22743 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 16, 1998 22 22744 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 22745 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 22746 1 2 INDEX OF PROCEEDINGS 3 Page 4 LEONARD LAPIDUS 5 Further Examination by Mr. Veis.........22748 6 Further Examination by Mr. Nickens......22770 7 Further Examination by Mr. Veis.........22788 8 Further Examination by Mr. Nickens......22790 9 MR. GRAEF CRYSTAL 10 Examination by Mr. Schwartz.............22793 11 Examination by Mr. Blankenstein.........22955 12 13 14 15 16 17 18 19 20 21 22 22747 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. GUIDO: Your Honor, I have a 6 preliminary matter. 7 THE COURT: Mr. Guido. 8 MR. GUIDO: Yesterday when we were 9 addressing the question of scheduling, I said that 10 Mr. Veis would be finished within a half an hour 11 to an hour. That is correct. I also added that 12 Mr. Crystal, the next witness, would be finished 13 at the first break. That turned out to be 14 incorrect, Your Honor. 15 What I've been told is that he has 16 scheduled himself so that he is available today 17 and tomorrow. Counsel will try and finish him as 18 quickly as possible, but we have made sure that 19 they had set aside time so that the respondents 20 have adequate amount of time to cross-examine him. 21 It's also my understanding that 22 Mr. Twomey will be here available to start as 22748 1 early as tomorrow. So, the abbreviated schedule 2 is going to be maintained. But I did misspeak 3 yesterday when I said that Mr. Crystal would be 4 finished at the first break yesterday. Counsel 5 for respondents indicated how unrealistic that was 6 to me, and I'm sorry I misspoke. 7 THE COURT: Mr. Veis. 8 MR. VEIS: Thank you, Your Honor. 9 10 FURTHER EXAMINATION 11 12 Q. (BY MR. VEIS) I would like to first 13 direct your attention to Exhibit B823, which is at 14 Tab 234. 15 Do you have that in front of you, sir? 16 A. Yes, I do. 17 Q. Now, Mr. Nickens asked you some 18 questions about that exhibit yesterday. 19 Do you recall that? 20 A. Yes. 21 Q. Now, do you have any basis to know 22 whether any statement in that article -- I'm 22749 1 sorry. 2 Do you have any basis to know whether 3 any statement in Exhibit B823 is true or false? 4 A. No, I don't. 5 Q. Let me now ask you -- I understand 6 we've had some difficulty locating the original 7 exhibit; but I want to ask you about Exhibit B4294 8 which, as you recall, was a packet of documents 9 from the FDIC with a cover letter from Eileen 10 Avila. 11 Do you recall that exhibit, sir? 12 A. Yes, I do. 13 Q. Now, Mr. Nickens showed you a letter 14 and a checklist or -- I'm sorry -- an index on 15 which you had checked off certain documents. 16 Do you recall that? 17 A. Yes, I recall. 18 Q. Would you please explain how this came 19 about? Now, I believe you testified that 20 Ms. Avila sent you the index; is that correct? 21 A. Yes, she did. 22 Q. Then you checked off documents. 22750 1 What were those documents? 2 A. I went through the index; and I checked 3 off with either a "yes," "no," or question mark 4 those documents that I thought might be of 5 interest or of help to me in further discussing 6 these issues with them. 7 Q. Now, did you subsequently receive the 8 documents that you checked off? 9 A. Yes, I did. 10 Q. And what did you do with them? 11 A. I put them in a box at my house. 12 Q. Did you look at any of those documents 13 after you received them? 14 A. No, I did not. 15 Q. Why not? 16 A. They didn't contact me about any more. 17 And until they contacted me, there was no reason 18 for me to look at them; so, I just put it away. 19 Q. Now, do you recall Ms. Avila's cover 20 letter dated January 7th, 1992, which is the first 21 page of Exhibit 1494? It refers -- she uses the 22 phrase "recreating" your work papers. 22751 1 Do you recall that? 2 A. Yes. 3 Q. Did you recreate any work papers? 4 A. No. 5 Q. Let me direct your attention -- and I 6 don't believe we have to pull these out. But if 7 you recall Exhibits A14101, 14102, 14103, and 104 8 and 105 were documents that you identified as your 9 work papers from the 1988 examination. 10 Do you recall that? 11 A. Yes, I do. 12 Q. Now, let me ask you: Are they copies 13 of your original work papers? 14 A. Yes, they are. 15 Q. And how do you know that? 16 A. When I went to Washington, D.C. and 17 here, I saw the original work papers; and those 18 were the original documents. They were documents 19 in my handwriting. They were documents that I had 20 copied. They were documents that my assistants 21 had done. They were basically the work papers. 22 The only thing that was missing were the piece of 22752 1 documents that Mr. Nickens gave us at the 2 deposition, and those have the same -- tie into 3 the numbers sequentially. As far as I know, they 4 are copies of the originals. I don't know what 5 happened to those work papers. 6 Q. Let me now ask you to look at 7 Exhibit B4193. It's Tab 1180. 8 9 (Discussion held off the record.) 10 11 A. I don't think I have that. 12 Q. (BY MR. VEIS) Let me -- I want to 13 address briefly the subject of gains trading. 14 Do you recall Mr. Nickens asked you a 15 number of questions about gains trading? 16 A. Yes, he did. 17 Q. First, before we get to the document. 18 I have a couple of questions about what you were 19 told during the examination. 20 Were you told that USAT was not 21 recognizing gains on sales of mortgage-backed 22 securities through June of 1986? 22753 1 A. No, I was not. 2 Q. Were you told that USAT did not need to 3 recognize income in the first quarter of 1986 4 because USAT had already met its income target for 5 that quarter? 6 A. No, I did not -- was not. 7 Q. Were you told that USAT was reducing 8 the basis on the mortgage-backed securities that 9 USAT purchased so that when they could take gains, 10 they would be larger? 11 A. No, I was not. 12 Q. Now, let me ask you to take a look at 13 Exhibit B4193 and, particularly, the page that's 14 been marked CN101330. That is -- that is the 15 eighth page; and it has a heading, "Trading in the 16 Investment Portfolio." 17 Are you there? 18 A. Yes. 19 Q. Now, Mr. Nickens asked you some 20 questions about this. 21 Do you recall that? 22 A. Yes, he did. 22754 1 Q. And he asked you in particular about 2 the definitional section under "A, Gains Trading" 3 on that page? 4 A. Yes. 5 Q. And he asked you about the first part 6 essentially which deals with the purchase and sale 7 within a few days or weeks. 8 Do you recall that discussion? 9 A. Yes. 10 Q. There were some things he didn't ask 11 you in that paragraph, weren't there? 12 A. The second half of it, I think. 13 Q. Let's look at the second half. I would 14 like to know if that is an important part of the 15 definition of gains trading. After this 16 discussion of sales in the third paragraph, it 17 says, "These securities initially -- those 18 securities initially purchased with the intent to 19 resell are retained as investment portfolio assets 20 if they cannot be sold at a profit. These losers 21 are retained in the investment portfolio because 22 investment portfolio holdings are accounted for at 22755 1 cost and losses are not recognized unless the 2 security is sold. Gains trading often results in 3 a portfolio of securities with extended 4 maturities, lower credit quality, high market 5 depreciation, and limited practice liquidity." 6 Do you see those sentences? 7 A. Yes. 8 Q. Is that part of your understanding of 9 what gains trading is? 10 A. Yes, it is. 11 Q. Is that in any way descriptive of the 12 activities of United Savings Association? 13 A. It's basically what they ended up with 14 after rates went up. 15 Q. Let's now turn to Exhibit B1619. 16 That's at Tab 237. 17 Do you recall yesterday Mr. Nickens 18 asked you a series of questions about 19 Exhibit B1619? 20 A. Yes, he did. 21 Q. And that was a Federal Home Loan Bank 22 Board research working paper by a gentleman 22756 1 named -- I believe it's Mr. Hjerpe, H-J-E-R-P-E? 2 A. Yeah. 3 Q. Mr. Nickens, I believe, asked you 4 questions about the appropriateness of 5 risk-controlled arbitrage. 6 Do you recall that? 7 A. Yes, I do. 8 Q. Let me ask you to look at the first 9 page after the cover. In particular, the third 10 paragraph. 11 Do you see a discussion there of 12 implementation or risk-related implementation of a 13 risk-controlled arbitrage? 14 A. (Witness reviews the document.) Yes. 15 Q. What does that sentence say? 16 A. It says, "The biggest risk that FSLIC 17 bears when a FSLIC-insured institution 18 participates in such a strategy is that imprudent 19 implementation may occur and may result in 20 magnified losses due to the highly leveraged 21 nature of the program." 22 Q. Now, let me direct your attention to 22757 1 Exhibit B4287, which is Tab 1850. 2 A. Okay. 3 Q. Now, do you recall that you identified 4 this as a part of the September 1988 Federal Home 5 Loan Bank System Regulatory Handbook on thrift 6 activities? 7 A. Yes. 8 Q. So, this was an official publication of 9 the bank system, correct? 10 A. Yes, it was. 11 Q. Now, I would like to direct your 12 attention to some portions of this Mr. Nickens 13 discussed with you. 14 Does Exhibit B4287 discuss the risks 15 associated with risk-controlled arbitrage? 16 A. Yes, it does. It's -- "The Risk" is a 17 title started on 450.1, and it goes down that 18 page. And then "implementation risk" starts at 19 the bottom of 450.2 and runs basically through 20 half of 450.3. 21 Q. Let me ask you about implementation 22 risk. That is the subject we were just 22758 1 discussing, I believe, Mr. Hjerpe's memo, 2 Exhibit B1619; is that correct? 3 A. Yes. 4 Q. I would like to direct your attention 5 to Page 450.3. Is there a section of the 6 implementation risk discussion that is titled 7 "Allure of Gambling"? 8 A. Yes, there is. 9 Q. Can you explain what that section -- 10 what bearing that section has on implementation 11 risk? 12 A. Basically, it says that some 13 institutions, instead of using a risk-controlled 14 arbitrage strategy, may use that as a mechanism to 15 guess which way rates are going to go and 16 basically gamble in an attempt to generate 17 profits, which is not really the reason for a 18 risk-controlled arbitrage. 19 Q. Is there a section that relates to 20 trading? 21 A. Yes. That's the next one down. 22 Q. How does that relate to implementation 22759 1 risk? 2 A. Well, basically, if the institution is 3 going to buy and sell securities on a regular 4 basis, they are basically speculating on the 5 short-term and they are impairing the long-term 6 viability of the risk-controlled arbitrage. 7 Q. Is there a section on mismatched 8 hedging? 9 A. Yes. 10 Q. And how does that relate to 11 implementation risk? 12 A. Well, basically, this is a discussion 13 of -- that a risk-controlled arbitrage -- the 14 control part of the risk is the hedging. And if 15 you have mismatched hedges or unhedged portions of 16 it, it's going to create additional risk or it's 17 going to remove it from what would normally be a 18 risk-controlled activity. 19 Q. Now, do you know whether there's any 20 discussion here of -- strike that. 21 Let me direct your attention to 22 Page 450.7. Do you see a section there headed 22760 1 "Accounting Gains and Losses Versus the Economics 2 of the Transaction" in the second column? 3 A. Yes. 4 Q. Would you please take a look at the 5 first paragraph of that section? 6 A. Okay. 7 Q. Now, does the discussion in the first 8 paragraph relate in any way to your understanding 9 of the concept of gains trading? 10 A. Yes. 11 Q. Could you explain how? 12 A. It talks about how the accounting for 13 gains and losses can diverge from the economics of 14 the transaction. It says, "This divergence could 15 result in an institution using uneconomic gains to 16 increase regulatory capital, and thus further 17 leverage the RCA. All gains recorded or losses 18 deferred..." 19 Q. Now, let's take a look at the second 20 paragraph, please. 21 Do you see an example there? 22 A. Yes. 22761 1 Q. Does the example set forth in that 2 paragraph describe a form of gains trading? 3 A. Yes, it does. Basically, the -- it 4 says in a decreasing interest rate environment, 5 they would sell the mortgage-backed securities and 6 book the profits and then they would defer the 7 losses from the futures positions over the 8 extended life of the liability, the 9 synthetically-extended life of the liability. 10 Q. Synthetically-extended life, is that a 11 discussion of hedging? 12 A. Yes. Basically, the concept is that 13 through hedging, you could take the short-term 14 liability and make it become a longer-term 15 liability. 16 Q. So, it's talking about deferring the 17 losses on the hedging instruments? 18 MR. NICKENS: Your Honor, I object to 19 this continuing leading. I mean, this is just 20 Mr. Veis testifying. 21 THE COURT: All right. Can you state 22 your questions in a non-leading manner? 22762 1 Q. (BY MR. VEIS) Is the example set 2 forth in the second paragraph in any way analogous 3 to the activities that were conducted at United 4 Savings Association of Texas? 5 A. It's almost identical. The institution 6 basically sold off their assets and generated the 7 profits. And while they did not have futures 8 contracts, what they did with the swaps is -- it 9 was basically in the same thing. They had 10 increased interest rate expenses because of the 11 swaps because of the decrease in interest rates, 12 and those basically were increasing the cost of 13 the liabilities and resulting in a negative spread 14 which is essentially the same thing. They took 15 the profits and income, and they deferred the 16 losses over the remaining life of the swaps. 17 Q. Do you recall that Mr. Nickens asked 18 you yesterday whether you would hold USAT to any 19 higher standard than you would hold yourself with 20 respect to documentation? 21 A. Yes. 22 Q. I would like to try to clarify just 22763 1 what those standards are, if I might. 2 What are your responsibilities as an 3 examiner with respect to documentation of your 4 conclusions? 5 A. Well, I need to -- of course, any work 6 papers I did would be put in through the work 7 papers. Any documents of the institution that I 8 thought were applicable to my review would go into 9 the work papers. And, of course, any comments 10 that I had in the report would need to be 11 supported by the work papers that I have in some 12 fashion. 13 Q. Well, do you recall that Mr. Nickens 14 asked you a number of questions relating to 15 documents that weren't included in your work 16 papers? 17 A. Yes, he did. 18 Q. Now, can you tell the Court why those 19 documents were not included in your work papers? 20 A. I didn't think they were germane to my 21 review. I didn't include them because they -- I 22 did not think they were -- they applied to what I 22764 1 did. 2 Q. Were they necessary to document your 3 conclusions? 4 A. No, they were not. 5 Q. Did you fulfill your responsibilities 6 with respect to the documentation of your 7 conclusions? 8 A. Yes, I did. 9 Q. Now, let's take a look at the 10 institution's responsibilities. 11 Would you please turn to 12 Exhibit A14106, which is at Tab 1847. 13 Before we look at that, I do have one 14 more question regarding a previous subject. You 15 stated you fulfilled your responsibilities to 16 document your conclusions. 17 Could you just tell the Court just 18 exactly what was your assignment when you came to 19 USAT? 20 A. Well, as I think I indicated before, my 21 assignment was basically to review the 22 mortgage-backed securities activity and 22765 1 corresponding hedging that went with it, determine 2 what exactly had happened, and, to the best of my 3 ability, who was responsible for what had 4 happened. 5 Q. And did you do that? 6 A. Yes. To the best of my ability, yes. 7 Q. And is that the subject matter on which 8 you wrote your conclusions in your report? 9 A. Yes, it is. 10 Q. Now, let's turn to A14106. I would 11 like to particularly look at Page OW154318. Do 12 you see the last two paragraphs on that page, the 13 one that starts out "The portfolio manager was 14 responsible"? 15 A. Yes. 16 Q. Now, does that contain a discussion of 17 the August 1988 investment policy? 18 A. Yes. 19 Q. And does that set forth the 20 responsibilities of the institution with respect 21 to the MBS investment portfolio? 22 A. Yes, it does. 22766 1 Q. Now, what was required by that policy? 2 A. Let's see. It says, "The new policies 3 and procedures indicated that all transactions 4 should be reviewed by the investment committee. 5 The MBS portfolio manager will prepare an analysis 6 of each transaction which indicates the risk 7 relative to the portfolio, the overall 8 asset/liability structure of the institution, and 9 USAT's capital position. This analysis will 10 estimate the change in net interest income for 11 interest rate changes of plus or minus 200 basis 12 points. The analysis will also reflect the 13 potential changes in market value of the 14 investment and the liquidity of this investment." 15 Q. And what is your current opinion 16 regarding the adequacy of that policy as of 17 August 1988? 18 A. I indicated that the new guidelines 19 appear to be adequate. 20 Q. Now, were there any different standards 21 applicable to USAT prior to August of 1988? 22 A. No. They should have followed the same 22767 1 standards prior to that point. 2 Q. Did they? 3 A. My review indicated that they did not. 4 Q. And what in particular did your review 5 indicate? 6 A. Well, while they did do some analysis, 7 as I indicated in my report and I believe in my 8 testimony, they did not prepare an analysis of the 9 risks relative to the portfolio and the overall 10 asset/liability structure and the capital 11 position. And they did not reflect the potential 12 changes in market value of the investment and, I 13 believe in some cases, liquidity of the 14 investment. 15 Q. Then did USAT's management fulfill its 16 responsibilities with respect to documentation and 17 analysis of mortgage-backed securities 18 transactions prior to August 1988? 19 A. No, they did not. 20 Q. Let's turn now to Exhibit A14105, 21 Tab 1846. Let me direct your attention in 22 particular to three items that Mr. Nickens asked 22768 1 you about yesterday. 2 Do you recall he asked you some 3 questions about the memoranda written by Dominic 4 Bruno? 5 A. Yes, he did. 6 Q. Let me direct your attention to 7 OW182275, OW182335, and OW182340. 8 Now, have you had an opportunity to 9 review these three memoranda? 10 A. Yes. I read through the three 11 memorandums last night. 12 Q. Now, do you recall Mr. Nickens asked 13 you some questions about the gist of the 14 memoranda? 15 A. Yes, he did. 16 Q. Can you tell the Court what the gist of 17 those memoranda is? 18 A. Well, after reviewing it last night, I 19 basically arrived at a conclusion that he 20 basically was trying to make two points. The 21 first point is that the institution had swung so 22 far on the pendulum that instead of being risk 22769 1 takers, that they were very risk averse and, as 2 such, were unwilling to take any risk and were 3 subjecting themselves to potentially harming their 4 interest income, their ability to generate 5 interest income from this portfolio. 6 The other thing I noted was he was 7 basically preaching moderation, that he was saying 8 that by being so risk averse, they were -- they 9 were becoming blind to the fact that they needed 10 to generate some income, whether it was to taking 11 some moderate risk with investments or in the 12 sales of the investments to not sell them off all 13 at once and use -- he used a term, if I could find 14 it. I don't see it right now. 15 He was basically saying that by selling 16 off huge blocks of securities at that time, that 17 they were taking a risk; that it would be 18 discounted by the market because the market would 19 basically feel that they could get more money from 20 them since they were selling off large portions at 21 a time. 22 Q. Are you referring to the term "fire 22770 1 sale"? 2 A. That's one way of putting it. I don't 3 know if that was the words he used. I know it's 4 in here somewhere. 5 Q. Was Mr. Bruno counseling USAT's 6 management that they should engage in high risk 7 investment activities? 8 A. No, he was not. 9 MR. VEIS: No further questions, 10 Your Honor. 11 THE COURT: Is there any recross? 12 MR. NICKENS: Yes, Your Honor, there 13 is. 14 15 FURTHER EXAMINATION 16 17 Q. (BY MR. NICKENS) Mr. Lapidus, 18 starting where Mr. Veis ended about Mr. Bruno, the 19 so-called references to a fire sale were to those 20 sales made in October of 1988 and those that were 21 contemplated in preparation for the restructuring 22 of USAT, were they not? 22771 1 A. I don't know. I assume they were. 2 Q. And those in October of 1988, were 3 those ordered by either Mr. Connell or the Federal 4 Home Loan Bank? 5 A. I don't know that. 6 Q. Have you read Mr. Bruno's testimony 7 concerning who was responsible for those orders 8 and the -- those sales? 9 A. No, I did not. 10 Q. So, you wouldn't be saying that it was 11 the management of USAT that was responsible for 12 this fire sale possibility? 13 A. I'm not sure what your question is. 14 Q. Well, you don't know who was 15 responsible, do you? 16 A. No. 17 Q. Okay. And -- now, let me ask you some 18 questions about Mr. Bruno's recommendation. He 19 was basically arguing that they should buy some 20 more adjustable rate mortgages, correct? 21 A. I believe that was part of one of his 22 arguments. 22772 1 Q. In fact, they did buy, pursuant to his 2 suggestion, a substantial number of adjustable 3 rate mortgages, did they not? 4 A. I don't know. 5 Q. You haven't looked at that? 6 A. No. 7 Q. So, you don't know whether his 8 suggestions were followed? 9 A. No, I don't. 10 Q. And do you know what their prior 11 experience with adjustable rate mortgages had 12 been? 13 A. No. 14 Q. Did they have good reason to be risk 15 averse to mortgage-backed securities, given their 16 prior experience? 17 A. I think they had some reasons. 18 Q. I believe you testified yesterday that 19 their experience was very much like the experience 20 of many other thrifts in the United States during 21 that period, correct? 22 A. I don't know that I testified that. 22773 1 Q. Well, I asked you questions about 2 whether other thrifts had similar experiences with 3 regard to the management of mortgage-backed 4 securities during that time frame. Right? 5 A. Yes, there were other thrifts that had 6 problems with -- I don't know if it was the volume 7 or extent, but yes. 8 Q. Now, Mr. Veis asked you some questions 9 about the policy guidelines. 10 You don't know what policy guidelines 11 were in place prior to August 1988, correct? 12 A. No, I don't. 13 Q. And you haven't audited them to 14 determine whether they complied with the 15 guidelines that were in effect? 16 A. No, I don't know that. 17 Q. And so, you don't know whether or not 18 these particular policies were followed or not, do 19 you? 20 A. No, I don't. 21 Q. Now, Mr. Veis asked you some questions 22 about the article put out by the Federal Home Loan 22774 1 Bank in their regulatory handbook. 2 Do you recall that? 3 A. The risk-controlled arbitrage one or 4 something else? 5 Q. Yes, the risk-controlled arbitrage one. 6 A. Okay. Yes. 7 Q. And that's the regulatory handbook that 8 you did not follow in this examination, correct? 9 A. No, I did not. 10 Q. And, in fact, the paragraph that he 11 referenced you to was that supervisory personnel 12 should be alert for the potential differences 13 between the accounting for gains and losses under 14 GAAP and the actual economic gains or losses in an 15 RCA. Right? 16 A. Yes. 17 Q. Now, that supervisory personnel would 18 be supervisory personnel of the Federal Home Loan 19 Bank? 20 A. Basically. 21 Q. And the Federal Home Loan Bank 22 conducted examinations of USAT in 1986 and 1987? 22775 1 A. I guess so. You've told me that. 2 Q. Okay. Well, it's referenced in your 3 comment, isn't it? If you look at the bottom of 4 Page OW154324, there's a reference to the 1987 5 exam. 6 A. That's -- I'm sorry. I need to find my 7 comment, I guess. 8 Q. It's 14106. 9 A. Okay. 10 Q. Do you see at the bottom of 11 Page OW154324, you reference the 1987 examination? 12 A. Actually, the assistant who wrote this 13 referenced it; but, yes, it references a 14 November 16, 1987 examination. 15 Q. Now, the regulatory handbook -- there 16 were two examinations conducted by others prior to 17 yours that you did not look at, correct? 18 A. No, I did not. 19 Q. And the handbook instructed them to 20 examine closely for these kinds of problems, 21 correct? 22 Well, let me ask you this question: Do 22776 1 you know if they followed the instructions of the 2 handbook in conducting their examinations? 3 A. I don't know. 4 Q. And do you know what, if any, problems 5 they reported? 6 A. No, I don't. 7 Q. Because you were instructed not to look 8 at those examinations. Right? 9 A. Yes. 10 Q. Now, with regard to this specific 11 question in response to questions from Mr. Veis, 12 you reported on futures contracts in the second 13 paragraph on Page 450.7 of Exhibit -- I don't have 14 the number, but it's the Section 450 from the 15 handbook. 16 A. It's Exhibit B4287, according to the 17 top page. 18 MR. VILLA: Tab 1850. 19 Q. (BY MR. NICKENS) Okay. Now, that 20 paragraph is referring to the use of futures 21 contracts. Right? 22 A. Yes, as an example. 22777 1 Q. And you specifically looked at USAT's 2 use of futures contracts in its risk-controlled 3 arbitrage, didn't you? 4 A. It was reviewed, yes. 5 Q. And, in fact, in this very section of 6 your report, it's called "Futures and Options"? 7 A. Yes. 8 Q. And you found that the transactions 9 were found to be adequately structured, closely 10 monitored, and eligible for hedge accounting 11 treatment under the Statement of Financial 12 Accounting Standards No. 80. 13 That was your finding. Right? 14 A. For the nine months ended September 30, 15 1988. 16 Q. And you referenced some prior 17 transactions that had been reviewed in the 1987 18 examination. Right? 19 A. It's referenced in the report, yes. 20 Q. So, you didn't even look at that prior 21 activity, did you? 22 A. No, I didn't. 22778 1 Q. You relied on what had been done in the 2 1987 examination for that small part of it? 3 A. Actually, it was an assistant who did 4 this review; and they relied on it. 5 Q. As far as this comment is concerned 6 with the use of futures contracts, you didn't find 7 anything wrong with what USAT had done? 8 A. In the review, no. 9 Q. So, now, let's go back -- you were 10 asked some questions about, quote, "gains 11 trading." 12 Your comment concerning gains trading 13 related solely to the rolldown, didn't they? 14 A. Yes. 15 Q. And we have established that at least 16 through July, there was no intent to take any 17 gains, correct? 18 A. That's the statement that you made. 19 Q. Well -- and you didn't review it to 20 determine anything differently, did you? 21 A. No, I didn't do that; so, no. 22 Q. Right. Now -- and your comment with 22779 1 regard to gains trading was totally related to the 2 rolldown? 3 A. Yes. 4 Q. Nothing else? 5 A. Well, it said that we related to higher 6 coupon rate and replaced with lower coupon rates. 7 And I believe that some of the swaps actually went 8 from -- on occasion went from higher to lower. 9 But most of them were at the same rate. But, 10 basically, it would have been the rolldown. 11 Q. Now, let me ask you to look at 12 Exhibit B4193, which is the -- at Tab 1180, the 13 C&L Banking Advisory that Mr. Veis referred to. 14 A. Okay. 15 Q. Do you see -- first of all, it says, 16 "The securities initially purchased with the 17 intent to resell." I'm referring to 18 Page No. CN101330, the same portions quoted by 19 Mr. Veis. 20 A. Okay. 21 Q. So, you, first of all, have to have an 22 intent when you purchase to resell them, correct? 22780 1 A. Yes. 2 Q. Now, let's look at what the portfolio 3 looked like. These losers are retained in the 4 investment portfolio. 5 Now, with regard to the mortgage-backed 6 securities in 1986, did USAT have losers in their 7 portfolio? 8 A. No. The rates were still going down; 9 so, they were still gaining. 10 Q. The mortgage-backs were all at a 11 positive market value over their book value, 12 correct? 13 A. Yes. 14 Q. Now, what you're referring to are the 15 swaps, correct? 16 A. No, because the securities that were 17 purchased during the rolldowns became the 18 securities that were swapped; and they eventually 19 all became what they had at that point. This is 20 something that happened over time. 21 Q. In 1986, they were all at a positive 22 market value? 22781 1 A. Yeah. In 1986, they were still rolling 2 down or trading. 3 Q. So, there weren't any losers retained 4 in the mortgage-backed securities portfolio? 5 A. Not at that point. 6 Q. Now, you say here -- or it is printed 7 here that you read that it results in a portfolio 8 of securities with extended maturities? 9 A. Right. 10 Q. That did not characterize USAT's 11 portfolio, did it? 12 A. They had long-term mortgage-backed 13 securities. 14 Q. That was just exactly like they were 15 when they began. Right? 16 A. I'm sorry. I don't get your point. 17 Q. The point is -- 18 A. They are long-term securities. 19 Q. Yes, sir. 20 From the beginning and to the end, when 21 they were purchased and when they were held? 22 A. Supposedly when they were purchased, 22782 1 they were part of a risk-controlled arbitrage. 2 Q. Yes, sir. But I'm talking about 3 whether you can say they had extended maturities. 4 A. I -- I don't think -- I think we're 5 coming up with a different interpretation. My 6 interpretation of saying with extended maturities 7 means basically long-term maturities or, in this 8 case, the -- 9 Q. The mortgage-backs' maturities had not 10 changed from the time they were purchased, had 11 they? 12 A. Actually, the original maturities 13 hadn't changed; but since rates went up, the 14 prepayments had slowed. And, essentially, the 15 estimated life of those securities would increase. 16 Q. Now, that's not maturity, correct? 17 A. Well, it depends on what the definition 18 is. 19 Q. Well, of course. Everything depends on 20 the definition. 21 But are you telling us that average 22 life is maturity? 22783 1 A. Average life is an estimate of the -- 2 of when the security will be repaid or -- 3 Q. How much had the average life of the 4 mortgage-backed securities extended, if at all, in 5 1986? 6 A. Well, I don't think they did extend in 7 1986. They would have been -- actually, the 8 weighted average life would be decreasing because 9 prepayments would have been up because rates were 10 going down. 11 Q. In 1987, interest rates went up in, 12 what, late March? 13 A. I don't remember the exact time, but -- 14 Q. After that point, you would expect that 15 the average lives of the mortgage-backs would have 16 extended somewhat? 17 A. Yes. 18 Q. How much? 19 A. I can't say for sure. You're asking me 20 to make a calculation -- 21 Q. It's not something you looked at at the 22 time, is it? 22784 1 A. No. 2 Q. And it's not something you know today? 3 A. No. 4 Q. Then why -- but yet, you're telling the 5 Court that this -- having not done the work and 6 not knowing the answer, you've told the Court that 7 this characterized the portfolio at USAT. 8 Is that what you've done? 9 A. It did. 10 Q. Now, let's look at the next item. You 11 say lower credit quality. 12 A. I did not say that. It says that. It 13 says that the credit quality was lower. 14 Q. Didn't you tell the Court in your 15 redirect 30 minutes ago that this described the 16 portfolio at United Savings, this very sentence? 17 A. I don't know if I said the entire 18 sentence applied to it. I would not say that the 19 credit quality on a mortgage-backed security would 20 change for Ginnie Mae and Fannie Mae, basically 21 government agency securities. 22 Q. The credit quality didn't change at 22785 1 all, did it? 2 A. It wouldn't. 3 Q. Third item, "High Market Depreciation." 4 We're talking about a loss of market value? 5 A. Yes. 6 Q. And we discussed yesterday how much as 7 a percentage the market value of the MBS had 8 decreased. 9 Do you recall that? 10 A. Yes. 11 Q. It was about 6 percent? 12 A. Yes. 13 Q. And you said that that was moderate to 14 high? 15 A. Yes. 16 Q. And limited practical liquidity. 17 Mortgage-backed securities didn't have any 18 liquidity issues, did they? 19 A. Well, there is limited practical -- 20 Q. Did they have any liquidity issues? 21 MR. VEIS: Your Honor, I object to 22 Mr. Nickens interrupting the answer. 22786 1 MR. NICKENS: Your Honor, I don't 2 believe he was answering the question. That's why 3 I interrupted. 4 THE COURT: All right. Let's have the 5 answer. 6 A. The term "limited practical liquidity" 7 means whether or not it's viable for the 8 institution to sell those securities. The 9 institution would have taken losses by selling 10 those securities; hence, there was limited 11 practical liquidity. Essentially, they were not 12 liquid because they would be unwilling to sell 13 them because they would be unwilling to take the 14 losses. 15 Q. (BY MR. NICKENS) In 1987 and 1988, 16 there were no liquidity issues with 17 mortgage-backed securities, were there? 18 A. I'm not sure of your question. 19 Q. Well, you could always find a buyer for 20 securities guaranteed by the Government, 21 Fannie Mae, Freddie Mac, and Ginnie Mae 22 securities, correct? 22787 1 A. Yes, that's true, for the right price. 2 Q. It was a very liquid market? 3 A. Yes. 4 Q. What you're saying is they would have 5 had to sell them at a loss? 6 A. Yes. 7 Q. And that would have been true of 8 anybody who had bought mortgage-backed securities 9 and then interest rates had gone up? 10 A. Yes. 11 Q. And the extent of that lowered market 12 value was something on the order of 6 percent. 13 Right? 14 A. That's what you said, yes. 15 Q. Well, we went through the calculation 16 yesterday based upon your numbers. Right? 17 A. I think so. I don't remember the exact 18 numbers. 19 Q. And the fact of the matter is the term 20 "gains trading," which we discussed yesterday, was 21 a term that you don't even know you used. Right? 22 A. It was in my final comment. I know we 22788 1 discussed as to when it was placed there. 2 Q. Or whether or not you put it there or 3 you were told to put it there, correct? 4 A. Yes. 5 MR. NICKENS: That's all I have. 6 MR. VEIS: Your Honor, just a couple of 7 questions. 8 9 FURTHER EXAMINATION 10 11 Q. (BY MR. VEIS) Mr. Lapidus, 12 Mr. Nickens just directed your attention to the 13 losses on the mortgage-backed security portfolio. 14 I believe that he indicated and you 15 agreed that the losses were somewhere in the 16 neighborhood of 6 percent of the entire portfolio? 17 A. Yes. 18 Q. Do you recall that? I don't want to -- 19 MR. NICKENS: Your Honor, my objection 20 is they were unrealized losses, not all losses or 21 recognized losses. 22 MR. VEIS: I'm certainly happy to make 22789 1 that correction. Thank you, Mr. Nickens. 2 Q. (BY MR. VEIS) He indicated that that 3 was some 6 percent; is that correct? 4 A. Yes. 5 Q. That is 6 percent of the portfolio? Is 6 that what he was comparing it to? 7 A. Yes. 8 Q. How much money, if you recall, was 9 that? 10 A. Well, I don't remember the exact amount 11 that was actually the mortgage-backed securities 12 and which was actually the hedging; but the total 13 was about 200 million. 14 Q. Let me direct your attention to 15 Exhibit A14106 and particularly Page OW154317. I 16 believe this is the -- do you see a reference to 17 $213.7 million? 18 A. Yes. 19 Q. Now, when discussing the significance 20 of a loss of $213 million in mortgage-backed 21 securities and unrealized losses of $213.7 million 22 in a mortgage-backed securities portfolio, is the 22790 1 comparison to the portfolio size an informative 2 comparison? 3 A. I'm not sure I understand the question. 4 Q. Well, does that tell you what you 5 really want to know about the condition of the 6 institution? 7 A. In part. But you would also need to 8 know what the institution's level of capital was, 9 how much they had in terms of dollars for capital, 10 how close they were to the minimum capital 11 requirements, and how these -- these unrealized 12 losses would impact on capital if they were 13 realized. 14 MR. VEIS: No further questions, 15 Your Honor. 16 MR. NICKENS: Just a few, Your Honor. 17 18 FURTHER EXAMINATION 19 20 Q. (BY MR. NICKENS) Yesterday you said 21 you had not criticized the structure of the 22 risk-controlled arbitrage programs at USAT. 22791 1 Right? 2 A. You mean how they were set up 3 originally? 4 Q. Yes, sir. 5 A. No, I did not. 6 Q. And that would have included whether or 7 not there was sufficient capital for them to enter 8 into those programs? 9 A. I didn't look at it. 10 MR. NICKENS: Thank you, Your Honor. 11 MR. VEIS: No questions, Your Honor. 12 THE COURT: All right. Thank you, 13 Mr. Lapidus. You may step down. 14 MR. GUIDO: Your Honor, I have to go 15 get the next witness and the lawyer. I thought 16 they would be here by now. 17 Could we please take a short break? 18 THE COURT: All right. We'll take a 19 short recess. 20 21 (Whereupon, a short break was taken 22 from 9:53 a.m. to 10:12 a.m.) 22792 1 THE COURT: Be seated, please. We'll 2 be back on the record. 3 Mr. Schwartz. 4 MR. SCHWARTZ: Good morning, 5 Your Honor. The Office of Thrift Supervision 6 calls Mr. Graef Crystal. 7 THE COURT: Would you take the oath, 8 please? 9 10 11 12 13 14 15 16 17 18 19 20 21 22 22793 1 MR. GRAEF CRYSTAL, 2 was called as a witness and, having been first 3 duly sworn, testified as follows: 4 5 THE COURT: Be seated, please. 6 7 EXAMINATION 8 9 Q. (BY MR. SCHWARTZ) Good morning. 10 A. Good morning. 11 Q. Would you please state your name. 12 A. My first name is Graef. I think you 13 already spelled it. Last name is Crystal. I'm 14 almost universally known by the nickname of Bud, 15 for almost obvious reasons. 16 Q. What business are you in, sir? 17 A. In the field of executive compensation. 18 Q. Do you have a particular business that 19 you are engaged in on a regular basis? 20 A. The most important piece I do is edit a 21 newsletter which is called "The Crystal Report on 22 Compensation." 22794 1 Q. How long have you been doing that? 2 A. For about nine years now. 3 Q. What exactly is the Crystal report? 4 A. It's a report that is published 5 generally around 10, 12 times a year but now is 6 going almost totally on the Internet. It deals 7 with issues of executive compensation. It 8 includes praiseworthy articles where I think 9 praise is deserved. It includes a lot of 10 criticism of certain CEOs who I don't think play 11 the game fairly. It includes a lot of data, 12 software, mathematical models, things of interest 13 to people in the field of executive compensation 14 which would include as subscribers major 15 companies, accounting firms, law firms, some 16 institutions of that sort. 17 Q. Have you come to this hearing, 18 Mr. Crystal, prepared to state your opinion as an 19 expert in compensation, programs and practices, 20 executive pay and pay competitiveness in the field 21 of compensation analysis? 22 A. Yes, I have. 22795 1 Q. Before we get to your opinions, 2 Mr. Crystal, I would like you to give us some 3 information about your qualifications to give that 4 opinion. Let's start with your education. 5 Where did you go to college? 6 A. I graduated in 1956 from the University 7 of California at Berkley. 8 Q. What was your major? 9 A. Industrial psychology. 10 Q. Did you take any courses in your study 11 that relate particularly to the areas of 12 compensation? 13 A. Well, there were in those days no 14 courses that related directly to compensation. 15 There were in some one or two courses a module, if 16 you will, on the evaluation of jobs, so-called 17 points and factors that allow companies to decide 18 whether a job should be a Grade 20 or 22, that 19 sort of thing. 20 Q. You're referring to hierarchal settings 21 of -- 22 A. Salary structures, right. 22796 1 Q. Okay. And what about statistics? Did 2 you take any courses in statistics? 3 A. Yes, I did take courses in statistics. 4 Q. Do you hold any advanced degrees? 5 A. Yes. I hold a master's degree from 6 Occidental College in Los Angeles, 7 O-C-C-I-D-E-N-T-A-L. 8 Q. When did you complete that work? 9 A. I completed the course work in 1957, 10 but I did not finish the thesis until 1962, about 11 one day before I had to finish the thesis or I 12 wouldn't have gotten the degree. 13 Q. Mr. Crystal, I'm going to hand you 14 what's been marked as Exhibit A14108, which is a 15 copy of your curriculum vitae. 16 First of all, is that your CV? 17 A. Yes, it is. 18 MR. SCHWARTZ: And Your Honor, I offer 19 Exhibit A140 -- 14108 into evidence. 20 MR. BLANKENSTEIN: No objection, 21 Your Honor. 22 THE COURT: Received. 22797 1 Q. (BY MR. SCHWARTZ) First of all, would 2 you just describe basically your background 3 experience in compensation and analysis of 4 compensation programs? 5 A. Well, I started in that field in 1959 6 with RCA Corporation where I was a -- an analyst 7 in wage and salary administration which is where 8 most people start in this field which, as you 9 suggested earlier, involves the analysis of jobs 10 and the placement of those jobs into various pay 11 grades in a hierarchal structure; but it did not 12 at that time involve any executive pay. 13 One in this field needs to be 14 experienced to handle large numbers. So, I moved 15 from there in 1960 to General Dynamics Corporation 16 in San Diego and was doing the same work with 17 higher-level people, engineers at this point and 18 more advanced levels of managers. 19 Then that led to my transfer and 20 promotion to General Dynamics in Rochester, 21 New York, in 1962 where again I was dealing with 22 even more high-level pay. 22798 1 Finally, in 1963, I was transferred to 2 the headquarters of General Dynamics which was 3 then located in New York City to join the 4 corporate staff. At that point, I began to deal 5 exclusively with executive pay, largely with 6 executive pay issues. 7 Q. When was that? 8 A. That was in June or July of 1963. And 9 I stayed with General Dynamics until January of 10 1968 except for one brief time when I joined Booz 11 Allen and Hamilton, B-O-O-Z, A-L-L-E-N, and 12 Hamilton, a nationally-recognized consulting firm 13 where I thought I was going to be doing 14 compensation work because that's what I wanted to 15 do. And I found that you would only be doing that 16 accidentally. You were just part of a talent 17 pool. You could be thrown into any subject. I 18 didn't care for that. 19 In the meantime, I was offered another 20 promotion to return to General Dynamics; and I 21 came back to the company as corporate director of 22 the company for the whole 100,000-person 22799 1 operation. 2 Q. What did you do in that capacity? 3 A. I did quite a bit of executive 4 compensation, advising the compensation committee 5 and the board on the issues of how much other 6 similarly-situated executives got paid at other 7 companies. I designed incentive plans, employee 8 savings plans. I also was the principal approver 9 of the merit increase budgets of all of the many 10 divisions of General Dynamics, some of which 11 contained as many of 25,000 employees. So -- 12 should we increase salary 5 percent or 8 percent. 13 So, those were the sorts of issues I handled. 14 That continued until January of 1968. 15 And at that point, I left General 16 Dynamics and joined Pfizer, P-F-I-Z-E-R, the drug 17 company, where I was director of compensation and 18 benefits for the international side of the 19 business, which was half the total business. I 20 did that because I wanted to gain some 21 international experience involving the pay of 22 employees in other countries other than the United 22800 1 States. 2 However, I was only there eight months 3 before Booz, Allen and Hamilton coaxed me to 4 rejoin them this time with the promise that I 5 would work exclusively in the field of executive 6 compensation; and more than that, that I would 7 head the firm's practice in that field. So, I 8 rejoined them. I stayed with them 15 months until 9 the end of 1969. 10 At that time, Towers Perrin, 11 T-O-W-E-R-S, P-E-R-R-I-N -- Towers Perrin, which 12 is another major consulting firm, offered me a 13 position to head their entire compensation 14 practice. And so, I joined them; and I stayed 15 there for 18 years. And I -- I was the head of 16 compensation. I rose to the rank of 17 vice president of the firm and a member of the 18 board of directors. And then I took early 19 retirement from the firm on December 31st, 1987. 20 And at that point, I had -- by the way, 21 I should mention that during the preceding 22 24 years, I was based in New York City most all of 22801 1 the time. And then I moved back to the 2 San Francisco Bay area and became an adjunct 3 professor at the Haas, H-A-A-S, School of Business 4 at the University of California at Berkley, had 5 the rank of full professor, but I was not a 6 tenured full professor. And I taught courses in 7 executive pay, management reward systems for 8 approximately the next ten years. 9 But that was just a part-time position. 10 I continued to do a little consulting for -- until 11 about the middle of 1989. And -- but I mainly 12 started writing. I became effectively a 13 contributing editor of Fortune Magazine and wrote 14 12 articles in rapid succession for that magazine 15 on the field of executive pay. And the early 16 articles attracted so much controversy on the part 17 of executives that it became apparent to me it was 18 going to be a difficult situation to be writing 19 critical articles and consulting with companies at 20 the same time. 21 So, I decided that I would no longer do 22 consulting for publicly-owned companies where I 22802 1 might have a critical role to play, although there 2 was one exception that I did make in 1996. 3 And then I established a newsletter and 4 started writing the newsletter and continuing to 5 write articles for Fortune Magazine. I got into a 6 conflict with the top management of Fortune where 7 they tried to make me pull punches on the 8 reporting of the pay of Steve Ross, the CEO of the 9 company. And I had to quit in a very public 10 manner because they were interfering with my 11 editorial efforts. 12 I went to work as a columnist for 13 Financial World Magazine; and six months later, I 14 was fired. I then went to work for Pension and 15 Investments Magazine and got fired again. I've 16 learned that I bear approximately the same 17 relationship to a magazine stream of advertising 18 revenues as a billion termites does to a woodpile. 19 So, I pick up my camp and keep moving 20 on. At the moment, I write a syndicated column 21 for about 20 newspapers around the country that 22 are owned by the Advance Publications, the 22803 1 Si Newhouse Publications. I've been doing that 2 for two or three years without losing my position. 3 I am a regular weekly or sometimes bi-weekly 4 contributor to CNN Financial News, the financial 5 news channel of CNN. 6 So, I write. I do some speaking, and 7 that's what I'm doing today. 8 Q. Two questions going back. First of 9 all, in your duties at Towers Perrin, what were 10 your responsibilities in connection with executive 11 compensation? 12 A. Well, I was -- 13 Q. This was the 18-year period? 14 A. Right. For approximately half the 15 period, I was in charge of the compensation 16 practice of the firm. It had five consultants 17 when I started and 200 when I left. And I had an 18 administrative role. The consultants did not 19 report to me directly. They reported to a 20 so-called dotted line. It was a spiritual 21 authority over the consultants. I did a lot of 22 consulting myself. And -- but it became the case 22804 1 that I became sort of torn between the growing 2 demand for my services on the part of many, many 3 companies and my needs to be an internal guide and 4 training and doing the things you need to do to 5 try to build up a practice. 6 So, I elected -- I believe it was in 7 1978, I elected to resign my position from the 8 board of directors, to continue to be a 9 vice president, and to do nothing but client work 10 because I much more enjoyed working with clients 11 and thinking about issues and writing reports than 12 I did doing internal administration. 13 So, I continued to do that right to the 14 day I retired in '87. 15 Q. What was the nature of the work that 16 you did? 17 A. Well, I had virtually every major 18 company in the United States as a client of mine 19 at one time or another. I would guess out of the 20 top 100 or 200 companies, at least 100 and some 21 were my clients at one point or another. And I 22 worked with the managements of the companies and 22805 1 with the boards of directors but mostly with the 2 managements of the companies to design incentive 3 plans, to design stock option plans, to design 4 various types of plans that had as their goal the 5 motivation of greater performance in return for 6 greater pay. 7 Then I spent considerable time in 8 analyzing the market in terms of what is a fair 9 pay package or what is a competitive pay package. 10 What do other companies of approximately the same 11 size, the same performance, the same industry, 12 what do they pay for their executives. In that 13 case, then, are these people paid correctly, 14 overpaid, underpaid. 15 Q. How do you go about doing that phase of 16 your work, comparing one salary to another? 17 A. Well, I mean, ideally, if -- you would 18 try to find companies that match precisely the 19 company you're doing the study for. So, if the 20 company had, you know, 50 billion in assets, you 21 would try to find a company with 50 billion in 22 assets. If it was in Texas or whatever, you would 22806 1 try to find one in Texas. If you did that, you 2 would probably find there was only one company 3 that fell through all your screens; and it was the 4 company you were working with. So, of necessity, 5 you have to broaden your spectrum. 6 So, you would pick companies of perhaps 7 varying size, of varying performance, possibly 8 more than a single industry if you felt that there 9 was some relevance for it and it wasn't distorting 10 your data. Then you would use statistical 11 techniques to sort through some of this noise in 12 your database. 13 For example, if you had companies in 14 the sales range of 10 to 50 billion, you might 15 then use a technique called regression analysis 16 where you're trying to determine whether there's 17 any statistical relationship between the 18 increasing size of the company and the increasing 19 pay package. Then if there was, then you could 20 derive a competitive level of pay. 21 Q. Page 1 through 11 of your CV, you 22 identify a number of publications; is that right? 22807 1 A. Yes, sir. 2 Q. I'm not going to ask you about all of 3 them, but I would like to identify a couple. 4 First of all, have you written any 5 books? 6 A. Yes. I have written six complete books 7 and parts of 11 others. 8 Q. And what was the nature of the writing 9 experience that have been the books and the 10 contributions to other books? 11 A. Well, they were all on executive 12 compensation. I am the most narrow specialist. 13 Q. And, also, on the first page under 14 "Books and Articles," there is a -- the third item 15 has a reference to the American Compensation 16 Association, a chapter of a book. 17 Do you see that? 18 A. Yes. 19 Q. What is that? 20 A. The American Compensation Association 21 is a -- likes to style itself as a professional 22 body for people who work in the compensation 22808 1 profession. I, first of all, with deference to 2 the lawyers in the room, do not consider this a 3 profession in the sense that it is not one that 4 can be taught in an organized way in a school. I 5 don't think this lends itself to that. 6 This is a group that tries to educate 7 its members and convey the latest techniques and 8 serve as a forum for ideas and concepts. It also 9 acts as a lobbying organization, too, in some 10 respects in taking positions that -- to influence 11 certain legislation and that sort of thing. 12 Q. Are you a member of the American 13 Compensation Association? 14 A. I am a life member of the association. 15 Q. How do you get to be a life member? 16 A. You are elected to that based on 17 contributions to the field over many years. 18 Q. Have you held any positions with the 19 association? 20 A. Early on, the American Compensation 21 Association had a deep -- and still does -- 22 abiding suspicion of consultants because the 22809 1 feeling was that if you were a consultant in a 2 high position in the association, you might use 3 your high position as a means of trying to get 4 further business. 5 And so, for many years, the association 6 had sort of a proscription on consultants serving 7 as officers. But before I became a consultant, in 8 fact, I was elected to the presidency of the 9 eastern region of the association. And then I 10 joined Booz, Allen. And technically, I should 11 have quit; but they said you can serve out your 12 term. 13 So, I did for one year become the 14 president of the eastern region. Then because I 15 was a consultant, I could no longer serve. 16 Q. On the fourth page of your CV, there's 17 a reference to an article you co-wrote with Merton 18 Miller in the Journal of Applied Corporate 19 Finance? 20 A. Yes. 21 Q. What's that? 22 A. Well, this is a scholarly type journal. 22810 1 I'm not sure exactly who publishes it. It's a 2 journal in the field of corporate finance, and it 3 contains more scholarly articles. 4 Q. What was the subject of the article? 5 A. The subject of the article involved the 6 issue of the charges to earnings for stock option 7 grants. It is the case in this country that every 8 known item of expense is charged to earnings with 9 one clarifying exception, and that is the grant of 10 a stock option. 11 So, for example, last year when Michael 12 Eisner in December of '97 -- he was the chairman 13 and CEO of the Walt Disney Company. When he 14 exercised options and received a gain of 15 $550 million, not one cent of that was charged to 16 the company's earnings. And because this is the 17 case in many companies, options have been treated 18 by boards of directors as if they are playing with 19 blanks and not live ammunition. They have been 20 given out in huge quantities. The movement 21 started in the early Nineties to try to get the 22 Financial Accounting Standards Board, the FASB, 22811 1 which is the American rule-making body for 2 accounting, to change its policy and to require a 3 company to charge its earnings for the estimated 4 present value of stock option grants. And that 5 caused a tremendous howl of anguish from the 6 business community, principally the business 7 community situated in Silicon Valley where stock 8 options have been given in huge quantities in lieu 9 of cash compensation. And to marshall support for 10 the side of supporting FASB, which I was on, 11 Merton Miller, who was a world-renowned economist 12 and Nobel Prize winner at the University of 13 Chicago and I authored an article which first 14 appeared as an op-ed piece in The Washington Post 15 and then was dressed up for this journal in which 16 we did argue that there should be a charge to 17 earnings, that there should be a level playing 18 field. And that was the genesis of that 19 particular article. 20 Q. Before I forget, you mentioned earlier 21 that during your work writing articles or comments 22 for financial magazines, that you were criticized 22812 1 for your efforts. 2 Do you only criticize company's pay? 3 A. No. On the contrary. I try to be 4 fair. Where I find companies that play the game 5 fairly -- for example, companies with CEOs with 6 poor performance really cut their pay a great deal 7 and take blame for the results or companies that 8 have very highly risky plans -- in those cases, I 9 take to my pen and write them complimentary 10 articles. I must confess that the ratio of 11 critical articles and complimentary articles is 12 approximately 2 to 10. 13 MR. SCHWARTZ: Your Honor, the Office 14 of Thrift Supervision tenders Mr. Graef Crystal as 15 an expert on compensation practices, practices, 16 executive pay, pay competitiveness in the field of 17 compensation analysis. 18 Mr. Crystal is qualified by virtue of 19 his education, experience, and research to provide 20 testimony in this case on compensation issues. 21 MR. BLANKENSTEIN: No objection, 22 Your Honor. 22813 1 THE COURT: So certified. 2 Q. (BY MR. SCHWARTZ) Mr. Crystal, you 3 were retained by the Office of Thrift Supervision 4 to render some expert opinions in this case; is 5 that correct? 6 A. Yes. 7 Q. Would you describe briefly how that 8 engagement came about? 9 A. I believe it was in February of last 10 year I received a call from Mr. Bruce Rinaldi and 11 Mr. Paul Leiman, who are attorneys with the Office 12 of Thrift Supervision and who had a rather lengthy 13 phone call with me on the issues that they have -- 14 they were going to trial over. And they 15 acquainted me with the outlines of the case as 16 they saw it and asked me if I would consider 17 becoming an expert witness for the Government. 18 And that's how it got started. 19 Q. Now, would you describe generally the 20 areas that you looked into? 21 A. Well, I looked into -- I guess one way 22 to put it is that there are really only two 22814 1 questions in the field of executive pay. One is 2 how much, and the other is how. That is to say, 3 how much, you know, should someone be paid? 4 $5 million or $4 million or $3 million? The 5 quantity issue, if you will. 6 And the second issue is the quality 7 issue. You know, perhaps a survey, for example, 8 would show that here is an appropriate going rate 9 for a position; but maybe the person should be 10 paid less than that because of poor performance or 11 maybe they should be paid more than that because 12 of excellent performance. 13 And so, you're going there into a much 14 more qualitative review of the plans that the 15 company has, what was intended as the objectives 16 of those plans, and did the company follow its own 17 script, if you will, for the way these plans were 18 supposed to operate. So, you have the "how much" 19 issue and the "how" issue. 20 Q. Did you look at competitiveness of UFG 21 and/or USAT's senior executive pay? 22 A. Yes, I did. 22815 1 Q. Did you look at the reasonableness of 2 the severance pay packages offered to the 3 executives? 4 A. In a brief manner. 5 Q. Did you look at the soundness of the 6 report prepared by Hewitt & Associates for USAT or 7 UFG? 8 A. Yes, I did. 9 Q. And the same question with regard to 10 the Wyatt Company? 11 A. Yes. I also looked at the Wyatt 12 report. 13 Q. And in reviewing -- in coming to the 14 conclusions that you came to, did you make your 15 own independent review and determination of facts 16 circumstances? 17 A. Yes, I did. 18 Q. Mr. Crystal, let me hand you your 19 report, which is marked as Exhibit A14107. 20 First of all, is this your expert 21 report in this case? 22 A. Yes, it is. 22816 1 MR. SCHWARTZ: Your Honor, I move the 2 admission of Exhibit A14107 into evidence. 3 MR. BLANKENSTEIN: No objection. 4 THE COURT: Received. 5 Q. (BY MR. SCHWARTZ) Would you describe 6 generally the layout of your report? 7 A. Yes. I made some brief introductory 8 remarks; and then I started to analyze the report 9 on my analysis of the pay competitiveness for 10 Mr. Jenard Gross, the CEO of USAT and UFG at the 11 time. 12 Q. Why did Mr. Gross get a section -- a 13 special section, if you will? Special mention? 14 A. Well, in the field of executive pay, 15 the most compelling place to start is always with 16 the CEO because the CEO sets the tenor of the pay 17 of almost all the other senior executive officers. 18 You know, I would note, awhile back I had a debate 19 on the phone with Steven Brill, the celebrated 20 legal commentator, and I told him I was going to 21 be doing an analysis of chief legal officers of 22 several hundred companies. And he said, "Well, 22817 1 you're never going to explain why one of these 2 people is paid more than another because you can't 3 get at the statistics of the number of lawyers 4 they have on staff inside, the extent they use 5 outside laywers versus they do work in-house." He 6 said, "You're just going to find that you have a 7 lot of garbage." 8 I found if I looked at the size of the 9 companies, I could account for maybe 30 percent of 10 the variation in pay of all these hundreds of 11 chief legal officers, which left me 70 percent 12 unexplained. Then I found if I added a second 13 factor, the extent to which the CEO of the company 14 earned more or less than what the trend line value 15 for a CEO of that company would be, I could 16 improve my explanation from 30 percent to 85 17 percent. The most powerful thing driving the pay 18 of these chief legal officers was the pay of the 19 CEO and whether it was high or low. 20 I did the same analysis about the same 21 time with respect to chief financial officers and 22 found exactly the same pattern. It becomes the 22818 1 lynch pin for the entire organization of 2 executives. 3 Q. You call it competitiveness of pay. 4 What is that? 5 A. This is the "how much" issue, 6 regardless of how you got there. You paid them so 7 much. Here is other companies' pay. Is it within 8 the range of reasonableness, or does it lie 9 outside that range. That is the next section. 10 Q. Continuing through the next section -- 11 A. Then I went on and briefly commented on 12 the pay of other UFG senior executives. I found 13 that because I had limited data available from 14 proxy statements, that I could get enough sampling 15 to make a really informed conclusions. Although 16 with various bits and pieces, I do have some 17 comments on some of those people. 18 The problem is that whereas a company 19 is required to report on the pay of its five most 20 highly-compensated officers, in its proxy 21 statement it does not necessarily always report on 22 the pay of the chief financial officer or the 22819 1 chief legal officer because he may be the seventh 2 most highly paid. 3 In some proxy statements, you find the 4 position; and in some, you don't. In the case of 5 Dr. Barry Munitz, you can find almost no 6 documentation because his position is quite 7 unique. Every company has a CEO; but not every 8 company has a chief legal officer, chief financial 9 officer. 10 Q. And you said that you -- you look at 11 other companies' proxy statements to make these 12 comparisons. 13 Why is that important? 14 A. Again, you know, compensation is 15 relative. Everybody has an opinion on -- on 16 whether someone is overpaid or underpaid. But at 17 the end of the day -- let me back up a second. 18 I mean, we can certainly advance an 19 opinion. For example, Aristotle told Plato that 20 no one in the community should earn more than five 21 times the pay of the lowest member of the 22 community. Unfortunately, he didn't supply any 22820 1 rationale for this number of five; and it's been 2 disputed over the last 3500 years. J.P. Morgan 3 said the ratio should be 20 times. 4 But in this case, we're taking a more 5 pragmatic reasoning, which starts with the notion 6 that there's some sort of labor market operating 7 out there, that the price -- that the person's 8 wages or salary -- that is the price of his 9 labor -- and that the market may be rather 10 inefficient, and it is. But nevertheless, there 11 is some influence on what someone earns based on 12 what other people earn in a similar position. Law 13 firms survey each other constantly, accounting 14 firms, savings and loan associations, companies, 15 because that's the only way they can come up with 16 any sort of informed judgment as to are we too 17 high or do we need to book Carnegie Hall for a 18 benefit concert for the CEO because he's so low. 19 That's how we do it. We have to go to the outside 20 and measure what other people earn. 21 Q. The next section, "qualitative 22 analysis" -- top of the page. Severance pay 22821 1 packages -- 2 A. I included some remarks on the 3 severance pay packages that were offered. 4 Q. Then qualitative analysis of the UFG 5 package, what is that about? 6 A. Here is where I moved into the "how" 7 issue. Leaving aside how much, we turn to the 8 issue of examining the intention of the plans that 9 were in place and then to evaluate whether those 10 intentions were met in actual practice. So, for 11 example, if you gave someone a stock option and 12 implicitly you entered into a contract with the 13 shareholders where you said, for example, "Today's 14 prices are $50 a share and I'm giving the 15 executive the right but not the obligation to buy 16 100,000 shares at $50 a share and, in effect, I've 17 retailed this plan to the shareholders as a plan 18 that will reward the executive for an increase in 19 the share price but will give the executive 20 nothing in the event the share price falls below 21 $50." 22 You say, "Okay. Well, that's the 22822 1 design. That is the goal." 2 Now, if I find later on that the stock, 3 instead of rising above $50, drops to $25 and we 4 now see evidence that the board calls the CEO in 5 and says, "Bring in your option agreement" and on 6 Page 3 where it says to exercise the option, you 7 shall pay $50 per share, the board erases $50, 8 puts down 25 and hands it back, this is the sort 9 of practice I would look at and say, "Well, that's 10 not the express intention of this plan." 11 It was intended to reward for an 12 increase. And now we find that if the stock were 13 to go back from 25 to 50, to the starting point, 14 what do you know? The executive gets a lot of 15 money. Yet, we thought he wasn't supposed to get 16 money under those circumstances. This is the sort 17 of analysis contemplated in here, which includes 18 taking your lumps if it turns out to be poor 19 performance. 20 Q. And the next section? 21 A. The next section is devoted to comments 22 on the report submitted by Hewitt & Associates, an 22823 1 outside consultant firm. 2 Q. I would like to review with you some of 3 the specific observations you make, the 4 qualitative analysis on Page 5. 5 Now, you state there in the opening 6 sentence that "The fact that UFG was in extremis 7 in late 1987 and early 1988" -- do you see that? 8 A. Yes, uh-huh. 9 Q. -- "should have led its board -- 10 compensation committee and its board of directors 11 to switch to an environment featuring ultra low 12 fixed costs combined with large incentive 13 opportunities conditional on turning around the 14 failing enterprise." 15 First of all, what did you mean by "in 16 extremis"? 17 A. I'm not sure the term "in extremis," 18 which is E-X-T-R-E-M-I-S -- I'm not sure whether 19 the term is a medical term or theological term. 20 Whatever its etiology, it is a term that describes 21 a person who is so close to death as to render his 22 chances of resuming viability as being very low. 22824 1 Not dead yet. "Moribund" might be another synonym 2 for that term. 3 Q. Was the fact that you considered the 4 company was in extremis crucial to your analysis? 5 A. Yes. 6 Q. Why? 7 A. Well, once again, if, for example, you 8 had a company -- and there are companies like this 9 that say, "Look. We're just going to pay someone 10 a salary. That's what they get. We don't believe 11 in incentives. We don't have any extra pay if we 12 have good years. By the same token, if we have 13 bad years, we don't cut their pay." 14 The company is saying this is how we do 15 it, and it matters not what the performance is. 16 At least you are doing philosophically what you 17 said you were going to do. If, on the other hand, 18 you have another company that has numerous 19 incentive plans, a bonus plan that is designed for 20 increased performance. You close your left eye 21 and read the letters, it says "incentive." If one 22 were a shareholder, one would hope that would be 22825 1 increased performance. You have a stock option 2 plan which is designed to reward you if, and only 3 if, the stock price rises. You have a performance 4 unit plan which is designed to reward you if the 5 book value of the company changes. And you 6 have -- well, you have these various incentive 7 plans. And you have a stock purchase plan where, 8 originally, you are giving the company a full 9 recourse note requiring you, under any and all 10 circumstances, to pay the company this amount of 11 money for the shares; but you're allowed to keep 12 any excess appreciation if the shares go up. If 13 they go down, that's your tough luck. These are 14 what the plans are supposed to accomplish. The 15 reason we have these plans in the first place is 16 to devise an acceptable way to cause the cost of 17 executive talent to decline in an almost automatic 18 fashion if the performance of the company declines 19 so that we don't have to have these agonizing 20 decisions in the board room of having to call the 21 CEO in and cut his pay. It gets cut 22 automatically. His options aren't worth anything 22826 1 anymore. He's holding a stock he owns a great 2 deal of money for. So, that's what you want to 3 look at and judge whether, in fact, these things 4 happen. 5 Q. All right. And going back to that 6 sentence, why should the fact that the company was 7 in such dire straits have led the board 8 compensation committee and board of directors to 9 switch to ultra low fixed costs with these large 10 incentive opportunities? 11 A. Well, you know, I'm reminded of Samuel 12 Jackson's remark that nothing concentrates a man 13 so much as the prospect of his hanging in a 14 fortnight. 15 In that case, if you looked at a firm, 16 a private law firm, where the firm got into 17 terrible trouble and the profits were turning to 18 losses, there would be no question in that firm, 19 for example, that the committee that ran the firm 20 would decide that the solution to the problems was 21 to raise the partners' salaries. It just wouldn't 22 happen. 22827 1 In the crisis, the talk would be how 2 much are we going to cut the salaries in order to 3 reduce the -- to increase the viability and the 4 chances of survival of this organization. Fixed 5 costs are like a dead hand to a company which is 6 in trouble. 7 The first thing you have to do is try 8 to reduce the fixed costs of the company, the cost 9 of talent being among the costs you want to 10 reduce. 11 Q. Compensation would be included in that? 12 A. Absolutely. I might add it would be 13 included not only for its value in reducing costs 14 but for its symbolic value as a signal to the 15 organization that we are in trouble and we, the 16 top management, are taking our lumps even more 17 than you down below, as a signal to the 18 shareholders that we're serious about trying to 19 save this company. So, it has a real value and a 20 transcending symbolic value. 21 Q. You go on at the bottom of Page 5 and 22 the middle of Page 6 to list bullet points 22828 1 regarding what you concluded happened with regard 2 to USAT in '87 and early '88. Right? 3 A. Yes. 4 Q. Instead of declaring no bonus for 5 performance in 1987, substantial bonuses were 6 declared including a 160,000-dollar bonus for 7 Mr. Gross. 8 Do you see that? 9 A. Yes. 10 Q. Does that calculation include any 11 amounts he received to repay interest he owed on a 12 loan made to him by UFG? 13 A. No, it does not. 14 Q. Would it be appropriate to add that 15 amount to the 167,000-dollar bonus to get a total 16 bonus amount? 17 A. Well, under current SEC disclosure 18 rules which were not in effect at that time, a 19 loan interest forgiveness payment such as the one 20 extended to Mr. Gross would not be included in the 21 bonus column but in one entitled "other annual 22 compensation." 22829 1 However, in this case, I would include 2 it in the bonus because I believe the records of 3 the company itself treated it as a bonus. It was 4 added to in various documents and lumped right in 5 with the 167. So, the 167 morphed into 235,000, 6 if you will, because the company itself called it 7 a minimum bonus at one point, I believe. It was a 8 bonus in the context of the company's own 9 thinking. 10 So, in this case, the number probably 11 should have been 235,000. I might add at that 12 time I had a little trouble with this number 13 because various internal documents said 167. The 14 proxy statement said 235,000. I didn't understand 15 the difference until I found out that the company 16 in the proxy statement said that the executives 17 would have to pay prime rate interest to the 18 company but the company omitted, intentionally or 19 not, that the executive was being provided the 20 funds to pay the prime rate interest. 21 Q. Well, assuming Mr. Gross' annual salary 22 for 1987 was $291,700, based on your knowledge and 22830 1 experience, was it unreasonable and excessive to 2 pay Mr. Gross an additional 167,000 plus a 3 68,000-dollar bonus in 1988 for 1987 performance? 4 A. I believe it was, yes. 5 Q. Why? 6 A. Well, you know, first of all, you look 7 at the income statement in the three years that 8 were provided in the 10K. And it's, like, 9 complete the series. A 3-million-dollar loss in 10 '85, 36 million in '86, and 118 million in '87. 11 Give me the number for '88, if you can. The -- 12 all the signs were going terribly downhill, and 13 the performance was going downhill. 14 Now, if we have a pay for performance 15 philosophy, the case I would put is to say 16 convince me as to why the CEO should receive 17 anything at all. And I would also observe that 18 this 167,000 for 1987 performance in the face of a 19 118-million-dollar loss, this 167,000 was more 20 than double the bonus given to him the year before 21 for a 36-million-dollar loss. I mean, it's almost 22 as though the people running these programs didn't 22831 1 understand the significance of the parentheses 2 around these net income figures. They saw these 3 figures getting bigger and gave larger bonuses. I 4 can't understand the reason for having a bonus at 5 all. But more than that, if we're going to have a 6 bonus, I certainly can't understand the reason for 7 having a bonus twice the size of last year when we 8 lost three times as much money. 9 Q. You go on to state, "Instead of 10 considering salary cuts or at least salary 11 freezes, the decision was made to incorporate 12 bonus for 1987 performance into base salary levels 13 thereby substantially increasing UFG's fixed 14 costs." 15 First of all, would you explain 16 generally what that's referring to? 17 A. My understanding here is that in 18 January of '88, Mr. Gross was paid a bonus of 19 167,000 based on his performance in 1987. And 20 then shortly thereafter, a decision was made to 21 increase his salary. And the amount of the 22 increase that he was given turned out to be 22832 1 precisely the amount of his bonus that had been 2 declared earlier. So, now his salary was $167,000 3 higher. Well, base salary -- 4 Q. Let me interrupt. You mentioned 5 specifically Mr. Gross. 6 Were other senior executives also 7 receiving the same benefit, although not the same 8 number? 9 A. Yes. I believe each one received a 10 salary increase equal in amount to the bonus he 11 had received with respect to the year 1987. 12 Q. Okay. And so, was that increase 13 retroactive at the time it was issued? 14 A. I believe it was retroactive to the 15 first of the year. 16 Q. Based on your knowledge and experience 17 in compensation practices, was it an unreasonable 18 compensation practice not to cut or at least 19 freeze salaries? 20 A. Yes, I believe it was. 21 Q. Would you please explain? 22 A. Well, a salary increase or salaries, 22833 1 base salaries in virtually every area of the 2 United States, including the federal government, 3 for example, salaries may go up; but they rarely, 4 if ever, go down. It is not considered good form 5 to cut someone's salary. 6 In fact, you have executives that might 7 face a salary cut telling the company they would 8 rather terminate their employment than have a 9 salary cut because at least they could go out with 10 their resume showing a higher salary which they 11 would hope might attract an equally higher salary 12 at the next employer. 13 When I was at Towers, Perrin, one of my 14 colleagues who was an actuary said to me, you 15 know, "The way the system works, a salary increase 16 is really a career annuity." 17 Q. Meaning what? 18 A. Meaning that if I give you a 19 10,000-dollar salary increase, you're going to 20 have 10,000 a year for the rest of your career 21 because it's not effectively going to get cut. 22 And so, the present value, if you 22834 1 discount -- if you're 40 years old and you have 25 2 years left and you get a 10,000-dollar increase, 3 if you discount $250,000 back to its present 4 value, it's a number that's many times bigger than 5 the 10,000-dollar increase. And so, it's the sort 6 of thing you're adding to the fixed cost of the 7 company with no realistic probability of getting 8 that back. 9 Q. So, how does that apply here with 10 respect to UFG not freezing or even cutting 11 salaries? 12 A. Well, again, I start from the notion 13 that here's a company that appeared to be in 14 extremis, that we need to -- by analogy, in World 15 War II, many of the B17s coming back from bombing 16 Germany were down to two engines, one engine, and 17 they were throwing out the machine guns, throwing 18 out even the parachutes, anything they could do to 19 lighten the plane to make it back to England and 20 not go right straight into the English Channel. 21 By the same token, here is an 22 organization which -- maybe that's hyperbole -- 22835 1 that at least three engines were out and the 2 fourth one was probably in flames and that we 3 really needed to lighten the burden here and that 4 the last thing you want to do is increase the 5 burden of fixed costs by giving people huge salary 6 increases even though it might be conceivably 7 impossible that those salary increases seem to be 8 mandated by looking at outside data. 9 Q. Just so the record is clear, based on 10 your knowledge and experience, was it an 11 unreasonable compensation practice to incorporate 12 an amount equal to the 1987 bonuses into base 13 salaries? 14 A. I believe it was, yes. 15 Q. And we talked about in that sentence 16 substantially increasing USAT's fixed costs. 17 Does this tie back to the -- 18 A. Lightening the load, yes. 19 Q. Okay. Now, you've used that term 20 several terms. 21 Would you describe what you mean by 22 "unreasonable compensation practices"? 22836 1 A. Well, I mean, pay could be deemed to be 2 unreasonable in one of two respects. One is that 3 the size of the pay package is so awesome in 4 relation to other pay packages that it just 5 staggers the imagination. Now, by that I don't 6 mean to say that any pay package that is above the 7 average is per se unreasonable because if you 8 grant me that argument, then the average would no 9 longer be the average. There's nothing wrong with 10 being paid above the average. 11 For example, if I were looking at a 12 distribution of pay as I have done recently in 13 many companies -- and I see CEOs and I did a study 14 for the New York Times of 279 CEOs and they 15 averaged $8.6 million apiece in 1987. And you 16 say, "Well, that's the average. What's the 17 range?" 18 Well, you had Warren Buffett down at 19 $100,000. We understand why he doesn't pay 20 himself very much. He has $37 billion worth of 21 stock. 22 But on the other side, we have numbers 22837 1 rising up to 10 million, 15 million, 20 million, 2 and so forth. And -- but then you begin to run 3 out of gas. And you get maybe -- you go from 4 $60 million to 140 million, and you get up to -- 5 in the case of Charles Wang, W-A-N-G, but it's 6 pronounced Wang, the chairman of Computer 7 Associates who on a single day this last March 8 received a bonus of $670 million and that was on 9 top of another 400 million of pay during the last 10 three years. He earned 1.1 billion. He's more 11 standard deviations out on the curve of pay than 12 Albert Einstein was on the curve of intelligence. 13 You say that's a clear case of unreasonableness. 14 You can't go that much away. 15 The second one doesn't refer to the 16 issue of the size of the pay package. It's the 17 more qualitative aspects. Again, in my mind, I'm 18 judging you by what you set forth to do. You set 19 up these incentive plans. You said you were going 20 to pay all these moneys if the performance was 21 good, and then you didn't pay it. I think that's 22 unreasonable. 22838 1 Q. We're going to talk a little bit later 2 about the Hewitt and Wyatt reports. I would like 3 to ask you now if you saw Hewitt and Wyatt 4 considering the conditions in their analysis. 5 A. My notion is that other than making 6 this sort of passing almost ritualistic nod, the 7 substance of the report acted as though this was a 8 going concern. To me, it would have been the same 9 report had it been given to Proctor & Gamble, for 10 example. 11 Q. We talked about the -- what you 12 describe as an unreasonable compensation practice 13 of rolling in the bonus for 1987 into a 1988 14 salary; and that occurred sometime in April, I 15 believe? 16 A. Yes. 17 Q. What about the 1987 bonus itself paid 18 in January of 1988? Did you reach a conclusion as 19 to whether or not that practice was unreasonable? 20 A. Well, as I said, the immediate issue is 21 given the very difficult performance circumstances 22 in which the company found itself, would you 22839 1 reasonably pay a bonus of substantial dimension to 2 a CEO who could be presumed to be the person who 3 brought you that performance and would you give 4 him twice the amount of bonus that he had the year 5 before when the loss has been deepened by three 6 times? And would you make a decision on 7 November 10, 1987, to do that when the year hadn't 8 even been completed yet and where the performance 9 numbers became very, very poor thereafter? They 10 were poor to begin with. 11 Q. Did you reach any conclusions regarding 12 how compensation decisions were made at USAT and 13 UFG? 14 A. Well, from the records that I could 15 examine, you had a process here which is not -- I 16 might say in fairness -- dissimilar to that at 17 many companies where the proposing parties for 18 compensation actions, whether that means an 19 increase or it means a new plan, the proposing 20 parties are the executives who are actually 21 affected by those actions, that they propose and 22 the board, if you will, disposes; that rarely does 22840 1 the board decide on its own recognizance that 2 something needs to be done. That's the sort of 3 pattern I saw here, that almost everything was 4 going up from the management to the board. 5 Q. Did you see any indication of 6 independent review by the compensation committee 7 or the board of those proposals? 8 A. Well, I didn't see any such indication. 9 One sign of that could be that you see a final 10 action approved by the board which is materially 11 different than what was proposed. So, it says we 12 like to give so and so a bonus of 200,000 and all 13 of a sudden there's a line across that say 100,000 14 or J.W. or Mr. Whatley. The indication I recall 15 seeing is that virtually everything or maybe 16 everything that was proposed was accepted. 17 Now, that doesn't necessarily mean that 18 that was wrong. Perhaps there was vigorous 19 discussion and that Mr. Whatley really convinced 20 themselves that this was the right thing to do, 21 although there was one thing that appeared to be 22 in his handwriting. That after taking action, 22841 1 that he decided that the company should hire 2 consultants to see if the actions he took were the 3 correct actions. 4 Q. That's the Hewitt consultants? 5 A. Right. 6 Q. The first paragraph at the top of 7 Page 6, there's a reference in there to a special 8 bonus? 9 A. Yes. 10 Q. Do you see that? 11 A. Yes. 12 Q. First of all, what is that all about? 13 A. Well, there seems to be almost some 14 schizoid behavior going on here at the time in the 15 sense of saying that we are not going to have 16 bonuses in 1988. I mean, we recognize that the 17 performance is terrible. But we're going to have 18 a special bonus. And, you know, I think the man 19 from Mars would say, "Well, pardon me. What's the 20 difference between 167,000 regular bonus and a 21 167,000 special bonus?" 22 I think the board was playing semantic 22842 1 word games with itself. The net effect was a 2 bonus was declared for 1988 performance. 3 Q. And when did that occur? 4 A. That's the amazing thing. It almost 5 establishes the board's clairvoyance. It was 6 declared in March of 1988 when the year was only 7 three months old. So, it would be like declaring 8 a victory because you were ahead at the third 9 inning. At the time it was declared, the team was 10 way behind even for the first three months. 11 Q. I have to ask: Did you reach a 12 conclusion as to whether it was an unreasonable 13 compensation practice and excessive compensation 14 practice to award that special bonus at that time? 15 A. Yes, I thought it was because, once 16 again, the performance certainly did not warrant 17 it and it was done prematurely without any 18 knowledge of what the performance of the year 19 would be. 20 Q. You go on to discuss interest due from 21 Mr. Gross and the forgiveness of a substantial 22 loan from Mr. Gross. 22843 1 Do you see that? 2 A. Yes. 3 Q. Why should vigorous efforts have been 4 made to collect those amounts? 5 A. Well, again, I find an irony here. 6 Now, for example, George M.C. Fischer, 7 F-I-S-C-H-E-R, left Motorola in 1993; and he was 8 given a loan of $8.5 million to buy Kodak shares. 9 It was expressly understood in the contract that 10 the loan would be forgiven at the rate of 11 20 percent per year and the interest with it would 12 also be forgiven if he remained with the company. 13 So, it is not totally unheard of, 14 although it's fairly rare for this sort of 15 arrangement to occur. But what I found sort of 16 ironic here is that a company which is in the 17 business of lending money and collecting interest 18 should be so quick to forgive interest. And a 19 company which is desperately needing to collect on 20 its loans should be so quick to forgive loans. It 21 just seemed rather bizarre to me that this was 22 happening at this company in this time. 22844 1 Q. Did you reach a conclusion as to 2 whether it was an unreasonable compensation 3 practice and excessive to forgive the interest due 4 in the manner UFG and/or USAT accomplished that 5 forgiveness? 6 A. I found it to be so. I mean, once 7 again, for example, in the case of George Fischer 8 of Eastman Kodak, you know, going in there with no 9 attempt to even say, "Look, George. You're going 10 to pay for it, come hell or high water." 11 That wasn't the intent. The intent 12 with Mr. Gross, I believe, however, was that very 13 intent. When you bought this stock, you were 14 going to pay this money. We were going to forgive 15 the interest, that's true. You're going to pay 16 this money until more recently when we decided to 17 change the terms. That was the way it was 18 supposed to work. 19 January of '88, the decision was made 20 to forgive the loan 10 percent per year, I 21 believe, for 10 years. And you know, one has to 22 assume that that decision was informed largely by 22845 1 the fact that the stock price had declined some 2 90 percent in value and that that was the 3 motivation. So, once again, if that logic is 4 correct, we find a company giving a CEO a 5 167,000-dollar bonus for '87 for losing 6 118 million. In March, giving him another bonus 7 of 167, a special bonus that would hopefully keep 8 him around, and then giving him a bonus, in 9 effect, the forgiveness of this loan that would be 10 over 10 years. 11 Q. What's wrong with that practice? 12 A. Again, I think the issue comes down to: 13 Is this the time to be blowing out huge amounts of 14 money for executive pay? I mean, can we maybe 15 wait for a year when we have lots of extra profit? 16 Q. Is there an incentive philosophy tied 17 to the -- the company offering a loan to purchase 18 stock? 19 A. I'm sorry. 20 Q. Is there an incentive philosophy tied 21 to the company offering a loan to purchase its 22 stock to its CEO? 22846 1 A. In some ways, I would look at this the 2 way the loan was originally structured to say, 3 "No, there was no particular incentive" because, 4 you know, if Mr. Gross could have borrowed the 5 money from the First National of Dallas or 6 whatever bank was around and went and bought the 7 stock on the open market, he would have paid 8 761,000 and he would have taken his chances. If 9 it went up, God love him. He gets whatever comes 10 out of it. If it went down, that's his tough 11 luck. In one sense, you could argue that the 12 company merely facilitated that sort of behavior 13 by saying, "Look, you don't have to go to the 14 First National Bank of Dallas. We'll loan you the 15 money ourself," leaving aside the interest 16 forgiveness portion because the First National 17 would have charged interest. 18 So, in that sense I'm not sure there 19 was any incentive until we get to the point where 20 we say, "Hey, let's forget about that provision 21 where you have to repay the loan. Now we're going 22 to be giving you compensation." 22847 1 So, what turned out to be a 2 convenience, if you will, "You don't have to go to 3 another bank; we'll loan you the money," now has 4 been transferred into a compensation. It, in 5 fact, becomes W-2 income at that time. 6 Q. What was the means by which the 7 companies gave Mister -- went about forgiving the 8 interest on the loan payments, the interest and 9 principal? What was the mechanism that was used? 10 A. My understanding on the interest was 11 that it was characterized as an extra bonus; that 12 for whatever reason, rather than saying that you 13 don't have to pay any interest on this loan, 14 rather the very explicit statement was made in the 15 proxy statement that says Mr. Gross has to pay 16 prime rate interest. 17 Now, an ordinary shareholder presumably 18 would read that and say, "That's fair. That's 19 what everyone else has to pay." Unfortunately, 20 the proxy did not explicitly state anywhere that I 21 can find that Mr. Gross was receiving an 22 additional bonus that was mathematically 22848 1 calculated down to the last dollar to enable him 2 to pay that interest, thereby effectively reducing 3 it to zero. 4 Q. And what about the loan payment, the 5 principal? 6 A. That was explicitly documented in the 7 proxy statement that it was going to be forgiven. 8 Q. What was the mechanism for forgiving 9 that? 10 A. That I believe every year, they would 11 forgive one-tenth of the loan. In effect, we're 12 giving you a guaranteed salary, if you will, of 13 76,000 more for each of the next 10 years. And I 14 believe it also said that if you were terminated 15 by a change of control or something like that, it 16 could be forgiven on an accelerated basis. 17 Q. In your opinion, was it an unreasonable 18 compensation practice and excessive for UFG and 19 USAT to arrange forgiveness of the note in this 20 manner? 21 A. Yes, I think it was. I would take 22 exception to that practice if the company was very 22849 1 robust in its profits because, once again, I would 2 say you entered into this arrangement and it said 3 you're going to get a lot of money if things go 4 well and if not, you're stuck with it. I presume 5 that no one forced Mr. Gross at gunpoint to take 6 this loan. I'm not sure whose idea it was, but he 7 freely took it. If he had gone to the First 8 National of Dallas and borrowed the money totally 9 apart from the company and then several years 10 later, he came and said, you know, "I bought this 11 stock and I've lost a lot of money," they would 12 say, "So." 13 So, I would like you to give me a check 14 to make up for my losses. I think most boards 15 would be absolutely bemused by that request. 16 Q. Would the same analysis apply 17 regardless of the size of the loan: Mr. Gross 18 having a 761,000-dollar note and, for example, 19 Mr. Crow having a smaller one? 20 A. Certainly there is the issue of the 21 size. Once again, saying that you did things 22 under certain circumstances, they didn't turn out 22850 1 for you. In my opinion, you don't have the right 2 to ask for relief. 3 MR. VILLA: Your Honor, I would like to 4 raise a little Motion in Limine here. The report 5 that was tendered and the testimony given by 6 Mr. Crystal in his deposition related exclusively 7 to Mr. Gross. He was questioned in considerable 8 detail in his deposition as to whether all of his 9 opinions related to Mr. Gross, and he said that 10 they did. I can give you the page cites. It 11 starts at Page 148 going through about a page and 12 a half of that. 13 He was asked, "Okay. Once again, try 14 to pin things down. Sitting here today, you don't 15 anticipate going out and doing any more work and 16 formulating more opinions before the time of the 17 hearing in September, do you, sir?" 18 "I sincerely hope not." 19 "Is it fair to say that your criticisms 20 of USAT and UFG on compensation issues are 21 contained in those three opinions?" 22 "Yes." 22851 1 The three opinions which are set out on 2 Pages 148 through 149, Line 16 relate all to 3 Mr. Gross. So, I want to make it clear in this 4 case that I object to this way of backing into 5 criticisms of the other respondents. 6 The report in this case was sent in 7 April of 1997. He was questioned at length in his 8 deposition about his report because there's some 9 ambiguity in his report as to whether or not it 10 related to the other three respondents, and he 11 said -- and this is at Page 149 -- "The third 12 opinion," talking about Hewitt, "erred in the 13 conclusion that the size and composition of the 14 pay packages extended to Mr. Gross and his key 15 subordinates were reasonable. Is that a correct 16 statement of the third opinion?" 17 "Yes. Although reading this now, I 18 would probably, if I were editing my own work, 19 would take out" -- 20 MR. SCHWARTZ: Your Honor, I don't 21 understand how this reference addresses my 22 question to the witness. 22852 1 Mr. Villa -- 2 THE COURT: Let's get it straight. 3 Is this witness testifying about any 4 respondents except Mr. Gross? 5 MR. SCHWARTZ: Yes, Your Honor, he is. 6 The question was whether his analysis would apply 7 in the same manner. The analysis that he 8 performed was in reference to Mr. Gross. The 9 question that I asked him is whether the same 10 analysis would apply to Mr. Crow; that is, the 11 practice of an institution forgiving a loan and 12 interest payments to one officer. Does it matter 13 in any way -- I'm not asking him about the amount 14 of it or anything like that. 15 I'm asking about whether the practice 16 is reasonable or unreasonable based on his 17 knowledge and experience. I don't think that goes 18 very far beyond what he's already testified with 19 respect to Mr. Gross. 20 MR. VILLA: Your Honor, it goes -- I'm 21 happy to take you through the transcript 22 because -- and I direct the Court's attention to 22853 1 Page 148 of the transcript in which we went 2 through the summary of the report with 3 Mr. Crystal. It starts at 148. And if we go 4 through the summary and we establish that the 5 summary of the report, all three aspects were 6 asked, "Does it relate only to Mr. Gross?" 7 And his answer was, "Yes." 8 It starts at Page 148, Line 17. And 9 then at the end of that colloquy, the question is 10 asked -- and Mr. Leiman is present -- "Do you 11 expect to have any other opinions?" 12 And the answer is, "No." 13 "Do you have any other criticisms?" 14 The answer is, "No." 15 So, we did not come here today to 16 listen to Mr. Crystal either directly or 17 indirectly, by the manner in which the questions 18 are asked, offer testimony against any other 19 respondent. He has not been designated on that 20 issue. He has not indicated that he would do that 21 in his testimony. That is far beyond what he said 22 in his 250-page deposition. 22854 1 So, I object to this; and I don't think 2 that it is pertinent to the testimony he gave in 3 his deposition. Whether or not the principle 4 applies to every person in USAT or not is not the 5 issue here. The issue is whether this person, 6 having said in his deposition specifically with 7 OTS present that he was not offering testimony or 8 an opinion against any other respondent than 9 Jenard Gross can now come in here and by the 10 manner in which he asks questions start offering 11 that opinion. 12 MR. SCHWARTZ: Your Honor, if the sky 13 is blue for Mr. Gross, it's blue for Mr. Crow. 14 The question is not whether or not Mr. Crow's 15 dollar figure in and of itself is unreasonable. 16 The question is whether or not the practice that 17 was applied to the analysis, that this expert 18 witness applied -- would apply the same to anyone, 19 regardless of who it was. Mr. Gross is just the 20 example that was used. But the analysis that he 21 applied is the same with everyone. The sky is 22 blue to Mr. Crow, as well. 22855 1 MR. VILLA: If that's the issue, let me 2 read the question and answer that was made. This 3 is classic sandbagging. Page 148. We're going 4 through the summary of Mr. Crystal's opinion. 5 "Now, the fourth paragraph on that page 6 starts out 'summary'?" 7 ANSWER: "Yes." 8 "It seems to me that it sets forth 9 essentially three opinions that you have arrived 10 at, the first opinion being that the pay of Jenard 11 Gross was excessive and unreasonable compared to 12 the pay offered by other similarly-situated thrift 13 organizations. Is that one of the opinions that 14 you arrived at?" 15 ANSWER: "Yes." 16 QUESTION: "Second is the compensation. 17 The composition of the pay package was also 18 unreasonable for an organization that at the time 19 the pay package was formulated was in terminal 20 condition. Is that the second opinion?" 21 ANSWER: "Yes." 22 QUESTION: "And just to be clear, is 22856 1 the pay package that is referred to in the second 2 opinion the Jenard Gross pay package?" 3 ANSWER: "Yes." 4 QUESTION: "The third opinion is that 5 Hewitt & Associates erred in its conclusion that 6 the size and composition of the pay packages 7 extended to Mr. Gross and his key subordinates 8 were reasonable. Is that a correct statement of 9 the third opinion?" 10 ANSWER: "Yes. Although reading this 11 now, I would probably, if I were editing my own 12 work, take out the phrase 'and his key 13 subordinates.'" 14 Then the question that I just read 15 before. "I asked you, are you going to offer any 16 other opinions than the ones that are set forth in 17 your report?" 18 "I sincerely hope not." 19 And then the question is: "Is that 20 fair to say that all of the criticisms are those 21 three opinions?" 22 ANSWER: "Yes, sir." 22857 1 So, Your Honor, I tell you, this is 2 not -- this is sandbagging. This man said in his 3 deposition at length -- and that's the reason he 4 wasn't questioned any more about it -- that he was 5 not offering an opinion against anybody but Jenard 6 Gross. That's why Mr. Blankenstein is sitting up 7 here, and that's why these questions are improper. 8 This is beyond the scope of his deposition. 9 MR. SCHWARTZ: First of all, the 10 questions that Mr. Villa is referring to deal with 11 the compensation of those individuals. If you 12 look at Mr. Crystal's report, he talks about the 13 compensation packages offered to the other 14 executives but specifically refers to the one 15 regarding Mr. Gross. 16 Secondly, the question -- I'm trying 17 to -- there's a clear distinction here between 18 what the overreaching that Mr. Villa is trying to 19 suggest is going on and what is actually 20 happening. What I am trying to do is apply the 21 same analysis regardless of who it was. If I 22 asked would the same analysis apply to Mr. X, if 22858 1 Mr. X's loan was forgiven under the same 2 circumstances, would that be unreasonable? It 3 doesn't matter if it was Mr. Crow or anyone else. 4 It matters about the practice. 5 MR. VILLA: That's the question that 6 was asked him. "Does your analysis apply to 7 anyone besides Mr. Gross?" And he said, "No." 8 That's what he was asked. In fact, he said "I 9 would edit it out." 10 Your Honor, this is sandbagging. They 11 know it, and they know he's here to testify about 12 Jenard Gross. And introducing any evidence and 13 receiving any evidence on any other respondents I 14 suggest is far beyond the scope of this witness' 15 purported testimony. 16 THE COURT: Are you saying that his 17 relates to all respondents or -- 18 MR. SCHWARTZ: With respect to -- in 19 answer to your question, no, I'm not. I'm saying 20 that his report deals with the people who are 21 enumerated in the report. He talks about senior 22 executives' compensation. He talks about senior 22859 1 executives' pay packages, including severance, for 2 example. 3 Those refer to everyone in the package. 4 That includes Mr. Crow. It includes Mr. Berner. 5 It includes Mr. Gross, and it includes Dr. Munitz. 6 That's clearly spelled out in the report, 7 Your Honor. The practice that I'm talking about 8 is not -- is not whether or not, as Mr. Crystal 9 testified, he talks about two analyses that he 10 makes, the how and the how much. That's what 11 we're talking about, the how and how much. We're 12 not talking about how much Mr. Crow got. We're 13 talking about how the forgiveness was accomplished 14 and whether or not that in and of itself is 15 unreasonable, regardless of what it is. 16 It's just the practice that's being 17 criticized. I don't think that's unfair, given 18 the testimony; and they were perfectly free to 19 address this. 20 What Mr. Villa is referring to here is 21 the "how much" issue. That's what is being 22 referred to in the transcript, not the "how." I 22860 1 think that I'm perfectly free to go into that, 2 especially in the very limited way that I've done 3 so which is only to ask whether -- 4 THE COURT: All right. I'm going to 5 allow it. 6 MR. SCHWARTZ: If I can remember what 7 the question was, I'll re-ask it. 8 MR. VILLA: May I have a standing 9 objection, then, to -- 10 THE COURT: Yes, you may. 11 Q. (BY MR. SCHWARTZ) Do you remember the 12 question, Mr. Crystal? The question was whether 13 or not your analysis of the manner in which the 14 companies accomplished the forgiveness of the loan 15 and the principal to Mr. Gross would apply in the 16 same way to anyone else. 17 A. I believe it applied to Mr. Crow. 18 Q. Your analysis I'm talking about, 19 whether or not it was a reasonable or unreasonable 20 practice. 21 A. As you said, I'm not competent to 22 comment on whether the amount forgiven for 22861 1 Mr. Crow was right or not right. But the 2 practice -- I would have made the objection over 3 $10 of saying that you set up a deal. You 4 presumably didn't enter into this deal without the 5 thought that the stock was going to rise. Well, 6 you know, sometimes we make assumptions; and they 7 don't come out right. Therefore, I'm not sure why 8 the board should bail out this executive, any 9 executive, no matter what the amount is. I think, 10 once again, you look at the plan and say what was 11 the intent and did you follow it. The answer is 12 no, you didn't follow it. 13 Q. The next bulleted paragraph talks about 14 the stock options pricing. You criticize that 15 practice. 16 Do you see that? 17 A. Right. 18 Q. Would you explain your criticisms of 19 the stock option repricing? 20 A. I jokingly said that we have the real 21 Olympics and the executive compensation Olympics. 22 In the real Olympics we ask you to jump over the 22862 1 bar at 5 feet. And if you do it, we move it up to 2 6 feet. The executive compensation Olympics, you 3 don't make it and we invite you to try again. 4 Q. That's the repricing analogy? 5 A. Yes. If we have to, we will bury the 6 bar. This is not a contest that the spectators 7 find particularly compelling but the participants 8 seem to like it. 9 So, there's this unfairness again that, 10 you know, you told the shareholders that there's 11 no money to be made unless the stock price rises 12 and now your response is, "Well, I was just 13 kidding." We've done this three times. This is 14 not the only time this has happened in American 15 industry. It is a practice that is condemned with 16 increasing severity in more recent years to the 17 point where the State of Wisconsin Investment 18 Board is on the warpath against companies that do 19 this and putting all sorts of resolutions on their 20 proxy statements and demanding that the company 21 get the shareholders' approval before each just 22 act of repricing occurs. 22863 1 Q. You talked about the act of repricing. 2 Is there any significance to the fact that there 3 were three stock repricings at UFG? 4 A. No more than the significance of three 5 murders over one murder. 6 Q. Based on your knowledge and experience, 7 is it an unreasonable compensation practice -- and 8 I don't know if "excessive" is the right word -- 9 but excessive to reprice stock options in this 10 manner? 11 A. Yes. I do believe it is the case. You 12 often find -- once again, I've noted that I think 13 that most CEOs carry in their briefcase a tiny 14 little wash basin and towel and soap and they wash 15 their hands in front of the shareholders and say, 16 "This is not my fault." 17 You say, "Well, wait a minute. If the 18 stock market had gone up by 500 percent, that 19 might have not have been your fault either." 20 It's funny how we blame Alan Greenspan 21 on the downside and President Clinton and 22 Monica Lewinsky. We blame the Asians. We blame 22864 1 interest rates. When the stock goes up, it's my 2 brilliance as a cause for reward. We don't care 3 what causes it to go up. The shareholders like it 4 to go up. If it goes up, you get a lot of money. 5 If it goes down, we don't care what causes it to 6 go down: The market crash, the Texas economy is 7 in the tank. It doesn't matter. You don't get a 8 lot of money. Now, that's fine. That's a fair 9 and symmetrical range. If we then say when it 10 goes up, that's your brilliance, I find that an 11 abusive practice in no matter what company it 12 occurs. 13 Q. In the next bulleted paragraph, you 14 commented on the performance unit plan or PUP? 15 A. Yes. 16 Q. And you state that an employee earning 17 units in the PUP for a reduction in losses 18 reflects the entitlement attitude at UFG. 19 What did you mean by that? 20 A. What I meant here is this ex-post 21 rewriting of the rules of the incentives. So, 22 originally, when the incentive plan was put in, it 22865 1 required a growth in the book value of not less 2 than 7 and one-half percent per year at which 3 point you could begin to get some money. If the 4 growth in the book value reached 15 percent per 5 year, you would end up receiving the maximum 6 amount allocated to you under the plan. Far from 7 the book value growing at 7 and a half or 8 15 percent per year, the book value, you know, 9 exhibited the aerodynamic characteristics of a 10 refrigerator and dropped, you know, right into the 11 ground at which point there's records here that 12 suggest the board is now saying, "Well, maybe we 13 have to find a new way of rewarding people." 14 So, it's generally believed that you 15 should have to tie rewards to something that's 16 going up because inverse series are hard to 17 understand. 18 So, somebody apparently latched onto 19 the notion that we could perhaps recycle this plan 20 and put it back to use by rewarding you if you 21 reduce the negative income of the company, that 22 you get the negative smaller even though you 22866 1 perhaps don't get back to the point where 2 parentheses are no longer needed. This is a 3 common -- unfortunately all too common behavior in 4 many companies. 5 It's what gives executive pay such a 6 bad name because people won't take their lumps 7 again. I keep saying that the easy pay for 8 performance is high pay for high performance. 9 That's the point where CEOs need to stand up and 10 be counted and say, you know, "I was perfectly 11 willing to take it on the up side and now there 12 isn't an up side." That's fair. That's the way 13 it should be. Here we're talking about recycling 14 the plan and giving people the chance to make a 15 lot of money. 16 Q. You state in the next paragraph that, 17 in short, the senior executives of UFG as well as 18 those outside directors who back them up 19 demonstrated that theirs was not a belief in pay 20 for performance. Theirs was a belief in pay 21 period and excessive pay at that. 22 Now, in your analysis, did you review 22867 1 any documents that indicated a pay philosophy of 2 rewarding performance? 3 A. Yes. I mean, I believe I did some see 4 notation that is -- for example, with merit 5 increases, we want a reward for meritorious 6 performance. But that was an explicit statement. 7 Other statements in effect are implicit. That is 8 to say, if we adopt a stock option plan, we are 9 implicitly buying into the notion that we are 10 rewarding for the performance. You get more if 11 the stock price goes up. And so, it was 12 abundantly clear to me that on the up side, for up 13 side performance, that the company was a stout fan 14 of pay for performance. 15 Before the performance turned south, 16 one would presume that they would have told you 17 that if it does, they were going to be tough. 18 Companies lose their heart and people say, "Well, 19 we have to keep the good people; and we have to 20 pay them a lot of money." 21 Q. Did you see anything in your review of 22 materials that, indeed, was the practiced 22868 1 philosophy at USAT and UFG, that there was a pay 2 for performance going on? 3 A. Well, I mean, I believe, as I 4 mentioned, I saw this reference to the salary 5 increases and then the implicit pay for 6 performance contracts that existed in the various 7 incentive plan. 8 Q. Now I'm asking you whether or not what 9 you saw evidence that pay for performance wasn't 10 the standard at UFG and USAT. 11 A. Well, I think we've been talking about 12 this all along. It wasn't the standard. 13 Q. I'm talking about the actions that were 14 taken, were they consistent with a pay for 15 performance system? 16 A. No. They were totally inconsistent 17 with that. 18 Q. Did you see any evidence that there was 19 any penalty or punishment for top management's 20 nonperformance? 21 A. That's an interesting question because 22 if you ask yourself, you say, "Well, is there 22869 1 anything in the record that I saw where someone 2 got less?" 3 And you say, "Well, they certainly 4 didn't get less salary. They got more salary." 5 They didn't get less bonus. Mr. Gross 6 got twice as much as he got the preceding year. 7 He got his loan forgiven. It's hard to think of 8 anything where someone lost anything. I suppose 9 you could say, "Well, wait a minute. The stock 10 options didn't pay off. In fact, they didn't pay 11 off even with three different repricings; and the 12 performance unit plan didn't pay off." 13 So, from an opportunity argument, you 14 could say, well, there was a penalty because the 15 receipt of the money never occurred. That's a 16 little different than a real cut where I saw last 17 year you got an 80,000-dollar bonus in your W-2 18 and this year it's zip. Last year your salary was 19 291, and this year you got 250. I saw no actual 20 real cuts in W-2 income. 21 Q. In the last paragraph on Page 6, you 22 state that, "It distresses me to observe the 22870 1 rationalization that takes place in the difficult 2 times in which some organizations, including UFG 3 in late 1987 and early 1988 find themselves. In 4 the good times, companies will often pay highly 5 and define their high payments as being fair and 6 just in relation to the performance that has been 7 delivered. But in the bad times, the very same 8 companies will switch seamlessly to a different 9 argument, namely that we, quote, 'have to keep our 10 people,' close quote. But if a company is going 11 to pay highly in the good times so as to reward 12 high performance and then pay highly in bad times 13 so as to retain its people and if there are only 14 two types of times, good times and bad times, when 15 is it that the company pays other than higher? 16 The answer is sadly for companies like UFG is 17 never." 18 Now, you say it distresses you to make 19 this observation of the rationalization of 20 switching from good pay to good times and bad 21 times. 22 Based on your knowledge and experience, 22871 1 was it an unreasonable compensation practice and 2 excessive for UFG and USAT to have done so? 3 A. Yes, I believe so. 4 Q. Why? 5 A. Once again, I go from two standards. 6 One is that the company was in such financial 7 straits that the notion of contemplating pay 8 raises just seemed to be bizarre. Secondly, that 9 the plans themselves that called for high pay in 10 good times and low pay in bad times were being 11 turned upside down and the contract, if you 12 will -- I don't necessarily mean legal contract -- 13 but the sole contract that you have with the 14 shareholders was being violated where we're really 15 in a position of saying, "we're just kidding when 16 we said there would be no pay in the bad times." 17 Q. On Page 5 of your report, you 18 criticized the severance pay packages. 19 Do you see that? 20 A. Yes. 21 Q. Would you explain your criticism? 22 A. Well, severance pay has certainly 22872 1 become quite common in the American business for 2 senior executives. And the size of severance pay 3 packages has grown and -- to the point where these 4 severance pay packages, were they judged by 5 today's standards, would be relatively modest. 6 The Congress in 1984 passed legislation, the 7 so-called golden parachute compensation tax, that 8 said if you had a severance pay in a change of 9 control that's valued at more than three times 10 your average annual pay or more, the company loses 11 its tax deduction on a great deal of the 12 compensation and the executive has to pay a 13 20 percent surtax. 14 So, in effect, three times or more of 15 total pay is unreasonable; and I suppose you would 16 have to argue logically that severance of less 17 than three times is not unreasonable. So, from 18 that standpoint, you look at these packages and 19 say they are relatively unremarkable. One does 20 have to raise the issue as to when they were 21 negotiated. 22 Q. What do you mean? 22873 1 A. Well, it's -- people, for example, get 2 life insurance with the sincere hope that they 3 won't be making a claim very soon. And companies 4 put in severance pay on sort of a hypothetical 5 possibility that if certain things should happen 6 at some very distant time in the future, there 7 will be some benefits for you. But most insurance 8 agents are loath to insure a terminally ill 9 patient where they are looking at the monitors and 10 seeing a flat green tracing. 11 By the same token, at the time when the 12 organization looked like the probabilities of 13 having to pay severance were, you know, very, very 14 high -- if not 100 percent, very close to it -- it 15 seemed to be not the right time to take a 16 broad-brush blanket approach and say that 17 everybody who fits a certain category, whether 18 they are good or bad, gets two times pay should it 19 be necessary for them to terminate their services. 20 Q. Was it an unreasonable compensation 21 practice and excessive to award contracts that 22 offer severance packages of two times salary? Was 22874 1 that an unreasonable practice? 2 A. I believe it was in the context of that 3 time. 4 Q. Now, do you have any criticism with the 5 calculation of the amount of the severance, the 6 base number before you get to the two times? 7 A. Yeah. Well, that's -- you know, 8 obviously, the severance in this case is the 9 product of two numbers. One is the number 2; and 10 the second is the number to which the 2 is 11 applied, the salary. 12 Now, we know that the salaries were 13 increased remarkably in, I believe, March of 1988 14 when Mr. Gross, for example, received a salary 15 increase of $167,000 so that when these severance 16 pay contracts were negotiated, that meant 17 automatically that should Mr. Gross' services be 18 terminated in such a way as to make him eligible 19 for severance, he would get an extra $340,000 of 20 severance solely because he got an increase of 167 21 which I do not believe was warranted. 22 My own posture would be that if you had 22875 1 to have severance, you would apply it before you 2 did that increase, that you wouldn't compound the 3 felony by adding it to the higher number. 4 Q. Now, I'll switch topics for a moment. 5 THE COURT: Mr. Schwartz, let's adjourn 6 for lunch until 1:15. 7 MR. SCHWARTZ: Yes, Your Honor. 8 9 (Whereupon, a lunch break was taken 10 from 11:48 a.m. to 1:20 p.m.) 11 12 THE COURT: Be seated, please. We'll 13 be back on the record. 14 Mr. Schwartz, you may continue with 15 your examination. 16 MR. SCHWARTZ: Thank you, Judge. 17 Q. (BY MR. SCHWARTZ) Before we broke, we 18 were talking about the severance packages. 19 A. Yes. 20 Q. And were there any other criticisms 21 that you make concerning the severance pay 22 packages that were offered to these senior 22876 1 executives? 2 A. Well, there was the issue of the 3 allocation of the severance pay as between UFG and 4 its subsidiary, USAT, and -- 5 Q. What do you mean? 6 A. I'm sorry? 7 Q. What are you referring to? What do you 8 mean? 9 A. Well, my understanding was that for 10 most employees, that UFG was underwriting 11 20 percent of the severance pay, although it was 12 15, I believe, for Mr. Gross. And USAT was 13 underwriting 80 percent, and that was 85 percent 14 for Mr. Gross, based on supposedly an allocation 15 of their time as between the two entities. And of 16 course, that allocation is commonly done in 17 enterprises where you have two different entities 18 for cost accounting purposes. 19 Q. So, what's the significance of that in 20 connection with the severance package? 21 A. Well, my -- you know, it would be one 22 thing if you then followed your accounting 22877 1 procedures and you paid 20 percent or 15 percent 2 to Mr. Gross out of one entity and 85 to Mr. Gross 3 out of another and just left it at that. But my 4 understanding is there was sort of a coinsurance 5 feature here such that if one entity could not pay 6 the whole -- if Mr. Gross, in effect, was not 7 going to get the whole 100 percent of his 8 severance, the other entity would pick up the 9 slack, whatever that was, which would be, in 10 effect, sort of a violation of the cost accounting 11 principle that led you to that allocation in the 12 first place. 13 So, you would be allocating cost for 14 someone's labor to an organization that received 15 nothing in return for those services by the 16 company's own allocation. 17 Q. And does that analysis have application 18 in connection with the amounts that -- the how 19 much of the severance package? 20 A. Well, I mean, if you were following the 21 allocation and it turned out that one of the two 22 entities could not pay its allocated share, I 22878 1 would think it would not be reasonable for the 2 other entity to pick up the allocated share. In 3 other words, rather, the other entity would pay 4 what it was contracting to pay, which would 5 obviously be a lesser amount. And I wouldn't see 6 the other entity as being reasonably picking up 7 the other share because, by definition, it would 8 be paying money for no services performed. 9 Q. Okay. Do you have any other criticisms 10 concerning the severance package? 11 A. Well, the only -- you're talking about 12 the design of it or the actual application of it, 13 payment of it? I'm not sure what you're -- 14 Q. Well, why don't you -- do you have any 15 comments concerning an analysis of any of those? 16 A. Well, there is the issue on the 17 severance as to -- I think we've already sort of 18 talked about the fact that at least my view of the 19 world was that it was not the proper time to have 20 a severance pay contract. That nevertheless, if 21 you did have one, I would think it would have been 22 more reasonable to think about applying it to the 22879 1 salary before the inclusion in the salary of these 2 bonuses. And then there is this further issue, 3 this 15 percent/85 percent aspect which muddies 4 the water still further. But there is finally a 5 fourth issue which I note from the agreements, the 6 severance agreements -- and, you know, I 7 previously confessed that I'm not a lawyer and 8 this is a legal agreement and maybe I'm missing 9 something, but the agreement would seem to suggest 10 that if someone resigns their employment -- that 11 is to say, they are not fired for other than 12 cause, they are not pushed out, they just say, 13 "Hey, I quit," that they would be entitled to no 14 severance whatsoever and that there just wouldn't 15 be any payment forthcoming with the single 16 exception that if they quit following a change of 17 control, then they would be able to claim those 18 benefits. But I could not see how there could 19 have been a change of control under the 20 circumstances at that point. And from what I can 21 gather from the correspondence, Mr. Gross, in 22 effect, freely resigned, that this was not one of 22880 1 these papered over terminations you see in often 2 many companies where we put out to the press that 3 the person's resigned but, in fact, we all know 4 wink, wink, wink that the person's been fired such 5 as, for example, happened to Michael Ovitz at the 6 Walt Disney Company where he -- it was said in the 7 press releases that he resigned. And then, of 8 course, people said, "Well, if that's the case, 9 how could he possibly have gotten severance pay 10 which was estimated to be north of $80 million?" 11 And the fact is he was fired. But we were just 12 playing a word game. 13 But in this case, from what I can read, 14 it does not appear that Mr. Gross was pushed out 15 but that he went out under his own power. And if 16 that's so and if I read the document correctly -- 17 maybe I'm not reading it correctly. But if I do 18 read it correctly, it would seem to me that he 19 would not have been able to receive any severance 20 pay given that set of circumstances. 21 Q. And what did you, in your review of the 22 documents -- what did you understand Mr. Gross 22881 1 received as severance? 2 A. Well, my understanding is that there 3 was a trade-off done at the last minute, that 4 Mr. Gross, when he was going to resign, owed the 5 company the 761,000 due in respect of the note 6 that he gave the company to purchase the shares of 7 stock that he purchased earlier and that the 8 company, in theory, owed him two years' of 9 severance pay and that there's some minutes that 10 refer -- or memos that reflect that -- some 11 calculations done that said, "Well, what do you 12 know? What Mr. Gross owes is pretty much the same 13 amount within just a few thousand dollars of what 14 we owe him and that, therefore, rather than him 15 paying us a check and we pay him a check, why 16 don't we just cancel the two out so that" -- 17 Q. That's assuming that the company did, 18 in fact, owe him some kind of severance? 19 A. Well, that assumption was made. I 20 mean, I happen to believe from what I read that 21 that assumption would fall into what was known in 22 academia as an heroic assumption. But I think 22882 1 that it was made. 2 Q. Did you reach any conclusions regarding 3 Mr. Gross' total pay? 4 A. Yes. 5 Q. And first of all, let's talk about your 6 methodology. 7 How did you go about identifying or 8 reaching those conclusions? 9 A. Well, the first thing I did was to pick 10 a group of thrift organizations to study for the 11 years -- for the year '88 to look at and see what 12 they paid their CEOs. And if memory serves, I 13 originally had identified, I think, something like 14 45 institutions I wanted to study; and I was 15 picking them in the range of -- I think it was 3 16 to $12 billion of revenues with, in effect, USAT 17 sort of in the middle of that range. And I was 18 paying particular attention to thrifts that were 19 headquartered sort of in the middle western area 20 of the United States because, unlike some of the 21 other companies of this sort of size which might 22 operate nationally, thrifts almost by extension 22883 1 sort of are in their small areas. And I wasn't 2 sure whether there might be some geographic pay 3 difference that would be operative there and, 4 therefore, I'd be better off concentrating in the 5 particular area. 6 And so, I tried to get the proxy 7 statements for these companies. I went to 8 Disclosure, which is the service -- the 9 subcontractor to the SEC which has all of the back 10 proxy statements. And they came back to me and 11 said, "We can only find 17 of the proxy 12 statements. We just don't have them." 13 And so, I worked with the 17. I mean, 14 I'm not aware that there was any bias to doing 15 that because I didn't call the 17 and there 16 wouldn't seem like there would be any systematic 17 reason why, for example, all the low-paying 18 thrifts were available but the high-paying 19 weren't, that sort of thing. 20 And I would have preferred to have 21 more, but I took everything I could get. And then 22 I started looking at all the various forms of 22884 1 compensation that go into an executive's pay 2 package. 3 So, we started with the base salary, 4 and I looked at the bonus for annual performance 5 that other companies would pay. And then I looked 6 at their various long-term incentive plans and 7 their values. Typically, there are three 8 long-term incentive plans that apply -- or up to 9 three that apply in various companies. And one, 10 the most common, is stock options where you are 11 granted an option where you have the right but not 12 the obligation to buy a number of shares of stock 13 at the current market price almost always and over 14 a 10-year period. 9 of the 17 companies had that 15 sort of an arrangement. Eight of them did not, at 16 least in the year '88. 17 Then I also looked at the grant of free 18 shares of stock where, in effect, the executive, 19 rather than being given an option to buy the 20 stock, is just given the shares totally free. 21 So, if the stock is $50, I'm giving you 22 10,000 shares free, that's worth $500,000. 22885 1 Typically, the condition precedent to receiving 2 those shares is that the executive must remain 3 with the company for a number of years. And if he 4 doesn't, the shares are forfeited. They are 5 restricted from resell for tax reasons, and hence, 6 they have been given the name restricted stock, 7 restricted shares. 8 Two companies had that sort of an 9 arrangement. And I would say that although the 10 USAT/UFG -- that loan arrangement for Mr. Gross 11 did not start out to be a restricted stock 12 arrangement, that effectively is what it ended up 13 being because we're going to now forgive all the 14 price. So, by forgiving it, we're driving the 15 price to zero and the person has to serve a number 16 of years. 17 Q. You mean the note, forgiving the note? 18 A. Forgiving the note. Excuse me. And 19 the person has to serve a number of years. And 20 those are the very hallmark characteristics of a 21 restricted stock grant. You pay nothing. You're 22 not required to do anything other than stay with 22886 1 the company. I mean, you didn't hear me say you 2 had to have a 15 percent growth in earnings or 3 something like that. So, two companies gave those 4 sorts of grants; but none of the others did in 5 that particular year. 6 Then the last form of executive 7 compensation is the form of compensation typified 8 by the so-called performance unit plan at UFG. 9 Q. I'm sorry. You said that the last form 10 of compensation -- 11 A. A long-term incentive compensation. 12 Excuse me. 13 Q. I'm sorry. 14 A. The long-term incentive compensation is 15 the plan typified by the so-called performance 16 unit plan that UFG adopted. And this is a sort of 17 plan where, like all long-term incentive plans, 18 you're trying to reward for performance not in a 19 single year like 1988 but over a series of years 20 taken together. 21 So, the underlying theory is that the 22 executive will exhibit, say, a get-behind-me-type 22887 1 of behavior and not maximize the earnings this 2 year by cutting the R&D budget or cutting the 3 management development, shaving the product 4 quality; but he will say, "No, no. If I do that, 5 I may have a good year this year but all my 6 long-term incentives will be worthless." 7 Q. I'm not sure I understand what you mean 8 by that. 9 A. What I'm saying here is that if I were 10 to just give you an incentive that said "I'll give 11 you every year 10 percent of the profits of the 12 company, you might decide that one way to get 13 there or to make the most money is to take such 14 actions as -- let's say you were a drug company. 15 Say, "Well, let's cut out the R&D budget and 16 reduce it down to almost nothing." That would 17 groove the profits by 100 million right there and 18 I'll get 10 million from it. And let's cut the 19 advertising down and let's cut the management 20 training down and, you know, do we have to put the 21 capsules in such fancy bottles? Why can't we just 22 use something cheap, put it in an envelope and 22888 1 lick it and say give it to people and various 2 techniques like that?" 3 Well, I would be getting very big 4 bonuses for a while. Now, if I could time it 5 right and I could quit and join another competitor 6 before my former company falls apart for lack of 7 any new products and good products, my legend 8 would be enhanced because they would say "when he 9 was there, the profits were awesome and now he's 10 making more profits at another company." 11 But short of that, you know, I -- well, 12 as I say, he would end up possibly doing something 13 you shouldn't be doing for the long-term welfare 14 of the shareholders. 15 So, the notion arose in the world of 16 executive pay that what you needed as sort of the 17 antidote -- you know, you have a drug here but it 18 has some side effects. So, we need another drug 19 to counter the side effects of this drug. And 20 this drug is going to make you look out for 21 several years. And so, you will say, you know, 22 "Gee, if I do cut the R&D budget, you know, there 22889 1 is not going to be any long-term profits. And 2 where -- and I've got now a stake in the long-term 3 future. And so, I'm going to do -- I'm going to 4 act more prudently and take the longer-term 5 interest into effect." 6 Well, that was the intention behind, 7 I'm sure, this performance unit plan that was 8 adopted by UFG which said "we're going to measure, 9 in this case, the performance of the growth in the 10 book value of the company over a period of years 11 and if it's less than 7 and a half percent 12 compounded growth rate, the executives will 13 receive nothing. And if it's a 15 percent, they 14 will get the full award promised to them. And in 15 between, we'll do some sort of interpolation. 16 So, the notion here was in this class 17 of plan that we're tying you to the future, 18 multiple year periods; but unlike the free share 19 plan, you do have to do something to earn this 20 because it says very clearly that just breathing 21 in and out 17 times a minute is not going to do 22 the trick. Under this plan, you have to have a 22890 1 growth in the book value of at least 7 and a half 2 percent per year, for example. 3 No other company had a plan like that 4 among the 17. In fact, I would observe 5 parenthetically that it is the rare company that 6 has three different incentive plans operating at 7 once. It turns out from my many, many studies of 8 executive pay that one of the most powerful 9 predictors of whether a CEO will be overpaid or 10 not overpaid is the number of long-term incentive 11 plans that he has operating at any point in time. 12 Q. Why is that? 13 A. It's because what happens here is as a 14 company adds a new long-term incentive plan to its 15 motivational arsenal, it almost never cuts back on 16 the plans it already has to -- at least to a 17 sufficient level to make room for the new plan. 18 So, pay just goes up. 19 So, you know, we were getting a 50,000 20 option share award, and you know, the stock isn't 21 doing so well. So, let's put in a new plan and 22 you'll still get a 50,000 option share award and 22891 1 now you have a new plan and you have the potential 2 for more compensation. 3 So, in this analysis, I looked at 4 the -- the -- first of all, I looked at the stock 5 options. So far, I've had salary and bonus for 6 Mr. Gross. I looked at the stock options. In 7 this case, you would -- you might look at them and 8 say, "Well, these stock options are valueless 9 because the market price has dropped so much." 10 And the options are, so to speak, under water as 11 the term is known where the strike price, i.e., 12 the price you must pay to exercise them, is higher 13 than the market price of the stock so that you 14 would then find that a person exercising an option 15 under those circumstances would be, you know, 16 admitted instantly to the masochist society as a 17 charter fellow member. 18 In any event, in this case, the options 19 for Mr. Gross were repriced in 1988. That is to 20 say, the price -- the strike price that he had to 21 pay which had been repriced twice before was 22 repriced again. This time, down to 69 cents a 22892 1 share. And economists look at a stock option 2 differently than most lay people do. And that is 3 to say, you know, if you say to an executive on 4 the day he gets a grant -- let's say in this case 5 300,000 shares at 69 cents and you say this option 6 has value and they would probably reply, "Well, 7 what are you talking about? The stock's at 69 8 cents. The price I have to pay is 69 cents. If I 9 were to exercise that option today, I would get 10 nothing from it. So, what do you mean it has 11 value?" 12 But an economist would say, "Well, wait 13 a minute. You know, you are getting a 10-year 14 call on the stock, if you will. You have the 15 right but not the obligation to buy the stock for 16 69 cents over the next ten years of time and 17 that's a very valuable right." Indeed, the entire 18 Chicago Board Options Exchange rests on the -- on 19 that very concept that options do have value, even 20 if they are under water, as long as there is some 21 time remaining to their expiration. 22 And so, what I do here as most 22893 1 economists would do is to apply a so-called option 2 pricing model. In this case, the Black-Scholes 3 option pricing model which is named after two 4 Nobel winning -- prize winning economists, 5 Fisher Black and Myron Scholes. And the model, in 6 effect, which is widely used in Wall Street, is 7 used to determine what the -- an option is worth. 8 So, you're almost answering this 9 question about Mr. Gross. You're saying, "Well, 10 on the day he got this option, one hundred 11 thousand -- excuse me -- 300,000 shares with a 12 price of 69 cents, the market price was 69 cents. 13 If he had been able to call Salomon Brothers and 14 Merrill-Lynch, Morgan Stanley, and say to them, 15 'Look. I have a 10-year call on this stock and 16 I'd like to sell it for some money, what would you 17 give me for it?'" 18 Well, we know that he can't sell it 19 because of the terms of the grant; but this is 20 sort of a hypothetical exercise. You know, they 21 would come back and probably -- depending on the 22 assumptions that go into these -- into the model, 22894 1 they would probably come back and say that option 2 has a value of about 30, 40 percent of the 3 underlying value of the common stock. 4 So, if we took 300,000 shares -- and 5 let's make it 70 cents a share to make it a round 6 number that I can use -- that's 210,000. You 7 might expect that option to have a value of around 8 $80,000 or something like that. Although, in this 9 case, I found the value to be somewhat higher 10 because the company does not pay a dividend. And 11 for certain technical reasons, an option is worth 12 more where there is no dividend. 13 So, what I did was to apply a 14 hypothetical value to Mr. Gross' option. And then 15 I did the same thing to every one of the nine of 16 the 17 thrift companies that gave options and got 17 values for them using the same methodology. 18 And then I turned to the -- the issue 19 of the performance unit plan, but I counted that 20 as nothing because there had been no payouts and 21 certainly, there was no evidence that there were 22 going to be any payouts. The board, I think at 22895 1 one point, talked about changing the methodology 2 for awarding payouts, but I don't believe they 3 actually adopted it. 4 And so, I counted that as nothing. And 5 then at this turned to the -- the issue of the 6 loan forgiveness. And I saw that basically as 7 being the equivalent of a restricted stock grant. 8 That in this case, we're just forgiving 761,000. 9 Now, of course, had the company been in 10 existence -- if you could have contemplated that 11 the company would stay in existence, you would 12 only account 76,000 of that against his '88 pay 13 because it was to be forgiven at the rate of 14 10 percent per year. But, of course, the 15 company -- 16 Q. You mean -- 17 A. -- went out of existence. 18 Q. You mean the loan amount? 19 A. Was to be forgiven at 10 percent a 20 year. So, you might say, "Well, in a going 21 concern basis, it would be gilding the lilly to 22 count the whole 716,000 in a single year because 22896 1 the service period over which the money was to be 2 earned was ten years." 3 However, I did count it as the full 761 4 for the simple reason that there was no 5 services -- there were no services after the end 6 of '88 and it has to be charged somewhere. We 7 can't just have it go into the heavens and 8 disappear. So, I charged the 761. 9 So, in summary, I added up all of those 10 items -- salary, bonus, the present value of stock 11 options, nothing for the performance units, 761 12 for the loan forgiveness. 13 One thing I neglected, I might add, was 14 I happened to be just looking at the proxy 15 statement this morning. And I noticed a footnote 16 which I hadn't noticed before which seems to 17 suggest that the top officers also received 18 $24,000 a year more for director's fees for being 19 directors of UFG and USAT. It's highly unusual 20 for officers of a company to receive fees for 21 being a director as if they were an outsider 22 because the argument is they are paid very 22897 1 substantial sums of money and that's plenty and we 2 don't need any more to attend a few meetings. 3 I forgot the 24,000. It's a minor 4 item. It wouldn't have changed my conclusions one 5 way or the other. But I put all that together, 6 and I looked at the competitive data. And the 7 competitive data, as in all surveys, you find a 8 wide range of pay. It's not that everybody is 9 earning, you know, within 10 percent of some 10 average. And what I did was I tried to ask the 11 question statistically. "Is there any way you 12 might explain this wide range in pay?" For 13 example, we have companies from 3 to $12 billion 14 in revenues. Is it possible that statistically 15 there is a correlation, albeit not a perfect 16 correlation between the size of the company as 17 measured by its revenues and the total pay? In 18 other words, other things being equal, the bigger 19 revenues, the bigger the pay. And the answer was, 20 yes, there is that sort of correlation. It's not 21 perfect, by any means, but it does exist. 22 I then said, well, what about 22898 1 performance against pay, past performance? Could 2 that be used to predict the pay? And the answer 3 there was no, it didn't seem -- it didn't seem to 4 rise to a level of statistical significance that I 5 would require to put that in. 6 So, basically, I came up with a size of 7 pay for Mr. Gross, a competitive size of pay based 8 on the size of the company. And then I reasoned 9 that -- I did two things. I sort of took 10 something away and added something. I added more 11 than I took away. I reasoned that, well, here's a 12 competitive level of pay. But in this situation, 13 a competitive level of pay is not deserved because 14 the performance is poor. 15 So, I cut that figure by a relatively 16 small amount, about less than 8 percent of the 17 total, I think, but some sort of symbolic cut. 18 But then on the plus side, I reasoned that -- I 19 reasoned that you don't have a monolithic 20 structure where everybody earns the same amount. 21 You have certainly people that are far above the 22 average and that, within reason, if UFG paid an 22899 1 amount that was significantly above the average, 2 you couldn't really call it unreasonable because 3 otherwise, the average wouldn't be the average. 4 And so, I posited a higher amount, 5 technically two standard deviations above the 6 trend line, but that took the amount up by a 7 substantial sum of money. 8 So, to make a long story short, I 9 pretty much ended up with a competitive pay level 10 of somewhere in the 800,000 range. I could 11 consult my report to give you the number. I think 12 it was about -- 13 Q. It's on Page 3. 14 A. Yeah. Well, it actually mentions it on 15 Page 3 -- oh, I'm sorry. I think it was $766,000, 16 I believe. The $766,100 that I came up with as a 17 competitive level of pay which added in a 18 substantial amount to recognize the fact that a 19 lot of -- there are companies that pay a lot more 20 than the trend line for whatever reason. 21 And so, I gave him the benefit of that 22 doubt. And then I added up all of his pay. And 22900 1 all of his pay added up to, by my estimation, 2 1,567,000, a number that was, you know, much 3 higher by -- almost by double. 4 Q. When you say "pay," you're talking 5 about the salary, bonus, the value of the stock 6 options -- 7 A. The loan forgiveness, the whole thing. 8 And that's what I came up with. 9 So, I concluded from that that at least 10 in this one year, 1988, that he was very much 11 excessively paid because my roughly 800,000-dollar 12 pay number already included an allowance for being 13 way above the trend line. And now, this was twice 14 above that. 15 So, to my mind of thinking, he was 16 clearly overpaid. And, of course, you can see 17 from this analysis that the largest portion of the 18 overpayment was being driven by the forgiveness of 19 this loan. But to forgive a loan is to grant pay. 20 In fact, the IRS considers that W-2 income every 21 time. That is W-2 income, and it is pay. 22 Now, I know there is an argument to 22901 1 offset it that says, well, we shouldn't count it 2 because there is a severance amount that he gave 3 back. But I would submit to you that Mr. Gross 4 gave the company the sleeves out of his vest 5 compensation-wise because, in my way of 6 understanding, he had no entitlement to any 7 severance pay. 8 So, if that argument is true, then, in 9 fact, he made about twice what even an extremely 10 generous level of pay would give him. 11 Q. In your earlier testimony this morning, 12 you talked about the decision-making process at 13 UFG/USAT. And Mr. Whatley was a name that was -- 14 that has come up as the independent director on 15 the compensation committee. 16 Did the fact that Mr. Whatley owned 17 shares of stock enter into your analysis? 18 A. Well, I certainly -- 19 Q. Shares of stock in UFG. 20 A. I certainly looked at it briefly. I 21 mean, I know that he owned, I believe, some -- 22 earlier, some 36,000 shares that had a market 22902 1 value of around $270,000 I think at the time that 2 Mr. Gross took his loan out. And the market value 3 by the time of the -- of these actions here had 4 dropped some 90 percent or so to about $25,000, 5 thereabouts. And I'm mindful of the fact that 6 there are different people who have advanced the 7 theory that a CEO -- or excuse me -- that outside 8 directors, if they own substantial amounts of 9 shares, will act in a better manner for the 10 shareholders, that they will keep the 11 shareholders' interest more firmly in mind than if 12 they didn't own a lot of shares. There have been 13 various academics from Harvard and elsewhere who 14 have advanced this theory. 15 And for my own part, I -- when some of 16 these experts were opining on this subject, I went 17 to my databases a few years ago and used this data 18 for an article I wrote for the Los Angeles Times. 19 And I was fascinated by the theory. I said, well, 20 maybe there is something to this. So, I went to 21 my databases and I picked the 15 most successful 22 companies I could find. And success was measured 22903 1 as their total shareholder returns, i.e., stock 2 price, appreciation, and reinvested dividends, 3 their total shareholder returns between '87 and 4 '94, a seven-year period. I did the study in '94; 5 so, that's where I had to end it. And I had data 6 going back to '87. So, that is what framed the 7 seven-year period. 8 I picked the 15 most successful 9 companies in terms of total shareholder return. 10 You would have loved to own those 15 stocks. And 11 I picked the 15 most unsuccessful companies, the 12 poorest-performing companies. 13 And then I went back to the proxy 14 statements of these companies in 1987 at the 15 beginning of the period and I looked up each 16 outside director and calculated the value of his 17 shares at that time and also the number of his 18 shares expressed as a percentage of the shares 19 outstanding. 20 So, I had two ways of looking at it. 21 One, a director owned, for example, $300,000 worth 22 of stock and that turned out to be .12 percent of 22904 1 the shares outstanding. And then, I ran a 2 statistical regression analysis where I asked the 3 question, well, knowing the shares of the 15 most 4 successful companies and the 15 least successful 5 companies, can those shareholdings be used to 6 predict the performance of the companies between 7 '87 and '94? And the machine came back and said, 8 no, there is no significant correlation whatsoever 9 between the shareholdings and the future 10 performance. I said, well, let's try '87 to '93. 11 And the machine came back and said, "Keep trying." 12 '87 to '92. "Keep trying." '87 to '91. This 13 went all the way back to '87 to '88. And the 14 answer was nothing. 15 Now, that was just one study. And 16 other studies might come up with a different 17 conclusion. But I would note, however, that just 18 in the last couple of weeks, the Conference Board, 19 which is a highly respected management research 20 organization based in New York City, issued a 21 report on this very issue of whether share 22 ownership motivates. And I believe it was sort of 22905 1 addressed at both directors and CEOs, not just 2 directors alone. And the professor who wrote the 3 study I think looked at some 79, if memory 4 serves -- some 79 studies done by academics over 5 the last number of years and applied some very 6 fancy statistical tools of which I'm not -- I 7 don't have any current knowledge of and concluded 8 that after sort of sifting through the radio 9 static and the various findings that were being 10 set forth, that there was no credible case to be 11 made that ownership of shares instantly makes you 12 into a wise person and a person who never makes a 13 mistake decision-wise. 14 But I would say there certainly have 15 been some studies which would still show you there 16 is some correlation. But I think the important 17 thing here to note is that even if there is a 18 correlation, the correlation is extremely modest. 19 You know, there is noise all over. We can't just 20 say that someone who owns 300,000 worth of shares 21 is going to be transformed into this wonderful 22 director instantly to a person who makes all the 22906 1 right decisions. 2 Among other things, I would note that 3 in this particular case, you have a person who 4 owned $300,000 of shares and steadily watched the 5 share price drop 90 percent and even then did not 6 take any action except to raise the pay of the 7 executives. 8 So, if anything, if there is such a 9 correlation, I would submit to you that 10 Mr. Whatley is an outlier in the statistical data 11 set of monumental proportions. 12 Q. I'm going to hand you what's marked as 13 A11030, admitted as Tab 466. 14 Mr. Crystal, are you familiar with this 15 document? 16 A. What is this? 17 Q. I'm sorry. 18 A. Well, I have one here but -- 19 Q. This is the Hewitt report. 20 A. Oh, I'm sorry. I have the wrong one. 21 Yes. Right. I am familiar with it. 22 Q. Okay. Now, did you review the Hewitt 22907 1 report? 2 A. Yes, I did. 3 Q. Have you formulated any opinions 4 concerning its content? 5 A. Yes, I have. 6 Q. All right. First of all, I would like 7 you to explain generally what Hewitt did. 8 A. Well, what Hewitt did, just in 9 overview, if you will, is to do somewhat the same 10 sort of analysis I did but, of course, with 11 respect to far more positions because Hewitt 12 had -- has more extensive or relied on more 13 extensive databases. 14 So, Hewitt started out the same way. 15 They said, "Let's find a group of companies that 16 we think are comparable. Let's measure the pay 17 of -- in this case, Mr. Gross, the position, the 18 CEO's position. Let's set up a range of 19 reasonable pay around our survey findings, and 20 then let's compare Mr. Gross' pay, actual package 21 to that reasonable range of pay and see where we 22 are." 22908 1 That's pretty much what they did. 2 There are some ancillary comments in this report 3 on benefits and possible so-called transitionary 4 long-term incentives and employment agreements. 5 But the main meat of the report was as 6 I've described it, an attempt to measure the 7 market and come back and then say, "This is about 8 the right size," and then "Where does Mr. Gross 9 fit?" 10 Q. Now, you identified in your report some 11 specific criticisms of the Hewitt report. 12 A. Yes. 13 Q. Would you walk us through and identify 14 what -- and explain your criticisms? 15 A. Yes. Well, if I might start by 16 referring you to Page 2ii at the very beginning, 17 about three pages in or so, there is a statement 18 that says, "Our analysis is based on several 19 information sources." And then the first bullet 20 says, "Competitive compensation data reported and 21 published in private surveys of banks and thrift 22 institutions." 22909 1 And right away, you know, we note from 2 this -- and one will see that more evidently as we 3 get into this a little bit more. One notes that 4 the survey well from which the data are being 5 drawn is not one confined to thrift institutions 6 alone as I did. It includes banks. 7 Now, the -- 8 Q. Why is that significant? 9 A. Well, when you start to add in another 10 industry, if you will, although you might see it 11 as being sort of a cousin of the thrifts. But I 12 mean, it's not like adding in General Motors, for 13 example; but when you add another industry, it 14 seems to me you as the consultant need to make a 15 showing here. You know, one showing is that, you 16 know, this industry doesn't pay significantly 17 differently than the thrift industry. Of course, 18 if you had that showing, you might then wonder why 19 you bothered to include it since you're not adding 20 any new information to the results. But you might 21 include it, for example, because you had not that 22 many data points. And so, you say, "Well, it 22910 1 doesn't seem to pay differently and if I add a lot 2 more data points, maybe I can sort through some of 3 this statistical noise in a better fashion." 4 The other showing could be that yes, 5 this industry pays differently. In this case, it 6 pays more, let's say. 7 Q. What do you mean it pays more? 8 A. Well, let's say we assume that this 9 other industry, banks, pays more than thrifts. 10 Then you would need to have a showing to include 11 in the report as to why you feel it's relevant to 12 include this higher-paying industry. I mean, for 13 example, you might say, "Well, I'm noting that 14 many of the executives at UFG have departed for 15 the banking industry. We've lost people that we 16 didn't want to lose. People we did not want to 17 lose have gone. Well, conversely, we're hiring 18 regularly from the banking industry and, yes, they 19 may pay more but we have to meet those competitive 20 labor market rates or we're not going to get any 21 talent." 22 If there is such a showing, it didn't 22911 1 appear in anything in the report that I could see. 2 And I need to back up a second and observe that 3 the evolution of pay packages in this -- both 4 these industries, I believe, the banks prior to 5 the deregulation of interest rates which, I think 6 was around 1973 or thereabouts, before the 7 deregulation of interest rates, the banks had pay 8 packages which were materially different than 9 those of other industries. Banks were 10 high-security environments that people selected 11 themselves into out of college. There wasn't a 12 lot of chance of being fired. The risks were low. 13 You got a very nice salary, a very excellent 14 pension when you retired, a big gold watch, and 15 that's the way it worked. 16 When the banks first became deregulated 17 in 1973, all of a sudden the risks of being a 18 banking person began to increase. And as a 19 result, the banks began to respond by starting 20 slowly to emulate the practices of other -- of 21 industrial companies. So, Walter Wriston, the 22 legendary chairman of CitiCorp, was the first 22912 1 person to come up in a major bank with a bonus 2 plan. And then somebody else came up with a stock 3 option plan. 4 But all during this period of the 5 Seventies and perhaps even early Eighties, it was 6 the case that if you were to do a survey of all 7 sorts of different industries, the banks, although 8 they were playing catch-up ball, were still behind 9 other industries. They had a bonus plan, but it 10 wasn't fueled with that much money. Maybe it's 11 20 percent of salary instead of 80 percent. The 12 options were maybe 20,000 shares instead of 13 100,000 shares. But they began to play catch-up 14 ball. And about the time of this particular 15 situation, around '87, '88, surveys would have 16 shown the banks to be fully competitive in every 17 respect with industrial companies. But now we go 18 to the thrifts. 19 Well, the thrifts were late to the game 20 of deregulation. They didn't become deregulated 21 effectively, I believe, until around '85 or '86. 22 And so, because of that, one would expect the 22913 1 thrifts to be slow off the blocks in starting to 2 devise new and different and innovative incentive 3 plans and to increase the size of the pay packages 4 of the executives. And one, indeed, finds this. 5 Not so much in Hewitt. I'm sure it's there, but 6 the data doesn't show it. But in the Wyatt 7 report, to which I will turn in a little bit, in 8 the Wyatt report there is abundant evidence that 9 the thrifts pay for the CEO every bit as much as 10 the banks but -- in salary. But in bonuses, 11 there's hardly any bonuses at all on the thrift 12 side and huge bonuses in banks. And I suggest to 13 you that reflects a much longer evolution going on 14 in the banks. 15 So, one thing I observe here is that 16 we're picking up data from a different industry 17 without very much philosophical support. And I 18 think it makes a difference because the data are 19 higher. The numbers are higher. 20 Q. So, it would skew the data? Is that 21 your point? 22 A. Yes. Well, I mean, it would certainly 22914 1 cause the resulting pay recommendations to be 2 higher. And if there is a good reason for that, I 3 don't think Hewitt has actually supplied it in any 4 serious way. And, you know, once again, I would 5 note here on Page 1 -- now, this is the 6 Arabic 1 -- there is a bullet here that says -- 7 Q. That's the page titled "management 8 summary"? 9 A. Yes. Sorry. "Management summary." 10 If you go down to the three bulleted 11 points, the second bulleted point says that 12 "Hewitt, in effect, collected competitive 13 compensation data using private surveys on 14 competitive pay practices in financial services 15 for service organizations and typical contract 16 arrangements in industry and financial 17 institutions." 18 So, you can see here we're picking up a 19 whole melang‚ of data here from various 20 industries. We're picking up from thrifts, from 21 financial institutions. Indeed, from general 22 industry where it apparently suits us to do that. 22915 1 And all of that raises sort of alarm 2 bells in my mind about, well, where are we being 3 taken with this foreign data, if you will, coming 4 from outside the industry? Is it only an extra 5 $2,000? Fine. You know, let's forget it. Is it 6 an extra $200,000? Not fine. I'd like to hear 7 why we have to even pay attention to this 8 industry, and I don't see any support for it. 9 If I can then refer you to Page 3 of 10 the report, just a few pages more, it's a page 11 that has two bulleted points. And it starts with 12 the title "competitive business environment and 13 operating conditions." And it goes on to say, "In 14 a highly volatile industry and risky environment, 15 many companies provide a conservative pay, quote, 16 'mix,' unquote, with higher fixed payments and 17 lower variable awards." 18 This -- my eyebrows went up to where my 19 hairline would have been had I not lost it some 20 years ago. And -- 21 Q. Why is that? 22 A. And I looked at this, and I said this 22916 1 seems to be standing the world of economics on its 2 head because in a highly volatile environment and 3 risky environment, my experience is that 4 companies, for the most part, do not adopt a 5 conservative pay mix. And for that proof, I can 6 immediately refer you to Silicon Valley, perhaps 7 the most risky business environment in the United 8 States if any of you happened to buy Netscape 9 Communication stock or Ya-hoo stock or Amazon. I 10 mean, we just have wild roller coaster rides. And 11 the hallmark of Silicon Valley is the payment of 12 low, fixed compensation and large stock options 13 which make your fortunes dependent on those of the 14 shareholders over a period of time. 15 That's the packet with the devil you 16 make when you go to work for some of these 17 companies. You might have been working for IBM at 18 100,000 a year; but they are going to say, "I can 19 only pay you 50 but I'll give you a 100,000 share 20 option and if we make it, hey, we have an IPO, an 21 initial public offering, you'll be seriously 22 rich." That's what I see as the more normal 22917 1 practice. 2 Now, I don't mean to suggest that CEOs 3 and other people do not push for exactly what 4 Hewitt is talking about. You know, in a highly 5 volatile environment, yes, I like big salaries, 6 guaranteed bonuses. Pay me lots of money. You 7 can't blame CEOs for wanting that. I mean, Adam 8 Smith said we should all pursue our self interest 9 to the maximum. And there is this invisible hand 10 guiding the market. But I certainly can blame the 11 board of a company for not resisting that sort of 12 thing because the surest ticket in the Chapter 11 13 in a highly volatile and risky company is to 14 increase the fixed cost. That almost guarantees 15 where you're going. 16 I then come onto Page 5. And at the 17 very top of the page, Hewitt makes an observation. 18 It says, "UFG's stock option and performance unit 19 plans currently lack motivational and economic 20 value for executives. Hewitt Associates suggests 21 UFG consider a transitionary" -- with the word 22 "transitionary" underlined -- "a transitionary 22918 1 long-term, quote, 'handcuff,' unquote, arrangement 2 to retain key executives and to motivate and 3 reward performance that restores USAT's regulatory 4 net worth requirements." 5 So, I presume when this report was 6 written that USAT was below its regulatory 7 requirements. That is what the statement would 8 seem to mean. 9 But my criticism here again goes to 10 this attitude that, you know, if you have an 11 incentive plan and it isn't paying off, well, that 12 means we just need a new incentive plan. I mean, 13 I've sort of jokingly said that there are no poor 14 performing CEOs in America. There are only CEOs 15 with deficits in managerial motivation, monetary 16 motivation, that need to be corrected, that right 17 away a plan that doesn't pay off is seen to be a 18 bad plan. 19 I might like to see it as an excellent 20 plan because it equated nonperformance with 21 non-reward. But Hewitt's view is no, there's 22 salvation. Always, there is salvation. We'll 22919 1 come up with a new plan with different measures of 2 performance that can become the vehicle for 3 rewarding executives for digging themselves out of 4 this massive pit that they have dug themselves 5 into. And I look at that and I see that as 6 self-serving behavior on the part of consultants 7 who are most anxious to retain the goodwill of the 8 client. 9 Q. What are you referring to? 10 A. Well, I'm referring to the fact that I 11 mean I was in this business for a long time and I 12 guess it takes a sinner to know sin. President 13 Clinton seems to be retailing that line right now. 14 The -- that your clients -- you know, 15 you always knew, in theory, your client was the 16 shareholders of the company. And after all, those 17 are the people who are paying the bill and that 18 you should then be directing your recommendations 19 in a way designed to protect the interests of your 20 client, the shareholders. 21 But in practice, your client almost 22 always became the CEO of the company. And if you 22920 1 were to do a big study and then conclude, as I did 2 early in my career, that the CEO really needed to 3 have his pay cut -- I mean, when I had the meeting 4 with the clients, I mean it was like a scene from 5 the Exorcist with eyes appearing on the windows. 6 And I never was invited back again because the 7 client -- in this case, the CEO -- is not 8 interested in hearing me tell him that he's 9 overpaid. Rather, the client wants good advice 10 meaning that he wants, if possible -- I mean, you 11 know, you don't want to sell your total soul. 12 Small pieces, okay. But, you know, you want to 13 satisfy the client and that may mean cutting some 14 corners. It may mean seeing things more the 15 client's way. It may mean this rationalization I 16 just described where you say, well, these plans 17 are burned-out shells of motivation. They 18 can't -- how are you going to motivate someone 19 with a stock option with a price of $6 a share 20 when the price is 69 cents a share? You know, how 21 are you going to do that? So, they are not 22 motivating anymore. Therefore, we need new 22921 1 motivation. 2 Now, lost in all that, I might add, is 3 the sort of thinking that says, "Well, pardon me 4 but if you gave someone an option and far from 5 motivating him to get the stock from $6 a share to 6 16, it caused the stock to go to 69 cents, don't 7 you think maybe that this plan isn't working?" 8 That we should come to some new drug of motivation 9 other than options because it seems to have been a 10 disaster. And yet, company after company will 11 say, "No. We'll try again. We'll give them a new 12 option. Maybe this time it will work." 13 And so, I just take exception to the 14 fact -- and it's not Hewitt, per se, that I'm 15 objecting to. It's all the consulting firms, that 16 they do not give proper regard to who their true 17 client is, the shareholders of the company. And 18 to say to them if you were -- if you had to 19 deliver this report at the annual meeting to the 20 shareholders, would you deliver the same report? 21 Because, you know, you just hope the shareholders 22 weren't carrying any overripe vegetables during 22922 1 your presentation. 2 Now, I would like to direct your 3 attention to Page 9 of the report. And there's a 4 number of bulleted points. And the third bulleted 5 point says that -- well, above it, it says, "The 6 following statement summarize UFG's objectives for 7 its executive compensation program." 8 So, one might take that to mean that 9 these are not Hewitt's objectives. These are 10 Hewitt's understanding of UFG's objectives as 11 distilled from interviews that Hewitt did with 12 many executives. Whether it's the understanding 13 of the board of UFG and specifically Mr. Whatley, 14 I don't know. I suggest to you it might be more a 15 reflection of Mr. Gross and some of his 16 colleagues' own aspirations because the third 17 bullet down says "One of the objectives is to pay 18 a, quote, 'cut above,' unquote, competitive 19 industry compensation levels for talented 20 executives." 21 So, here we're introducing a concept 22 which unfortunately has become quite common in the 22923 1 world of executive compensation. Now, some years 2 ago when I was in charge of the Towers, Perrin 3 compensation practice, I commissioned a survey in 4 which we called up 100 major companies and we said 5 to each one or asked each one, "Where do you want 6 to position your pay levels vis-a-vis whoever it 7 is you consider to be your competitors?" And 8 one-third of the companies came back and said, "We 9 want to be in the top quartile of the 10 distribution." They would commonly say. "We want 11 to be at the 75th percentile, meaning that we want 12 our pay levels to be such that only one quarter of 13 companies out there who we consider our 14 competitors would pay more than we would pay." 15 But three quarters would pay the same or lower. 16 So, we want an edge. So, that was one-third of 17 the companies. 18 Two-thirds of the companies said they 19 wanted to be at the average. Not one company said 20 they wanted to pay below the average. Well, now, 21 statistically, if you have one-third of the 22 companies aiming for the top quarter of the 22924 1 distribution and two-thirds aiming for the 2 average, you will never catch the average. 3 And that, in essence, is what we have 4 today. A wild escalation in competitive pay where 5 in my New York times study, the year-over-year 6 increase in CEO pay was 38.6 percent, ten times 7 the rate of increase for the average American 8 worker. 9 Well, that sort of mentality is common 10 with consulting firms who almost routinely 11 recommend to their client that, while it's all 12 right for you to pay the 75th percentile, even 13 though if you were to back off and fly up 14 20,000 feet and look over the landscape, you say, 15 "Well, not everyone can do that." This is not -- 16 this is like Lake Woebegone. The average CEO is 17 paid above the average. And -- but nevertheless, 18 they do this routinely. 19 And so, Hewitt seems to be implying 20 that it is the UFG's executives' desire to be paid 21 a cut above. I probably am more of a persuasion 22 that this is their standard sort of 22925 1 recommendation. As it was at Towers, Perrin and 2 elsewhere to curry favor with the client, we're 3 going to put you in a premium position. 4 And yet, this report which, as I say, 5 would have been fine reading in the Proctor & 6 Gamble board room or the Coca Cola board room, 7 fine performing companies, this is total 8 disconnect in the board room of this company where 9 we're talking about meeting the -- not only 10 meeting the average but paying a, quote, "cut 11 above" the average at a time when -- when, you 12 know, you are pulling your pockets out and there 13 is a hole in them and there are no coins level. 14 They have fallen through. 15 Down on the same page at the 16 next-to-the-last bullet point, we talk about -- we 17 say, "To compensate executives for the, quote, 18 'extra,' unquote, time and effort required to 19 negotiate a successful outcome to the Southwest 20 Plan and satisfy regulatory requirements, 21 specifically when these executives have 22 opportunities to work in less volatile 22926 1 environments." 2 Well, the first thing I would observe 3 from that is that we're going to compensate 4 executives for extra time and effort to negotiate 5 a successful outcome -- in this case, to the 6 Southwest Plan. And in this process, we seem to 7 have mixed up input and output. Most incentive 8 plans, the whole structure of incentive pay in 9 this company, as in most companies, is linked to 10 output. If you do certain things, if you have 11 certain out comes, you get paid. You don't get 12 paid before the outcome has materialized. At 13 least you don't in proper incentive plans because 14 there would be no more incentive. And you don't 15 get paid because you had to work harder. That's 16 the input side of the effort, of the equation. 17 Executives commonly will say, "Well, I work harder 18 than ever in the difficult times." And I bet you 19 they do. It must be tougher to work in a company 20 with terrible problems than one where everything 21 is sailing smoothly. But the compensation plans 22 were not designed to be reward for input, nor were 22927 1 they designed to pay in advance for an outcome 2 that hasn't materialized yet and may not 3 materialize. So, once again, I would take 4 exception here. 5 And then furthermore, there is a 6 statement about executives having opportunities to 7 work in less volatile environments. That may be 8 so, but I'm not aware of it, I mean, from what 9 I've read, because my understanding is that there 10 were an awful lot of people out on the street in 11 the thrift industry looking for jobs and that 12 maybe these opportunities to work in less volatile 13 environments were not as coming around the bend as 14 frequently as suggested by that statement. I 15 would just observe that sort of, so to speak, in 16 passing. 17 Now, if I could recall your attention 18 to Page 12 of the report. And we notice here 19 we're getting more specific at the top of the 20 page. It says we're making reference to Hewitt 21 Associates private database. It says, "This 22 private database includes information on all 22928 1 elements of executive compensation for 88 2 financial institutions" -- or excuse me -- 3 "organizations. We referenced the data for banks 4 with less than 15 billion in assets." 5 And then a little further down, about 6 five or six lines, "We note that we took a count 7 of 12 savings and loan associations." 8 So, that's 12 out of 88. So, that 9 means that 76 of these organizations were not 10 thrifts. The great majority of them were not 11 thrifts. Moreover, we note in the middle of the 12 page that these 12 savings and loan organizations 13 had assets ranging between 7 and $15 billion. 14 Q. Is that significant? 15 A. Well, it's significant because UFG or 16 USAT, as you will, had assets at the bottom of the 17 range of $7.2 billion. In fact, of the 12 listed 18 on this page, there is only one that had assets 19 down in that range. That was Anchor Savings Bank 20 on the first line with assets of 7.4 billion. And 21 then the next stop up would appear to be 22 10.8 billion. I guess it would be the very next 22929 1 line. And we had assets all the way up here to 2 34 billion, even though it says "almost all with 3 assets between 7 and 15 million -- billion," 4 excuse me. In fact, we have one, Glen Fed, at 5 19 billion 1; Financial Corporation of America at 6 34 billion. 7 Well, the significance of this is that 8 there is a positive and significant statistical 9 relationship between the pay of the CEO and the 10 size of the institution as measured by its assets. 11 I found that relationship in my study of 17 12 thrifts, and I dare say if I would have taken the 13 time with Hewitt's data -- I don't think they 14 published individual data. Maybe they did. Maybe 15 they didn't. One could presumably find the same 16 sort of relationship. 17 So, if one does find that relationship, 18 then it would follow that the simple average of 19 these 12 thrifts would be a number that was too 20 high for a thrift whose sales were at the bottom 21 of the distribution, that the trend line value for 22 that when you adjust for size differences would be 22930 1 substantially lower than the simple average. And 2 note -- we'll come back to this in a minute -- 3 that not only did Hewitt seemingly adopt the 4 simple average, it added 15 percent to it, the cut 5 above, if you will. So, Hewitt's going the other 6 direction in determining its pay data. 7 Q. There's -- this proxy comparator group 8 on Page 12 lists -- 9 A. Page 12? 10 Q. That we were just looking at lists 11 institution, asset size, and it lists net income 12 in millions? 13 A. Yes. 14 Q. Does the information contained in that 15 column indicate anything to you in connection with 16 Hewitt's comparator group? 17 A. Once again, we have the same sort of 18 issue, which is to say that the -- the positioning 19 of UFG/USAT was at the bottom of this range, if 20 you will. As you can see here, all but two of the 21 12 companies had positive net incomes ranging 22 from, I guess, up to $149 million. And there were 22931 1 two others, both institutions much larger than 2 UFG, which had negative net incomes, both of which 3 were higher than UFG's loss -- than the losses 4 that were greater, I should say. One, 131 million 5 which is passively close to the 118 million of 6 UFG. 7 Q. But the other institution was twice the 8 size? 9 A. Twice the size. My own studies showed 10 that whereas the size is measured by assets was a 11 significant predictor of pay, the higher the size, 12 the higher the assets, other things being equal, 13 the higher the pay. But the net income and ROE, 14 numbers like that, didn't really give you a lot of 15 comfort in terms of saying that you had the big 16 numbers paid a lot more than the small numbers. 17 There didn't seem to be much relationship there. 18 If I could refer you to Page 18, which 19 is a table here, we find that Hewitt has put 20 together its data. It's 76 banks and 12 thrifts. 21 And it's come up with a table showing for 22 Mr. Gross, in this case, a salary of $459,000 22932 1 rounded and then Hewitt provides a range and it 2 says rather than give you a single number for an 3 approximation of the market, we're going to give 4 you a range. Some companies would do that. Some 5 would just give you a single number representing 6 our best guess. 7 In this case, they said the range is 8 376 to 432 rounded in thousands of dollars. But 9 then next to it, they give you what we began to 10 discuss earlier, the 75th percentile. The famous 11 75th percentile has now made its first formal 12 appearance in this study. And we're going to tell 13 you that the cut above, if you will, is a much 14 higher number. We have a maximum of the average 15 range of 432; but for the 75th percentile, we're 16 going to take it all the way up to 501,000. And I 17 just wanted you to note that that was the case. 18 Then, if I can refer you to Page 19, 19 there is another table. And in this case, Hewitt 20 has taken its earlier table where it has a range 21 for the average and then a range for the 75th 22 percentile. And Hewitt has distilled this into a 22933 1 recommendation for UFG. 2 Q. Hold on for a moment. 3 MR. SCHWARTZ: Your Honor, I don't know 4 if there is a collating problem with the copies. 5 Mr. Rinaldi just informed me that there may have 6 been a problem in the photocopying. 7 THE COURT: Well, I find out that I 8 almost go from 17 to -- 9 MR. RINALDI: Your Honor, I believe 10 it's Pages 40 through 44 apparently are out of 11 place. So, it goes 17 and then 40, 41, 42, 43, 12 44, and then it goes to 18. So, all the pages 13 appear to be here; but there are about four pages 14 that are out of -- 15 THE COURT: Well, it would be helpful 16 if they were in order, but let's proceed. 17 MR. RINALDI: I just noticed that. 18 THE WITNESS: Your Honor, would it be 19 improper if I ask if I can take my coat off? 20 THE COURT: Yes, you may. We'll take a 21 short recess. 22 22934 1 (Whereupon, a short break was taken 2 from 2:27 p.m. to 2:55 p.m.) 3 4 THE COURT: Be seated, please. We'll 5 be back on the record. 6 Mr. Schwartz, you may continue. 7 MR. SCHWARTZ: Thank you, Your Honor. 8 I've made an effort to come up with a correctly 9 paginated version of this. We're working on 10 another one for Mr. Langdon, and we'll provide 11 that as soon as it's ready. 12 THE COURT: Thank you. 13 MR. SCHWARTZ: And if I could have -- 14 if I could have your copy back, then we could set 15 that one in correct order. Thank you. I 16 apologize for the error. 17 Here you go. That's a correct one. 18 Q. (BY MR. SCHWARTZ) Okay. I believe 19 that we were now going to look at Page 19 of the 20 Hewitt report. 21 What were your comments regarding that 22 chart? 22935 1 A. Well, I was noting here that earlier, 2 you saw a chart that showed a range of average 3 salary and a range of what purports to be the 75th 4 percentile salary, say, for Mr. Gross. And now, 5 Hewitt has distilled its recommendations for 6 salary onto this Page 19 where we have a target 7 market base salary, 414,000 to 476,000 rounded. 8 And if you actually compared it to Page 12, you'd 9 find that this range is somewhere between the 10 average and the 75th percentile, probably closer 11 to the 75th percentile. And, in fact, there is a 12 footnote on this page which says that it's a 13 10 percent premium over the market average. 14 So, Hewitt, notwithstanding the dire 15 straits in which this institution found itself at 16 the time, is recommending that the institution, 17 far from paying its CEO merely the average, should 18 be paying him 10 percent above the average. He 19 should be compared to that higher range. 20 Q. Is the snapshot condition of the 21 company the only factor, or should it also 22 consider the trends of that industry, what's 22936 1 happened in the past and how the performance of 2 the company is -- has been going? 3 A. Well, what Hewitt is doing here, I 4 think, is actually doing -- it just occurs to 5 me -- something a little different than you 6 normally see. Typically, a consultant will come 7 up with a single number. In this case, let's say 8 a number that would probably be about halfway 9 between 414 and 476. Let's say roughly around 10 $445,000. And then they would build a range 11 around that. Most typically, a range where the 12 minimum would be about 80 percent of that middle 13 number, the 445, and where the maximum would be 14 about 120 percent, 130 percent of that number. 15 That's sort of general practice. 16 And then the way these consulting firms 17 tend to sidestep this issue of pay for performance 18 is they would tell you that you need to pay your 19 CEO somewhere in that range and that, you know, if 20 the performance isn't very good, you ought to 21 consider paying him below the market. And if it's 22 good or he has long service, you could pay him 22937 1 higher than that. 2 But in this case, we don't really even 3 have a range. We're just simply -- they are 4 almost simply saying, "Look. We've gone through a 5 number of exercises here. We've come up with a 6 range of 414 to 476. And guess what? The CEO's 7 pay of 459 falls right inside that range, quite 8 comfortably. Ergo, there is no competitive 9 problem here." 10 In this case, we're not even addressing 11 the issue of performance. We're just simply 12 saying, "Well, he's in that range which -- let's 13 sidestep the whole issue." 14 Q. What's wrong with that practice? 15 A. There may not be a lot wrong with it in 16 terms of policy because most companies don't have 17 it as their intent to embed performance in the 18 salary. Probably the single most important 19 predictor of salary will be the number of years 20 the person has held the position. So, the more 21 you hold the position, you get a salary increase. 22 Remember, we said before salaries go up but they 22938 1 rarely go down. 2 So, you gradually will march steadily 3 toward the maximum of the range. And so, in this 4 case, I don't think it was necessary for them to 5 resort to an argument about performance in salary. 6 We'll get to the other part later. 7 But nevertheless, they are validating 8 the pay of Mr. Gross using what I think of as some 9 tortured assumptions here. That is to say, we got 10 there. We got a range that happened to fit his 11 pay, but we got there by relying, I believe, on 76 12 banks which sure helped to some degree -- I think 13 they did. I can't prove that to you, but I think 14 they did. We got there by using thrifts that all 15 but one of which were substantially larger. And I 16 know that would have had an impact. And then for 17 good measure, we added 10 percent more. 18 So, if you say, "Well, it was like 19 taking the layers of an onion off, if we take off 20 any bias from the banks, we peel that off and we 21 peel off the size problem with the thrifts and we 22 finally peel off the 10 percent premium, I think 22939 1 you're going to end up with a range" -- I'm 2 convinced you'd end up with a range where 3 Mr. Gross' 459,000 of salary, far from being seen 4 to be competitive, would seem to be high. That's 5 what I think you're going to find. 6 In the very next page, Page 21 -- and I 7 can move much faster now. 8 Q. 20 was the next page. 9 A. Well, it's Page 21 I'd like to refer 10 to. For some reason, I don't have a Page 20 in my 11 copy. But 21 is the one I'd like to refer you to. 12 This now switches the scene from base salary to 13 the combination of base salary and the bonus for 14 annual performance. 15 So, now we've got two elements. If you 16 want to think of executive compensation as being 17 sort of like a stool with three legs: We have one 18 leg is the salary, one leg is the bonus for annual 19 performance, and the third leg are the so-called 20 long-term incentives which themselves can consist 21 of little tiny legs as part of the big leg. But 22 three legs. Now we have two of the three legs 22940 1 together for the first time, salary and bonus. 2 And Hewitt once again goes through the same 3 exercise and says, "Here is a range for the -- for 4 the average and here is a range for the 75th 5 percentile." And we call this here total direct 6 compensation, you see from the header. 7 In this case, for reasons that escape 8 me, we're comparing Mr. Gross' salary, just one 9 leg of his stool, to two legs of the competitive 10 stool. I'm not sure what the purpose of that was. 11 But I just noted here once again, we have the 12 salary and we have -- I mean the average and we 13 have the 75th percentile. And if you go to the 14 very next page, Page 22, Hewitt distills this into 15 its recommended range which, once again, is 16 between the average and the 75th percentile. If 17 you look at Page 21, you see the top of the 18 average range is 622. The top of the 75th 19 percentile, 733. So, we're 622 to 733. And the 20 top of this recommended range is 715, a number 21 that's much closer to the 75th percentile than it 22 is to the average. And, indeed, when you look at 22941 1 the footnote, which is Footnote 1 on Page 22, it 2 tells you that whereas before we added a 3 10 percent premium above the market, a cut above 4 for salary, now when we put salary and bonus 5 together, we're adding 15 percent more. So, the 6 bonus, of course, is going to be much larger now 7 than norm. 8 Q. Is there any justification based on 9 your knowledge and experience for adding a premium 10 over the range? 11 A. Well, the justification that 12 consultants often produce for that sort of 13 reasoning is sort of twofold. I mean, one is that 14 others do it; so, therefore, it's all right to do. 15 And they might also take the argument of saying 16 that, "Well, you know, if we did our survey 17 absolutely correctly and gave you an average as 18 the number to shoot for and then you went out to 19 hire someone, you'd probably find you couldn't get 20 them for the average because they were already 21 earning the average at their other place of 22 employment, let's say, if we did our statistics 22942 1 right." So, you'd have to pay a premium to get 2 them to come across the street and work for you. 3 And so, by embedding a 75th percentile 4 number here, we will facilitate the ability to 5 bring people across the street to our shop, people 6 who are already earning the average and who want 7 premium to join. We can bring them in. And if we 8 pay that same premium to the people who already 9 are there, well, then God's in his heaven and we 10 don't have people getting mad at each other and 11 saying, "Hi, I'm Bill Smith. I just hired in. I 12 make 200,000. How much do you make?" And then 13 there is a revolution on your hands. 14 I mean, there is some potential wisdom 15 to that on a company-by-company basis. If you can 16 demonstrate you really do have a lot of 17 transactions with the outside, you know, it 18 doesn't always follow that companies have a lot of 19 traffic in high-management positions. Some 20 companies you rise up through the ranks and you 21 retire out of the job. And someone behind you 22 rises up through the ranks. Other companies 22943 1 constantly go to the outside. They hire more from 2 the outside than they do from promotion from 3 within. I'm not sure what the policy is here. 4 But I do raise the issue of even if that is -- 5 even if there is a valid intent to do that, can we 6 afford it at this time? In other words, it's like 7 we can hardly get to the average, much less you 8 want us to go to the 75th percentile. We're going 9 the wrong direction. 10 And once again, we seem to be comparing 11 Mr. Gross, his salary, to this range that includes 12 salary and bonus which, of course, conveniently 13 shows him to be 26 percent under the market. But, 14 of course, we haven't added in any bonus for him 15 at this point. I don't know what that means. It 16 may be Hewitt, in effect, fell for the argument 17 that that bonus, the special bonus, the so-called 18 25 percent/75 percent bonus, that we pay you 19 25 percent now even though the year's only three 20 months old and put the rest in escrow for later, 21 that maybe they bought the argument that that's 22 not a real bonus and, therefore, shouldn't be 22944 1 counted. I certainly would count it. 2 The -- Hewitt also on Page 23 goes and 3 talks about bonuses at other companies. In the 4 first paragraph, it mentions the phrase "typical 5 target awards." And once again, we're dealing 6 with a sort of hypothetical concept here where 7 Hewitt is saying that a typical target bonus as a 8 percent of base salary for the CEO is 45 to 9 50 percent of salary. And if you say, well, what 10 do you mean by -- what does that mean, a typical 11 target bonus? The answer in general is going to 12 be that, hypothetically, if the company has 13 performed in an average manner and if the CEO has 14 performed in an average manner, then his bonus 15 ought to be right around 50 percent of salary. 16 But the corollary to the argument is 17 that if the company is performing in a 18 below-average manner and/or the CEO has performed 19 in a below-average manner, then the number should 20 be substantially lower than that, potentially even 21 zero. 22 But Hewitt, in effect, has embedded in 22945 1 these numbers a target bonus concept without 2 particularly noting strongly, you know, sort of a 3 Surgeon General's warning to the client that this 4 is all well and good, but you can't pay this 5 because you don't have the wherewithal financially 6 to do that. I mean, maybe this is nice at some 7 point in time if you get in the Southwest Plan, if 8 you turn around, sure. I mean, we can talk. But 9 right now, all this is interesting; but I don't 10 see how you can do much with it. 11 I think my final observation on the 12 Hewitt report can be found with reference to 13 Page 37. I'm sorry. I still have -- I have just 14 two pages left to go. Sorry. And there we get 15 into long-term incentives, the ones I told you 16 about: Stock options, free shares of stock, 17 so-called performance unit plans. 18 Hewitt has provided some targeted 19 opportunities and said the CEO in the outside 20 world would be given an opportunity to earn 21 another 60 percent of salary. So, a number that's 22 even higher than the normal bonus, the annual 22946 1 bonus. The annual bonus, you may recall, they 2 said 45 to 50 percent. Now we're saying there is 3 still another 60 percent to be earned for 4 long-term performance out there in the outside 5 world. 6 So, if the salary is 100,000, just to 7 use a simple number, why, you could look forward 8 to a 45- to 50,000-dollar annual bonus for normal 9 performance and you could look forward to another 10 $60,000 for long-term performance. I presume 11 normal long-term performance. So, the 60 and 45 12 effectively doubles your salary. So, what started 13 out as a 100,000-dollar salary becomes, in total 14 pay, about $200,000. 15 And Hewitt follows that up on the very 16 next page, which is the last page I would offer to 17 comment on, on Page 38. And they put all three 18 legs of the study together. They have apparently 19 made an error in their heading because they call 20 it "total cash compensation" and that cannot be 21 because of the long-term incentives. I think they 22 just mean total compensation, if you will. But 22947 1 what they are doing, if you follow their 2 methodology, is they are picking up, now, the 3 salary. They are picking up the normal bonus 4 range, and they are picking up the long-term 5 incentives. And remember that in the case of the 6 long-term incentives, since they are stated as a 7 percentage of salary and since the salary is a cut 8 above salary of 10 percent more than the average, 9 then of course the long-term incentives are 10 10 percent more than the average, too. 11 And these numbers are more hypothetical 12 at this point in Hewitt's report because the 13 company went out of business before they could act 14 on them. But I would still offer a criticism of 15 it in the sense that I believe very strongly here 16 that -- you may recall before we talked about 76 17 banks and 12 thrifts -- that it's the banks that 18 are jerking the chain in this area because in my 19 study of the 17 thrifts directly, I found only 9 20 of them with options very modest in size, two of 21 them with free shares, very modest in size, eight 22 with nothing. And you weren't adding very much in 22948 1 long-term incentives. In fact, I was adding maybe 2 about $100,000 to the value of the package from 3 long-term incentives based on my analysis, whereas 4 Hewitt is coming up with something approaching 5 $300,000. 6 This is more hypothetical because no 7 actions were taken. But had they been, you would 8 have been sending the compensation up to very, 9 very high levels with premiums built in, modeled 10 on the pay of much more than simply thrift 11 institutions which, as I mentioned earlier, were 12 late to the game in adopting these types of plans, 13 were slow off the blocks, and were, you know, more 14 modest in their pay offerings to their executives. 15 So, that would conclude my remarks on 16 Hewitt. 17 Q. Were you able to identify in your 18 review of the materials, based on your experience 19 and education and knowledge in the area, any 20 problems in connection with UFG or USAT requesting 21 this report in the first place -- and I'm talking 22 about the timing -- and then utilizing it for 22949 1 justifying compensation decisions that had already 2 been made? 3 A. Well, I mean, the normal practice, of 4 course, is to bring in the consultants before you 5 decide to do something. And it's rarely the case 6 that you would bring in the consultants after 7 because the nature of a lot of these actions that 8 you take are such that you can't very easily get 9 back the money if you should be -- if you should 10 decide after reviewing the consultant's report 11 that you acted in haste. 12 So, in the case of Mr. Gross, you gave 13 him a bonus of 167,000 and let's say you find that 14 you shouldn't have done that. Well, how do you 15 get him to write a check to the company? You gave 16 him a salary increase of 167,000. Now, you 17 certainly can stop that as of today; but you can't 18 very easily get the retroactive part back from 19 going back to December 31st. You agreed to 20 forgive a loan. How do you unforgive the loan? 21 So, you know, the cat's out of the -- 22 whatever the expression is. And so, now you are 22950 1 asked for a report. And if Hewitt had come back 2 and said, "Oh, you've done everything wrong. This 3 is a disaster. You should have called us 4 earlier," what are you going to do at that point? 5 And if everything's right and they have 6 rationalized your actions, then what did you need 7 them for? 8 So, once again, I mean, I find it so 9 curious that in the death throws of an 10 organization that we're throwing money at the 11 executives and then spending further money to get 12 a high-priced consulting firm to tell us that we 13 were right to throw money at the executives. 14 Q. Based on your analysis, your review of 15 the Hewitt report, was it a reasonable study? 16 A. Not in the context of this company, I 17 believe. I mean, it was a very fine study. As I 18 say, if you could just put in an edit find command 19 in Microsoft Word and say wherever you see the 20 word "USAT," put in Proctor & Gamble and send it 21 right over to them, they would love it. 22 Q. Because why? 22951 1 A. You'd have to change some of the 2 numbers, though. 3 Q. Why is that significant? 4 A. Because it's a report that in my 5 opinion is perfectly suited for a very going 6 enterprise, one that has if not robust returns, at 7 least substantial average returns. It's a solid 8 company. It's in no danger of dying. It isn't 9 losing money. It hasn't fallen below any 10 regulatory barriers that might have been imposed. 11 It's just doing very well. And maybe under those 12 circumstances, it would be appropriate to consider 13 these types of recommendations and to act on them. 14 But here's a company that has a totally different 15 picture. So, I find it puzzling that they would 16 submit a report to this company at this time with 17 these recommendations. 18 Q. Do you know who prepared the Hewitt 19 report? 20 A. Well, the name I keep seeing in a 21 number of the correspondence, many of the pieces 22 of correspondence, is Mark Gordon. 22952 1 Q. Do you know Mr. Gordon? 2 A. Yes, I do, as a matter of fact. He was 3 a student of mine in my very first MBA class when 4 I taught at Berkeley in the spring of '86. And he 5 was a very good student, in fact. And he then got 6 his MBA, and I believe he joined Hewitt right off 7 the bat. And so, he would have been working for 8 Hewitt I guess -- let's see, about -- I think the 9 first study was done around March of '88, I 10 believe. 11 Q. This is dated September of '88. 12 A. Two years in September, a little bit 13 more than that at the time this report was 14 written. 15 Now, in fairness to him, I'm sure there 16 was some Hewitt partner who undoubtedly was 17 involved somewhere along the line in reading this 18 or whatever. I would think, from my knowledge of 19 what happens at consulting firms, they would not 20 have turned a young man loose that early in his 21 career development. 22 Q. Okay. Exhibit B2495 at Tab 471 is the 22953 1 report prepared by Wyatt Company. 2 Now, have you reviewed this report? 3 A. Yes, I have. 4 Q. Okay. This is dated November 1988. 5 Have you formulated any opinions 6 concerning its content? 7 A. Yes, I have. 8 MR. BLANKENSTEIN: Your Honor, I'm 9 going to object. In his expert report, 10 Mr. Crystal limited his comments to the Hewitt 11 report. It says on Page 7, "Since Wyatt largely 12 backed up Hewitt's findings and conclusions, I'll 13 confine my comments here to Hewitt's report." 14 I think it's inappropriate now, having 15 limited himself in his own report, for 16 Mr. Schwartz to try and elicit testimony with 17 regard to the Wyatt report. 18 MR. SCHWARTZ: During Mr. Crystal's 19 deposition, counsel was free to ask questions 20 concerning the Wyatt report. They were aware of 21 this report. Mr. Crystal, in his prior testimony, 22 indicated that comparing this report to the two -- 22954 1 his analysis that he performed in the Hewitt 2 report was relevant to his opinions there. 3 THE COURT: When did he say that? 4 MR. SCHWARTZ: Earlier today. And so, 5 therefore, I think that he should be able to 6 explain those -- those comparisons. 7 MR. BLANKENSTEIN: The fact that he 8 made reference earlier today and there was no 9 testimony elicited wasn't a waiver on our part 10 with regard to an objection to his testimony with 11 regard to the Wyatt report which he specifically 12 said he wasn't going to comment upon in his expert 13 report. There was no basis for us in those 14 circumstances to depose him on that matter, Your 15 Honor. 16 MR. SCHWARTZ: Your Honor, this is the 17 last area of Mr. Crystal's examination on direct 18 that I have. I am finished after this. He only 19 has a few comments regarding this, and I think he 20 should be able to state his opinions regarding it. 21 MR. BLANKENSTEIN: I'm not sure that 22 that's an excuse to the prejudice, Your Honor, 22955 1 that this is the last few questions that he has. 2 THE COURT: Well, I did see his 3 statement in his -- Mr. Crystal's report that he 4 was not going to go into the Wyatt study because 5 it merely confirmed the earlier one. I -- the 6 Hewitt report. I'm going to sustain the 7 objection. 8 MR. SCHWARTZ: No further questions, 9 Your Honor. 10 MR. BLANKENSTEIN: Your Honor, I have 11 some cross-examination. 12 THE COURT: Yes. 13 14 EXAMINATION 15 16 Q. (BY MR. BLANKENSTEIN) Good afternoon, 17 Mr. Crystal. 18 A. Good afternoon. 19 Q. My name is Paul Blankenstein, and I 20 represent Jenard Gross who is one of the 21 respondents in this case, as you know. 22 Do you remember that we met back on 22956 1 May 7th, 1997, when your deposition was taken in 2 this case? 3 A. Yes, sir, I do. 4 Q. Have you reviewed your deposition -- 5 A. I'm sorry. 6 Q. Have you reviewed your deposition in 7 preparation for your testimony today? 8 A. No, sir. I didn't actually. When I 9 got to the deposition, I modified some pages and 10 sent the whole thing back and neglected to make a 11 copy of it. I would have if I had found one in my 12 files, but I have none there. 13 Q. Did you meet with OTS counsel in 14 preparation for your testimony today? 15 A. Yes, I did. 16 Q. Who did you meet with? 17 A. I met with Mr. Schwartz almost 18 exclusively and to some small degree, Mr. Rinaldi. 19 Q. And what did you and Mr. Schwartz 20 discuss? 21 A. I'm sorry. What or when? 22 Q. What did you and Mr. Schwartz -- what? 22957 1 A. Well, we discussed the basic 2 architecture of his examination of me and then 3 where he was going and what sections he was going 4 to cover. And he asked me questions of the style 5 that I anticipate he expected to ask me in the 6 real world. 7 Q. Thank you, Mr. Crystal. 8 Would it be fair to say that since you 9 left Towers, Perrin, you've become a very vocal 10 and prolific critic of the way executive pay is 11 structured in -- by most American companies? 12 A. Yes. And also, a cheerleader, too, for 13 some companies. But certainly -- probably more 14 known as a critic than a cheerleader, I'll grant 15 you that. 16 Q. And in 1991, you published a book 17 titled "In Surge of Excess, The Overcompensation 18 of American Executives"; is that right? 19 A. That's correct. 20 Q. And you've written many articles 21 criticizing compensation pay practices? 22 A. I have. And some praising them, too. 22958 1 Q. A ratio of about two to one, I think 2 you testified? 3 A. I think that's approximately right. 4 Q. And would you agree that during the 5 last decade or so, you've earned your income 6 from -- as being a critic of executive pay? 7 A. Actually, I'm not sure how to answer 8 that because I've been told by a number of people 9 that if I keep my mouth shut and just publish data 10 and software and more neutral things, I could have 11 even more subscribers. I note that about every 12 time I write an article, I lose a few subscribers, 13 and I deliberately don't look to see who's 14 subscribing when I write. So, I'm not sure that I 15 can buy into the proposition that I've done 16 terribly well by keeping my mouth wide open. 17 Q. Well, I guess the question I'll ask you 18 is: Do you principally earn your income as being 19 a critic of executive pay practices? 20 A. Well, again, I'd have to dispute that 21 to some degree because a lot of what I put into my 22 news letter -- a lot of what I put in my news 22959 1 letter is what you might think of as neutral. 2 That is to say, databases on here's what people 3 are earning in 250 companies or a thousand 4 companies. 5 For example, I'm about to put in 6 software that will allow the universe to simulate 7 mathematically a competitive rate of pay for 8 boards of directors, CEOs, chief financial 9 officers, and there is no value judgments here. 10 It's all based on data, multiple regression 11 analysis. You put in your sales. You put in your 12 performance. You put in your industry. And the 13 machine comes back and says, "Well, for these 14 characteristics, the going rate of pay is so much 15 and you happen to be 30 percent above. Don't 16 worry. That's only the 52nd percentile. There is 17 so much variation or whatever." 18 That -- a lot of what I do is that. 19 And only a portion of it -- not even, I think, 20 50 percent is the heavy criticism. 21 Q. But some part of it is? 22 A. Some part of it is. 22960 1 Q. And because you are a well-known critic 2 of executive pay, are you often sought out by the 3 media to comment about executive pay issues? 4 A. Yes, constantly. 5 Q. And would you also agree that because 6 you're so you well-known the media come you to 7 because of the perception that you'll take a blast 8 at the particular executive pay practice in 9 question and give them the sort of critical sound 10 byte that members of the media often look for? 11 MR. SCHWARTZ: Objection, Your Honor. 12 That's calling for speculation on the reasons why 13 some mythical person that Mr. Blankenstein hasn't 14 identified is calling Mr. Crystal. 15 Q. (BY MR. BLANKENSTEIN) Let's see if he 16 has an appreciation, Your Honor, as to why he 17 might be called by the media. 18 THE COURT: All right. 19 A. Well, this might be self-serving; but 20 my first thing I would offer you is the reason 21 they would call me is because I am by far the 22 country's leading expert in this field. And that 22961 1 may be a self-serving remark, but all my peers 2 would universally concede that to be so. I am in 3 my 39th year, and I do nothing but this small 4 area. 5 So, I think for one thing, they might 6 ask me because I am such an expert. But they 7 might also ask me because they hope to get an 8 unbiased answer because consulting firms are not 9 going to comment negatively about anyone. 10 I remember when I was at Towers, 11 Perrin, they said to me -- you know, there were 12 two types of firms that they would hope I wouldn't 13 criticize. I said, "What are those two types?" 14 They said, "Actual clients and 15 potential clients." And that didn't leave me many 16 that I could criticize. That's one of the reasons 17 I retired early, so that I could nail people if I 18 thought they needed to be nailed. 19 So -- but I also concede to you that 20 there's certainly, for some people, a perception 21 that they need a hatchet job. So, they will call 22 me because I am free of restraints and conflicts 22962 1 and I can say my mind. So, yes, that would be 2 true. But I don't think it's exclusively true. 3 Q. (BY MR. BLANKENSTEIN) And they will 4 do that because you blast people when no one else 5 will; is that right? 6 MR. SCHWARTZ: Objection, Your Honor. 7 It's the same objection. You're asking him to 8 speculate about why some person, mythical unknown 9 person, would call Mr. Crystal. He's already 10 indicated that he is attempting to be objective 11 and fair to his clients, but he's willing to speak 12 his mind. I think that this is belaboring this 13 point. 14 THE COURT: All right. Sustained. 15 THE WITNESS: I'm sorry? 16 THE COURT: Next question. 17 Q. (BY MR. BLANKENSTEIN) Are you fond of 18 using sharp comments to illustrate your points? 19 A. I'm afraid so, yes. 20 Q. And I think you made reference in your 21 report to Mr. Gross is a rat deserting a sinking 22 ship; is that right? 22963 1 A. I don't think I actually characterized 2 Mr. Gross, per se, as a rat. I think I might have 3 spoken metaphorically of rats without particularly 4 naming them. But if that's the one you had in 5 mind, I guess we can go with that. 6 Q. And you suggested earlier today that 7 repricing the stock options was akin to triple 8 murder; is that right? 9 A. Well, that was triple repricing. 10 Actually -- 11 Q. Is that right? You made that analogy? 12 A. Yes, I think so. 13 Q. Do you think that tart phrasing is a 14 substitute for analysis? 15 A. No, but nor do I think that it destroys 16 the analysis. In fact, I would submit to you it 17 sharpens it. 18 Q. And so, it would be fair to say that 19 understatement is not within your arsenal when 20 you're making comments about executive pay 21 matters; is that right? 22 A. Understatement is not something that is 22964 1 unfamiliar to me, but it is one which I guess I 2 don't use always as perhaps -- perhaps to the 3 extent I should. 4 Q. And you pin a good deal of the blame of 5 what's wrong with executive pay practices on the 6 executive pay consulting firms; isn't that right? 7 A. You mean in this case or in general? 8 Q. In general. 9 A. Yes, I do. Yes, I do. 10 Q. And you believe that they contributed 11 to a culture of the overcompensation of American 12 executives in most companies; isn't that right? 13 A. They certainly are a substantial 14 contributing factor. By no means the only one; 15 but certainly, yes, I do believe that. 16 Q. And would you include Towers, Perrin, 17 your former employer, within that group of 18 consulting firms that you believe shoulder some 19 responsibility at least for the prevailing culture 20 of overpayment of executives? 21 A. Yes. I certainly would, yes. 22 Q. And while you were at Towers, Perrin, 22965 1 did you contribute to that culture? 2 A. Yes, I think that's probably true in 3 the sense that I was -- I can see some material in 4 these reports that is reminiscent, if I think back 5 about my own career, the holding out of a new 6 incentive plan, the holing out of a premium range, 7 things that, you know, were stretching the limits 8 perhaps a little bit. 9 Q. Isn't it true, Mr. Crystal, that some 10 of your critics charged that you, while at Towers, 11 Perrin, were responsible for creating the entire 12 executive compensation culture that you now find 13 objectionable? 14 A. I've heard that remark before; but I 15 reject it out of hand because, you know, the 16 idiocy of the remark is that if I were -- that 11 17 years ago, like Joshua at the Battle of Jericho, I 18 took my hands down and I left the field. 19 Now, if I was the person responsible 20 for that, one might have thought that pay would 21 have dropped after the departure of this devil or 22 at least it wouldn't have risen very much. And 22966 1 pay has gone crazy since I left. So, I don't 2 think you could tag me with that responsibility. 3 I may have had some contribution way back; but 4 I've been out on parole for 11 years, 5 Mr. Blankenstein. 6 Q. Would you agree that during that 7 11-year period of time as a reformed sinner, to 8 use your phrase, that your mission has been to 9 change the executive pay culture for your 10 writings? For your writings and speeches? 11 A. My mission has been to try to get 12 companies to do what they say they are going to 13 do, which is to pay for performance. I am not, as 14 popularly supposed, a great huge basher of high 15 pay, per se. If you've got the numbers, I'm on 16 your side. 17 Q. But you want to turn around what -- the 18 culture that you say exists to which you 19 contributed in some part; is that right? 20 A. Well, certainly for any CEO who is -- 21 let me put it this way. If we're talking about 22 the present day, I think you could count on the 22967 1 fingers of one hand any CEOs who I ever worked 2 with because they are all gone. They have 3 retired. 4 Q. But you want to turn that culture 5 around, don't you? 6 A. Yes. I want companies to do what they 7 say they are going to do, which is to pay for 8 performance and, conversely, not to pay for no 9 performance. 10 Q. And you laid some of the foundations 11 for that culture that you now find so 12 objectionable when you were at Towers, Perrin and 13 working as a consultant; isn't that right? 14 A. I did help, in some cases, companies to 15 do some rationalizing, yes. 16 Q. So, would you agree that you're not 17 simply a neutral observer of executive pay 18 practices? 19 A. I don't quite understand what you're -- 20 Q. You're not an observer. You have a 21 mission. You want to change things; isn't that 22 right? You have a particular point of view? 22968 1 MR. SCHWARTZ: Objection. Are you 2 talking in reference to this case, or are you 3 talking -- 4 Q. (BY MR. BLANKENSTEIN) In general. 5 MR. SCHWARTZ: I object to the 6 relevance of it, Your Honor. 7 A. Well, I mean, the statement -- 8 THE COURT: Let's have the answer. 9 THE WITNESS: I'm sorry? 10 THE COURT: I'll deny the objection. 11 You may answer. 12 A. On a mission, he can't be neutral and 13 he must be a vela and he must have an agenda which 14 is not necessarily accurate. I have a mission, to 15 get people to pay for performance, which is what 16 they say they are paying for. And if you pay -- 17 if you do what you say you're going to do, you're 18 not going to hear anything but praise from me. 19 Q. (BY MR. BLANKENSTEIN) Haven't you 20 called yourself a fierce critic of the way most 21 companies structure executive pay? 22 A. I don't know if I style myself that. 22969 1 I've been called that, I know. I don't know if it 2 was I who said it, but I certainly wouldn't 3 disagree with it. 4 Q. You don't remember saying that in 5 response to a question at your deposition? 6 A. No, but I wouldn't contest it. If you 7 said I said it, I'll be happy to agree with it. 8 Q. And you're not dispassionate on this 9 subject, are you, Mr. Crystal? Haven't you 10 characterized yourself as being enraged by the way 11 the executive compensation game is played in the 12 United States? 13 A. In some companies. Not in every 14 company. Some companies, yes. 15 Q. But you're enraged by it; isn't that 16 right? 17 A. Yes, I am. I think it's wrong. 18 Q. In fact, Mr. Crystal, didn't you take 19 this assignment from OTS at a lower hourly rate 20 than you would normally in order to pay penance 21 for your involvement in the Michael Ovitz 22 severance pay package that he got from the Disney 22970 1 Company? 2 A. I think -- well, let's parse your 3 statement because there is a number of pieces in 4 it, I think. 5 The first is did I take a reduced 6 hourly rate? Yes. The answer is yes because I 7 learned from the government that there would 8 probably be some difficulty in meeting the hourly 9 rate that I would normally have charged. And I 10 felt that this was a case where the government 11 deserved what I hope was good representation. So, 12 I said, "Fine. Pay me whatever you think is 13 reasonable, and I'll take it." And the government 14 did and is paying me a lower rate. Half of what I 15 normally get. 16 Then you say about doing penance. I 17 mean, if there is a remark about that, I mean, I 18 make a lot of facetious remarks or humorous 19 remarks. I mean, yes, I have a lot of penance to 20 do, I think. All of us probably do. But, you 21 know, I sinned in some of the earlier days, and 22 now I'm trying to prepare myself for perhaps a 22971 1 greater judge some day. 2 And -- but as to Mr. Ovitz, I think 3 you're a little off base on that because my 4 involvement in Michael Ovitz' hiring and firing 5 was very marginal. I was an advisor to the board. 6 But unlike Mr. Eisner, who you may yet turn to, I 7 simply sort of kept score for the board. If they 8 asked me how much an option was worth, I ran the 9 model for them and told them and made a few 10 comments here and there. But basically, they did 11 whatever they decided they were going to do, which 12 I don't actually think was necessarily wrong. But 13 I just didn't have much to do with it is all. 14 Q. But didn't you, in connection with your 15 preparation for your expert report, note that you 16 were taking this lower salary to pay penance for 17 Michael -- for what happened in the Ovitz case? 18 A. I might have said that just jokingly 19 because the press, when Michael Ovitz got a 20 contract, I guess I -- you require me to back up a 21 little bit. 22 Q. Well, I guess the question is -- 22972 1 A. Do you want me to answer this question 2 or not? 3 Q. My question is: Did you say that in 4 connection with -- 5 A. Yes, I said it; but I'd like to explain 6 why I said it. Am I permitted to do that? 7 Q. Sure. I just wanted to know whether 8 you said it or not. 9 A. Thank you. Thank you. 10 I had been a consultant to Walt Disney 11 in 1984 when Michael Eisner joined the company. I 12 was consultant to the board and not to him. He 13 had his own advisor. I was a consultant in 1989 14 when Michael Eisner renewed his contract. And he 15 called me in 1996 -- '95, '96, and he said, "We're 16 going to hire Michael Ovitz and we're -- and after 17 we do that, we're going to have a new contract for 18 me and I'd like you to help me out again." 19 And I said to him at the time -- I said 20 "Well, you know, I think this is a conflict of 21 interest because I'm the critic here and I write 22 these nasty articles sometimes. And here I'd be 22973 1 helping you." 2 And he said, "Well, think about it 3 because we'd like to have the continuity. You've 4 been with us before twice, and it would be nice to 5 have you back with the board. Remember you're 6 with the board, not with me." 7 And I thought about it. I called him 8 up. And I freely guess that in light of what 9 happened, I regret my decision. I said to him, I 10 said, "Well, against my better judgment, I will do 11 this consulting work." I said, "But you have to 12 understand that I'll keep your confidence during 13 the consulting period. But when you release 14 documents to the public, I reserve the right to 15 read them with my critic's glasses and, without 16 knowing anything other than what's on the printed 17 page, to come and blast you for whatever I see." 18 And he said, "Well, you would have done 19 that any way. So, I haven't lost anything. So, 20 come and help us." 21 So, I said, "Okay. I will." 22 Well, it turned out -- as I say, I was 22974 1 peripherally involved with Michael Ovitz' pay, and 2 he was then subsequently fired. And what's what 3 gave rise to this massive severance contract, 4 because he had a five-year contract and they fired 5 him one year into it. But I was very heavily 6 involved with Michael Eisner's pay contract with 7 the board. 8 And when I finished that and the 9 board -- I mean when the company published this in 10 his proxy statement, sort of all hell broke loose 11 and a lot of people got very angry and said "You 12 are doing the wrong thing." Fortune Magazine 13 called me up and did an extensive interview and 14 they said -- their first question was, "Well, let 15 me ask you" -- they said, "How would you compare 16 yourself to a person who used to run with gangs 17 and who then went straight and delivered sermons 18 in churches and synagogues only to pull one job, 19 last job, with your old gang again?" And they 20 wrote a full page blast at me called "The Gadfly 21 Who Blinked." And people were quite irritated by 22 it. 22975 1 As for my part, I did what I told 2 Mr. Eisner I would do. I wrote a 15-page 3 newsletter analyzing Mr. Ovitz' package. And -- 4 but especially Mr. Eisner's new pay contract. And 5 near the end of that, I said to the readers -- I 6 said, "I recounted this conversation with Michael 7 Eisner, that I was going to criticize it if I felt 8 it needed criticizing." 9 I spent the next three pages trashing 10 his pay contract. In effect, you know, if I could 11 have tied him to a tree, I would have made him do 12 this. I would have take him take more risk, fewer 13 options, higher threshold on his bonus. 14 Q. And this is Mr. Ovitz' contract? 15 A. Mr. Eisner's contract. And Mr. Ovitz' 16 contract, I merely noted that I had a very 17 peripheral role. And that, actually, his contract 18 was actually quite defensible given the 19 circumstances. 20 What caused this obscenity was the fact 21 that Michael Eisner made a tragic mistake because 22 after one year, he decided the man he had hired, 22976 1 the person who was called the most powerful man in 2 Hollywood, turned out to be someone he thought was 3 a dog and he threw him out. And he had four years 4 of pay at about 25 million a year. He was earning 5 that in cash. Incidentally, he was head of 6 creative artists. 7 So, there wasn't much to be done about 8 that. I had very little role. But I merely say 9 that, in retrospect, I wish I had not done that. 10 I have said that I will never again get involved 11 with a company where I might have some role 12 involving their pay, the size of their pay 13 packages. But at the end of the day, I did do 14 what I said I was going to do. I freely stood up 15 and criticized the person who I had taken money 16 from, if you want to think of it that way. It was 17 the board. I was a consultant to the board, not 18 to him. 19 Q. Has the board of Disney been sued over 20 the Ovitz severance? 21 A. There is a lawsuit pending, yes, over 22 that. 22977 1 Q. Well, let's move on to the conclusions 2 that you reached in your report, Mr. Crystal. 3 One of the things that OTS asked you to 4 do was to examine the reasonableness of the pay 5 arrangements for certain senior executives of 6 United; is that right? 7 A. Yes, sir. 8 Q. And those included Mr. Gross, 9 Mr. Munitz, Mr. Berner, and Mr. Crow? 10 A. Right. 11 Q. And you examined the available data 12 from comparable thrifts; is that right? 13 A. Yes, sir. 14 Q. And those were thrifts you selected in 15 order to determine an appropriate comparator 16 group; is that right? 17 A. Well, they were thrifts that in one 18 sense you have to say disclosure, neutral parties 19 selected out of a group of thrifts I submitted to 20 them as being representative of the USAT 21 situation, the same geographic area of the same 22 approximate size. 22978 1 Q. And with regard to Messrs. Munitz, 2 Berner, and Crow, you didn't have enough 3 information to reach any judgment; is that right? 4 A. Any judgment as to the size, 5 appropriate size of pay package for them, yes. 6 Q. So, you weren't unable to reach any 7 opinion that the pay arrangements for Mr. Munitz, 8 Mr. Gross, or -- Mr. Munitz, Mr. Berner, or 9 Mr. Crow were unreasonable or excessive; isn't 10 that right in size? 11 A. No, that's not correct. It's not 12 correct. 13 Q. You reached the conclusion that they 14 were unreasonable? 15 A. Perhaps it was an inartful phrase you 16 meant. Perhaps it wasn't. But you used the 17 phrase "pay arrangements." I limited it to the 18 size of the package. 19 Q. The amount of the pay they received. 20 A. The amount? 21 Q. Right. The size. 22 A. The how much, not the how. 22979 1 Q. The how much? 2 A. Right. 3 Q. So, you couldn't conclude that the how 4 much was unreasonable or excessive; is that right? 5 A. I could make no conclusions. 6 Q. You did conclude, however, that Jenard 7 Gross' pay arrangements were unreasonable and 8 excessive; is that right? 9 A. Yes, I did. 10 Q. And if I understand what you did, you 11 tried to determine what reasonable pay would be by 12 two separate measures; is that right? 13 A. I'm not sure if I understand your 14 question. 15 Q. You said something called total current 16 compensation; is that right? 17 A. On my way to the overall total, I 18 stopped at total current compensation, yes. 19 Q. But the first measure that you 20 identified was something called total current 21 compensation; is that right? 22 A. That is correct, yes. 22980 1 Q. And that measure is annual salary -- 2 base salary plus annual bonus, correct? 3 A. That's right. 4 Q. And then you used the broader measure; 5 is that right? 6 A. Yes. 7 Q. And that's called total compensation? 8 A. Yes. 9 Q. And that includes -- in addition to the 10 annual salary and the bonus -- stock options, 11 direct stock branch, and other incentive pay 12 programs; is that right? 13 A. Yes. 14 Q. And with regard to the total current 15 compensation, you concluded that 560,000 was a 16 competitive level for Mr. Gross, is that right, in 17 1988? 18 A. May I consult my report? 19 Q. Why don't you take a look on Page 2? 20 A. Thank you. 21 Q. If you look at the next-to-the-last 22 paragraph. 22981 1 A. Yes, I did. Yes, I did, uh-huh. That 2 would be the sum of salary and bonus. 3 Q. 560,000; is that right? 4 A. Uh-huh. (Witness nods head 5 affirmatively.) 6 Q. And use using the same comparator 7 group, you went on to calculate what you thought 8 would be the average level of total compensation, 9 the broader measure. Right? 10 A. Yes. 11 Q. And that you concluded should be 12 $598,000; is that right? 13 A. I'm trying to see where -- oh, wait a 14 second. Here we go. 15 Q. If you look on Page 3. 16 A. That's right. 598,600. 599, yes. 17 Q. And for the total compensation, you 18 made another calculation. And that was the point 19 where the total compensation might cross the line 20 from reasonableness to excessive; is that right? 21 A. Yes, yes. 22 Q. And that you concluded was $766,100. 22982 1 Right? 2 A. That was after I took a certain haircut 3 to the first number for the performance of UFG. 4 Q. I think that's not right yet. I think 5 this is before you did the performance haircut. 6 If you look at your report when you did your 7 performance haircut, you lowered both numbers. 8 A. Oh, you said 761. You're right. I'm 9 sorry. Then I took it down. Excuse me. Yes. 10 Q. Now, I notice you didn't do a similar 11 calculation of the upper limit of reasonableness 12 for total current compensation; is that right? 13 A. I guess I did not. I probably have it 14 in my notes, but I didn't do it with the report. 15 Q. Could you estimate for me what it might 16 be? 17 A. Unfortunately, I didn't -- it's -- in 18 my briefcase downstairs, I may have my regression 19 sheets. I just don't know if I have them or not. 20 If I had them, I could tell you in a few seconds 21 what the answer is. 22 Q. I tried to estimate it. And what I did 22983 1 is I used the same percentage that 5 -- that 766 2 exceeded 598. 3 A. Nice try, but no cigar. 4 Q. No cigar? 5 A. Yeah. The reason is that there's much 6 more variance statistically in the total series 7 than there is in the base and bonus series. 8 Companies -- when you come above base and bonus, 9 you begin to get more idiosyncratic practices 10 like -- as I mentioned. You have 17 companies 11 paying a salary, but you only have nine companies 12 giving an option and two companies giving 13 restricted stock. So, you tend to be get a bigger 14 spread around. 15 So, when I'm estimating two standard 16 deviations out, the number for the other series, 17 the base and bonus, would be a smaller percentage 18 that I multiplied by 2 to come out. So, you know, 19 something smaller. 20 Q. 15 percent? 21 A. Oh, probably higher than that. 22 Q. 20 percent? 22984 1 A. If you could just give me a second 2 here. 3 Q. Sure. 4 A. We've got 639, 9 divided by 500. The 5 standard error in this regression is about 6 64 percent, meaning that about two-thirds of the 7 cases would fall within plus or minus 64 percent 8 of the trend line and 95 percent, which is what I 9 use, would be plus or minus 128 percent of the 10 trend line. Well, I'm guessing that the standard 11 error -- and it's just a guess, but it probably 12 would have been not about 646 percent. Probably 13 about 35 percent, something like that. 14 So, you might have added as much as 15 75 percent to the figure for total current 16 compensation. You could have, in theory, done 17 that. 18 Q. You mean the upper range could have 19 been 70 percent higher? 20 A. The base and the bonus could have been, 21 yeah. One might hope. 22 Q. Did you hear the last question, 22985 1 Mr. Crystal? 2 A. Perhaps it would be nice to read it 3 back. 4 Q. (BY MR. BLANKENSTEIN) I want to know 5 if you could assume a 25 percent above 560,000 as 6 being the upper range of reasonableness for total 7 current compensation. 8 A. It's a -- I mean, it's sort of a more 9 complex answer than perhaps you'd like. But if I 10 take the 560 just in raw numbers, if I'm guessing 11 correctly -- and I don't think I'm that far off. 12 I would say no, you want the equivalent number to 13 that other bigger until the two standard 14 deviations out -- I'd probably give you 70 percent 15 more and take it up to as high as perhaps 16 $952,000, a rather large number. 17 However -- but then I would note to 18 you -- the first thing I'd want to say is, "Well, 19 we've got" -- that would imply there is a lot of 20 so-called scatter around this trend line. I mean, 21 all the dots don't line the lines. Some are very 22 high. That's how we would get to the 950. And I 22986 1 would like to be able to say to you, "Well, that's 2 reserved for outstanding performance." 3 Now, having said that -- and I'm trying 4 to be very honest here. You say, "Well, if I look 5 at the numbers here" -- I already disclosed at one 6 point that I couldn't find a relationship between 7 pay and performance in this series. 8 And so, you might say, "Well, all 9 right." You got all this scatter, but there's 10 some people up there obviously who are earning a 11 lot of money who aren't performing. There must be 12 some people down below who might be earning a lot 13 of money who are performing. But then I still 14 come back to no, matter what the data say, if you 15 are performing at this level, can you afford to be 16 talking about going up to that level of pay? And 17 I submit to you you can. 18 Q. Well, let's -- you've got well ahead of 19 my question. 20 A. Sorry. 21 Q. All right. Let's see if we can try and 22 find what that upper level would be of 22987 1 reasonableness. 2 Do you still have the Hewitt report in 3 front of you? 4 A. Yes, sir, I do. 5 Q. And if you turn to Page 21. 6 A. Just one second here. 7 Q. And we're -- this is Exhibit -- 8 that's -- 11030 at Tab 466. 9 A. Well, I have Page 21, if that's what 10 you're referencing, yes. 11 Q. Is that a chart? 12 A. Yes, that's a chart. Yes. 13 Q. And if we look at for Mr. Gross, it 14 lays out an average range of total direct 15 compensation which is, I believe in your lexicon, 16 total current compensation? 17 A. That's right, yes. 18 Q. And the range goes from 540 to 19 $621,500; is that right? 20 A. The average range, yes. 21 Q. Could we agree that 621 or 625,000 is a 22 reasonable upper range for total current 22988 1 compensation? 2 A. For -- you mean just for the industry? 3 Q. No. For Mister -- for Mr. Gross. 4 Would 621,000 be a reasonable upper limit for his 5 total current compensation? 6 A. Well, the -- one answer is it would be 7 a reasonable upper limit given that pay levels 8 that are probably out there around the trend line, 9 yeah, you could certainly get there. 10 Another answer is it would not be a 11 reasonable proper limit for a company that is so 12 near death as this company was. 13 Q. I don't want to talk about performance 14 yet. I just want to talk about what statistically 15 works. 16 Can we focus on that? Because that's 17 what you did for the total compensation number. I 18 would like to find that be same place for the 19 total current compensation number. Could we do 20 that? 21 A. We can certainly try. 22 Q. Okay. And would 621 or 620, in that 22989 1 neighborhood, be something you could agree to? 2 A. I wouldn't have any problem with it. 3 Q. Do you remember how much Mr. Gross' 4 base salary was for 1988? 5 A. 458,700. 6 Q. And how much was the bonus that he was 7 scheduled to receive? 8 A. 167. 9 Q. And what does that add up to? 10 A. 626,000 rounded. 11 Q. About $4,000 or so above what we just 12 agreed to was the upper level of reasonableness? 13 A. With that -- 14 Q. For total current compensation? 15 A. It is -- 16 MR. SCHWARTZ: It's an incomplete 17 hypothetical. Mr. Blankenstein is excluding the 18 performance element. 19 Q. (BY MR. BLANKENSTEIN) I'm excluding 20 the performance element. 21 A. Yes. So long as you exclude that 22 dependent clause, excluding performance element, 22990 1 yeah, that's fine. 2 Q. And you couldn't say that 625 or 3 26,000, which is a few thousand over the line, 4 would on that statistical basis be unreasonable 5 compensation. Right? 6 A. So long as there's -- we're not talking 7 about performance. 8 Q. Just on a statistical basis. 9 A. So long as we're not talking about 10 performance. 11 Q. Okay. Now, you used another -- you 12 used the current compensation number; is that 13 right? Current compensation? That was the other 14 measure you used? Excuse me. Total compensation. 15 A. Total compensation, yes, uh-huh, right. 16 Q. That was the other measure you used? 17 A. Right. 18 Q. And that should be -- it's a more 19 inclusive number, correct? 20 A. Yes. 21 Q. And you calculated that about -- you 22 calculated that out before the performance haircut 22991 1 to be about $598,000? 2 A. Uh-huh. 3 Q. Lower average with -- and with 766 at 4 the upper level; is that correct? 5 A. Is that what I said? Just one second. 6 I think that is correct, but let me just take one 7 more look. Yes, that's correct. 8 Q. And that -- and when you -- you put a 9 16 percent performance haircut? 10 A. Yes. Then I took the 599 down to 500. 11 Q. And that was 16 percent. Right? 12 A. Yes. 13 Q. And that reduced the upper level of 14 reasonableness to about $639,900; is that right? 15 A. Yes. 16 Q. And let's call it 640. 17 A. Okay. 18 Q. And you did this performance haircut 19 because in your view, the CEO's performance is 20 presumptively poor if the company's performance is 21 poor as measured by the stock price; isn't that 22 right? 22992 1 A. Well, it would -- in general, it would 2 be measured by the stock price; but it could also 3 be measured by the return income, return on 4 equity, return on assets, other measures. 5 Q. Is the stock price, in your view, the 6 best measure? 7 A. The stock price is the best measure in 8 the long run, but not in any short period of time. 9 Q. Would the actual cause of United's poor 10 performance matter in your evaluation of 11 Mr. Gross' compensation package? 12 A. No. 13 Q. No. So, if Mr. Gross was not at 14 fault -- is that right -- you would still, for the 15 poor performance of the company, you would still 16 give him a performance haircut; is that right? 17 A. Yes. I would do that under the 18 assumption that if Mr. Gross were "not at fault," 19 in quotes, and the performance soared, that he 20 would not be inclined to return the extra money he 21 would otherwise have received. 22 Q. I'm sorry. I didn't hear you. Can you 22993 1 say that again? 2 A. You're saying if he's not at fault, I'm 3 saying that I would not take into that -- listen 4 to that argument that he's not at fault because 5 I'm assuming that had the performance gone the 6 other way and he were also, quote, not at fault 7 because the Texas economy boomed and the whole 8 stock marked went up, that he would not cut a 9 check back to the company and say, "Look, I don't 10 deserve this money. Take it back." I'm making 11 that assumption. I think it's a pretty good one. 12 Q. Do you remember I asked you this 13 question at your deposition? 14 A. No. 15 Q. Well, why don't you turn -- do you have 16 your deposition there, sir? 17 A. No, sir. I told you I don't have a 18 copy. I haven't seen one since last night, a year 19 ago last night. 20 Q. If you turn to Page 108. 21 A. 108. All right. 22 Q. And if you look at the question that 22994 1 begins on Line 11. 2 A. Line 11. 3 Q. The question is posed to you, "In your 4 methodology, does the cause of a company's poor 5 performance matter in your evaluation of the 6 senior executives' compensation package?" 7 What's your answer? 8 A. Are you asking me to read what is in 9 there? 10 Q. What did you answer there? 11 A. I answered "yes." 12 Q. Have you changed your mind? 13 A. It would appear that I have, but I 14 think I can explain that, if you'd like. 15 Q. Well, you changed your mind. Right? 16 MR. SCHWARTZ: Well, he wants -- 17 THE COURT: All right. Let's hear the 18 explanation. 19 A. In the case -- I mean, again, it comes 20 back to the issue of "what are you paying for?" I 21 mean, if you -- if you're specifically enunciating 22 a philosophy that we try to reward people for 22995 1 factors over which they have control and, 2 conversely, not to reward or penalize them for 3 factors over which they do not have control as is 4 often done with the pay of middle management, 5 things like that, I say, "Fine." Then yes, 6 absolutely, this answer would apply, that you 7 would look and say, "Well, gee, this person is 8 blameless. How can you blame this person for the 9 fact the stock market crashed?" 10 But on the other hand, if you base the 11 reward structure on external events where you're 12 saying, "Look, whether I thought about it or not, 13 the rewards would be heavily influenced by macro 14 economic events, events outside the control of 15 anyone in this company. Then by the same token, 16 if the reward -- if the actual performance out 17 there, the macro economic events go against you, 18 well, there goes your pay." 19 And at that point, I say, "Well, I 20 didn't hear you say you wanted to be rewarded for 21 controllable events. We could have done that, but 22 probably if we had done that, we would have gotten 22996 1 the eye of the shareholders if we ended up giving 2 you a big pile of money when the performance 3 looked to be terrible." 4 But again, I'm sort of value neutral 5 here in the sense of saying, "If you wanted to go 6 that way, we could certainly talk about that." 7 But if you were basing almost everything in the 8 pay package on numbers that were heavily subjected 9 to macro economic events, then you can't come back 10 to me and say, "Hey, you've got to give me relief 11 because the events didn't go the way I anticipated 12 they would go." 13 Q. (BY MR. BLANKENSTEIN) In analysis -- 14 is this a new analysis that you've come up with 15 since your deposition, or was that -- 16 A. No. It's an extension of my thinking. 17 It's not, I don't think, new as much as -- 18 Q. And you -- this deposition was taken 19 after you prepared your report; is that right? 20 A. Yes. 21 Q. And that was after you had done 22 extensive review and analysis; is that right? 22997 1 A. Yes. 2 Q. And you were unable to come up with 3 this analysis at the time of your deposition; is 4 that right? 5 A. I don't know if I was unable to as -- 6 Q. Were you unwilling? 7 A. No. I certainly wasn't unwilling, but 8 it certainly may not have been the nature of the 9 question in that I didn't happen to think of it in 10 that context. But I can assure you my basic 11 thinking hasn't changed a bit. I understand that 12 it would appear that I have changed my whole way 13 of looking at it, but I don't see it quite that 14 way. 15 MR. SCHWARTZ: Your Honor, if I may, if 16 you look at the entire context of the colloquy at 17 the deposition, you'll see that the questions and 18 answers skewed solely towards the poor performance 19 side, and that's what Mr. Crystal was focusing on. 20 However, it's certainly a logical -- 21 it's certainly a local extension that the opposite 22 would hold true concerning whether or not the 22998 1 executive would pay money back down the road if 2 performance -- for which the executive was not the 3 cause of, caused the profits of the -- 4 THE COURT: I think you're arguing the 5 evidence. Next question. 6 MR. BLANKENSTEIN: Thank you, Your 7 Honor. 8 Q. (BY MR. BLANKENSTEIN) Did you 9 undertake any study to determine how Mr. Gross 10 carried out his job as CEO to determine whether it 11 was something he did or didn't do that caused 12 United's poor performance? 13 A. The narrow answer is no, I did not. 14 Q. Did you try and study how United fared 15 in comparison to other thrifts that were operating 16 in Texas in the 1980s? 17 A. That were operating in Texas? 18 Q. Yes. 19 A. No, I didn't make any -- I mean, I 20 certainly did some comparisons to the 17 in my 21 database, some of which were in Texas, I think, 22 but not all of them. 22999 1 Q. Okay. Now, could we go back a minute? 2 If counsel for OTS had shown you evaluations by 3 the federal regulators of Mr. Gross saying that he 4 was held in high esteem, would that have any 5 effect on your opinion that he deserved a 6 performance haircut for United's poor performance? 7 A. Well, I start with two propositions. I 8 mean, one is that the CEO's performance appraisal 9 is basically the annual report on the tables in 10 the New York Stock Exchange or wherever else the 11 stock is trading. 12 So, it's hard for me to say, well, 13 notwithstanding this horrible result, the CEO was 14 blameless and performed beautifully. That brings 15 up my second point. But when we come to a 16 situation where the company is basically saying 17 you live by the sword, you die by the sword, the 18 macro economic events go in your favor, you're 19 going to make millions. And hey, they didn't. 20 You're not going to make millions, then you've set 21 in train the fact that you should be paid almost 22 nothing at that point. 23000 1 Q. So, the answer to my question is it 2 would have no effect on your opinion? 3 A. I'm sorry. You've got to rephrase it 4 or -- 5 Q. Well, my question was if the federal 6 regulators -- 7 A. Would have no -- 8 Q. -- had held Mr. Gross in high esteem, 9 that would have no effect on your opinion that he 10 deserved a performance haircut; is that right? 11 A. Given the plans under which he was 12 operating, the incentive plans, I would say I 13 would have no opinion. 14 Q. And you you've already told us that you 15 didn't make any study to see how United compared 16 with other thrifts that were operating in Texas in 17 the 1980s; is that right? 18 A. Save only that maybe one or two or 19 three could have been in the 17-company group, 20 yes. 21 Q. Do you know how the thrifts fared in 22 Texas in the 1980s? 23001 1 A. Not in detail, but I'm aware that there 2 was a real terrible time. But there was also in 3 other parts of the country -- I do remember 4 someone called Keating who was in my neighborhood, 5 I think. 6 Q. If United had performed better than the 7 other thrifts that were operating in Texas in the 8 1980s, would that have any effect on your opinion? 9 A. Well, I have to answer in this way. If 10 United had done what most every economist 11 recommends, for example, and you had granted 12 so-called indexed options where you said the 13 strike price is not whatever today's price is -- 14 well, it starts to be today's price but we're 15 going to index the strike price over time to a 16 price of a whole bunch of thrifts, let's say, in 17 Texas. And if it turns out that their price has 18 dropped 50 percent and our price only dropped 19 25 percent, that would be the cause of significant 20 reward because you say you outperformed the 21 market. Again, the standards of that plan would 22 be that we want you to outperform relatively the 23002 1 performance of Texas thrifts. But that isn't the 2 plans that were put in here. We had a plan that 3 said "we're going to pay you if the stock price 4 rises, you know, with the stock price" -- I'm not 5 finished, please. If the stock price rises 6 50 percent on -- and the Texas thrifts go up 100, 7 we're not going to take any money away from you. 8 You're still going to get money. We're still 9 going to pay you for increasing the book value of 10 the company, even though you don't increase it at 11 the same rate as the Texas thrifts. 12 So, it's like, which one do you want to 13 be judged on? You picked your standards. I'm not 14 judging you. The standards are judging you. 15 You're damned by your own standards. 16 Q. Would you have altered any of your 17 opinions as it affected Mr. Gross' base salary and 18 annual bonus? 19 A. As to the performance relative -- 20 Q. That's right. Relative to those items. 21 A. Well -- 22 MR. SCHWARTZ: To which items? I'm 23003 1 sorry. 2 Q. (BY MR. BLANKENSTEIN) Relative to his 3 base salary and annual bonus. 4 A. Well, first of all, salary would rarely 5 ever be -- have a performance component in it to 6 begin with. 7 Q. I'm talking about total current 8 compensation which has bonus and salary. 9 A. Salary would not have a bonus element 10 in it to begin with. The bonus, I guess my answer 11 there would depend on exactly what standards were 12 applied to the bonus. For example, if there was 13 minutes that said, "Look. We are going to reward 14 him in his annual bonus, not the options, but his 15 annual bonus based on how the institution 16 performed in relation to 52 other Texas thrifts" 17 and it turned out that yes, we lost 18 million but 18 they lost 236 million in the same scale of things 19 and, therefore, we're giving him a big reward, I 20 would say, "Well, that's what you did." And maybe 21 we can argue about it after the fact. But you 22 said you would reward him this way. It didn't 23004 1 seem unreasonable at the time, and now you're 2 going to pay off. That doesn't seem unreasonable 3 either. 4 Now, I'm not aware that there was any 5 particular equations governing the payment of the 6 annual bonus, that it was a stick your finger in 7 the air sort of number, which I don't say 8 disparagingly. Most boards do that. They use 9 their discretion and come up with a number. 10 Q. Was the performance haircut you gave 11 Mr. Gross supported by some statistically 12 significant relationship between performance and 13 compensation in the comparator group that you 14 looked at for determining Mr. Gross' total 15 compensation? 16 A. No. On the contrary, I couldn't find 17 any relationship between performance and pay. And 18 I rather used the alternative argument of saying 19 that even though -- it's like even though the rest 20 of them may be sinking, I think this company, 21 given the circumstances, shouldn't be sinking. 22 That it should -- it should operate with a higher 23005 1 standard, if you will, than simply to say, "Well, 2 if everyone else isn't paying for performance in 3 their pay package, therefore, we don't need to pay 4 for performance." But if I turn to the company 5 and say, "Well, if that's the way you want to 6 argue, how about let's give him 599 a year flat 7 out, no bonus, no profits, no options, no 8 performance units?" Let's just say, "Hey, that's 9 how we'll get there." 10 Q. So, you based your performance haircut 11 on your subjective judgment as to what the best 12 policy for United should have been in setting pay, 13 not based upon what was happening in the 14 comparator group that you looked at; isn't that 15 right? 16 A. I mean, you state that as if it were 17 some dazzling insight, but I believe you're just 18 paraphrasing what's in my report. That's exactly 19 what I said I did, that I took an arbitrary 20 adjustment. 21 Q. And you decided to just lop off 22 $98,000; is that right? 23006 1 A. It's your words, "lop off." But let's 2 accept them, yeah. Can I read to you from my 3 report? 4 Q. Was there any statistical basis for the 5 16 percent -- 6 A. May I read to you from my report? Do 7 you mind? 8 Q. Did -- was there some statistical basis 9 for the 16 percent discount that you took or did 10 you back in that number by first taking the 98,000 11 off and then calculating the 16 percent? 12 A. No. It was an arbitrary number. I 13 mean, that's the case, that I felt that one should 14 give due recognition to the fact that this is a 15 company that is so far from the average, it would 16 be like looking at it through the wrong end of a 17 telescope. 18 Q. Did you examine how United fared 19 against the other comparator thrifts in its 20 performance? 21 A. Against the other comparator -- well, 22 yeah. I certainly had that -- I don't recall just 23007 1 right now whether -- exactly what I did. The 2 performance was into my regressions, and I 3 discovered their -- I'm sure I looked at United's 4 performance versus each one of them. I just don't 5 remember -- 6 Q. You don't remember what it is; is that 7 right? 8 A. -- at the moment. It's in my 9 databases, which I can dig out if you'd like to 10 see them. 11 Q. What factors other than United's 12 performance did you take into account in deciding 13 to give Mr. Gross this 16 percent haircut? 14 A. I can't think of anything other than 15 performance. 16 Q. Did you take any mitigating factors 17 into account? 18 A. What did you have in mind? 19 Q. Well, I'm just asking: Did you take 20 any mitigating factors into account? 21 A. What did you have in mind? I keep 22 saying it over and over again because I don't know 23008 1 what "mitigating" means in the context of your 2 question. I'm sorry. 3 Q. Haven't you acknowledged that one 4 factor, mitigating factor, that should be 5 considered before making a performance based cut 6 in an executive compensation is whether the 7 executive was being paid below competitive level 8 during prior periods? 9 A. Could you -- I'm sorry. I'm sort of 10 lost in exactly what you're saying here. I don't 11 want to answer the wrong question. 12 Q. Well, did you ever say that one thing 13 to look at before making a performance cut in 14 compensation is whether the executive had been 15 underpaid in prior periods? 16 MR. SCHWARTZ: Objection, Your Honor. 17 I don't understand what he means by "performance 18 cut." 19 Q. (BY MR. BLANKENSTEIN) A cut in 20 compensation based on performance. 21 A. Did I ever say that? 22 Q. Did you ever say that? 23009 1 A. I don't recall whether I said it or 2 not. 3 Q. Well, why don't you take a look at 4 Page 156 of your deposition. 5 A. Okay. I'm there. 6 Q. And if you start looking at page -- on 7 Line 13. 8 A. Line 13. (Witness reviews the 9 document.) 10 Q. Now, you -- if we look at your answer 11 to -- your answer that begins on Line 17, you say, 12 "In fairness, I would suggest to you that if you 13 know -- I suppose you could say, 'Well, if it had 14 been demonstrated that there were, No. 1, good 15 times in earlier periods and these executives were 16 not paid commensurately, that is to say their pay 17 seems to be no more flat, then that itself would 18 be some defense for not giving them substantial 19 cuts in the bad times.' I suppose you could 20 argue." 21 Do you remember saying that? 22 A. I'm reading it, yes. 23010 1 Q. Do you remember that? 2 A. I read it. I don't remember it. I 3 read it just now. 4 Q. Is that a mitigating factor that you 5 would take into account before you would do a cut 6 in executive compensation based upon performance? 7 A. I think you're getting into an area 8 that I categorize as sort of redress of grievance. 9 That is to say, if you are underpaid in a certain 10 area, you know, what claim do you have to get a 11 redress in some other area? There are some people 12 who would say caveat emptor. You know, you took 13 the lower pay and we're not going to make it up to 14 you. But let's take a more expansive view and 15 say, you know, if, in fact, you could demonstrate 16 you were underpaid in some earlier area, maybe you 17 have a claim, at least on the sympathies of the 18 board. But should those sympathies be expressed 19 in this era when we don't have any money or should 20 we simply say to you, "Hang on. We want to do 21 something for you; but we're going to have to 22 wait, for example, until the Southwest Plan is 23011 1 right there and the ink is signed. We can't do it 2 now." 3 Q. Didn't the Hewitt report and your own 4 study show that there was some evidence that 5 Mr. Gross may have been working for below-standard 6 pay before 1988? 7 Do you remember that? 8 A. I certainly think there was evidence 9 that Mr. Gross was working -- we can't talk about 10 anybody else because, as you've made it quite 11 clear and from my report, that I don't have any 12 data on anyone else. 13 Q. I'm just talking about Mr. Gross now. 14 A. I thought you mentioned some other 15 people. I'm sorry. 16 Q. No. Just Mr. Gross. 17 A. Mr. Gross -- I think there certainly 18 was evidence that his salary was below competitive 19 levels taken all by itself. But that's before we 20 put in bonuses, loan forgiveness, and other such 21 items. And I know -- I'm pretty sure his salary 22 was on the low side, yes. 23012 1 Q. And was low -- on the low side up to 2 and including the time that they incorporated the 3 $167,000 into his base salary; isn't that right? 4 A. And they overshot the mark on the other 5 side. 6 Q. Isn't that right? 7 A. Yes. 8 Q. And you say they overshot the mark. 9 Don't you say in your report that his base salary 10 should be something about 361 or 391,000? 11 A. 391, something like that. 12 Q. And don't you also say that you really 13 have no basis -- that the difference between the 14 391 and the 458 was not significant in your mind? 15 A. I think you're right. I mean, I don't 16 think -- if the whole issue was revolving around 17 whether 459,000 salary was obscene, you wouldn't 18 see me up here pushing the point. 19 Q. Now, you didn't take into account -- 20 A. I'm sorry. You did or did not? 21 Q. You did not take into account the fact 22 that Mr. Gross' salary was below standard prior to 23013 1 1988. Right? 2 A. No, but nor did I take into account 3 anything about his bonus or the loan forgiveness 4 either. And if I had, that may or may not have -- 5 you know, if you want to talk about mitigating 6 circumstances, that might have mitigated an 7 observation that he was underpaid. I don't know. 8 Q. Now, would you agree that the total 9 compensation number should usually be greater than 10 the total current compensation amount? 11 A. I'm sorry. I don't -- 12 Q. Would you agree that the total 13 compensation amount should normally be greater 14 than the total current compensation amount? 15 A. Yeah. I can't conceive a circumstance 16 where it would be less. 17 Q. Well, you -- before the performance 18 haircut, you calculated, did you not, that 19 Mr. Gross' total compensation should be about 20 $598,000? 21 A. Yes. 22 Q. And if I remember your testimony right, 23014 1 about $100,000 -- you attributed about $100,000 of 2 that amount to stock options. Right? 3 A. I -- no, sir, I did not. 4 Q. Did I mishear your testimony? 5 A. I'm afraid that would be the inference 6 I would encourage you to draw, yes. 7 Q. Excuse me? 8 A. I would encourage you to draw that 9 inference. 10 Q. And did you -- do you remember what 11 your testimony was? 12 A. Yes, I do. 13 Q. Can you tell me what it was? 14 A. I think -- if I recall, I think that I 15 said that a competitive level of total current 16 compensation, base and bonus, competitive level 17 would be about 566 and that that went up to about 18 599 in total current compensation. 19 I think your -- the point you're making 20 of the 100 some thousand was an analysis of what 21 Mr. Gross was earning, not the competitive 22 numbers. 23015 1 Q. I think we may be miscommunicating. 2 Your report identifies only one number for total 3 current compensation. 4 That's $560,000; is that right? 5 A. That's right. 6 Q. Okay. And I might -- and for total 7 compensation, which is the broader measure, you 8 start out at 598,000? 9 A. That's right. 10 Q. And you go up to 766 before the 11 performance haircut; is that correct? 12 A. But what I'm saying is that on a trend 13 line, competitive basis, 566 is the base and bonus 14 and we're adding only about 30,000 more 15 competitively for long-term incentives. That's 16 what I'm saying. The 107 or the number you're 17 thinking of is Mr. Gross' number, not the 18 competitive number. 19 Q. Well, what would the range be 20 between -- the range would be between 40,000 -- 21 the difference would be -- between 560 and the 22 upper range would be 766. Right? 23016 1 A. Oh, I think I begin to see the 2 confusion here. I think what you may be doing in 3 your mind is saying we've got 560 base and bonus. 4 We have 30 or so competitive long-term, but that 5 30 can go all the way up to a number when added to 6 go to 766. But you've put all of the extra money 7 on the long-term side; but I remind you, in an 8 earlier argument, you used a lot of that money on 9 the base and bonus side. You can't use it twice. 10 Q. Well, after you did your haircut, you 11 reduced Mr. Gross' salary to a range between 500 12 and 640,000; is that correct? 13 A. I reduced it -- I said that I -- a 14 competitive level would be 500 without arguing 15 about where he should be. And if you had a 16 package that went as high as 640, that would be 17 the competitive level so long as we don't start 18 talking about performance. 19 Q. What would the additional amount -- 20 what would the average additional amounts to base 21 salary and bonus be in that scenario? 22 A. Well, first of all, I don't think you'd 23017 1 be talking about any additional amounts. Let's 2 say you said, "Well, I want to get to a package of 3 640." I don't think you'd be increasing the base 4 because we already have a sense that the base is 5 above the competitive level to begin with. 6 So, then, you'd say, "Well, 7 nevertheless, if we argue the base is 459, we 8 can't cut it." We've got about 40,000 to five -- 9 about $180,000, if I'm doing this right -- about 10 $180,000 above the base of 460 that we play with 11 in a combination of salary -- excuse me -- 12 short-term bonus and long-term incentives. 13 Presumably we wouldn't put it all on the 14 short-term side; but we can put it somewhere, 15 again leaving aside any consideration of 16 performance. 17 Q. You had a total current compensation 18 amount of 560,000 as being the average. Right? 19 A. As being the average, competitive 20 number. 21 Q. You have a total compensation after the 22 haircut of 500,000? 23018 1 A. Total compensation, 500, yeah, after 2 the haircut. 3 Q. Now, the total compensation is lower 4 than the total current compensation, correct? 5 A. Well, it's not lower than the total 6 current compensation after I put a haircut on 7 total current compensation. 8 Q. And how much would that haircut be? 9 A. Well, it would probably be I take it -- 10 I'd take it down to under 500. 11 Q. 470,000, if you use the same 12 16 percent -- 13 A. I would probably give him no bonus at 14 all or the tiniest bonus because he's got 460. We 15 only have 40 to go. I would say no, you should 16 have no bonus based on your performance; but there 17 is some long-term money out there we could offer 18 you. In fact, we might offer you a lot more than 19 that. We might offer you a pretty good-sized 20 stock option because you're taking a risk at this 21 point. 22 Q. Did you -- did it cause you any concern 23019 1 at all that your total compensation amount was 2 less than the total current compensation amount? 3 A. No. 4 Q. Now, isn't it true, Mr. Crystal, that 5 the 640,000-dollar figure in your report 6 substantially underestimates the upper limit of 7 reasonable total compensation for Mr. Gross in 8 1988? 9 A. That it underestimates? 10 Q. Underestimates it. 11 A. Well, I had said originally that we 12 could go up as high as 766. 13 Q. Didn't you calculate originally that it 14 should be 820,000? 15 A. 820? 16 Q. Not in your report. You forgot to put 17 it in your report. 18 Didn't you testify at your deposition 19 that the upper level could be as much as $820,000 20 of total compensation? 21 A. Well, I'm sure you're going to show me 22 where I said it; but I don't seem to recall it. I 23020 1 don't recall it. 2 Q. Why don't we take a look at Page 216 of 3 your deposition. 4 A. Okay. I'm there. All right. 5 Q. Just give me a minute. I'll get to you 6 the right page, sir. 7 If you look at page -- Line 18. 8 A. On page -- 9 Q. 216. 10 A. Line 18. Okay. 11 Q. And the question posed to you is: "Is 12 it fair to say in your view the 820 is the upper 13 end of the range of reasonableness?" 14 And your answer is, "You're getting up 15 there." 16 Then the question was posed, "But is it 17 still within the reasonable range?" 18 And you say, "Oh, yeah. I wouldn't 19 want to say if someone was making 820,000. That's 20 horrifying." 21 MR. SCHWARTZ: Objection, Your Honor. 22 I would encourage Mr. Blankenstein to include 215 23021 1 which includes the outliers of Columbia and 2 Centrust or St. Paul Bank Corporation. 3 Q. (BY MR. BLANKENSTEIN) Now, the 4 outliers are the ones that you took out of your 5 calculation; isn't that right? So, it wasn't 6 included in your calculation. And you were, in 7 fact, concerned that the 766 was understated. And 8 you came back at your deposition and told me 820 9 was the right number; isn't that right? 10 A. No. 11 Q. That's not what happened? 12 A. No. 13 Q. What happened then? 14 A. I believe, reading this, that I could 15 reconstruct what went on here. Let's talk about 16 how I arrived at the 766. I did a regression 17 analysis where if you think about it, if you had a 18 piece of graph paper on the horizontal axis, you 19 would put the size of the company, the revenues, 20 and the vertical axis, the total compensation. 21 And you have a dot at the intersection of size and 22 pay for each of the 17 CEOs. And you look at the 23022 1 dot -- the dots and you see that there is a 2 generally upward slope, that as you go to the 3 right on the horizontal axis, you get bigger. The 4 numbers continued to get bigger in pay. Not 5 perfect, but there is a relationship. 6 I thereupon had the computer draw a 7 trend line through that, a so-called lease squares 8 trend line. And I read that trend line at the 9 $7 billion of assets for United. And then that 10 was the number that gave me the 599. And then I 11 said, "Well, you could pay more than that." I 12 mean, we certainly do see dots above the trend 13 line. How high is high is the issue. 14 Well, in arriving at the 766 number, I 15 took a number that was two standard deviations 16 above the trend line, two standard errors, if you 17 will, above the trend line, which is a 18 mathematical concept derived from the regression 19 routine that in a normal distribution, you would 20 have only about 2 and a half percent of the cases 21 above this two standard deviation level. Of 22 course, that sort of analysis supplies very much 23023 1 so if you're talking about hundreds and thousands 2 of cases. 3 In this case, we have very few cases. 4 Well, I believe what happened here is that we got 5 into a discussion of a different way of going at 6 it of saying, "Well, forget these fancy statistics 7 and regression statistics. Let's just look at the 8 17 numbers and let's array them from high to low. 9 And let's sort of -- sort of use almost a smell 10 test, if you will, as to, you know -- or think 11 about it this way. Let's arrange them from low to 12 high." And we're going up and we've got numbers 13 at 730 and 760 and so forth. And pretty soon, we 14 all of a sudden have a great big leap to a number. 15 It's not where there's just a little bit of 16 daylight between each number. There is a huge 17 leap, and then there is another huge leap. And 18 clearly you could see and hear that there were 19 some outliers here that we had $1.8 million for 20 Columbia and say, "Well, that's clearly an 21 outlier." We have a 1.1 million -- we come down. 22 And I think at that point, coming down, 23024 1 I said, "Well, a different way you might get there 2 is to go that way." And you might somewhere -- 3 around 820 or so, you could come to a stop. And 4 you know, I wouldn't say that one necessarily 5 contributes the other. 760, 820, we're talking 6 about a difference of 10 percent. And when you're 7 dealing with the extreme ends of distribution, I 8 wouldn't say you'd be wrong necessarily to say 9 820. I came up with 760. This is more of an art 10 than a precise science. 11 Q. So, 820 would in your view would be the 12 upper end of the range of reasonableness; is that 13 right? 14 A. It could be so viewed. Yes, it could 15 be so viewed. 16 Q. And would you also agree that if you 17 put aside Mr. Gross' loan forgiveness, that what 18 he was scheduled to receive in total compensation 19 was not unreasonable? 20 MR. SCHWARTZ: Excuse me. Objection. 21 Did you say putting aside the loan forgiveness? 22 Not including it? 23025 1 Q. (BY MR. BLANKENSTEIN) Putting aside 2 the loan forgiveness. 3 A. Why would I want to put aside the loan 4 forgiveness? 5 Q. Because I asked you to. Putting aside 6 the loan forgiveness, how much was Mr. Gross 7 scheduled to receive as you calculated? 8 A. Well, I'd have to consult my report. 9 Q. Why don't you take a look at your 10 report? 11 A. Let's see. 12 Q. And why don't you take a look on 13 Page 4? 14 A. That's what I'm doing here. 15 Q. I think you'll see a figure of 16 $805,400; is that right? 17 A. Yes. $805,400. 18 Q. And that includes the interest payment 19 for 1988, correct? 20 A. That does. Yes, it does. 21 Q. And 805 is less than 820; is that 22 right? 23026 1 A. Yes. And once again, you keep -- I 2 know you don't want to get to that performance, 3 but I sure do at some point. 4 Q. Well, let's talk about that. Why don't 5 you take a look at Page 213? 6 A. Of my deposition? 7 Q. Of your deposition. 8 A. Yes. 9 Q. Now -- and read your answer starting on 10 Page 18 -- Line 18. It says, "Well, let me cut to 11 the chaise here. If you were to take out these 12 two adjustments, the loan forgiveness and interest 13 at that point, I would have looked at this and 14 said, 'I have no firm statistical foundation with 15 which to say this man is unreasonably paid.'" 16 Do you remember saying that? 17 A. Yes. 18 Q. And "this man" is Mr. Gross; is that 19 correct? 20 A. It's the same thing to say if I could 21 take out your bonus in the law firm, I'm 22 absolutely sure I could show you to be underpaid, 23027 1 too, or reasonably paid. 2 Q. Let's assume -- let's put those things 3 aside for the moment. Can we do that? 4 A. In this world, I guess we can do it, 5 yeah. 6 Q. And that's what you were able to be do 7 at your deposition. Right? You said, "Let's cut 8 to the chaise," didn't you? 9 A. Well, I knew where you were going with 10 the argument, yes. 11 Q. So, you weren't surprised by it? 12 A. No. 13 Q. So, you understood it? 14 A. I understood the argument. But again, 15 I stopped by saying, "Well, why am I being forced 16 to exclude pay that is pay?" Would you have had 17 so much success with the IRS to get them to 18 exclude it off of your W-2? You really have made 19 a great contribution for your client. 20 Q. Let's talk about what Mr. Gross 21 actually received as opposed to what he was 22 scheduled to receive in the way of compensation. 23028 1 Is that okay? 2 A. He didn't receive loan forgiveness? 3 Q. Let's talk about what he received and 4 what -- 5 A. Okay. 6 Q. His base salary was how much? 7 $458,000? 8 A. 458. 9 Q. And he was scheduled to get a bonus of 10 $167,000? 11 A. Right. 12 Q. Did he get the full bonus? 13 A. He got 41.75, right. 14 Q. And that comes out to how much? 15 $500,406? 16 A. 499,750. 17 Q. I think you're leaving out -- it's 18 458,656 in salary. 19 A. I thought you said -- 458,656. Pardon 20 me. I'll go back and do it again. 458,656 plus 21 167,000 and 500,406. 500 406. 22 Would that suit you better? 23029 1 Q. That's right. Now, Mr. Gross didn't 2 work the entire year, did he? 3 A. This is -- he worked in November, yes. 4 Q. So, we have to multiply his salary by 5 eleven-twelfths to get what he, in fact, received 6 in salary. Right? 7 A. We also have to multiply the 8 competitive data by the same number if you don't 9 mind, correct? 10 Q. I just want to find out what he 11 actually received. 12 A. Do you want to go through that routine? 13 Q. I want to find out what he actually 14 received. Is that okay? Can we do that? 15 A. As long as you're not going to compare 16 it to anything. 17 Q. I'm not going to compare it to 18 anything. I just want to know what he received. 19 We'll come back to the 820. 20 And how much would that be if we 21 multiplied his base salary by eleven-twelfths? 22 MR. SCHWARTZ: Are you going to include 23030 1 in this analysis the entire 41,000 -- 2 MR. BLANKENSTEIN: Yes. 3 A. If we take 458,656 times 11 divided by 4 12, that's 420 435. And to that, we add 41,750. 5 I get -- wait a minute. How could that be? 6 Excuse me. I think there's something wrong. 7 420,435 plus 41,750. 462,185. 8 Does that sound about right? 9 Q. (BY MR. BLANKENSTEIN) Sounds good to 10 me. 11 A. Okay. 12 Q. Now, in your report, you attribute the 13 value of Mr. Gross' stock options at about 14 $111,000; is that right? 15 A. Yes. 16 Q. Did he receive -- did he ever exercise 17 those options? 18 A. Not to my knowledge. 19 Q. Did he receive any income from those 20 options? 21 A. Not to my knowledge. 22 Q. Was he required to recognize those 23031 1 options on his tax returns? 2 A. No, not unless he exercised them, and I 3 don't think he did. 4 Q. So, right now, what we have for 5 Mr. Gross was $462,185? 6 A. Uh-huh. Okay. 7 Q. Now, that's less than the $500,000 in 8 total compensation you identified if we put aside 9 loan forgiveness. Right? 10 A. You've recreated a preposterous 11 situation. I'm sorry. I have to respond to you. 12 First of all, you've taken away the present value 13 from his side on the options. You have not taken 14 it away from the competitive. You have reduced 15 his salary by eleven-twelfths. You have not done 16 that with the competitive. You have created 17 something that is a statistical monstrosity and 18 defies logic. I cannot respond further than that, 19 sir. So, let's get it consistent. Which way do 20 you want to go? 21 Q. We're just trying to identify how much 22 he actually received. 23032 1 A. 462,185. Don't we have a loan 2 forgiveness in here? 3 Q. Let's deal with the loan forgiveness. 4 Let's deal with that now. 5 A. Okay. 6 Q. The loan forgiveness was treated as 7 serves, wasn't it? 8 A. I don't believe that's so. 9 Q. You don't believe that -- did Mr. Gross 10 reach an accommodation with United in November 11 of -- 12 A. The interest forgiveness. We haven't 13 talked about that. 14 Q. The interest -- wasn't that part of the 15 loan forgiveness, as well, as part of the -- 16 MR. SCHWARTZ: I'm sorry. I'm 17 confused. Are you talking about the bonus 18 agreements or the minimum bonus? 19 MR. BLANKENSTEIN: No. 20 Q. (BY MR. BLANKENSTEIN) I'm talking 21 about what -- Mr. Gross was forgiven his loan, his 22 indebtedness, correct, on his loan for the stock? 23033 1 A. Yes. And you treated that as a bonus 2 in the proxy statement. 3 Q. I'm not asking you that question. 4 In connection with the separation 5 agreement that he had. 6 A. Was it a separation agreement, or was 7 it a separate agreement earlier than that? 8 Q. You testified earlier today that in 9 connection with his leaving United, there was an 10 accommodation made where his entire loan was 11 forgiven; isn't that right? 12 A. No. Well, I believe earlier, there was 13 an intention to forgive the entire loan over a 14 period of years. It was accelerated when he left 15 United. 16 Would that not be a correct 17 characterization? 18 Q. And that was in exchange for severance 19 rights that he had of about a million dollars? 20 Did -- 21 A. I'm not convinced he had severance 22 rights. 23034 1 Q. I'm not asking you whether you're 2 convinced or not. I want to know whether you saw 3 a document today that Mr. Schwartz had shown you 4 that indicated a value placed on those severance 5 rights by Mister -- by United of about a million 6 dollars? 7 A. It's a fine point, but I don't believe 8 Mr. Schwartz showed me that document. I have seen 9 something along the lines you've described, yes. 10 Q. Now, if we treat that loan forgiveness 11 and the interest due in 1988 as severance, can you 12 calculate how much that would have been? The loan 13 forgiveness -- the loan was $761,250. 14 How much was due in interest in 1988? 15 A. I don't know. I know in '87, it was 16 68,000. So -- 17 Q. Assume $68,000 again. Didn't you 18 assume $68,000 in your report? 19 A. That was an actual. That was no 20 assumption. That's what you paid him. 21 Q. No. Look at your report for what you 22 calculated the interest to be in 1988. 23035 1 A. Let me repeat my statement. It is 2 characteristic in these studies to take the bonus 3 for the -- earned with respect to the preceding 4 year because the year of the study, you don't know 5 what the bonus is for '88 for the other people. 6 So, I compared his bonus for the year 7 '87 to the bonus paid by the other 17 thrifts 8 which included a 68,000-dollar interest 9 forgiveness which was in the proxy. 10 Q. In your report, if you look on Page 4, 11 the third bullet point, you assume that the 12 interest due on Mr. Gross' loan for 1988 was 13 $68,000. Right? 14 A. Yes. 15 Q. Now, if we add 68,000 to the $761,250, 16 we get about $829,000? 17 A. Right. 829. Okay. 18 Q. I want you to assume for me that that 19 was the severance amount. 20 Can we assume that that was what -- 21 that was treated as severance? And if Mr. Gross 22 had been paid that severance, would that -- would 23036 1 that be a reasonable severance payment? If he had 2 been paid $829,000 in severance, would that have 3 been reasonable? 4 A. Well, I think you're coming up with 5 these hypotheticals. I mean, are you asking me 6 that -- 7 Q. I'm asking you whether -- let me 8 rephrase the question. 9 If Mr. Gross' severance package had 10 been $829,250, would that be reasonable severance? 11 A. How did it get to be that number? 12 Q. I'm asking you, in your expert opinion: 13 Would that be a reasonable severance in general? 14 MR. SCHWARTZ: Again, are you excluding 15 performance of the company and the condition of 16 the company from your hypothetical? 17 MR. BLANKENSTEIN: I'm excluding 18 performance of the company. 19 A. It would be unreasonable, yes. 20 Q. (BY MR. BLANKENSTEIN) Now, is it a 21 rule of thumb and don't you indicate in your 22 report that two times pay would -- is reasonable 23037 1 severance? 2 A. For someone who's been fired. He quit. 3 He walked out under his own power. 4 Q. I'm not asking for your evaluation of 5 the evidence. I want you -- can you -- 6 A. I can't answer that without adding 7 that. 8 Q. I want you to assume that Judge Shipe 9 finds that Mr. Gross was effectively dismissed. 10 A. Oh, that he was -- 11 Q. I want you to assume that. Can you do 12 that? 13 A. Yes, I can assume that. 14 Q. Would the severance be reasonable under 15 those circumstances? 16 MR. SCHWARTZ: Again, excluding the 17 performance of the company; is that correct? 18 Q. (BY MR. BLANKENSTEIN) In general, 19 would severance pay, a severance payment for 20 Mr. Gross of $829,250 be reasonable? 21 A. On the presumption that His Honor would 22 declare that this was a constructive discharge, 23038 1 that he was fired for other than cause, then I 2 would consider a payment of that level to not be 3 unreasonable. 4 Q. Did you review Mr. Berner's trial 5 testimony in connection with your preparation for 6 your testimony here today? 7 A. I believe I was given a copy of the 8 trial testimony. 9 Q. Did you -- did you happen to notice 10 what Mr. Berner's testimony was in connection with 11 the circumstances surrounding Mr. Gross' departure 12 from United? 13 A. I probably skimmed a part of it. I 14 just don't remember. Nothing comes to mind at the 15 moment. I'm sorry. 16 Q. So, your statement that Mr. Gross left 17 voluntarily was based upon a less than complete 18 understanding of the record; isn't that right? 19 A. Well, it was based on Mr. Gross' own 20 declarations in writing to the company and the way 21 the negotiations went, that "I've decided, you 22 know, I should leave." 23039 1 Q. It was based on last -- 2 A. I didn't see anything that said, "We're 3 pushing you out." I saw nothing in writing about 4 that. Maybe I wasn't given the document. 5 Q. But again, if we assume that Mister -- 6 that Judge Shipe finds that Mr. Gross was 7 effectively discharged, constructively 8 discharged -- 9 A. For other than cause? 10 Q. For other than cause -- would you 11 conclude that a severance payment to him of 12 $829,250 would be reasonable? 13 A. I think I already answered the 14 question, did I not? 15 Q. If you did, I'm sorry. Can you answer 16 it again? 17 A. I said assuming that His Honor made 18 that ruling, that he was effectively -- 19 constructively discharged for other than cause, I 20 would conclude that that size of a package and the 21 way things go these days or even probably back 22 then would not be unreasonable. I'm not sure I'd 23040 1 wish to call it reasonable, but let's say it's not 2 unreasonable. 3 Q. Now, Mr. Schwartz asked you some 4 questions about Mr. Gross' 1987 compensation; is 5 that right? 6 A. Perhaps you could refresh my memory. 7 Q. He asked you about Mr. Gross' bonus in 8 particular in 1987. 9 A. Yes. 10 Q. The bonus that he was paid in 1988 for 11 work done in 1987. 12 A. Uh-huh, yes. 13 Q. And I think you testified that it was 14 $167,000 plus an amount that -- another $68,000; 15 is that right? 16 A. In nineteen -- 17 Q. Bonus for 1987. 18 A. Well, what I said, I think, is that 19 there's the issue as to how you characterize that 20 68,000. Is that a bonus? Is it additional 21 compensation? You could certainly go either way 22 you want as long as you're consistent. 23041 1 Q. And did you see any documents about 2 whether it was treated as part of his bonus? 3 A. Well, the most compelling document was 4 your statement in the proxy statement without any 5 elaboration of the shareholders that it was part 6 of the bonus. 7 Q. And -- I'm going to show you exhibit 8 T8026, which is Tab 410. 9 A. Yes. 10 Q. Does this show a bonus for Mr. Gross? 11 A. Yes. I see it on No. 7. 12 Q. Right. What's the amount of the bonus? 13 A. It says $235,000. 14 Q. Now, you said Mister -- if I remember 15 your testimony correctly, correct me if I'm wrong, 16 you said that Mr. Gross' bonus was excessive in 17 your view? 18 A. Yes. 19 Q. And you said it was more than two times 20 the bonus he had received for 1986; is that right? 21 A. It depends on how we define "bonus." I 22 mean, if you define it as including the loan 23042 1 forgiveness, then it was not two times. It was 2 about 15 percent higher or something like that 3 because if memory serves, his bonus in '86 was 4 80,000 plus 120 for loan forgiveness. I'm not 5 sure why it was such a large amount. Maybe it 6 covered '85, as well, or maybe it was because 7 interest rates were soaring. I just don't know. 8 And the way I reason here was I said to myself, 9 well, we have a -- if we want to call it bonus, we 10 have two parts to this bonus. One part pertains 11 to the loan forgiveness, which is 120 in 1986 and 12 68 in 1987. And the other part is what you might 13 say pertains to his performance, which went from 14 80 to 167, which is the basis for my saying that, 15 in effect, the performance-oriented part doubled 16 in the face of a tripling of the loss. 17 Q. Let me -- does the CEO of a company 18 usually get the biggest bonus as a percentage of 19 his base salary? 20 A. It is generally the case, yeah. 21 Virtually always the case. 22 Q. All right. Now, if you look at 23043 1 Exhibit T8026 and you take out the $68,000 from 2 the 235, you get a bonus of 167, which is about 3 57 percent of Mr. Gross' base salary for that 4 year? 5 A. Well, it was 167 over 291, thereabouts. 6 57 percent, yes, sir. Right. 7 Q. And that would make Mr. Gross -- his 8 bonus as a percentage of base salary lower than 9 other executives who were subordinate to him; 10 isn't that right? 11 A. Yes. 12 MR. SCHWARTZ: Well, objection, Your 13 Honor. I think that assumes that the other 14 bonuses were reasonable in and of themselves. 15 THE WITNESS: Well, the statement as it 16 stands is correct. I mean, I don't know where 17 he's going with it; but it's fine. I wait with 18 interest to see where you're going. 19 Q. (BY MR. BLANKENSTEIN) Now, did 20 Mr. Gross pay taxes on the 235? 21 A. I surely hope he did. 22 Q. And would you have expected Mr. Gross, 23044 1 as the CEO, to get a percentage -- a bonus that is 2 a percentage of the salary that's higher than 3 other executive officials of United? 4 A. Well, in the normal course of events, 5 that would be the case. I mean, I suppose from 6 here, maybe he's decided that he was, in fact, 7 more the cause of this poor performance than his 8 subordinates. I don't know. 9 Q. That's your speculation; is that right? 10 A. Yes. 11 Q. Is another possibility that the 235 was 12 intended to be the amount of Mr. Gross' bonus and 13 he was supposed to pay the $68,000 out of that 14 amount and the bonus would have been 235,000, even 15 if he had no interest to pay? Isn't that another 16 reasonable assumption that one could make? 17 A. Well, I believe the record specifically 18 states that the bonus -- part of the bonus, Part B 19 of the bonus is that sum required to pay his 20 interest. 21 Q. What record are you talking about? 22 What document are you making reference to? 23045 1 A. I can't cite chapter and verse where I 2 found it, but I think I found the evidence that 3 that was the intent. I mean, maybe I've been 4 standing in the Houston sun too much, but there 5 hasn't been any. 6 Q. Now, Mr. Gross' total compensation in 7 1987 was 291,000 for base salary and 235,000 for a 8 bonus; is that correct? 9 A. Yeah. I think you can throw in 24,000 10 for director's fees, too. 11 Q. His -- his compensation from USAT; is 12 that right? 13 A. Well, some of the director's fees were 14 for meetings at USAT, I believe. 15 Q. All right. That brings it up to about 16 550,000; is that correct? 17 A. Whatever the number was in the proxy. 18 I thought it was 291 plus 458 plus 24. Wait a 19 minute. How did that happen? I'm sorry. 458 -- 20 oh, that was the both together. Let me go back. 21 291 plus 235 plus 24. About 550, that's right. 22 THE COURT: Mr. Blankenstein, how much 23046 1 more do you have? 2 MR. BLANKENSTEIN: I have -- I have 3 about another hour perhaps. If I could just 4 finish this line of questioning, and then I can 5 move on to the Hewitt report. 6 THE COURT: Okay. 7 MR. BLANKENSTEIN: Thank you. 8 Q. (BY MR. BLANKENSTEIN) Was United's 9 performance better in 1987 than it was in 1988? 10 A. I don't ever recall seeing any 11 financial statements for the year '88 because I 12 don't believe there was an annual report or, if 13 there was, I didn't see it. 14 So, I don't know the answer to the 15 question. I'm sorry. 16 Q. Now, I asked you that question at your 17 deposition. 18 Do you remember? 19 A. No. No, sir, I don't. 20 Q. Why don't you take a look at Page 173 21 of your deposition? 22 A. 173. Okay. 23047 1 Q. Look at page -- Line 20. And I -- and 2 the question I asked you: "Was the performance of 3 USAT better in 1988 or 1987?" 4 And what's your answer? 5 A. I said, "I'm hard-pressed to remember 6 at the moment. But given that the company slid 7 into bankruptcy or into total insolvency" -- I 8 think this should read by the end of '88 -- "I 9 presume 1988 would have been worse than 1987." 10 Q. Would you conclude that Mr. Gross' 11 compensation for 1987 was reasonable? 12 A. No. 13 Q. Now, why don't we look at Line 26. 14 A. I'm sorry. May I modify that a bit? 15 For 1987, I was focusing on the bonus which I 16 still have trouble understanding why you would 17 have paid much of a bonus. But it is true, I 18 think -- he certainly didn't get any loan 19 forgiveness that year. And he didn't get any 20 performance unit payouts. 21 So, probably, if you added it all up, 22 it would not have been unreasonable in '87 because 23048 1 he -- although I might characterize it that he 2 shouldn't have gotten such a big bonus, he didn't 3 get a lot of other things. 4 Q. So, you could not say that Mr. Gross' 5 compensation, what you call total current 6 compensation, for nineteen -- 7 A. Well, I'm thinking of total 8 compensation. 9 Q. Fine. Let's use the broader measure, 10 your measure of total compensation from 1987 was 11 not unreasonable -- was unreasonable? You could 12 not say that; is that right? 13 A. I don't think so because -- I mean, 14 probably there was an option repricing or two in 15 that period, but that would have added something 16 to my definition of pay. And you would have 17 had -- you would have had the base salary, the 18 bonus, and the loan forgiveness. But the main 19 thing you wouldn't have had is that big bolus of 20 pay coming from the forgiveness of the principal 21 sum of the loan because there wasn't any provision 22 for that in 1987, as I recall. 23049 1 Q. So, again, just to make the record 2 clear, total -- you could not say that the total 3 compensation that Mr. Gross received in 1987 was 4 unreasonable? 5 A. No, I could not say that based on what 6 I know at the moment. 7 Q. And you've done an extensive analysis, 8 haven't you? 9 A. No, sir. Not for '87. 10 Q. So -- I see. You offered your opinion 11 about his bonus without doing an extensive 12 analysis about 1987 and the circumstances 13 surrounding 1987? 14 A. No. What I'm saying here is that I 15 didn't examine the pay data from these comparator 16 companies for the year '87. I examined them for 17 the year '88. So, I don't know what I would find. 18 But probably, because we don't have -- I mean, the 19 likelihood is because we don't have the big bolus 20 of loan forgiveness, that you would not be able to 21 make a clear showing of unreasonableness in '87 22 compared to '88. 23050 1 MR. BLANKENSTEIN: Your Honor, thank 2 you. I've finished this line of questioning. 3 THE COURT: All right. We'll adjourn 4 until 9:00 o'clock tomorrow. 5 6 (Whereupon at 4:47 p.m. 7 the proceedings were recessed.) 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23051 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 16th 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 23052 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 16th 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