. Yes, it was. 9 Q. And let me then request that you look 10 at OW182340. Is that another memorandum that was 11 provided to you by Mr. Bruno on a confidential 12 basis? 13 A. Yes, it was. 14 Q. Now, do you recall why you marked these 15 three memoranda confidential? 16 A. Yes, I do. While technically an 17 institution's employees are supposed to give the 18 examiners any document that they request or might 19 need to do their job, Mr. Bruno was concerned as 20 to his further employment at the institution if I 21 were to reveal to management that I had received 22 these from him. And as such, I marked them that 22450 1 they were confidential so that the EIC or some 2 other person, if they were reading them, would not 3 talk to the institution about them and thus 4 endanger his job. 5 Q. Did Mr. Bruno tell you he was afraid of 6 being fired? 7 A. I don't really remember. He might 8 have. 9 Q. Well, did he express fears for his 10 retaining his job? 11 MR. NICKENS: Your Honor, he's just 12 leading the witness. This is not his testimony. 13 THE COURT: Sustained. 14 Q. (BY MR. VEIS) Do you recall anything 15 further that Mr. Bruno told you about his 16 prospective continued employment? 17 A. I don't think so. 18 Q. But he didn't want you -- or did he say 19 anything about not disclosing that he had given 20 this information to you? 21 MR. KEETON: Objection. Leading for 22 the 80th time. 22451 1 THE COURT: Sustained. 2 Q. (BY MR. VEIS) Do you recall anything 3 else that Mr. Bruno told you on this subject of 4 his continued employment? 5 A. No, I don't think so. 6 MR. VEIS: Your Honor, this would be a 7 convenient time to take a break. 8 THE COURT: We'll adjourn until 9 2:00 o'clock. 10 11 (Whereupon, a lunch break was taken 12 from 12:37 p.m. to 2:05 p.m.) 13 14 THE COURT: Be seated, please. We'll 15 be back on the record. 16 Mr. Veis, you may continue. 17 MR. VEIS: Thank you, Your Honor. 18 Q. (BY MR. VEIS) Mr. Lapidus, I'm going to 19 hand you an exhibit that's been marked A14106. 20 Now, we spoke at some length this morning about 21 the information you had gathered in connection 22 with your examination. I would like now to turn 22452 1 to the use you made of that information. 2 Do you recognize Exhibit A14106? 3 A. This was shown to me this year. 4 Q. Let me clarify the question. There are 5 two parts to it. The first, which you would not 6 have seen necessarily, is -- purports to be a 7 cover memo or memorandum from Brenda Bese, senior 8 examiner, to Neil Twomey, supervisory agent, which 9 comes from the supervisory files of the OTS. And 10 it's Ms. Bese's report of examination on USAT and 11 includes a number of enclosures. Not all of those 12 enclosures are included in this document. 13 Particularly, attached Enclosure 8 which begins at 14 the fifth page of the document, it is referenced 15 in the line of enclosures on the first page where 16 it's described as "interest rate risk management 17 write-up." 18 Do you see Enclosure 8? 19 A. Yes, I do. 20 Q. What is Enclosure 8? 21 A. This is a copy of the comment that I 22 sent to Brenda Bese through the E-mail system. 22453 1 Q. And does it represent the comment that 2 was prepared as a result of your work at United 3 Savings Association of Texas? 4 A. Yes, to the best of my knowledge. 5 MR. VEIS: Your Honor, I move the 6 admission of A14106. 7 MR. NICKENS: No objection. 8 THE COURT: Received. 9 Q. (BY MR. VEIS) Can you please explain 10 briefly the process by which you prepared the 11 comment which begins at Page OW154317? 12 A. Well, basically, I would have written 13 several drafts; and people that contributed, that 14 were assisting for me, may have written some 15 portion of it for me. And I would have 16 incorporated that into the comment. I wrote the 17 majority of the comment during that week in 18 January of 1989. 19 Q. I'm sorry. Which week in January of 20 '89? You're referring to the week -- 21 A. The one that ended January 20th that 22 was on my time sheet. 22454 1 Q. Which was in A14101? We don't really 2 need to go to the time sheet. 3 Was that the week ending January 20? 4 Is that right? 5 A. Yes. 6 Q. Now, did you seek any editorial 7 comments in connection with preparation of this 8 comment? 9 A. Yes, I did. Late Thursday night, early 10 Friday morning, I E-mailed it to Larry Kenney in 11 our Chicago office. And he reviewed it and made 12 recommendations to me for changes which I would 13 have incorporated and put into the comment. Then 14 I would have E-mailed it to Brenda. 15 Q. Now, do you know whether Ms. Bese made 16 any changes to your comment after she received it? 17 A. She might have. It's part of her -- 18 part of her job. It's her responsibility to make 19 sure that the comment is accurate and meets the 20 requirements of the examination. 21 Q. And she was the examiner-in-charge, 22 correct? 22455 1 A. Yes, she was. 2 Q. So, did she have the authority and 3 responsibility to make changes that she thought 4 were appropriate? 5 A. Yes, she did. I don't know if she made 6 any; but if she were to make any, that would be 7 her prerogative. 8 Q. Have you reviewed the comment that 9 begins at OW154317 prior to your testimony today? 10 A. Yes. 11 Q. Does the comment that is reflected 12 there accurately state your observations and 13 conclusions concerning the management of the 14 mortgage-backed securities portfolios of United 15 Savings Association of Texas? 16 A. Yes, it does. 17 Q. Does the comment reflected in this 18 exhibit accurately state your observations and 19 conclusions concerning the hedging instruments and 20 activities associated with the mortgage-backed 21 securities portfolios of United Savings 22 Association of Texas? 22456 1 A. Yes, it does. 2 Q. Does the comment reflected in this 3 exhibit accurately state your observations and 4 conclusions concerning the funding for the 5 mortgage-backed securities portfolios of United 6 Savings Association of Texas? 7 A. Yes, it does. 8 Q. Now, I would like to turn to the 9 comment. I would like to ask you a quick 10 question. 11 The first section I notice is called 12 "summary." Do you see that on the page ending 13 with Bates No. 317? 14 A. Yes, I do. 15 Q. Now, does that summarize your 16 conclusions and findings from the other sections 17 of the report? 18 A. Yes. It's basically the way we write 19 reports. 20 Q. The summary and then the supporting 21 matter? 22 A. Yes, pretty much. 22457 1 Q. Okay. If you would, please, turn to 2 the Bates number that's ended OW154319. What I 3 would like to try to do here is to, for selected 4 portions and paragraphs, tie some of the figures 5 and facts that you have laid out in your comment 6 in the work papers that we reviewed this morning. 7 Now, in the second paragraph on 8 Page OW154319, there is a comment concerning -- 9 and I will try to avoid long quotes here because 10 it's a long document. I'll try to paraphrase and 11 point out particular sentences. 12 The comment that begins by describing 13 yields on June 30, '85 and June 30, '87, do you 14 see that? 15 A. Yes. 16 Q. And then it refers -- it refers to it 17 as having decreased by 410 basis points. 18 Do you see that? 19 A. Yes, I do. 20 Q. And following that, you say, "The 21 decreased yield resulted from the increased 22 investment in lower coupon rate MBS. Higher 22458 1 coupon rate MBS had been sold for a profit when 2 interest rates had decreased. The unrealized loss 3 based on" -- no. I'll stop right there. 4 Now, have you heard of the term "the 5 rolldown" in connection with USAT? 6 A. Yes, I have. 7 Q. Now, are you referring, in part, to 8 what's been called the rolldown in the sentences I 9 just quoted to you? 10 A. Yes. 11 Q. Now, let's -- let's take a look at 12 OW181953, which is in Exhibit A14101. Actually, 13 let me first -- let me first have you look at -- 14 let me have you first look at the Bates number 15 ending 950. 16 A. Okay. 17 Q. Now, if you would look at the second 18 paragraph, do you see where it refers to 19 Exhibit 3? 20 A. Yes. 21 Q. And it indicates, "Joe Phillips has 22 continued the rolldown program through May"? 22459 1 A. Yes, I do. 2 Q. Now, I would like you to turn to 3 OW181953, if you would. 4 Does that appear to be Exhibit 3 as 5 referred to in the memorandum at 950? 6 A. Yes, it does. 7 Q. And does that, in part, support the 8 statement in your comment concerning the sales of 9 higher coupon MBS and investment in lower coupon 10 MBS? 11 A. Yes, it does. 12 Q. And in what way? 13 A. As you can -- well, basically, for 14 example, it says for May 2nd, 1986 -- for May 2nd, 15 '86, the broker was Goldman. There was a sale of 16 49.9 million in 10 and a half percent Freddie Macs 17 and the purchase of 52.2 million in Freddie Mac 18 9 percents. 5/28/86, there's a transaction with 19 Drexel as the broker. There's a sale of 20 76.5 million in 10 percent Fannie Maes and the 21 purchase of 80 million in 9 percent Fannie Maes. 22 And the pattern is similar. There's more 22460 1 transactions pretty much like that. 2 Basically, this is where they are 3 selling the higher rate coupon and they are 4 replacing it or buying a lower rate coupon. This 5 exhibit does not indicate whether there was any 6 profits or losses on these transactions. 7 Q. Let me now ask you to look at OW181986, 8 which is also in Exhibit A14101. 9 A. Okay. 10 Q. Now, is this another document that 11 supports your observations concerning the sale of 12 higher coupon MBS and the purchase of lower coupon 13 MBS? 14 A. Yes. It's a similar type of sheet, 15 except these are trades that were made in July and 16 it looks like August. I'll have to assume that -- 17 the trade date was in July, but some of the 18 settlement dates were in August. 19 Q. Now, directing your attention to the 20 following page, OW181987. 21 Do you see that? 22 A. Yes. 22461 1 Q. Now, it began -- again, do these two 2 pages comprise one document? 3 A. I believe so. 4 Q. All right. Now, if you line them up 5 side by side -- tell me if I'm wrong -- it appears 6 that the comments concerning rationale on the 7 second page, 187, line up and appear to relate to 8 the transactions indicated on the first page 9 ending in 986; is that correct? 10 A. Yes. 11 Q. Now, are there indications there that 12 there were profits taken on those sales? 13 A. Let's see. The first one says "Profit 14 of $196,875 reinvested in Freddie Mac 9s." Next 15 one says "Profit of 375,096.96. Assets retained 16 versus swaps." 17 Q. Let me then ask you to take a look at 18 0W182411, which is in Exhibit A14102. 19 MR. NICKENS: Your Honor, may I have 20 the number again? 21 MR. VEIS: OW182411, which is in 22 A14102. 22462 1 A. Okay. 2 Q. (BY MR. VEIS) You previously identified 3 this as a schedule that you prepared. Right? 4 A. Yes. 5 Q. Now, does this schedule, beginning at 6 OW182411, in part support the statements made 7 concerning decreased yield in the MBS portfolio? 8 A. Yes, it does. 9 Q. Can you explain that for us? 10 A. The -- let's see. I said in June '85 11 the yield on the MBS portfolio was 12.3 percent. 12 If you look on this sheet for June '85, there were 13 $940,776,000 in mortgage-backed securities with a 14 yield of 12.31. If I remember correctly, they 15 were -- I believe they were monthly averages, not 16 month end; but I'm not sure. 17 Q. Is there an indication there of a basis 18 point spread on those MBSs? 19 A. Yes. In comparison to the reverse 20 repos that were at that time, the basis point 21 spread was 369 basis points. 22 Q. Let's move forward, then, to later 22463 1 periods. Would you take a look at OW182414 which, 2 if I understand your previous testimony, is the 3 fourth page of this schedule; is that correct? 4 A. Yes, that's correct. 5 Q. What does that indicate concerning 6 yields on both the mortgage-backed securities 7 portfolio and the basis point spread? 8 A. Oh, at September '88, the yield was at 9 8.66 percent; and the spread between the combined 10 rates for the reverse repos and the dollar rolls 11 was 35 basis points. 12 Q. I would like you to take a look at, 13 please, OW182752, which is in Exhibit A14103. 14 MR. NICKENS: I apologize, Your Honor, 15 but I missed the number again. 16 MR. VEIS: OW182752 in Exhibit A14103. 17 Q. (BY MR. VEIS) Are you there? 18 A. Yes, I am. 19 Q. Now, we briefly discussed this when we 20 were identifying work papers. Does this also 21 provide support for the statements regarding sales 22 for profits in your comment? 22464 1 A. Yes. The sentence in there says, "Many 2 of the swaps of securities was for a profit on the 3 sale, improved yields, or both." 4 Q. Now, in the next paragraph, you 5 discussed the total investments in mortgage-backed 6 securities and off balance sheet hedging items. 7 In the third sentence, you state, "Based on 8 available market values, the unrealized losses for 9 the securities and off balance sheet hedging items 10 was $213.7 million." 11 Do you see that? 12 A. Yes. 13 Q. Now, I would like you to take a look at 14 Exhibit A14102, specifically at OW182431. 15 A. Okay. 16 Q. Now, does that document relate to your 17 statement concerning the unrealized losses being 18 $213.7 million? 19 A. Yes, it does. The summary says for 20 unchanged or, basically, the current markup, the 21 total gains and losses, which in this case was a 22 loss, was 217,650,000 or 217.7 million. 22465 1 Q. Was this provided by the association? 2 A. Yes, it was. 3 Q. Now, you then discuss in the following 4 paragraph USAT's finance subsidiaries. 5 Do you see that? 6 A. Yes. 7 Q. Now, you discuss there the spread data 8 with respect to three finance subsidiaries. 9 Do you see that, where it starts 10 "September 30th, 1988"? 11 A. Yes. 12 Q. It says, "USAT Finance, Inc. has a 13 spread of 33 basis points. USAT Finance II, Inc. 14 had a negative spread of had already been 15 dissolved into the institution." 16 Do you see that? 17 A. Yes. 18 Q. I would like to ask you to look at -- 19 for the record, I'm reading from Page OW154319. 20 Let me ask you to look at Page -- again at -- I'm 21 sorry -- 14102 and particularly at Page OW18420. 22 A. Okay. 22466 1 Q. OW182420. Now, can you tell us whether 2 or not this page of the work papers supports the 3 observation in the comment concerning the interest 4 spreads of USAT's finance subsidiaries? 5 A. Yes, it does. It indicates the yield 6 on the mortgage-backed securities and the stock 7 rates for the three subs, and those numbers tie 8 into the numbers in the report. 9 Q. Okay. Well, in particular, if you 10 could point to where it describes the spread for 11 USAT Finance I. 12 A. Okay. For September '88, the yield on 13 the mortgage-backed securities is 8.58 percent. 14 The stock rate was 8.25 percent, the difference 15 being 33 basis points. 16 For Finance Sub 2, the mortgage-backed 17 security yield was 8.54 percent. The stock rate 18 was 8.79 percent, which resulted in a negative 19 spread or yield on the investment of 25 basis 20 points. 21 And as indicated in the report, the 22 balances for Finance Sub 3 are zeroed out because 22467 1 that was absorbed back into USAT. 2 Q. Would you turn to the next page, 3 please? That's OW154320. 4 At the top of the page, there's Item C, 5 "derivative MBS mortgage loans." Is that the 6 heading that covers the entire page and the 7 following pages that refers to residuals, interest 8 only MBS, and principal only MBS? 9 A. Yes. The capital A, B, and C on the 10 next two pages are subcategories of the small C, 11 which is what you -- 12 Q. Now, you state in the third paragraph 13 of the sentence under Item C, "In late 1986 and 14 early 1987, the institution began purchasing 15 various high risk mortgage derivative securities 16 such as the residuals, IOs, and POs." 17 Now, what is the high risk associated 18 with the derivative securities that you've listed 19 there? 20 A. Well, derivative securities, by their 21 very nature, are higher risk than the -- than a 22 normal mortgage-backed security. The -- 22468 1 basically, what happens is the security is taken 2 apart and sold off in different pieces. And 3 residuals, IOs, and POs all have a higher degree 4 of risk than a normal mortgage might have. 5 Q. And why is that? 6 A. Well, for instance, residuals are 7 basically -- you might call them collateral. When 8 you split up a -- a number of mortgage-backed 9 securities and you create different tranches 10 within a CMO, some of those tranches have variable 11 rates; and you took a fixed rate instrument. And 12 they have to put aside a certain amount of 13 interest income to cover the possibility of rates 14 going up and the variable rate tranche needing 15 more interest to be paid on it. As a result, 16 there's the possibility or potential that you 17 might get nothing out of a residual. You may lose 18 your entire investment or a portion of it. 19 Q. Let's talk about the section on 20 residuals. You indicate under Item A on the page 21 ending with Bates 320 that there was a 22 reference -- a first reference to residuals in the 22469 1 investment committee minutes of December 4th, 2 1986; is that correct? 3 A. Yes. 4 Q. I would like to direct your attention 5 to Exhibit A14103 to Page OW182023. I'm sorry. 6 Exhibit A14101. Now, I'll direct your attention 7 here to -- 8 A. I'm sorry. 9 Q. I'm sorry. Do you have that? 10 A. Which exhibit am I on? 11 Q. This is A14101, which is the investment 12 committee minutes. 13 A. Now, you want me to go to -- 14 Q. OW182023. 15 A. Okay. 16 Q. You state that that's the first mention 17 of residuals in the investment committee minutes. 18 Do you see that? 19 A. Yes. The fourth paragraph down, it 20 starts out, "Ms. Laurenson then discussed the 21 potential purchase of CMO residuals." 22 Q. Then you go on to say in your comment 22470 1 that there were -- upon review of trade tickets, 2 there were commitments to purchase investments 3 prior to the meeting. 4 Do you see that? 5 A. Yes. 6 Q. Is there support for that anywhere in 7 the work papers? 8 A. Yes, there is. 9 Q. Let me ask you to look at OW182841, 10 which is in Exhibit A14103. Let me also ask you 11 to look at the following page, OW182842. 12 A. All right. I have those two pages. 13 Q. Now, do those documents indicate 14 commitments to purchase residuals prior to the 15 date of the investment committee minutes, 16 December 4th, 1986? 17 A. Yes, they do. The -- at the top of the 18 trade ticket that's the 841 number -- not the 19 trade number, but the OW number -- it says the 20 trade date is 12/01/86, which means it took place 21 a day or so before that meeting, several days. 22 And the same is true for the OW that ends in 842. 22471 1 That trade date says 12/02/86. Both of those 2 dates were prior to that meeting. 3 Q. Let me direct you back to the minutes 4 of that meeting. You refer in there that the 5 report submitted to the investment committee 6 indicated that the residuals had already been 7 purchased. 8 Do you see that? 9 A. I'm sorry? 10 Q. Let me direct your attention to 11 OW182024 and ask if you can tell whether that's 12 what you've indicated to the committee, that the 13 residuals had been purchased? 14 A. What was the rest of that number? 15 Q. 024. 16 A. 024. All right. I see that. What was 17 the question? 18 Q. Does that indicate that there was a 19 report to the committee that the residuals had 20 been purchased? 21 A. Yes. After "activities," it says 22 "portfolio"; and it shows that there's an ML-5 22472 1 residual and then -- an MLT-5 residual for 2 28.2 million and an MLT-4 residual where there was 3 not an amount indicated. And that's listed as 4 part of the portfolio, meaning that it's -- it's 5 already there. 6 Q. All right. Now, it says in the next 7 paragraph that the report indicated a maximum 8 duration of the residual and indicated the 9 expected yield under different interest rate 10 scenarios. 11 Do you see that sentence? 12 A. Yes. 13 MR. NICKENS: Are we back in the 14 comment? 15 MR. VEIS: We're back in the comment. 16 Q. (BY MR. VEIS) Okay. 17 A. I see that in the report. 18 Q. Now, you say there that -- where do you 19 see that in the report? 20 A. It says the report provided to the 21 committee indicated that the maximum duration of 22 the residual was 4.1 years. 22473 1 Q. What about the -- let me move on to the 2 sale of residuals, OW182371. I'm sorry. The next 3 paragraph on OW154320. 4 A. Okay. 5 Q. It indicates -- there's an indication 6 of a sale at a loss of $33.4 million. 7 Do you see that that in the fifth 8 sentence? 9 A. Yes, I do. 10 Q. It indicates that the senior management 11 directed that the residuals be sold due to lack of 12 liquidity? 13 A. Yes. 14 Q. Let me direct your attention to 15 Page OW182371. 16 THE COURT: Which exhibit? 17 MR. VEIS: I believe it is A14105, 18 Your Honor. 19 A. What was that number? 20 Q. (BY MR. VEIS) OW182371. 21 A. Okay. 22 Q. Now, does OW182371 support the 22474 1 statement in the comment at OW154320 that there 2 had been a sale of residuals at a loss of 3 $33.4 million at the direction of senior 4 management? 5 A. Yes. It is a memo from Dominic Bruno 6 to the investment committee. At the top, after 7 the subject, it says, "At the direction of senior 8 management, the mortgage-backed securities 9 portfolio area implemented a sale program of its 10 residual position." And down below, underneath 11 the list of the sales, under the "loss" category, 12 the total comes out to 33.4, which is 13 33.4 million. 14 Q. Thank you. 15 Now, let's look at the heading 16 "interest only MBS" at OW154320. 17 Do you see under heading "B"? 18 A. Yes. 19 Q. Now, there's a discussion there of the 20 investment committee minutes of January 28th, 21 1987. 22 Do you see that? 22475 1 A. Yes. 2 Q. And that indicated that the institution 3 would purchase Fannie Mae IOs? 4 A. Yes. 5 Q. And further indicated that the 6 investment had attracted yields and the 7 investments could be repo'd and were qualifying 8 assets? 9 A. Yes. 10 Q. I would like you to look at OW182066, 11 which is in -- in A14101. Does -- in particular, 12 let me ask you to look at the bottom paragraph of 13 that page. Is there support there in OW182066 for 14 the statement concerning the January 28th 15 investment committee minutes regarding the 16 purchase of Fannie Mae IOs? 17 A. The last bullet point under "plans and 18 goals" says, "Buy up to 25 million Fannie Mae 19 strip securities. Buy the interest-only component 20 yield 289 BP," basis points, "over the ten-year 21 UST," which is U.S. Treasury. "The securities are 22 wireable, repoable, and are qualifying assets." 22476 1 Q. Now, let me direct your attention then 2 to the next sentence. This is the sentence on 3 OW154320 that starts out, "At the February 18th, 4 1987 meeting, members unanimously approved the 5 acquisition of IOs. No additional reasons for the 6 investment were provided. There was no indication 7 that the institution analyzed the potential 8 changes in yield or market value of these 9 investments under different interest rate 10 scenarios." 11 Do you see that sentence in your 12 comment? 13 A. Yes, I do. 14 Q. Let me ask you to look at OW182079, 15 which is also in A14101. 16 A. I am looking at that right now. 17 Q. Does that provide support for your 18 statement regarding the approval of the 19 purchase -- of the acquisition of IOs and -- well, 20 does that provide support for that statement? 21 A. Yes, it does. 22 Q. And in the course of your -- there are 22477 1 attachments here to the investment committee 2 minutes, is that correct, following OW182079? 3 A. OW182080 is the statement of strategies 4 and objectives. 5 Q. And then following -- 6 A. And mortgage-backed securities. 7 Q. Following that, there is another 8 attachment? 9 A. Well, that's -- that's on 182081, as 10 well. After that, there is a market review, more 11 market review. There is an MBS portfolio activity 12 sheet from that meeting. 13 THE COURT: Would you state the OW 14 number down there? 15 THE WITNESS: 182084. 16 A. There's a mortgage-backed securities 17 performance report for UMBS. And the last one is 18 OW182086. That's a summary of strip 19 mortgage-backed deals in something week, probably 20 previous week or prior week. Probably prior week. 21 Q. (BY MR. VEIS) And these are at least 22 some of the attachments to those investment 22478 1 committee minutes; is that right? 2 A. They are the ones I copied or had 3 copied. 4 Q. And there is, in the attachments that 5 you copied, no indication that the institution 6 analyzed potential changes in yield or market 7 value of investments at different interest rate 8 scenarios; is that -- 9 A. That is correct. 10 Q. Let's turn to the following page, 11 OW154321, of the comment. Now, the final 12 paragraph under IOs which is on this page, 154321, 13 indicates, "As of September 30, 1988, UMBS held 14 53.4 million in IOs with an average yield of 15 11.4 percent. The unrealized loss on these 16 securities was $3.2 million." 17 Do you see that? 18 A. Yes, I do. 19 Q. Is there support for that in the work 20 papers? 21 A. Yes, there is. 22 Q. Let me ask you to look at 22479 1 Page OW182865, which is in -- which is in A14103? 2 A. Okay. 3 Q. Now, can you tell me whether that 4 supports your statement regarding any unrealized 5 loss in those securities? 6 A. The statement regarding unrealized loss 7 is correct. It's $3,181,343. 8 Q. Where is that found in this document? 9 A. Under "10/4/88 market loss," which is 10 the information at the -- the market prices that 11 the institution used. 12 Q. These losses are derived from the 13 institution's data? 14 A. Yes, it is. 15 Q. Let's now turn to principal-only MBS, 16 still on Page 154321. The statement concerning an 17 April 8th, 1987 committee meeting, "A strategy 18 involving the purchase of high coupon POs to hedge 19 against rising interest rates was presented," do 20 you see that? 21 A. Yes, I do. 22 Q. It says, "Members approved the purchase 22480 1 of up to $50 million in the POs to hedge a portion 2 of the MBS's portfolio." 3 Do you see that? 4 A. Yes. 5 Q. Let me direct your attention to 6 OW182107, which is in Exhibit A14101. Now -- 7 A. All right. I have that. 8 Q. Now, does that support your statement 9 concerning the approval of -- I'm sorry -- 10 concerning strategies involving the purchase of 11 high coupon POs and the approval of $50 million 12 for purchases of POs? 13 A. Yes. The second paragraph deals with 14 this issue. It says, "In order to hedge the 15 portfolio in a rising rate environment, various 16 strategies were discussed, including the purchase 17 of high coupon principal-only securities." And 18 down a little more, it says, "After a lengthy 19 discussion, the committee approved the purchase of 20 up to 50 million high coupon principal-only 21 mortgage-backed securities to hedge the 22 Arbitrage 1 portfolio." Then it says further, "To 22481 1 purchase interest-only mortgage-backed securities 2 as a replacement for mortgage-backed securities in 3 the investment portfolio, and to purchase up to 4 100 million of interest rate caps to hedge the 5 preferred stock subsidiaries." So, they approved 6 several things in there. 7 Q. All right. Now, you indicate, then, 8 following the approval that -- we're back now on 9 OW154321 -- that there was no indication that the 10 impact of potential yield in market value 11 fluctuations for the POs was compared to the 12 entire MBS portfolio. 13 Do you see that? 14 A. Yes. 15 Q. You say, "It should be noted that POs 16 backed by high coupon rate MBS do not provide 17 protection against rising interest rates. If 18 interest rates increase, yield and market value of 19 these securities will decrease significantly." 20 I would like to address the first 21 sentence concerning a lack of or the -- that there 22 was no indication that there was a comparison or 22482 1 that the impact of a potential yield in market 2 value fluctuations as compared to the entire MBS 3 portfolio. If you take a look at the pages 4 following OW182107, that appears to be attachments 5 to -- 6 THE COURT: Which exhibit? 7 MR. VEIS: We're back in A14101, which 8 is the investment committee minutes for that date. 9 Mr. Lapidus is looking at OW182107. What I was 10 asking him to do was to look into the attachments 11 that he copied and ask him whether he agrees 12 that -- whether he concludes that there was no 13 discussion of the impact of potential yield in 14 market value fluctuation in potential purchase of 15 POs. 16 A. I don't see anything in here that would 17 show that kind of analysis. 18 Q. (BY MR. VEIS) All right. Now, let me 19 direct your attention back to the sentence on 20 OW154321 that indicated there was a loss in 21 Arbitrage 1, unrealized losses in Arbitrage 1 of 22 $7.1 million. 22483 1 A. Yes. 2 Q. Now, directing your attention to 3 OW182112, which I think is the last page of 4 information attached to the April 8th, 1987 5 minutes. It's headed "MBS sensitivity analysis." 6 A. Yes, I see that. 7 Q. Now, is there support for your 8 statement concerning the 7.1-million-dollar loss 9 on that document? 10 A. Yes. It says -- I think that's an 8. 11 It says there's a loss of 7,085,000, which would 12 be rounded off to 7.1 million. 13 Q. Now I would like you to look two 14 paragraphs down on that document. 15 A. Okay. 16 Q. All right. You note there -- "We noted 17 a 10-million-dollar variance between the trade 18 tickets received from the broker and the purchase 19 price recorded to the general ledger." 20 Do you see that? 21 A. Yes. 22 Q. Now, is that a significant discrepancy? 22484 1 A. Yes, it is. 2 Q. Now, let me ask you to take a look at 3 OW182568, which is in A14102. We talked about 4 this document a little bit earlier today. You 5 started to discuss it. 6 A. Okay. 7 Q. You indicated this was a memorandum 8 from you to Bruce Williams, correct? 9 A. Yes. 10 Q. I'm afraid it's a little hard to read, 11 but can you explain what that memorandum relates 12 to? 13 MR. NICKENS: The second page is more 14 legible. It's a copy of the same thing. Mine is 15 copied twice. The second one is much more 16 legible. 17 MR. VEIS: Would you mind if 18 Mr. Lapidus looked at yours, Mr. Nickens? 19 MR. NICKENS: No. 20 THE WITNESS: Thank you. 21 Q. (BY MR. VEIS) Okay. 22 A. Okay. There's some headings at the 22485 1 top. It says "description," "collateral," 2 "purchase par value," "price," and "purchase book 3 value." 4 The first two entries are per the 5 institution's records, what they indicated the 6 price and the book values were. And the second 7 two entries are the same securities. And the 8 amounts indicated there are what the broker's 9 advices indicated which were significantly less 10 than what the institution had indicated they had 11 paid. 12 Q. Let's look then at OW182859 -- 13 A. Does Mr. Nickens want his book back? 14 Q. -- which is in Exhibit A14103. 15 A. I'm sorry. What number am I looking 16 for? 17 Q. It's OW182859 and 860. 18 A. All right. I see 182859 and 860. 19 Q. Now, what are those two documents? 20 A. These are printouts from the 21 institution. And, basically, it's part of their 22 tracking, their accounting tracking, for the 22486 1 actual payments on -- and the cash flows on these 2 two -- these two POs. 3 Q. Now, does that indicate the purchase 4 price? 5 A. Yes, it does. It shows -- the first 6 numbers under the cash flow entries are the 7 negative number which is the outlay. For 859, it 8 shows 20,815,676. And for 860, it shows 9 10,250,954. 10 Q. Now look at OW182871 and OW182872. 11 What are those two documents? 12 A. These are the broker advices on the 13 transactions for those -- for the two POs. As you 14 can see, I have written down "PO Trust No. 8" on 15 871. And on 872, I wrote "PO No. 3." 16 Q. Is that a 3 or 35? 17 A. 35. I guess that's 35, not an S. 18 Sorry. 19 Q. Are those the broker advices relating 20 to the same securities that are reflected on the 21 institution's books at OW182859 and 860? 22 A. Yes, they are. 22487 1 Q. And is this the source of the 2 information that you had with respect to the price 3 discrepancy? 4 A. Yes, they are. 5 Q. Now, what in particular was it that 6 bothered you about this price discrepancy, 7 Mr. Lapidus? 8 A. Well, if you look at 871, under "amount 9 due," this is the amount -- now, the -- sorry. 10 Maybe I should start at the beginning. 11 The quantity or the par value of the 12 principal is 25,875,000. And that is -- if you 13 look on 859, it says 25,875,000. So, you're 14 starting with the same principal balance. Now, 15 the problem is the price. The institution 16 indicated that they had paid 20.8 million for 17 this, and the broker advice says that the 18 institution only paid 13.2 million for this PO. 19 That is -- that's a significant difference. In 20 fact, that was the majority of it. 21 MR. NICKENS: Your Honor, may I ask 22 where he's referring to, what was paid? What 22488 1 column? 2 THE WITNESS: Where it says "amount 3 due," that's the amount that the broker billed the 4 institution. 5 MR. NICKENS: Your Honor, on the 6 internal accounting page, the amount -- what 7 column is he relying on -- 8 MR. VEIS: The negative number here. 9 MR. NICKENS: Under "cash flow"? 10 THE WITNESS: Yes. 11 Q. (BY MR. VEIS) Similarly, there's a 12 discrepancy between 2860, the institution's 13 records, and OW182872 of the broker advice? 14 A. Yes. The amount isn't as great, but 15 it's a similar variance where the institution 16 showed in its records that it had paid out 17 $10,259,954 and the bill from the broker and the 18 amount due the broker was 7,625,803.21. 19 MR. NICKENS: Again, relying on the 20 amount paid out as being the "cash flow" column? 21 THE WITNESS: Yes. 22 MR. NICKENS: Thank you. 22489 1 Q. (BY MR. VEIS) Mr. Lapidus, I would like 2 you to turn to the next page, please. 3 A. In the comment? 4 Q. Yes. Now, on OW154322 which is headed 5 "funding sources," do you see that? 6 A. Yes, I do. 7 Q. Now, it refers there to management's 8 forming of some finance subsidiaries. 9 Do you see that in the first paragraph? 10 A. Yes. 11 Q. In the second paragraph, you make the 12 statement, "Considering the institution's 13 financial condition, creating a finance subsidiary 14 to further leverage the MBS was unsafe and 15 unsound." 16 Can you explain that? 17 A. Well, I was aware of the fact that the 18 institution had capital problems and earning 19 problems and that that -- by creating a finance 20 sub and basically creating more leverage, I 21 considered this to be unsafe and unsound. As it 22 further indicates, which basically is what 22490 1 happened as the -- if the institution's financial 2 condition deteriorates, the preferred stock would 3 have to be redeemed which would create a further 4 burden on their capital because they would have 5 basically a lower capital ratio as a result of the 6 additional assets being placed on the 7 institution's books from the failure of the 8 finance subs. 9 Q. Now, what about additional funding 10 requirements? There's some discussion there, as 11 well? 12 A. If they didn't have the cash available, 13 they would have had to go out and basically get 14 more reverse repos, which would have increased 15 their cost of funding. 16 Q. All right. Let's move on to the fourth 17 paragraph. It states that "the average cost of 18 financing ranged from a low of 6.1 percent to a 19 high of 8.6 percent. Until June of 1987, the 20 spread between the reverse repos and the MBSs was 21 in excess of 200 basis points." 22 Do you see that? 22491 1 A. Yes, I do. 2 Q. Now, let me direct your attention back 3 to 0W182413 which I believe we just discussed. 4 That is in Exhibit A14102. 5 A. Okay. 6 Q. Now, does that support your statement 7 that until June 1987, the spread was over 200 8 basis points? 9 A. Yes, it does. If you look at 182411, 10 412, and 413, as I indicated, it's a running 11 monthly summary of the institution's activities 12 regarding mortgage-backed securities and the 13 funding regarding the reverse repos and the dollar 14 rolls. It was -- in '85, it was over 300. In 15 '86, it dropped below 300 a couple times; but it 16 was also relatively high. And in '87, it had 17 quickly dropped from -- from a high of 275 in 18 February of '87 to -- in June of '87, that was the 19 first time in my calculations that their spread 20 had dropped below 200. 21 Q. All right. Now, let me just -- to 22 clarify the schedules here that you have starting 22492 1 at OW182411 and, I guess, going through OW182414, 2 now, when you talk about the spread as a general 3 matter, does that include hedging costs? 4 A. No, it does not. 5 Q. This is exclusive of hedging costs? 6 A. Yes. It is also exclusive of the rest 7 of the financing, the rest of the liability. 8 Q. Now, you're talking here about sale of 9 higher coupon securities for a profit and 10 replacement with lower coupon rates. 11 Do you see those sentences? 12 A. Yes. 13 Q. Now, is that the same sale of 14 securities that you spoke of earlier when we 15 talked about the MBS portfolio activity? 16 A. Yes, it is. 17 Q. Now, you say here that the combination 18 of MBS with low yields and increasing funding 19 costs reduced the spread by 142 basis points 20 between May of 1987 and June of 1987 to 77 basis 21 points. Is that also documented in the -- 22 A. (Witness reviews the document.) Okay. 22493 1 I'm trying to -- okay. At May '87, it was 238 2 basis points. In June '87, it was 122 basis 3 points. That's a drop of 116 basis points. I'm 4 trying to read this. Let's see. The combination 5 of -- I'm sorry. 6 Q. Well -- 7 A. I'm -- 8 Q. In the interest of time, this is a -- 9 let's move to September 30, '88, which is the 10 statement you make at the end of the paragraph. 11 THE COURT: Where are we now? 12 Q. (BY MR. VEIS) Same paragraph on 13 Page OW182414, you state, "As of September 30, 14 1988, the spread between the $1.8 billion in the 15 reverse repos and the MBSs was 16 basis points." 16 Do you see that? 17 A. Yes. 18 Q. Now, what's the basis for that 19 statement? 20 A. The yield on the mortgage-backed 21 securities at September '88 was 8.66 percent. The 22 cost of the reverse repos was 8.5 percent. 22494 1 THE COURT: Can you give us the 2 reference for that? 3 A. OW182414 under the month September '88 4 for mortgage-backed securities, it shows a yield 5 of 8.66 percent; and for the reverse repos, it 6 shows a yield of 8.5 percent. The difference 7 between that is 16 basis points. 8 Q. (BY MR. VEIS) That is also separate for 9 dollar rolls. Right? 10 A. Yes. The last column has the basis 11 point spread. That is a combination of the two 12 costs: The reverse repos and the dollar rolls. 13 Q. Is that a weighted average? 14 A. Yes, it is. 15 Q. Now I would like you to take a look at 16 OW -- before we get to that, at the bottom of 17 Page OW154322, you indicate that the review of the 18 dollar rolls indicated two areas of concern. 19 Do you see that? 20 A. Yes. 21 Q. Now, what were those two areas of 22 concern? 22495 1 A. One was that management had always 2 been -- had made a statement basically that they 3 were requiring the brokers to always deliver 4 mortgage-backed securities of the same or greater 5 amount, which basically would mean that you 6 wouldn't -- the institution basically would not be 7 receiving any principal payments on these 8 mortgages. They would -- I mean, when you do a 9 dollar roll, you're taking one security and you're 10 exchanging it for a security that's similar. If 11 you're not giving the -- if the dollar amount that 12 they are returning is greater than -- if the 13 dollar amount that the institution buys back is 14 always greater than what they sell, there will be 15 no reduction on that particular security even if 16 the actual security changed. The institution's 17 investment, instead of decreasing as you normally 18 would with mortgage-backed securities, they 19 essentially would be artificially extending the 20 life of those mortgage-backed securities. 21 Q. And why is that a concern? 22 A. It certainly increases the interest 22496 1 rate risk that the institution is exposed to for 2 holding those securities and artificially 3 lengthening the life. 4 Q. How does it increase unrealized losses? 5 A. Well, the institution already had 6 unrealized losses on these securities; and they 7 had -- and by essentially getting a great dollar 8 amount in terms of more mortgage, they were 9 actually increasing their unrealized loss. 10 Q. They were essentially buying the 11 losses? 12 A. Essentially. 13 Q. Let me ask you about the review of the 14 dollar roll transactions. You talk about 15 reviewing 24 dollar roll transactions. 16 Do you recall this morning that we 17 looked at the work paper that Mr. Kiner prepared? 18 A. Yes. 19 Q. Now, I believe we already looked at the 20 section where Mr. Kiner describes the transactions 21 in question. 22 Do you recall that? 22497 1 A. Yes, I do. 2 Q. And his memo I think is at OW182786, 3 which is in Exhibit A14103 and carries through to 4 OW182787. Now, I direct your attention in 5 particular to the second paragraph of Mr. Kiner's 6 memorandum or work paper at OW182786 where he 7 talks about -- the paragraph beginning "three 8 dollar roll transactions entered into." 9 Do you see that paragraph? 10 A. Yes, I do. 11 Q. Now, does that paragraph support the 12 statement in the comment at OW154322 that 13 $78 million were to be substantially different in 14 maturity? 15 A. If you take the 59.5 million from USAT 16 and the 18.5 million, the two of them should equal 17 the $78 million that were found to be 18 substantially different. 19 Q. And your conclusion was they should be 20 accounting for those purchases and sales? 21 A. Yes. 22 Q. Now, I would like you to move on to 22498 1 OW154324. This begins the section regarding caps. 2 Do you see that? 3 A. Yes, I do. 4 Q. Now, you state -- you state that a 5 review of investment committee minutes for 6 January, February, and March 1987 did not reveal 7 any mention of interest rate caps. 8 Do you see that? 9 A. Yes, I do. 10 Q. Now, why is that significant? 11 A. Usually, when you're getting involved 12 in something new or something that you haven't 13 done -- even if you haven't done it in a while, 14 usually there's some kind of discussion and 15 analysis or even approval for that type of 16 activity. 17 Q. Let me direct your attention to 18 A182065, which is in -- I'm sorry -- OW182065, 19 which is in A14101. 20 Now, are these -- is this the first 21 page of the investment committee minutes? 22 THE COURT: Would you state that page 22499 1 number again, please? 2 MR. VEIS: OW182065, Your Honor. 3 THE COURT: Thank you. 4 A. I'm sorry. What was the question? 5 Q. (BY MR. VEIS) Well, I haven't finished 6 my question. 7 Is this the first page of the 8 investment committee minutes that you're 9 discussing here where you talk about reviewing the 10 investment committee meetings for January, 11 February, March of '87, at least the part that you 12 copied and put in the work papers? 13 A. That's the first page of this meeting 14 that I copied. 15 Q. And if you look at the prior page, 16 you'll notice that that's a December '86 meeting; 17 is that correct? 18 A. I suspect that -- I don't know why -- 19 either that it was taken out of order or, for some 20 reason, this copy of this minute was put in 21 those -- in the investment committee of 22 January 14th. I'm not sure why it's there in that 22500 1 order. 2 Q. They are out of order? 3 A. I suspect they are out of order. 4 Q. If you go to the 1/28/87 minute, 069, 5 you have a February 4th minute -- 6 A. I'm sorry. What did you say? 7 Q. Well, what I'm trying to establish is 8 whether these are the minutes that you reviewed 9 going on through OW182101 which support your 10 statement that there was no mention of interest 11 rate caps in the investment committee minutes. 12 A. Yeah. I believe they are; but as I 13 said, these are out of order. It's possible that 14 some of these may be missing, but I can't tell if 15 they are missing right now. 16 Q. All right. Now, let's go to the 17 committee meeting in the following sentence. 18 Do you see where it says "committee 19 meeting dated April 4th, 1987"? 20 A. Yes. 21 THE COURT: What exhibit? What page? 22 MR. VEIS: This is back on OW154324, 22501 1 Your Honor. 2 THE COURT: All right. 3 A. I see where it says the committee 4 meeting dated April 4th. 5 Q. (BY MR. VEIS) Let me direct your 6 attention then to OW182107 which I suspect is a 7 typographical error. It says investment committee 8 meeting on April 8, 1987. 9 Do you see that? 10 A. Yes. 11 Q. And it says -- there's no mention of 12 how the caps reversed interest rate risk to the 13 hedge. 14 Do you see that? 15 A. Yes. 16 Q. Okay. Now, I just want to clarify 17 because we have in the minutes an April 1st 18 meeting and an April 8th meeting. 19 My question to you is whether you are 20 referring there to the April 8th meeting. I 21 direct your attention to the second page of 22 OW182107. 22502 1 A. I must have been referring to the 2 April 8th meeting because it says at the last 3 portion of the second paragraph, "and to purchase 4 up to $100 million of interest rate caps to hedge 5 the preferred stock subsidiaries." 6 Q. Okay. Thank you. 7 Let's go to the next section. Now, 8 under "futures and options," do you see that? 9 Section C of 154324? 10 A. Yes. 11 Q. It says, "A review was made of the 12 futures and options transactions for the 13 nine-month period ending September 30th, 1988." 14 Do you see that? 15 A. Yes. 16 Q. Now, why was a review of futures and 17 options limited to that nine-month period? 18 A. That was probably done on specific 19 instructions from either Brenda as the EIC or 20 someone in Dallas. 21 Q. Now, it indicates in the following 22 paragraph that certain transactions had been 22503 1 reviewed in the previous examination. 2 Do you see that? 3 A. Where it says, "These transactions are 4 discussed in detail in the previous examination 5 report dated November 16th, 1987"? 6 Q. Yes, sir. 7 A. Yes, I see that. 8 Q. And those were found in that 9 examination to be speculative in nature, correct? 10 A. That's what it says here, yes. 11 Q. And it says here that transactions of 12 this nature were not found during this review? 13 A. They were not. 14 Q. And that -- and that relates to a 15 review of the period from -- for the nine-month 16 period ending September 30th, 1988? 17 A. Yes. 18 Q. Okay. Now, let me address you then to 19 the -- back to the paragraph above. It says -- 20 with respect to the review of the period that you 21 did review, it says, "The majority of transactions 22 were made through the service corporation UMBS, 22504 1 the one hedge made by USAT is detailed below. 2 Examiners reviewed this activity in order to 3 evaluate current management and their compliance 4 with the revised guidelines, policies, and 5 procedures." 6 Do you see that? 7 A. Yes. 8 Q. Now, who was managing the 9 mortgage-backed portfolio and its hedging 10 activities of the period that you were reviewing 11 it? 12 A. The -- for the nine months ended 13 September 30th? 14 Q. Yes. 15 A. Dominic Bruno, I think, for most of it. 16 Q. Now, you said that you didn't find any 17 transactions of this nature at the bottom of the 18 paragraph. I assume by that you're referring to 19 speculative transactions? 20 A. Yes. It was referring to speculative 21 transactions. 22 Q. And by that comment, you're referring 22505 1 to speculative transactions in the futures and 2 options? 3 A. Yes. 4 Q. Now, would that mean that speculative 5 transactions didn't exist? 6 A. No. 7 Q. What would it mean? 8 A. It means that we didn't find any in the 9 futures and options during our review. 10 Q. Now, did you specifically review for 11 speculative activities in the swaps or caps 12 portfolios? 13 A. No, I did not. 14 Q. Did you find any speculative activity 15 in the swaps or caps portfolios? 16 A. No, I did not. 17 Q. Would that mean that there was no 18 speculative activity in the swaps or caps? 19 A. No, it does not. 20 Q. What does it mean? 21 A. It means if there was any there, that I 22 missed them. Or in my -- I probably did not 22506 1 consider that in my scope when I was reviewing 2 those activities. 3 Q. Now, let me ask you just a couple -- a 4 few final questions. 5 Now, prior to submitting your comment 6 to Ms. Bese, did you ever report orally to her on 7 your review of the MBS portfolios at USAT? 8 A. Yes, I did. 9 Q. And you kept her posted on the progress 10 of your review? 11 A. Yes. 12 Q. Did you report orally to anyone else 13 concerning your review of the MBS portfolios at 14 USAT? 15 A. Yes, I did. I -- Brenda and I flew 16 from Houston to Dallas in mid-December to attend a 17 meeting where my part in it was to present my 18 findings to date to the people that were at the 19 meeting. 20 Q. To the best of your recollection, was 21 that oral report different in any material respect 22 from what's stated in the final comment? 22507 1 A. I don't believe there was any 2 substantial difference. 3 Q. Now, when did you go to this meeting 4 where you made your oral report? 5 A. In mid-December. Somewhere in the -- 6 probably the third week I was down there maybe. 7 I'm not really sure. 8 Q. Sometime around the week of the 12th or 9 13th? 10 A. Yes. That would be about right. 11 Q. Because you came right after 12 Thanksgiving; is that correct? 13 A. Yes. Whenever the Thanksgiving weekend 14 was over, I went down there. 15 Q. After your report in Dallas, what 16 further work did you do at USAT? 17 A. Well, I went back; and I finished my 18 review. I looked at whatever else needed to be 19 looked at. I filled in the details and made sure 20 I got all the numbers down. 21 Q. What do you mean by "filling in the 22 details"? 22508 1 A. Well, we had to -- there was a lot 2 of -- there was a lot of papers we went through 3 and a lot of the institution's work papers we had 4 to review. And as you could tell by the work 5 papers we discussed, a lot of that information was 6 consolidated onto a few pages; and some of that 7 took quite a bit of time to do that. 8 Q. Well, did you feel that you had the big 9 picture by the time you went to Dallas? 10 A. Yes, I did. 11 Q. And how was that? 12 A. The activities of the institution -- 13 when I got there, they -- basically, they were on 14 the end of what their activities were; and I was 15 basically looking at the history of what they had 16 done. And I could see the patterns, and I could 17 see the activities. It was just a matter of 18 getting the numbers and the details. I can't 19 remember the exact process. 20 Q. Let me go back to your comment. If you 21 would look at OW154317, that's the first page. 22 And that's the summary. 22509 1 Do you see that? 2 A. Okay. Yes. 3 Q. Now, you describe the strategy or the 4 activity by saying, "The institution and the 5 service corporation engaged in a high interest 6 rate risk leveraging strategy in an attempt to 7 generate a large net interest spread between 8 long-term fixed rate assets and short-term 9 liabilities." 10 A. Okay. 11 Q. Now, can you explain that? 12 A. Basically, they went out and bought 13 long-term assets and financed them with short-term 14 liabilities and -- I'm trying to remember the -- 15 they basically leveraged a small amount of capital 16 into a large investment. They -- as I indicated, 17 they had several billions of dollars worth of 18 mortgage-backed securities of which their deposit 19 base only funded a small portion of that in the 20 overall history of their activities in that area. 21 Q. Now, you indicate that their interest 22 rate risk was partially hedged in the last 22510 1 sentence of the first paragraph. 2 Do you see that? 3 A. Yes. 4 Q. Can you explain that? 5 A. Well, they did not fully hedge their 6 activities. They -- they had established swaps at 7 one point when they were -- I guess when they 8 established a risk-controlled arbitrage, they put 9 caps on and used options and futures. But what 10 they did did not hedge the full risk or exposure 11 they had from changes in interest rates. They 12 hedged a portion of it. 13 Q. And did that change over time? 14 A. Yes, it did. The hedge, per se, grew 15 less. One of the reasons it grew less was that 16 the swaps that they had originally put on against 17 the higher rate mortgage-backed securities no 18 longer really provided any adequate protection in 19 terms of interest rate risk to the institution or 20 for those securities that they were hedging. 21 Q. Now, in the second paragraph, you 22 state, "The institution did not maintain 22511 1 documentation which would indicate the impact of 2 these investment strategies on its asset/liability 3 structure or capital position under different 4 interest rate scenarios. Furthermore, in many 5 instances, they did not analyze the impact of 6 individual transactions such as the purchase of 7 the residual interest from a multiple class 8 security (residual) or the interest only portion 9 (IO) or the stripped MBS in the MBS portfolio." 10 Do you see that? 11 A. Yes. 12 Q. Can you explain that, please? 13 A. Well, basically, they -- as we 14 discussed in the body of the report, they did more 15 than just purchase mortgage-backed securities and 16 do reverse repos. They had residuals, IOs, POs. 17 They used swaps and caps and collars. And some of 18 these were investments. Some of these were -- the 19 institution indicated that they were hedges. But 20 there really wasn't an analysis that showed how 21 these hedges were supposed to benefit them or how 22 these investments would benefit them, how it would 22512 1 impact on the institution if rates went in one 2 direction or the other. 3 That analysis, when it was not there, 4 basically -- it was -- as we discussed in the work 5 papers, they just said, "Well, this is a good 6 investment because it will benefit us," or, "This 7 is a good activity because it will benefit us in 8 this way" and then they approved it. 9 Q. Well, let me ask you a question. There 10 are in your work papers and, I suspect, in the 11 investment committee minutes, generally a number 12 of sensitivity analyses. 13 Do you recall that? 14 A. Yes, I do. 15 Q. Well, doesn't that address the problem 16 that you've described? 17 A. Well, what that is is that's basically 18 their current portfolio, what they have -- it's 19 basically the value and the change in value of 20 their current set of investments and hedges. And 21 my complaint or my problem with this was that they 22 didn't say, "Oh, we're going to buy -- we're going 22513 1 to get $100 million in POs and this is how it's 2 going to impact on our investment portfolio under 3 different interest rate scenarios. This is what's 4 going to happen to the value. If this -- this 5 security -- if rates go up 100 basis points, this 6 is what's going to happen. If rates go down, this 7 is what's going to happen to our portfolio under 8 those circumstances." 9 That's the kind of analysis that they 10 should have been doing -- should have been 11 presenting to the investment committee and the 12 investment committee should have been using in 13 making their decisions. 14 Q. Well, now, is that what you're talking 15 about when you talked about not analyzing the 16 impact of individual transactions in the second 17 sentence of the paragraph? 18 A. Yes. Not only on the impact on the 19 institution but the impact on that transaction 20 itself, like what happens to, say, residual if 21 rates go up or rates go down 100 basis points. 22 Q. Now, you then say in the next 22514 1 paragraph, "The institution also engaged in a form 2 of gains trading." 3 Do you see that? 4 A. Yes. 5 Q. What is gains trading? 6 A. Well, in the case of this institution, 7 basically it is the sale of a security to generate 8 bottom-line or accounting profits while deferring 9 losses on something compensating, such as a hedge 10 or in the case of -- in the later time period when 11 they -- their mortgage-backed securities were 12 incurring unrealized losses because of the 13 increase in rates, they didn't sell those either. 14 Basically, their transactions were, for the most 15 part, to generate income. From what I could see, 16 that's what the basis of those transactions were. 17 Q. And is the description of -- well, let 18 me ask you: Is gains trading a risky activity? 19 A. It can be. 20 Q. And why is that? 21 A. Well, you can be basically foregoing 22 future income; and you could be creating not only 22515 1 unrealized losses somewhere in your investment 2 structure but you could also be saddling yourself 3 with negative interest income or interest expense 4 which would impair your future earnings ability. 5 Q. Is that what happened at USAT? 6 A. Yes, it is. 7 Q. Now, you speak further in the paragraph 8 about when interest rates declined, the 9 institution sold higher coupon MBS and replaced 10 them with lower coupon MBS. 11 Are you referring there to the rolldown 12 that we've previously discussed? 13 A. Yes. 14 Q. You then say, "When interest rates 15 increase, the risk of these lower coupon MBS was 16 not adequately hedged." 17 Do you see that? 18 A. Yes. 19 Q. Could you explain that, please? 20 A. Well, basically, a large portion of the 21 mortgage-backed security portfolio was relatively 22 unhedged. There was some protection from changes 22516 1 in interest rates, but there wasn't as much as you 2 might think. For example, not all of the -- not 3 all of the institution's mortgage-backed 4 securities were hedged to begin with. They also 5 had swaps where the rates were so high that had 6 been put on when they had higher coupon 7 mortgage-backed securities that the only thing 8 that an increase in interest rates would do for 9 those swaps is to decrease the unrealized loss on 10 those swaps rather than increase the value on 11 those swaps to compensate for the unrealized loss 12 on the mortgage-backed securities from the 13 increase in interest rates. 14 Q. Now, let me move on to -- 15 THE COURT: Mr. Veis, we'll take a 16 short recess. 17 18 (Whereupon, a short break was taken 19 from 3:37 p.m. to 3:53 p.m.) 20 21 THE COURT: We'll be back on the 22 record. 22517 1 Mr. Veis, you may continue. 2 MR. VEIS: Thank you, Your Honor. 3 Q. (BY MR. VEIS) I would like to direct 4 your attention now back to Page 0W154317. 5 THE COURT: State the exhibit number 6 again. 7 MR. VEIS: Exhibit A14106, Your Honor. 8 Q. (BY MR. VEIS) OW154317. In the last 9 paragraph there, you indicate in the summary you 10 also noted numerous document deficiencies and lack 11 of proper monitoring and planning by the board of 12 directors. 13 What are you referring to there? 14 A. Well, as we talked about throughout 15 this report, there's indications where there were 16 either document problems or what I consider a lack 17 of documents in the monitoring of these potential 18 activities that they became involved in and the 19 planning just wasn't there. And the investment 20 committee is basically a representative of the 21 board of directors; and there's a certain 22 fiduciary responsibility that they have to make 22518 1 sure that the activities that the institution is 2 involved in -- that they understand it, that they 3 comprehend the impact of these activities, and 4 that they are acceptable to their existing 5 strategies and plans. 6 Q. Now I would like you to turn to the 7 next page, OW154318. Now in the third sentence -- 8 let me first address you to the third paragraph. 9 It starts out "the portfolio manager was 10 responsible." Look at the third sentence. 11 Do you see it refers there to policy 12 and procedural guidelines revised in August 1988? 13 A. Yes, I do. 14 Q. And it indicates that you reviewed the 15 policy and procedural guidelines, correct? 16 A. Yes. 17 Q. Now, it says, "The new guidelines 18 appear to be adequate. However, no new activity 19 was reviewed to determine compliance with these 20 policies and procedures. The new policies and 21 procedures indicated that all transactions should 22 be reviewed by the investment committee. The MBS 22519 1 portfolio manager will prepare an analysis of each 2 transaction which indicates the risk relative to 3 the portfolio, the overall asset/liability 4 structure of the institution, and USAT's capital 5 position. This analysis will estimate the change 6 in net interest income for interest rate changes 7 of plus or minus 200 basis points. The analysis 8 will also reflect the potential changes in market 9 value of the investment and the liquidity of this 10 investment." 11 Do you see that? 12 A. Yes, I do. 13 Q. I would like to direct your attention 14 to -- 15 THE COURT: Where was that that you 16 just read? 17 MR. VEIS: That was the third paragraph 18 on OW154318 starting with the fourth sentence 19 which begins "the new guidelines." 20 Q. (BY MR. VEIS) Mr. Lapidus, if I could 21 direct your attention now to Exhibit A14103 and 22 particularly to the investment policies and 22520 1 procedures for United Financial Group. They start 2 at Page OW182933. 3 And I want to ask you in particular 4 about one page of that policy and procedure. That 5 is OW182941. 6 A. Okay. 7 Q. Are you at 941? 8 A. Yes. 9 Q. Now, would you look under Section 3 to 10 Subsection A just under the middle of the page? 11 Do you see that? 12 A. Where it says "three mortgage-backed 13 securities portfolio..."? 14 Q. Right. Below that, there's a 15 Section A. 16 A. Yes, I see that. 17 Q. Could you read that paragraph, please? 18 A. "Except as provided in Subparagraph B 19 hereof, transactions will be reviewed on a 20 security-by-security basis (whether increasing or 21 decreasing exposure) by the IC," which means 22 investment committee. "The manager of the 22521 1 mortgage-backed security portfolio will provide 2 the IC an analysis of each transaction which 3 addresses the impact to interest risk of United 4 and the total MBS portfolio. The analysis will 5 include the impact to net interest income, market 6 value, and liquidity over an interest rate range 7 of plus or minus 200 basis points." 8 Q. Now, is that the work paper material 9 that supports your statements in the paragraph 10 that we've been discussing on Page OW154318? 11 A. Yes. 12 Q. Now, you indicate that those policies, 13 I believe you said, appear adequate? 14 A. Yes. 15 Q. Now, they indicate that there is to be 16 an analysis containing certain items, correct? 17 A. Yes. 18 Q. Did you find anything that indicated 19 that these sorts of analyses had been carried out 20 at USAT? 21 A. No, I didn't. 22 Q. You didn't review any new activity, 22522 1 correct? 2 A. Right. 3 Q. Now, let me ask you: Is this the type 4 of analysis that would have addressed the problems 5 or the criticisms that you were making of the 6 prior conduct of the mortgage-backed securities 7 portfolio? 8 A. It would have addressed my concerns in 9 those areas in terms of analysis and proper 10 monitoring and planning. 11 Q. And was this -- the policy of the 12 institution going forward was to do that kind of 13 analysis that's indicated in the investment 14 guidelines, correct? 15 A. Yes, it was. 16 Q. And had any analysis similar been done 17 in connection with the mortgage-backed securities 18 portfolio prior to these guidelines being adopted? 19 A. No, they were not. 20 Q. And that was the area -- one of the 21 areas that you criticized, correct? 22 A. Yes, it was. 22523 1 MR. VEIS: I have no further questions, 2 Your Honor. 3 THE COURT: Are there any other matters 4 we should consider before we adjourn? 5 MR. NICKENS: Not that we have, 6 Your Honor. 7 MR. GUIDO: No, Your Honor. 8 THE COURT: Do we have a date for the 9 February -- 10 MR. NICKENS: We did not discuss that 11 at lunch, Your Honor. We'll get that to you by 12 the end of the week. 13 THE COURT: All right. We'll adjourn 14 until 10:00 o'clock on September the 14th. 15 MS. CLARK: Your Honor, did you say the 16 14th was the date to resume? 17 THE COURT: Yes. Isn't that a Monday? 18 MS. CLARK: We understood your order to 19 have meant to extend through that Monday. I'm 20 glad you clarified it. 21 THE COURT: Okay. 22 MR. GUIDO: Thank you, Your Honor. 22524 1 (Whereupon at 4:01 p.m. 2 the proceedings were recessed.) 3 . 4 . 5 . 6 . 7 . 8 . 9 . 10 . 11 . 12 . 13 . 14 . 15 . 16 . 17 . 18 . 19 . 20 . 21 . 22 . 22525 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 2nd day of 17 September, 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 . 22526 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 2nd day of 18 September, 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