23375 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 17, 1998 22 23376 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 23377 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 . 23378 1 2 INDEX OF PROCEEDINGS 3 Page 4 NEIL TWOMEY 5 Continued Examination by Mr. Rinaldi....23379 6 . 7 . 8 . 9 . 10 . 11 . 12 . 13 . 14 . 15 . 16 . 17 . 18 . 19 . 20 . 21 . 22 . 23379 1 P-R-O-C-E-E-D-I-N-G-S 2 (9:50 a.m.) 3 THE COURT: Be seated, please. The 4 hearing will come to order. 5 Mr. Rinaldi, you may continue with your 6 examination of Mr. Twomey. 7 8 CONTINUED EXAMINATION 9 10 Q. (BY MR. RINALDI) Mr. Twomey, when we 11 stopped yesterday, we were on Enclosure 5 of 12 Exhibit B2699. That was the 1988 Southwest 13 examination report. 14 Directing your attention to 15 Page OW154220, that's the first page of 16 Enclosure 5. And I believe when we stopped, we 17 were talking about the second paragraph on the 18 front page. And in the second sentence there, it 19 says -- making reference to Mr. Gross and Mr. Crow 20 and Mr. Berner -- "These individuals are involved 21 in all major committees." And then he goes on and 22 says, "Their decisions have had a significant 23380 1 negative impact on the viability of the 2 association." 3 Do you see that? 4 A. Yes, I do. 5 Q. After you reviewed the five interim 6 reports, did you concur in Ms. Bese's conclusions 7 in that regard? 8 A. Yes, I did. 9 Q. In the next sentence, Ms. Bese 10 indicates that -- I'm sorry. The next paragraph, 11 she indicates that serious consideration should be 12 given as to whether Michael Crow and Arthur Berner 13 should continue employment at United Savings. 14 Do you see that? 15 A. Yes, I do. 16 Q. Did you also concur in that observation 17 that Ms. Bese made? 18 A. Yes, I did. 19 Q. Now, if you'll turn about five pages 20 into the document to Bates OW154226, it makes 21 reference to a receivable from the holding company 22 at the bottom of the page. 23381 1 Do you see that? 2 A. Yes, I do. 3 THE COURT: Excuse me, Mr. Rinaldi. I 4 don't have a copy of that exhibit. Could somebody 5 supply me with a copy? 6 MR. RINALDI: I'm sorry. We probably 7 have an extra copy of it right here. 8 MR. VILLA: B2690. 9 10 (Discussion held off the record.) 11 12 THE COURT: Thank you. 13 Q. (BY MR. RINALDI) And Mr. Twomey, would 14 you take a look at Page OW154226? It's about five 15 pages into the -- or six pages into Enclosure 16 No. 5. 17 A. Yes. 18 Q. Would you read the paragraph at the 19 bottom of the page? 20 A. Aloud or -- 21 Q. No. Just to yourself. 22 A. Okay. (Witness reviews the document.) 23382 1 Yes. 2 Q. Now, it makes reference to United 3 Savings having a 13.9-million-dollar receivable 4 from the holding company, United Financial Group. 5 Do you see that? 6 A. Yes. 7 Q. Do you know what that was referring to 8 in the report? 9 A. Yes. 10 Q. Can you explain to the Court what your 11 recollection is with respect to that reference? 12 MR. VILLA: Your Honor, there's nothing 13 in this case about a receivable from a holding 14 company. It happens to be an extraordinarily 15 difficult tax issue that arose before the merger 16 occurred in 1983. I think to have them introduce 17 it with a witness after 24,000 pages of transcript 18 is really inappropriate. There's nothing in this 19 case about a receivable from a holding company, 20 and I don't believe what we should start 21 introducing it at this point. 22 I didn't see anything in the Notice of 23383 1 Charges or in the complaints that related to a 2 receivable from a holding company, and I move to 3 exclude it. 4 THE COURT: I don't recall hearing 5 about this before. Why is this brought up now? 6 MR. RINALDI: Well, there's later a 7 demand made upon UFG in this regard. It also goes 8 to the question of Mr. Berner because you'll see 9 later that there are documentation in here where 10 they suggest that Mr. Berner, because he was 11 representing both UFG and USAT on both sides of 12 the issue, had a conflict of interest. As a 13 predicate for referring to that complaint 14 regarding Mr. Berner which I believe was one of 15 the bases upon which he makes his recommendation 16 that he thought Mr. Berner was unsuited to 17 continue his employment, I just wanted him to 18 explain in very broad terms what this made 19 reference to because later we will ask him did 20 Ms. Bese determine that there was a conflict of 21 interest that arose with respect to Mr. Berner's 22 handling of this matter. 23384 1 THE COURT: Well, is that an issue in 2 this case? 3 MR. RINALDI: Yes, I think it is. It 4 goes to the whole question of why Mr. Berner was 5 terminated, whether he was a suitable individual 6 to be employed -- continue his employment at 7 United Savings Association of Texas. 8 MR. VILLA: Your Honor, the idea that 9 this witness would testify about what Ms. Bese 10 determined about an issue that isn't in this case 11 seems to me so far-fetched, it indicates that 12 we're not trying the issues in this case. 13 We're not trying the three complaints 14 here. We're trying some things they are trying to 15 pull out of Ms. Bese's determinations. I move to 16 exclude it. 17 We didn't have Mr. Berner here 18 testifying about it because it is such a 19 complicated tax issue and they didn't see fit to 20 raise it in the Notice of Charges and it shouldn't 21 be raised at this point in the case. 22 THE COURT: All right. I'll sustain 23385 1 the objection. 2 MR. RINALDI: Fine. 3 Q. (BY MR. RINALDI) Directing your 4 attention to the next page, it talks about a 5 mortgage-backed security analysis. 6 Do you see that? 7 A. Yes, I do. 8 Q. And if you turn to the second -- the 9 next page, which is OW154228, it makes reference 10 to the fact that -- in the third full paragraph 11 down, the last sentence -- that there was an 12 unrealized loss based on the market value of the 13 MBS and the hedges at the date that was in excess 14 of $200 million. 15 Do you see that? 16 A. Yes. 17 Q. When you received Interim Report No. 5, 18 had you previously been aware that there existed 19 an unrealized loss of $200 million in the 20 mortgage-backed portfolio at USAT? 21 A. No, no. 22 Q. Prior to receiving this report from 23386 1 Ms. Bese, had it been your general impression that 2 the mortgage-backed security risk-controlled 3 arbitrage portfolio at United had been financially 4 successful? 5 A. Yes. 6 MR. VILLA: Objection, Your Honor. 7 Leading. 8 THE COURT: Denied. 9 A. Yes. 10 Q. (BY MR. RINALDI) Were you surprised 11 when you learned this? 12 A. The facts in this report, yes. 13 Q. And were those facts ones which 14 influenced your ultimate decision on whether 15 Mr. Berner or Mr. Crow or the existing management 16 of USAT were suitable to participate as -- 17 continue to participate as management of USAT? 18 A. Yes, it had an impact on my decision. 19 Q. Okay. Now, at the end of -- of 20 Enclosure No. 5, Ms. Bese again has a tentative 21 MACRO rating. And again, with respect to 22 management, it indicates a 4 level. 23387 1 Based upon these five interim reports, 2 did you form some conclusion as to the suitability 3 of USAT's management to continue to serve at 4 United Savings Association of Texas? 5 A. Yes, I did. 6 Q. And what was your opinion at that point 7 in time? 8 A. My opinion at that point in time was 9 that despite the fact that at certain levels 10 regarding their investment portfolios, they had 11 the right people in there running those 12 portfolios, senior management hadn't been making 13 the correct overall decisions; and there were 14 other areas in management regarding their real 15 estate and loan transactions that were 16 questionable. But overall, there was a severe 17 problem with the management of USAT at that time. 18 Q. Now, on the next page, there appears an 19 Enclosure 6; and it's a letter to Mr. Lawrence 20 Connell. 21 You recall yesterday you indicated that 22 ultimately the results of the examination were 23388 1 conveyed to Bank United? 2 A. Yes, I did. 3 Q. And is this letter in connection with 4 the meeting at which the examiner's results were 5 conveyed to Mr. Connell? 6 A. Yes, it is. 7 Q. And attached to it is an agenda. 8 Do you see that? 9 A. Yes, I do. 10 Q. And it sets out a number of items. 11 Does the agenda generally relate to the 12 matters of concern that you had found or Ms. Bese 13 had found during the Southwest exam? 14 A. It rates the matters of concern raised 15 through her examination report. 16 Q. Okay. Now, at one point in particular 17 I'm interested in, it talks about a business plan. 18 Do you recall what that was in 19 reference to? 20 A. Yes, I do. 21 Q. Okay. Can you explain to the Court 22 what the concern was there? 23389 1 A. Regarding the business plan that -- 2 that's contained in this addendum, normally where 3 an institution has a serious problem with its 4 financial operations and other concerns, we ask 5 the institution to develop a plan in which it will 6 address and correct those concerns in a timely 7 manner and correcting its financial imbalance, et 8 cetera. We ask them to update it on a timely 9 manner, usually annually. And it's something that 10 the board of directors would adopt and basically 11 become a policy for the institution to follow. 12 Q. And were you addressing these concerns 13 to Bank United, or had you previously had some 14 concern with respect to the sufficiency of the 15 business plan developed by USAT? 16 MR. VILLA: Objection. Leading. 17 THE COURT: Denied. You may answer. 18 A. This again would be pretty much 19 standard for an institution that was still 20 existing. We were not addressing this requirement 21 to Bank United. But if USAT had continued, this 22 would have been a requirement that we would have 23390 1 looked to USAT to adopt and address as part of the 2 examination report. 3 Q. (BY MR. RINALDI) Okay. Now, if you 4 would turn to the next enclosure, which is 5 Enclosure No. 7, it talks about asset 6 classification write-ups. It's OW154239. This 7 appears to be, far and away, the largest part of 8 the exam report. 9 Did Ms. Bese and her examination staff 10 prepare Enclosure 7? 11 A. Yes, they did. 12 Q. Okay. And can you just describe very 13 briefly for the Court what the asset 14 classification write-up refers to? 15 THE WITNESS: Your Honor, as you can 16 see in the beginning where it refers to A, B, C, 17 D, E, and F, the examiners were required as part 18 of the scope of their normal exam to go in there 19 and review the way the institution classifies its 20 own assets. And as I said previously yesterday, 21 institutions are required quarterly to review all 22 of its assets and to classify them. 23391 1 As part of the examination process, the 2 examiners also review what management does and 3 makes further tests and further analysis. As part 4 of the examination, this is their rendering of 5 what they determine to be classified through this 6 exam process. 7 Q. (BY MR. RINALDI) And do you recall, had 8 Ms. Bese identified a number of weaknesses with 9 respect to the classification? 10 A. Yes, she did. 11 Q. Was that a factor that you took into 12 account in considering whether existing management 13 of United was suitable to continue to participate 14 in the management of United or its successor? 15 A. Yes, I did. 16 Q. And then finally, there's an 17 Enclosure 8. This is just the enclosure related 18 to interest rate risk management. We've already 19 had some considerable testimony on this. 20 Did you receive a copy of this in the 21 normal course of events from Ms. Bese and her 22 examination staff? I'm sorry. OW154317 is the 23392 1 Bates stamp number. 2 A. I've got it. 3 Q. Now, I noticed the document does not 4 have any date. But if you look back on the cover 5 page of the exam report, it follows after a 6 closing conference agenda that's dated 7 January 11th, 1989. 8 Do you recall when you would have 9 received this Enclosure No. 8? 10 A. Probably sometime in January of 1989. 11 Q. Now, was there something that delayed 12 the conclusion of the 1988 exam in December? 13 A. In December, Ms. Bese was winding up 14 the exam; but she had to leave and take vacation. 15 She was getting married; and, basically, the last 16 two weeks of the month, she was -- she had left 17 Texas and gone back to Seattle. And when she 18 finally returned in early January, she wrapped up 19 the exam and then prepared the final report and 20 sent it to my office. 21 Q. Now, following the receipt of at least 22 the first five -- four or five interim reports, 23393 1 did you come to some conclusion regarding the 2 continued participation of Mr. Berner and Mr. Crow 3 and Mr. Munitz at USAT? 4 A. Yes, I did. 5 Q. And what was that, sir? 6 A. I felt it was time for them to leave. 7 Q. Now, prior to your reaching that 8 conclusion, you had had occasion over the previous 9 two years to review the sufficiency of management 10 at USAT, had you not? 11 A. Yes. 12 Q. Okay. Now, directing your attention to 13 what's been marked as A11094, do you recognize 14 that document? It should be the next document in 15 your book. 16 A. Yes. It's a rating sheet. 17 Q. Okay. And at the bottom of the 18 sheet -- well, if you look at the top, it has your 19 signature or an initial. Is that "NT" yours, the 20 supervisory agent? 21 A. Yes. 22 Q. And then as we go across, it appears 23394 1 that the rating, the composite rating, was changed 2 from a 3 to a 4 from that which had been 3 recommended by the district office. 4 Do you see that? 5 A. Yes. 6 Q. Can you explain to the Court what 7 happened with respect to that rating? 8 A. Well, this was in regard to the 1986 9 exam, the one where Vivian Carlton had been the 10 examiner-in-charge. After reading the examination 11 report, especially with regards to various 12 regulatory deficiencies, primarily because of the 13 failure of the institution to keep proper books 14 and records, I felt that I couldn't agree with the 15 composite 3; and I changed it to a composite 4. I 16 downgraded the institution. 17 Q. And in your own sort of words, what 18 does a 4 rating for management reflect? 19 A. Poor. 20 Q. Okay. Now, directing your attention to 21 the next document, which is A11160, this is a 22 document which we saw yesterday. This is a memo 23395 1 dated May the 27th, 1988, in which you were 2 reflecting your views on the strengths and 3 weaknesses of the potential acquirers for the 4 Southwest Plan. 5 Do you see that? 6 A. Yes. 7 Q. Okay. And yesterday you indicated, I 8 believe, that you ultimately came to the 9 conclusion that with -- this document is A11160. 10 THE COURT: That's in evidence? 11 MR. RINALDI: Yes. It was put in 12 evidence yesterday, Your Honor. 13 THE COURT: Is A11094 in evidence? 14 MR. RINALDI: No. I would move the 15 admission of A11094. 16 MR. VILLA: No objection. 17 THE COURT: Received. 18 MR. RINALDI: Thank you, Your Honor. I 19 appreciate that. 20 Q. (BY MR. RINALDI) Now, directing your 21 attention to the second full paragraph of A11160, 22 does that reflect your view of USAT's management 23396 1 at or about April 27th, 1988? 2 A. Yes, it does. 3 Q. And just a few questions with respect 4 to that. First of all, it says, "Management is 5 generally considered motivated and skillful in 6 their respective areas." 7 What were you referring to when you 8 said that, sir? 9 A. Again, it was overall. It seemed to me 10 that management was proactive in dealing with me. 11 And, again, I was aware of certain strengths in 12 certain areas of the institution. 13 Q. Okay. And then it goes on and says, 14 "None of the 11 senior managers have strong S&L 15 banking backgrounds and only four have any banking 16 and two any S&L experience." 17 Was that a concern to you as a 18 supervisory agent? 19 A. Yes. 20 Q. Were there other areas -- well, strike 21 that. 22 It goes on and says, "United has 23397 1 postured itself as a nontraditional institution 2 focusing heavily on investment and mortgage-backed 3 securities areas which have generally been quite 4 successful." 5 Do you see that? 6 A. Yes. 7 Q. Was it your view at this point in time 8 that the mortgage-backed securities investments 9 that had been engaged in by United Savings 10 Association of Texas were generally very 11 successful? 12 A. Yes. 13 Q. And what was your view of the 14 individuals that were managing the portfolio? Did 15 you view them as being competent? 16 A. Yes. 17 Q. Is the same true with respect to the 18 high-yield bond -- 19 A. Definitely, yes. 20 Q. Okay. And do you recall the individual 21 that was managing the high-yield bond portfolio at 22 that time? 23398 1 A. I think at this time it was Gene 2 Stodart. 3 Q. Okay. Now, then it goes on and it 4 says, "In addition, the money desk operation is 5 very effective, as are existing branch 6 operations." 7 Do you see that? 8 A. Yes. 9 Q. That seems to be fairly positive. Were 10 there any criticisms that you had about 11 management's ability at this point in time? 12 A. Well, we had concerns regarding other 13 areas. 14 Q. Okay. What were those areas, sir? 15 A. We had concerns regarding deficiencies 16 noted in the lending area, REO management, solving 17 loan problems, generally things on the operational 18 side. 19 Q. Are those the kinds of things that are 20 normally associated with a more traditional 21 thrift? 22 A. Yes. 23399 1 Q. Were those the kinds of things that 2 would have been important to you in considering 3 whether to permit USAT to become an acquirer under 4 the Southwest Plan? 5 A. It was a concern that would have to be 6 addressed at that time. 7 Q. And why was that, sir? 8 A. Again, it was an ongoing deficiency 9 that was noted in a number of examinations 10 regarding appraisals, loan underwriting, that had 11 not been corrected so far. 12 Q. Okay. Now, directing your attention to 13 the third page of Exhibit A11160 and in specific 14 to Paragraph Roman Numeral II, it -- it talks 15 about the computer system in the first sentence. 16 And then it goes on and says, "Management has 17 demonstrated its ability to dispose of REO often 18 at a profit. However, management has not proven 19 successful in managing major asset quality 20 problems. As expressed above, senior management 21 has little financial operations experience and 22 does not seem to possess the ability to operate 23400 1 the various components of United as a cohesive 2 whole." 3 Do you see that? 4 A. Yes. 5 Q. What were you referring to when you 6 wrote that? Strike that. 7 Did you write this, sir? 8 A. I participated in the writing of the 9 memo. 10 Q. Okay. What were you referring to when 11 you made mention of that? 12 A. We were concerned because there were a 13 number of large assets on their books that seemed 14 to be impaired, and there was a relatively -- 15 there was a problem in dealing with those assets 16 and curing the deficiencies. 17 Q. And then the next sentence goes on and 18 says, "The addition of a strong, experienced CEO 19 may provide the leadership to ensure that every 20 department of United operates effectively." Then, 21 "If a strong CEO is brought in, United's senior 22 management may be considered more favorable." 23401 1 Do you see that? 2 A. Yes. 3 Q. At this point in time, was 4 management -- United's management looked upon 5 unfavorably by the Federal Home Loan Bank of 6 Dallas, or how would you characterize it? 7 A. We were concerned about the weakness in 8 senior management for some time, a very a long 9 time. I had been talking to Jenard Gross and 10 others down there about bringing in a strong chief 11 operating officer, president, or CEO. And we felt 12 once that person would get in there, he would then 13 bring on other staff members and strengthen senior 14 management and cure -- take actions to address 15 some of the deficiencies that we have seen through 16 the examination process. 17 Q. Now, at the bottom of the page -- it's 18 the -- two paragraphs down -- the paragraph that 19 begins with the word "examiners," it states that 20 "The examiners noted the high turnover in senior 21 management and directors. Two officers have 22 resigned or been terminated since the last 23402 1 examination in May of 1986; and five directors 2 have resigned since May of 1987, leaving only one 3 outside director." 4 MR. VILLA: Mr. Rinaldi, I believe it's 5 a copying mistake. It's 12 officers. By the way, 6 I didn't correct you at the time. I think you 7 said April 27, 1988. You meant May 27, 1988, in 8 connection with this document. Right? 9 MR. RINALDI: I'm sorry. Thank you. 10 Q. (BY MR. RINALDI) Now, Mr. Twomey, were 11 you concerned about the turnover that's referenced 12 here in your memo? 13 A. Yes, I was. 14 Q. Okay. And what in particular was of 15 concern to you? 16 A. The number of outside directors that 17 had resigned their positions. 18 Q. And why was that of concern to you, 19 sir? 20 A. Because, relatively, there was no -- 21 that diminished greatly. There was only one 22 outside director left, and that diminished greatly 23403 1 the oversight of the management by independent 2 directors. 3 Q. And were the people that then composed 4 the board of directors of USAT also in management 5 positions? 6 A. Yes, I believe so at that time. 7 Q. And was that of concern to you? 8 A. Yes, it was. 9 Q. And notwithstanding the concerns that 10 you had about management as we saw yesterday at 11 the conclusion of this memo, you recommended that 12 if there was a bolstering of senior management and 13 depending on the results of the final examination 14 report, you would recommend that United be allowed 15 to participate as an acquirer in the 16 Southwest Plan. 17 Do you recall that? 18 A. Yes. 19 Q. Now, then, we turn to the next exhibit, 20 which is T8145; and I'll ask you if you 21 recognize -- it would be in the binder, sir. 22 I'll ask you if you recognize that 23404 1 document. 2 A. Yes, I do. 3 Q. Okay. And was this a document that you 4 prepared and submitted to the individuals 5 identified at the top of the document? 6 A. Yes, it was. 7 Q. Would you take a moment to look at the 8 document? And then I have a couple of questions 9 for you. 10 A. (Witness reviews the document.) 11 Q. Now, attached to the document are three 12 attachments. Would you take a look at the first 13 attachment which is dated December 15th, 1988? 14 This is a letter or memo from Neil Twomey and 15 Marc Dunn to Robert Brick. 16 Do you see that? 17 A. Yes. 18 Q. Did you prepare this first attachment 19 which is dated December 15, 1988? 20 A. I participated in it. 21 Q. And who was Mr. Brick? 22 A. Mr. Brick was another supervisory agent 23405 1 involved with the Southwest Plan at the Federal 2 Home Loan Bank of Dallas. 3 Q. Okay. And this document purports to be 4 an update of the management assessment. 5 Do you see that? 6 A. Yes. 7 Q. It makes reference to "This memorandum 8 will serve as an update to the assessment 9 previously submitted on May 27, 1988." 10 Is the reference to the document of 11 May 27, 1988, the internal memorandum which is 12 marked as A11160 that we looked at just a moment 13 ago? 14 A. Yes, it is. 15 Q. Okay. And what had transpired since 16 the previous memo dated May 27th, 1988, that 17 affected your recommendation with respect to the 18 December 15th, 1988 memo? 19 A. Primarily the Southwest Plan 20 examination and the interim reports that were 21 filed with me. 22 Q. Based upon those interim reports, had 23406 1 you then come to a conclusion regarding the future 2 participation of Mr. Crow and Berner in the 3 operations of USAT? 4 A. Yes, I did. 5 Q. Okay. And does this memo then set 6 forth your -- the reasons or your recommendations 7 regarding their future participation? Take a look 8 at the last page of the document which sets forth 9 the recommendations. In particular, No. 2. 10 Do you see that? 11 A. Yes. 12 Q. And on what do you base your conclusion 13 that these people should be terminated? 14 A. Again, on the information that I had 15 received in the interim reports and, also, my own 16 subsequent discussions with USAT's senior 17 management at different times. 18 Q. And was it also based upon the 19 weaknesses that are identified in this memorandum? 20 If you'll notice, the third full paragraph in the 21 first page talks about "A number of weaknesses 22 have been noted in the following functions as 23407 1 exhibited below." 2 A. Yes. 3 Q. Now directing your attention, then, to 4 the second attachment to Exhibit T8145, can you 5 tell me what that is? This is a memorandum to you 6 from Donna Guthrie dated December 12th, 1988, 7 regarding management assessment. 8 Do you see that? 9 A. Yes, I do. 10 Q. Who was Ms. Guthrie? 11 A. Ms. Guthrie was one of our staff 12 attorneys at the Federal Home Loan Bank of Dallas. 13 Q. Okay. And had you asked Ms. Guthrie to 14 assist you with a particular part of the 15 management assessment? 16 A. Yes. 17 Q. And what had you asked Ms. Guthrie to 18 do? 19 A. I asked her to review particularly -- 20 based on the information we had that we supplied 21 her, I asked her to review Art Berner as he was 22 acting as the general counsel for USAT. 23408 1 Q. And does this represent the report that 2 she gave you regarding Mr. Berner's -- or her 3 views of Mr. Berner's performance as general 4 counsel of USAT? 5 A. Yes. 6 Q. Okay. Now, directing your attention to 7 the paragraph that has the heading "Disregard for 8 regulations," it indicates, "Our review of the 9 employment contracts between United and 10 approximately eight top executives reveals that 11 none of the contracts complied with or ever 12 referenced the applicable regulations." Then it 13 cites to Section 563.39 of the insurance 14 regulations. 15 Then it goes on, "Berner was general 16 counsel when the contracts were drawn and, by his 17 own admission, was responsible for their 18 drafting." 19 Was it your opinion that Mr. Berner had 20 engaged in conduct that was inconsistent with 21 Section 563.39 in the drafting of the contracts? 22 A. Well, I felt that the -- basically, 23409 1 what I knew and also what my attorneys told me, 2 those particular contracts did not comply with our 3 insurance regulations. 4 Q. Did that color your decision as to 5 whether Mr. Berner was a suitable person to 6 continue with his employment at USAT? 7 A. It had a significant impact on it. 8 Q. Now, if you turn to the next page and 9 go down to the third full paragraph, could you 10 just read that to yourself for a second? And then 11 I have a couple of questions I want to ask you? 12 MR. NICKENS: For the record, could we 13 identify which page -- 14 MR. RINALDI: Page No. OW028479. It's 15 the third full paragraph that begins with the 16 sentence "As a condition of becoming a holding 17 company." 18 A. (Witness reviews the document.) 19 Q. (BY MR. RINALDI) Have you had a chance 20 to read that, Mr. Twomey? 21 A. Yes, I have. 22 Q. It says, "As a condition of becoming a 23410 1 holding company, UFG agreed to maintain the 2 capital of United at the level required by the 3 regulation but has refused to infuse capital when 4 directed to do so by the agency." 5 Do you see that? 6 A. Yes. 7 Q. Now, I believe we spoke yesterday about 8 at least one letter that you sent to the board of 9 directors regarding the -- the question of 10 infusion of capital. 11 Were there additional letters that you 12 sent? 13 A. I believe I also sent another letter in 14 December of 1988. 15 Q. Then it goes on and says, "The dual 16 contracts appear to serve no purpose other than to 17 assure that money will be available at the holding 18 company level to cover the severance payments in 19 case of a FSLIC receivership. Funds available at 20 the holding company level should go to United to 21 maintain its capital level rather than being held 22 to guarantee management's severance payments. 23411 1 Berner devised the dual contract scheme, drafted 2 the contracts under which he is a beneficiary and 3 is a director of both UFG and United." 4 Do you see that? 5 A. Yes. 6 Q. What was your understanding of what 7 Ms. Guthrie's criticism there was referring to? 8 A. Well, it was unusual to have a contract 9 set up this way. We normally would like to see, 10 if you're working for an association, a savings 11 and loan that also has a holding company, that if 12 you are being paid maybe for duties at both, that 13 pro rata -- 20 percent of the work for the holding 14 company -- 20 percent should be paid for the 15 holding company and 80 percent should be paid by 16 the S&L. 17 This arrangement seemed more like a 18 guarantee that if something was to happen with 19 USAT, UFG would be there to pay the -- underneath 20 these contracts to pay out the sums. And the only 21 significant asset that we were aware of that UFG 22 had other than the ownership of USAT was a 23412 1 13-million-dollar tax refund. And, therefore, 2 they had ready cash to meet these obligations. 3 Q. And did you agree with her assessment 4 that's set forth in this paragraph that the dual 5 contracts appear to serve no purpose other than to 6 assure that money will be available at the holding 7 company level to cover the severance payments in 8 case of FSLIC receivership? 9 A. I agreed with it. 10 Q. Then finally, if we turn to the last 11 page, the summary makes reference, again, to the 12 fact that -- of the employment contracts. If you 13 read that summary, I just have one or two 14 questions regarding the summary. 15 Have you had a chance to read that, 16 sir? 17 A. Yes, I have. 18 Q. Now, it says in the second sentence -- 19 strike that. 20 It says, "First glance at the 21 employment contracts scenario at United indicates 22 that, when declining capital and FSLIC action 23413 1 became likely possibilities, senior management 2 took actions through employment contracts, special 3 bonuses, escrow accounts established outside the 4 institution to safeguard their compensation and 5 severance pay." 6 Did you agree with that? 7 A. Yes. 8 Q. It goes on and says, "Further, the 9 holding company appears to be a vehicle for 10 shielding the stockholders' and senior 11 management's interests rather than a vehicle -- 12 rather than being a source of strength for the 13 insured institution." 14 What did you understand that to mean? 15 A. Well, under the net worth maintenance 16 agreements, they are supposed to be a source of 17 strength for the S&L, not a liability to the S&L. 18 Again, under a net worth maintenance agreement, 19 UFG was supposed to take steps to cure any 20 deficiencies, particularly net worth maintenance 21 deficiencies, at the institution. 22 And in this case, when the institution, 23414 1 particularly by mid-1988, was already reporting 2 insolvency, Mr. Berner had structured a number of 3 employment contracts that basically guaranteed 4 payments of some money in the event of anything 5 happening to USAT; and that money would then come 6 from UFG. 7 Q. And was it your belief that under the 8 net worth maintenance agreement, that money should 9 otherwise go to USAT as a source of strength? 10 A. That was my opinion. 11 Q. So, do you concur with the summary that 12 was reached by Ms. Guthrie in this memorandum? 13 A. Yes, I do. 14 Q. Now, the next attachment is a board 15 briefing summary. And I would point out to you 16 that the board briefing summary, while it does not 17 have a date on it, is referenced on the first page 18 of T8145. If you look at the third paragraph 19 down, it says, "Additionally, as indicated in the 20 attached board briefing summary..." 21 Do you see that? 22 A. Yes. 23415 1 Q. What -- what is a board briefing 2 summary? Do you recall why this would have been 3 prepared? 4 Perhaps I can move this along a little 5 bit. If you look at OW028483, the 6 next-to-the-last paragraph begins with the 7 sentence "Based on the lack of direction and 8 proper oversight exhibited by Messrs. Crow, 9 Williams, and Berner in the lending and securities 10 area, we cannot endorse or recommend their 11 continued employment after the receivership." 12 Do you see that? 13 A. Yes. 14 Q. Now, was that your recommendation to 15 the board regarding the future employment of 16 Mr. Crow and Mr. Williams and Mr. Berner? 17 A. If USAT had been an ongoing 18 institution -- ongoing, namely existed after 19 January 1st, 1989 -- it would have been. 20 Q. Then in the next sentence, it says, "In 21 addition" -- strike that. 22 The next paragraph goes on and says, 23416 1 "We also recommend the immediate termination of 2 Mr. Munitz based upon his questionable 3 contribution to United as well as his apparent 4 affiliation with Charles Hurwitz." 5 Do you see that? 6 A. Yes, I do. 7 Q. What was that making reference to? 8 A. Although Mr. Munitz wasn't an employee 9 of USAT, he was deeply involved with its 10 management and its -- its daily decisions. 11 Q. And did he have an employment contract 12 with USAT? Do you recall? 13 A. Yes. 14 Q. Were you ever able to determine why, if 15 he wasn't an employee, he had an employment 16 contract? 17 A. No, I didn't determine that. 18 Q. Now, as a result of this 19 recommendation -- was this recommendation that's 20 contained in this board briefing then incorporated 21 into T8145, which is the memo that was sent on by 22 you to Ron Brown and Robin Sneff and Ann Barnes 23417 1 and Debby Skoler? 2 A. Yes. The people at FSLIC, yes. 3 Q. And do the attachments then form the 4 basis or the justification for the recommendation 5 that appears in the memo dated December 21st, 6 1988? 7 A. Yes, it does. 8 Q. And that justification, again, was that 9 based upon the results of the 1988 Southwest 10 examination conducted by Ms. Bese? 11 A. Based on the interim reports that we 12 had received. 13 Q. Was it also based upon your own 14 personal observations and interaction with the 15 individuals that you were recommending be 16 terminated? 17 A. Yes. 18 Q. Now, I would like to move on to another 19 set of documents. I'm going to hand up to you a 20 second book -- 21 THE COURT: Mr. Rinaldi, is T8145 in 22 evidence? 23418 1 MR. RINALDI: I'm sorry, Your Honor. I 2 forgot to move it into evidence. I would move its 3 admission. 4 MR. VILLA: No objection. 5 THE COURT: Received. 6 Q. (BY MR. RINALDI) Now, yesterday you 7 testified that you had been involved over some 8 period of time in communications with Mr. Berner. 9 Do you recall the series of documents I 10 showed you regarding your conversations with 11 Mr. Berner? 12 A. Yes. 13 Q. And throughout 1988, did you continue 14 to have an ongoing intercourse or discussions with 15 him regarding the operations of USAT? 16 A. Yes. We had constant discussions. 17 Q. And during about the month of May, I 18 believe you had mentioned the fact that you had 19 requested from Mr. Berner that he provide you with 20 employment contracts relating to United and/or its 21 subsidiaries. 22 Do you recall that? 23419 1 A. Yes. 2 Q. Would you take a look at what's been 3 previously admitted as T8069 at Tab 429? This is 4 a letter dated May 13th, 1988. 5 Do you recognize that document, sir? 6 A. Yes. 7 Q. And can you describe for the Court why 8 you wrote -- or what caused you to write that 9 document? 10 A. Primarily, because USAT was inquiring 11 of Washington to be involved in the 12 Southwest Plan. We were starting to put together 13 a package of information on their management team. 14 Part of that included a review of all existing 15 employment contracts. 16 Q. Now, was USAT the only institution that 17 you were doing these kinds of reviews for or that 18 you were requesting this information from? 19 A. I was doing it on at least a dozen 20 other institutions. 21 Q. And what was the purpose for requesting 22 these contracts? Did you want to analyze them for 23420 1 legal sufficiency or what? 2 A. We wanted to review the contracts for 3 compliance with the Insurance Regulation 563.39. 4 Q. And you were doing this also with 5 respect to a dozen or so other institutions? 6 A. At least. 7 Q. And in the event that the -- you found 8 a contract that was not in compliance with the 9 regulation, were you requiring people to take 10 corrective action? 11 A. Yes, I was. 12 Q. Now, as a result of your sending this 13 letter to Mr. Twomey (sic) requesting the 14 employment agreements of United, did Mr. Twomey 15 (sic) get back to you with a letter? 16 A. Well, I sent this to Mr. Berner. 17 Q. I'm sorry. Mr. Berner. 18 A. I believe he did tell me there were no 19 contracts with USAT. 20 Q. And actually, maybe we should correct 21 your last testimony. It appears it went to Jenard 22 Gross in the first instance; is that correct? 23421 1 A. Yes. 2 Q. But Mr. Berner, then, as you recall, 3 got back to you. 4 Would you take a look at what's been 5 previously marked as Exhibit 430? It's T8071. 6 This is a letter dated May 13th, 1988, from 7 Mr. Berner to you. 8 A. Yes. 9 Q. Is this the response you received from 10 Mr. Berner? 11 A. Yes. 12 Q. Now, he indicates in the letter that 13 "The holding company has entered into certain 14 employment agreements which have been provided to 15 Vivian Carlton in connection with our 16 examination." 17 Do you see that? 18 A. Yes. 19 Q. To your knowledge, did Mr. Berner ever 20 give any contracts of USAT to Ms. Carlton? 21 A. Not that I'm aware of. 22 Q. And when you learned that Ms. Carlton 23422 1 had received contracts relating to the holding 2 company, did you request the contracts from her; 3 or did you request they be provided by Mr. Berner? 4 A. No. I wrote to the holding company and 5 requested them. 6 Q. Now, directing your attention to what's 7 been -- the next document in your book, which is 8 Tab 1376 and has previously been admitted as 9 B2211. 10 Do you recognize that document? 11 A. Yes. This is the letter going to the 12 holding company. 13 Q. Okay. And it specifically requests the 14 holding company contracts. But then in addition, 15 it goes on and says, "Therefore, please provide us 16 with copies of such contracts between UFG, Inc. 17 and any of its subsidiaries." 18 Do you see that? 19 A. Yes. 20 Q. And what did you mean by "any of its 21 subsidiaries"? 22 A. The holding company could have other 23423 1 subcorporations and not just USAT. 2 Q. Okay. What was the principal 3 subsidiary of United -- of UFG? 4 A. I believe USAT. 5 Q. So, in effect, you were asking a second 6 time if there were any subsidiary contracts? 7 A. I was covering all the bases. 8 Q. And did Mr. Berner ever write back to 9 you and indicate to you that contracts had been 10 entered into by United Savings Association of 11 Texas and certain senior management on or about 12 February 11th, 1988? 13 A. I believe he did. 14 Q. You believe he did. 15 When would that have been? 16 A. I'm trying to remember. I recall that 17 we became aware of the UFG contracts. I'm not -- 18 I'm not sure when I became aware of the 19 February '88 contracts. 20 Q. All right. Now, in the next document, 21 which is the letter that Mr. Berner writes back to 22 you, he indicates to you that -- 23424 1 MR. VILLA: Sir, could you give us the 2 number of the document so we can pull it out? 3 MR. RINALDI: It's Tab 431, T8072. 4 Q. (BY MR. RINALDI) He writes back and 5 says, "I am enclosing a copy of the executed 6 employment agreements entered into between United 7 Financial Group and the following persons." And 8 he identifies them. 9 Do you see that? 10 A. Yes. 11 Q. At this point in time, did he produce 12 to you any contracts entered into between USAT and 13 USAT's executive management? 14 A. No, he didn't. 15 Q. Did he advise you at this point in time 16 that any contracts existed, that you recall? 17 A. No, he didn't. 18 Q. Okay. Now, did he tell you that USAT 19 was paying the salaries and bonuses that were in 20 the UFG contracts that he provided you? 21 A. I don't believe he did. 22 Q. Were you aware that the UFG contracts 23425 1 that were provided to you at this point in time 2 were only for the purposes of providing severance 3 benefits and that the salaries provided under 4 those contracts were being paid by USAT? 5 A. No, I wasn't. 6 Q. Now, it goes on and says, "Please be 7 advised that in connection with the Federal Home 8 Loan Bank Board request to employ a senior 9 executive officer (of which you are aware), we 10 have discussed the need for providing employment 11 agreements to this person and other key 12 personnel." 13 Do you see that? 14 A. Yes. 15 Q. Who is he referring to here? 16 A. Well, the pending hiring of Larry 17 Connell as president. 18 Q. Okay. And he states in the last 19 sentence of that paragraph, "We expect that" -- 20 well, strike that. 21 He makes reference to a compensation 22 consultant. And then he says in the last 23426 1 sentence, "We expect a report within the next 2 three weeks and it is, therefore, probable that 3 United Savings Association will enter into 4 employment contracts with these (and perhaps other 5 key employees). Any such contracts will, of 6 course, comply fully with applicable regulations." 7 Do you understand at this point in time 8 that there were no contracts between USAT and its 9 executive officers? 10 A. Yes. 11 Q. Now did you expect as a result of 12 receiving this letter that if any contracts had 13 been entered into by USAT, that they would have 14 been provided to you by Mr. Berner? 15 A. Yes. 16 Q. And why was that? 17 A. Again, at the time, we explained to 18 Mr. Berner that the reason we were going through 19 this process that anybody that was going to be 20 participating in the Southwest Plan -- we needed 21 to see copies of any existing employment contracts 22 along with what it says in this letter where if 23427 1 Mr. Connell is hired, his contract would be sent 2 in for us to take a look at. And it was 3 anticipated that if anybody else was hired or 4 anybody else received a contract, their contracts 5 would also be sent in. It would be the only way I 6 would have a complete set of what existing 7 contracts were. 8 Q. Turning your attention to the next 9 document, this is the board minutes of United 10 Savings Association of Texas dated June 28th, 11 1988. It's Exhibit T8078 and appears at Tab 434. 12 A. Yes. 13 Q. Now, you did not -- you were not 14 present at this meeting of the board. However, I 15 direct your attention to the fourth full paragraph 16 down. It makes reference to the fact that -- I'm 17 sorry. Sixth Paragraph -- that after the 18 presentation of proposed new employment contracts 19 which are described in Paragraph 4, that the board 20 had voted to approve contracts for the individuals 21 that are identified in Paragraph 4. 22 Do you see that? 23428 1 A. Yes. 2 Q. Now, if you turn to the next page, it 3 indicates that on this same day, Mister -- I'm 4 sorry -- the board of USAT also approved the 5 contract of Lawrence Connell. 6 Do you see that? 7 A. Yes. 8 Q. Now, did there come a time when 9 Mr. Berner advised you that the board had approved 10 Mr. Connell's contract as reflected in the minutes 11 of June 28, 1988? 12 A. Yes, he did. 13 Q. Okay. And take a look at Exhibit -- 14 Tab 1377. It's Exhibit T8081. Now, this purports 15 to be a memo of a conversation between you and 16 Mr. Berner on June the 30th -- I mean on 17 June 29th, 1988. 18 Do you see that? 19 A. Yes. 20 Q. Do you recall whether Mr. Berner 21 contacted you by phone and advised you that the -- 22 that the board was in the process of finalizing 23429 1 the offer to Larry Connell? 2 A. I don't remember it specifically, but I 3 knew as soon as they hired Mr. Connell I was 4 contacted by Mr. Berner. 5 Q. Okay. At least based upon Mr. Berner's 6 memo, it appears it would have been the day after 7 the board of USAT voted to hire Mr. Connell; is 8 that correct? 9 A. That's correct. 10 Q. Now, in that conversation, do you 11 recall whether Mr. Berner advised you that at that 12 same board meeting, the board had agreed to enter 13 into new employment contracts with eight members 14 of executive management? 15 A. No, I don't recall that. 16 Q. And does it reflect it in his memo, 17 that he made such a disclosure to you? 18 A. I don't see that here. 19 Q. At this point in time, were you still 20 under the impression that USAT had no employment 21 agreements with its senior executive management as 22 Mr. Berner had represented to you in his May 18th 23430 1 letter, which is Exhibit T8071? 2 A. The only contract that was discussed 3 was Larry Connell's. 4 Q. And turn to the next document, which is 5 dated June 30th, 1988. Did, thereafter, Mister -- 6 THE COURT: Give us the citation, 7 please. 8 MR. RINALDI: It's Tab 467, and it's 9 Exhibit A11031. 10 Q. (BY MR. RINALDI) Have you had a chance 11 to look at that letter, sir? 12 A. Yes, I have. 13 Q. Do you recognize it? 14 A. Yes, I do. 15 Q. What is it, sir? 16 A. It's basically the transmittal letter 17 for Mr. Berner sending me Larry Connell's 18 contract. 19 Q. And when he transmitted the contract to 20 you, did he enclose any other contracts pertaining 21 to the senior executives of USAT? 22 A. Only Mr. Connell's. 23431 1 Q. And did you understand that Mr. Berner 2 was transmitting the Connell contract to you as 3 a -- how should I say this -- a model contract for 4 your approval? 5 A. No. 6 Q. Did you understand that if you had no 7 objection to Mr. Connell's contract, that USAT 8 intended to enter into similar contracts with 9 eight or nine members of its senior executive 10 staff? 11 A. I had no such understanding. 12 Q. And Mr. Berner didn't relate that to 13 you at the time? 14 A. No, he didn't. 15 Q. Now, after you received the contract, 16 did you turn the contract over to anyone for their 17 review? 18 A. I sent it to my legal department. 19 Q. And if you take a look at 20 Exhibit T8090, this is a new document; so, it 21 doesn't have a tab yet. 22 I'm sorry. I'm told that it's Tab 485. 23432 1 It was admitted as Exhibit B2313. This is a memo 2 to you from Beverly Isaiah-Bermudez. 3 Do you see that? 4 A. Yes. 5 Q. It's in reference to Mr. Connell's 6 contract? 7 A. Yes, it is. 8 Q. And who was Ms. Bermudez? 9 A. She was one of the staff attorneys 10 working at the Federal Home Loan Bank of Dallas' 11 legal department. 12 Q. Had you asked her to review the 13 contract when you received it? 14 A. I had asked the legal department to 15 review the contract. 16 Q. And someone in the legal department 17 gave it to Ms. Bermudez for her review? 18 A. Deborah Jenkins assigned it to her. 19 Q. Is this memo, which is dated July 15th, 20 1988, the memo that Ms. Bermudez sent back to you 21 regarding Mr. Connell's contract? 22 A. Yes. 23433 1 Q. Now, she raises several criticisms 2 regarding the contract and its structuring. And 3 then it goes on in the last paragraph and says, 4 "This department suggests that the proposed 5 contract be submitted to the Regulatory Review 6 Committee (RRC) for recommendations due to policy 7 considerations involving the excessive 8 compensation and the golden parachute provisions." 9 Do you see that? 10 A. Yes. 11 Q. What were the concerns Ms. Bermudez 12 raised regarding the contract? 13 A. She had concerns about the way the 14 contract was structured and, basically, the amount 15 of bonuses, the -- that were incorporated in the 16 contract and the golden parachute she thought was 17 pretty large. 18 Q. Okay. And when you made reference to 19 the golden parachute, does that mean the severance 20 provision? 21 A. Yes. 22 Q. Now, did you then -- what action did 23434 1 you take, or do you recall? 2 A. We prepared to send this to the RRC and 3 ask them to review the contract. It was our 4 recommendation that despite the provisions that 5 were incorporated in the contract, there was a 6 supervisory need to move ahead and let this 7 contract go ahead between Mr. Connell and USAT. 8 So, basically, we were going to take a 9 supervisory exception. 10 Q. And was it submitted, then, to the RRC? 11 THE WITNESS: At this time, Your Honor, 12 the Dallas bank was again going under another 13 reorganization; and the new acting head of 14 supervision had decided to disband the RRC 15 committee. 16 So, instead of meeting with a group of 17 our senior regulatory officials, we then just 18 handled this through the normal chain of command. 19 Q. (BY MR. RINALDI) Now, directing your 20 attention to T8093, it appears to be a memo from 21 you to Dave Bradley dated July 27th, 1988. 22 Do you recognize this document? 23435 1 A. Yes. 2 Q. Directing your attention to the last 3 paragraph of the first page, if you can just read 4 that to yourself. 5 A. (Witness reviews the document.) Yes. 6 Q. Have you had a chance to look at it? 7 A. Yes. 8 Q. Now, it says that "As the RRC has been 9 dissolved, we proposed directing United to revise 10 the agreement in accordance with Federal Home Loan 11 Bank Board policy in Section 563.39 and 12 Section 563.17 of the insurance regulations." 13 Do you see that? 14 A. Yes. 15 Q. Did you ever follow-up on that -- 16 well -- did you ever follow-up on that proposal? 17 A. I can't recall how it was handled. 18 THE COURT: Excuse me. I didn't hear 19 your answer. 20 THE WITNESS: I can't recall how we 21 specifically handled that, namely notifying USAT 22 of the corrections that might be needed in 23436 1 Mr. Connell's contracts. 2 Q. (BY MR. RINALDI) Do you know whether 3 they were ever notified regarding those 4 corrections? 5 A. No, I don't recall. 6 Q. At or about this point in time in July? 7 A. No, I don't recall. 8 Q. As the supervisory agent, were you 9 concerned about the level of compensation that 10 Mr. Connell was receiving under the contract? 11 A. No. 12 Q. Why not? 13 A. I felt that it was in dire need to get 14 somebody with Mr. Connell's background involved 15 with the senior management and running that 16 institution. I felt that if that had to be the 17 price, then that's the price we pay. 18 Q. So, you just swallowed hard and went 19 along with it? 20 A. I made the decision. 21 Q. Was that your decision as the 22 supervisory agent? 23437 1 A. It was my responsibility. 2 Q. Now, Mr. Twomey, did there come a time 3 subsequent to the submission of the contract to 4 Ms. Bermudez that we've been talking about on 5 July 15th, 1988, that you learned that in addition 6 to Mr. Connell's contract, there were a number of 7 additional contracts that had been entered into on 8 the same -- or approved by the board of USAT the 9 same day Mr. Connell's contract was approved? 10 A. I only learned about it from Ms. Bese's 11 interim reports that weren't filed with us until 12 the fall of 1988. 13 Q. And that would have been the report 14 that we looked at previously that was Interim 15 Report No. 2 that was filed on October 17th, 1988? 16 A. Yes, it is. 17 Q. Now, did Ms. Bese learn of the 18 contracts at some time prior to filing the report, 19 that you know of? 20 MR. VILLA: Your Honor, I think we can 21 stipulate that Ms. Bese had to learn of the 22 contracts before she sent the report. But if the 23438 1 intention of this is to get Ms. Bese's testimony 2 about when she found out about the contracts, 3 we're going to go right back to where we were 4 yesterday. 5 I'll stipulate she found out about the 6 contracts some time before she wrote about them. 7 MR. RINALDI: Will you stipulate 8 that -- 9 THE COURT: What is your question, 10 Mr. Rinaldi? 11 MR. RINALDI: I simply wanted to 12 establish when Ms. Bese found out about the 13 contracts through the work papers that appear in 14 the 1988 Southwest Plan, Your Honor. I believe 15 that every examination has a log of requests that 16 are made for information from the institution. In 17 this case, a log was maintained by Ms. Bese; and 18 the log demonstrates quite clearly when the 19 contracts were requested and when she was advised 20 of the existence of the contracts. 21 This was a document that originally was 22 put together by the other side and put into the -- 23439 1 THE COURT: Where is that document? 2 MR. RINALDI: That's the next document 3 I'm going to show Mr. Twomey. 4 Q. (BY MR. RINALDI) If you'll turn the 5 page, Mr. Twomey, to Exhibit -- I believe it's 6 T8176. 7 THE COURT: Mr. Rinaldi, is T8093 in 8 evidence? 9 MR. RINALDI: T8093? No, it is not. I 10 move the admission of T8093, Your Honor. 11 MR. VILLA: No objection. 12 THE COURT: Received. 13 MR. RINALDI: And I would -- 14 Q. (BY MR. RINALDI) Have you had a chance 15 to look at what's been marked as T8176? 16 A. Yes, I have. 17 Q. Okay. And can you describe for the 18 Court what that is? 19 A. During the examination, the examiners 20 would keep a log of when items were requested from 21 the management, what items were requested, and 22 when they were received from the management of the 23440 1 institution. 2 Q. Now, do you recognize what this 3 document is? Is it a log from a particular 4 examination? 5 A. Well, by the heading on the page, it's 6 the log from Brenda Bese's exam of September 7th, 7 1988, of USAT. 8 MR. RINALDI: Your Honor, I would move 9 the admission of the log. 10 MR. VILLA: Well, Your Honor, you know, 11 this is a document they showed us. I don't 12 remember that we put it together. This is the one 13 I objected to before by Ms. Bese. I think -- you 14 know, every time they have an examination, they 15 ask for the same set of questions. They ask for 16 employment contracts. They ask for all these 17 different things, and they are all put on a log. 18 And then the dates they are received are put on 19 there. 20 Now, if they are going to try to 21 introduce this document for the fact that this is 22 the first time anybody knew about the contracts, I 23441 1 would object because that's exactly what we were 2 talking about with Ms. Bese. If they are simply 3 going to say this is a log of the regular 4 examination requests that are made every time and 5 responded to, there's no objection. 6 If the point of this document is to try 7 to get around bringing in Ms. Bese, then I object. 8 MR. RINALDI: The point of the document 9 is not to get around bringing in Ms. Bese. It's 10 to show the request for the documents. 11 Your Honor, this is a business record -- 12 THE COURT: All right. I'll receive it 13 for that purpose. 14 Q. (BY MR. RINALDI) Now, Mr. Twomey, can 15 you tell by looking at Item 5 of the log when -- 16 strike that. 17 Take a look at Item 5 of the log. Do 18 you see that? 19 A. Yes, I do. 20 Q. That's a request made on 9/13/88. Now, 21 the first pages of this log are a list of summary 22 requests. But if you look further back, does it 23442 1 appear that each of the requests that are made are 2 written out on a separate sheet of paper? Take a 3 look at OW127285? 4 A. Yes, I see it referred to as Request 5 No. 5. 6 Q. Okay. And can you tell from the 7 document log when Ms. Bese requested the 8 employment contracts? 9 A. She requested it on September 13th, 10 '88. 11 MR. NICKENS: Your Honor, I object. 12 What the request is is for a list of all employees 13 that have any employment contracts. 14 MR. RINALDI: Thank you for the 15 clarification. I was going to make that myself. 16 Q. (BY MR. RINALDI) Did she actually 17 request the employment agreements themselves? 18 A. At this time, she was requesting a 19 list. 20 Q. And then if you turn back to the first 21 page, can you determine what date she had 22 requested or it indicated she needed the 23443 1 information by? 2 A. I believe she said September 20th, '88. 3 Q. Okay. And then it indicates the date 4 that she received the information. 5 Do you see that? 6 A. Yes. 7 Q. And that was what date? 8 A. September 21st, '88. 9 Q. Does it appear from the log, then, that 10 Ms. Bese was advised of the existence of contracts 11 on -- 12 MR. VILLA: I can't -- do you have a 13 more legible copy than we do? I can't read 14 anything about dates received. As a matter of 15 fact, we can't even see -- 16 MR. RINALDI: You objected to the good 17 copy is the problem. Here. I can give you that 18 page. 19 MR. NICKENS: Is the witness reading 20 from something different than we have is our 21 problem. 22 THE COURT: All right. We'll be off 23444 1 the record. 2 3 (Discussion held off the record.) 4 5 THE COURT: All right. Back on the 6 record. 7 Q. (BY MR. RINALDI) Can you tell from the 8 log when Ms. Bese was provided with a list of 9 employment contracts? 10 A. Yes. It says here September 21st, '88. 11 Q. And then it was approximately three and 12 a half weeks after that that she presented the 13 second interim report to you? 14 A. It was in mid-October, yes. 15 Q. And that analyzed the contracts? 16 A. Yes. 17 Q. Now, directing your attention back 18 to -- well, strike that. 19 When you received the second interim 20 report, I believe you testified yesterday that you 21 were surprised -- or strike that. 22 What was your reaction when you 23445 1 received the report and found out about the 2 contracts? 3 A. I was surprised because I didn't know 4 they existed. 5 Q. Okay. And after you learned about 6 their existence and learned about their content as 7 reflected in Enclosure 2, did you contact 8 Mr. Berner? 9 A. I believe I did. 10 Q. Okay. And did you have occasion to 11 write Mr. Berner -- well -- a letter -- strike 12 that. 13 I notice that in the -- in the second 14 interim report, if you take a look at 15 Exhibit 2699 -- that's in the other binder -- and 16 you take a look at Page OW154209 -- I think it's 17 the large document -- Bates stamped 154209. 18 A. Yes, I have it. 19 Q. Okay. The second full paragraph says 20 that "The July 1st, 1988 employment contracts are 21 complicated and are not complete without copies of 22 the June 30th, 1988 and June 9th, 1987 UFG 23446 1 employment contracts." 2 Do you see that? 3 A. Yes. 4 Q. Was an effort made by representatives 5 of the Bank Board to obtain additional information 6 related to the contracts and bonuses that are 7 described in Enclosure No. 2? 8 A. Yes. 9 Q. Take a look at what's been previously 10 marked as T8110. 11 A. Is that in the second binder? 12 Q. Yeah. It should be about another 13 document or two along. It's not been admitted 14 before. 15 Now, who was Donna Guthrie? 16 A. Again, Donna Guthrie was an attorney 17 who worked for the Federal Home Loan Bank of 18 Dallas' legal department. 19 Q. And it indicates here that she received 20 a letter from Mr. Berner? 21 A. Uh-huh. (Witness nods head 22 affirmatively.) 23447 1 Q. And a copy of that was sent to 2 Mr. Dunn? 3 A. Uh-huh. (Witness nods head 4 affirmatively.) 5 Q. And Mr. Dunn is your -- 6 A. Analyst. 7 Q. -- analyst. Okay. 8 Did Mr. Berner then submit to 9 Ms. Guthrie additional documentation relating to 10 the employment practices of USAT? 11 A. Mr. Berner did submit additional 12 information to Donna Guthrie. 13 Q. And it's listed there at the bottom of 14 the page, is it not? 15 A. Yeah. 16 Q. And it included the 1988 executive 17 bonus plan? 18 A. Yes. 19 Q. And the escrow agreement dated 20 10/17/88? 21 A. Yes. 22 MR. NICKENS: Your Honor, I have an 23448 1 objection about reading a document into evidence 2 before it is offered. It happens we have no 3 objection to this document. But for a document 4 that we do have an objection to, this practice of 5 reading it into the record before it's offered 6 doesn't really leave much decision for you and 7 doesn't really allow us to object. 8 MR. RINALDI: I apologize, Your Honor. 9 THE COURT: Are you going to offer the 10 document? 11 MR. RINALDI: Yes. I would offer it, 12 Your Honor. 13 MR. VILLA: No objection. 14 THE COURT: Received. 15 Q. (BY MR. RINALDI) Now, a moment ago, I 16 had asked you whether you had contacted Mr. Berner 17 regarding your concerns with respect to the 18 employment agreements. 19 Would you take a look at the next 20 document in your binder? It's T8111, and it's 21 Tab 444. 22 Do you recognize that document, sir? 23449 1 A. Yes. 2 Q. Is that your signature that appears on 3 the second page of the document? 4 A. Yes. 5 Q. Why did you write this letter to the 6 board of directors of United Savings Association 7 of Texas? 8 A. Well, based on what information we 9 received from the interim report and based on our 10 follow-up request for information and based on 11 information -- the reports we were getting back 12 from our legal department who, also, we asked to 13 review the contracts, I wrote this letter to the 14 board of directors of USAT. 15 Q. And in the second sentence in the first 16 paragraph, it says, "Each and every contract 17 review was found to be in violation of 18 Section 563.39 of the insurance regulations." 19 A. Uh-huh. (Witness nods head 20 affirmatively.) 21 Q. Do you see that? 22 A. Yes, I do. 23450 1 Q. As the supervisory agent for USAT, was 2 it your conclusion that all of the employment 3 agreements violated Section 563.39? 4 A. Yes. 5 Q. And then in the next sentence, it 6 indicates that you had some views regarding the 7 safety and soundness of the contracts. 8 Do you see that? 9 A. Yes, I do. 10 Q. Okay. Can you describe for the Court 11 what your opinion was with respect to the safety 12 and soundness of these contracts? 13 A. Upon learning of the contracts and 14 after our review, we were concerned that at the 15 time they were entering into these large contracts 16 which included severance agreements and other 17 bonus money, that the institution was materially 18 insolvent. It was not appropriate to enter into 19 these type of large contracts with these 20 individuals at this time. 21 And through this letter, basically I 22 was telling their board of directors, you know, 23451 1 "Don't pay out any of this money. Don't pay out 2 the severance. If the money has been placed 3 outside the bank, I want the money requested and 4 brought back inside the bank." I didn't want 5 money sitting in trust accounts which we had no 6 control over. 7 Basically, I was saying to stop where 8 you are and correct these contracts and, you know, 9 bring them into compliance. 10 Q. And was it your opinion that these 11 contracts represented an unsafe and unsound 12 banking practice because they were entered into at 13 the time United was insolvent or approaching 14 insolvency? 15 A. Yes. 16 Q. Now, in Paragraph 1, it indicates 17 that -- you talked about trying to stop everything 18 in place. 19 What was the purpose of Paragraph 1 in 20 terms of the directions that you gave to the board 21 of directors? 22 A. Well, we were aware that certain 23452 1 provisions of the contract would require payment 2 of money based on if there was a termination or a 3 person actually worked on January 3rd of 1989. 4 And there was six-point-something-million dollars 5 in one group regarding severance; and there was 6 other bonuses of $800,000 set aside. 7 Q. And what did you intend to convey to 8 the board in Paragraph 1? 9 A. I thought the payment of bonuses and 10 severance in the manner they prescribed in these 11 contracts was totally inappropriate. 12 Q. And were you directing them to provide 13 notice to terminate these arrangements? 14 A. Yes. 15 Q. Now, Paragraph 2 indicates that they 16 were to make no payments. 17 Did you understand that they would 18 continue to make the base salary payments? 19 A. I believe we -- we weren't excluding 20 base monthly salary. 21 Q. And then at the end of that paragraph, 22 it talks about before any other -- that before any 23453 1 actions were taken by the board with respect to 2 the payment of any severance, you wanted to 3 receive notice and give your prior written 4 approval? 5 A. Yes. I had written this letter under 6 563.13(d) which was basically -- this made this a 7 supervisory directive. It was an order to the 8 institution. Based on what was in this letter, 9 they had to comply. 10 Q. And when you say it was an order to the 11 institution, what -- what is the impact of that or 12 the import of having written it in that fashion? 13 A. 563.13 is our net worth regulation. 14 And underneath 563.13, if the institution is 15 taking actions I deem inappropriate, unsafe, 16 unsound, I can direct the institution to stop 17 those actions. And by this letter, it was 18 basically an order to them saying not to do that. 19 If they violated this, we would have to go for 20 cease and desist. 21 Q. Did you believe at this point in time 22 that the contracts proposed a material risk of 23454 1 loss or damage to the institution if they had not 2 been terminated? 3 A. There was a potential for damage to the 4 institution, yes. 5 Q. Now, after you brought this to the 6 attention of the board of directors of USAT, do 7 you recall whether they acted upon your directive? 8 A. Yes. They took certain steps to unwind 9 the contracts, and the different employees were 10 agreeing to the modifications and unwinding of the 11 financial deals. 12 Q. Now, do you recall attending a board of 13 directors meeting on November 7th of 1988 at USAT 14 at which the consent agreement was discussed? 15 A. Yes. 16 Q. Let me direct your attention to the 17 next document in your book, Tab 447. It's 18 Exhibit T8117. 19 A. I have it. 20 Q. And I believe it indicates on the first 21 page that you were in attendance at the board 22 meeting of USAT on November 7th, 1988, does it 23455 1 not? 2 A. Yes. 3 Q. Do you recall attending this board 4 meeting? 5 A. Yes, I do. 6 Q. And before I talk about the contracts 7 and the consent agreement, could you direct your 8 attention to Paragraph 2 -- I mean Page 2 and the 9 last or the next-to-the-last paragraph that begins 10 with the word "Mr. Berner"? 11 A. Yes. 12 Q. And could you read that paragraph to 13 yourself? 14 A. (Witness reviews the document.) 15 Q. Now, it makes reference there to the 16 current status of the associations in the 17 Southwest Plan. 18 Do you see that? 19 A. Yes. 20 Q. And it notes one potential bidder was 21 MAXXAM. 22 Do you recall who MAXXAM was, or what 23456 1 MAXXAM was? 2 A. MAXXAM is a corporation controlled by 3 Mr. Hurwitz. 4 Q. Okay. And did MAXXAM have a 5 relationship to United Financial Group of Texas or 6 USAT? 7 A. They owned a material portion of UFG 8 stock. 9 Q. And do you recall, was MAXXAM one of 10 the entities that was being considered to acquire 11 USAT as part of the Southwest Plan? 12 A. Yeah. We were aware at that point in 13 time that Mr. Hurwitz and MAXXAM were negotiating 14 for a possible FSLIC deal regarding the 15 Southwest Plan. 16 Q. Then it says that Mr. Berner -- it 17 states, "He also noted that the board of directors 18 of the association had supported the bid of this 19 party because, of among other things, the 20 possibility of increased shareholder or creditor 21 value, its local ownership, its proposal for 22 management and employee retention, the 23457 1 capitalization of the new entity, and its cost to 2 the FSLIC." 3 Do you see that? 4 A. Yes. 5 Q. Was it your understanding that the 6 board of USAT was supporting the MAXXAM bid to 7 acquire USAT? 8 A. Yes. 9 Q. Were there members of the USAT board 10 that were affiliated with MAXXAM at this point in 11 time? Just if you recall. 12 A. I can't remember clearly if somebody 13 was, you know, employed or an officer or director 14 of MAXXAM and also involved with UFG at this time. 15 Q. Do you know whether Mr. Munitz was on 16 the board of USAT at this point in time? 17 A. UFG? 18 Q. Of UFG or USAT. 19 A. Yes. 20 Q. One or both? 21 A. I don't recall. I know he was a 22 director. I believe of UFG. 23458 1 Q. Okay. And was it your understanding 2 that MAXXAM was in favor of -- well, it makes -- 3 strike that. 4 It makes reference to the directors 5 being in favor of MAXXAM because of its proposal 6 for management and employee retention. 7 Do you see that? 8 A. Yes. 9 Q. Do you know what that was making 10 reference to when Mr. Berner talked about MAXXAM's 11 retention of management and employees? 12 A. From what I remember at the time is 13 that if MAXXAM's bid was successful, he was going 14 to use primarily the management of USAT when 15 several acquisitions would be made through the 16 Southwest Plan. 17 Q. Now, moving on to the next paragraph 18 below that, it indicates that Mr. Berner raised 19 the question of the compensation and indicated 20 that the Federal Home Loan Bank Board had 21 expressed concern about the employment contracts. 22 Do you see that? It's the last 23459 1 paragraph on the page. 2 A. Yes. 3 Q. And it -- he says that the contracts 4 and level of compensation could be a factor in the 5 association participating in the Southwest Plan. 6 Do you see that? 7 A. Yes. 8 Q. Do you know what he was referring to 9 when he made that statement? 10 A. We had already indicated to him that I 11 was very unhappy regarding the employment 12 contracts and the way they were structured. 13 Q. And -- 14 A. And that impacted my view of 15 management. 16 Q. And would that, in turn, impact on the 17 association's participation in the Southwest Plan? 18 A. Yeah. We were required to provide 19 updates to the FSLIC regarding changes in our 20 assessment of management. 21 Q. After you had advised Mr. Berner about 22 your concerns relating to the contract, did the 23460 1 board thereafter then take action to at least 2 attempt to correct certain of the deficiencies you 3 had identified with respect to the contracts? 4 A. Yeah, they were taking corrective 5 action. 6 Q. And do you recall, did they attempt to 7 take any action with respect to the $6.6 million 8 that had been placed in an escrow account to fund 9 the severance benefits? 10 A. I believe that was returned to USAT. 11 Q. And that was returned after you 12 requested that they do so? 13 A. Yes. 14 Q. And do you recall that moneys were -- 15 you made mention of the fact that money had been 16 set aside to fund a bonus program. 17 Do you remember that? 18 A. Approximately 800,000. 19 Q. Okay. And did you also request that 20 they take steps to recover that 800,000? 21 A. Yes, I did. 22 Q. Were they successful in recovering the 23461 1 800,000, sir? 2 A. Not in 1988. 3 Q. What do you recall of that? 4 A. Before the institution was placed in 5 receivership, the money had been placed in a trust 6 in another bank here in the Houston area; and the 7 trustees wouldn't release the money. 8 Q. Now -- 9 THE COURT: Mr. Rinaldi, we'll take a 10 short recess. 11 12 (Whereupon, a short break was taken 13 from 11:20 a.m. to 11:40 a.m.) 14 15 THE COURT: Be seated, please. We'll 16 be back on the record. 17 Mr. Rinaldi, you may continue. 18 MR. RINALDI: Thank you, Your Honor. 19 Q. (BY MR. RINALDI) Mr. Twomey, if I may, 20 I would like to just go back to Exhibit T8145. 21 A. Yes. 22 Q. And in particular, this is the document 23462 1 by which -- dated December 21st, 1988, where you 2 recommended that Mr. Twomey and Mr. Berner -- I'm 3 sorry -- that you recommended that Mr. Munitz, 4 Mr. Crow, Mr. Berner, and Mr. Williams not be 5 retained. 6 Now, in particular, I'm interested in 7 one item that appears at Bates stamp No. OW028477. 8 And this is part of the December 15th, 1988 memo 9 that you and Marc Dunn sent to Robert Brick. 10 Do you see that? 11 A. Yes. 12 Q. And in particular, I would like to 13 direct your attention to the paragraph prior to 14 the word "recommendation." 15 Do you see that? 16 A. Yes. 17 Q. Would you read that paragraph to 18 yourself? And then I have a couple of questions 19 that I would like to ask you. 20 A. (Witness reviews the document.) Okay. 21 Q. Now, do you recall yesterday you 22 testified that your staff had conducted a 23463 1 compensation survey regarding what other thrifts 2 were paying at or about this point in time? 3 A. Yes. 4 Q. And does this paragraph that appears in 5 your memo reflect the results of your survey? 6 A. Yes, it does. 7 Q. And in specific, it indicates that you 8 had surveyed six insured institutions with assets 9 greater than a billion? 10 A. Yes. 11 Q. Approximately how many institutions do 12 you recall that you surveyed? 13 A. It would be approximately two dozen. 14 Q. And were these all Texas institutions? 15 A. Yes. 16 Q. And were most of these institutions in 17 about the same financial condition as USAT? 18 A. Most were. There were only two or 19 three exceptions. 20 Q. And it states in your -- in the second 21 sentence of the paragraph, "In each category, with 22 the exception of one position, executive 23464 1 management at United are the recipients of 2 significantly higher compensation than their 3 peers." 4 What did you mean by their being 5 recipients of significantly higher compensation 6 than their peers? 7 A. Base salary and bonuses, annual amounts 8 the person may be receiving. What I was saying 9 there regarding base salary and bonuses was that 10 the USAT agreements, the people were -- the senior 11 officers at USAT were receiving in excess of what 12 you might normally see at another institution in 13 Texas based on this survey. 14 Q. And the last sentence says, "Indeed, in 15 some instances, the levels of compensation were 16 more than double the amounts paid to individuals 17 performing comparable duties at similarly-situated 18 institutions"? 19 A. Yes. 20 Q. Does that accurately reflect the 21 results of your survey? 22 A. Yes. 23465 1 Q. Was it based upon that survey that you 2 concluded that the compensation that was being 3 paid to USAT was excessive? 4 A. Yes. 5 Q. Now, directing your attention to 6 Book 2 -- we're finished with that one, Book 1. 7 Directing your attention in particular 8 to Exhibit T8127. This has been previously 9 admitted as Tab 451. 10 Do you recognize this document, sir? 11 A. Yes, I do. 12 Q. Okay. And it was sent by you to 13 Mr. Berner on or about November the 21st, 1988? 14 A. Yes. 15 Q. And what was the purpose of this 16 document? 17 A. To make a complete record of all the 18 items contained in the employment contracts that 19 we had a supervisory problem with. 20 Q. And if we look at the first, I guess, 21 paragraph in the indented section, it talks about 22 level of compensation. 23466 1 Do you see that? 2 A. Yes. 3 Q. And in the middle of the paragraph, it 4 talks about how the level of compensation paid to 5 senior management generally appears to be 6 excessive. 7 Do you see that? 8 A. Yes. 9 Q. And what did you base that conclusion 10 upon, sir? 11 A. Again, based on the internal survey 12 that we had done of other FSLIC-insured 13 institutions in the Texas area. 14 Q. And then second, it talks about the 15 severance provisions. It indicates that "Although 16 not specifically prohibited by the regulations, 17 severance payments of two times annual salary may 18 be considered excessive in light of the 19 institution's financial condition." 20 Was it your opinion that two times 21 annual salary as severance was unreasonable or 22 excessive given the financial condition of USAT? 23467 1 A. Yes, it was excessive. 2 Q. And when you talk about given the 3 financial condition, what was it about the 4 condition of USAT that made it excessive in your 5 view? 6 A. At that time, USAT was insolvent. 7 Q. When you say "at that time," are you 8 talking about the time that the severance 9 provision was entered into on July the 1st, 1988? 10 A. Yes. 11 Q. And then on the next page, it talks 12 about the term. It says, "The contracts terminate 13 on December 31st, 1991, and therefore 14 automatically extend -- and thereafter 15 automatically extend for annual periods without 16 60 -- without 60 days prior written notice. Terms 17 of three years may be considered excessive without 18 adequate justification." 19 Do you see that? 20 A. Yes. 21 Q. Was it your opinion that there was 22 adequate justification for creating a contract 23468 1 over a three-year term with United's executives on 2 or about July 1st, 1988? 3 A. Yes. I thought the terms -- the way 4 this automatically would continue to roll would be 5 excessive. 6 Q. And then finally, it makes reference to 7 a trust account. What were your views regarding 8 the creation of a trust account in order to secure 9 the severance benefits? 10 A. The severance or the bonus? 11 Q. The severance. 12 A. I didn't feel putting the money in a 13 trust account was appropriate. 14 Q. And why was that? 15 A. Because now an outside party would be 16 controlling the moneys in accordance with those 17 contracts and it wouldn't be under the control of 18 the institution. 19 Q. And did you feel that if a termination 20 were to occur, that there was a potential risk of 21 damage to USAT and that such moneys could be lost? 22 A. Yes, because under the contracts -- 23469 1 based on the contracts, that money could be paid 2 out by the trustee. 3 Q. Now, turn to Document T8138. 4 Do you recognize that document? 5 A. Yes. 6 Q. Just to clarify your answer to a 7 question I had a moment ago, I asked you whether 8 you thought a three-year or three-year-plus term 9 for the contracts that were entered into on 10 July 1st, 1988, was justifiable given the 11 condition of USAT. I wasn't sure what your answer 12 was to that. 13 A. Well, I think generally under 563.39, 14 contracts of three years or more are looked at as 15 excessive without having proper justification. 16 Given USAT's financial condition, going 17 out three years seemed to be unsafe and unsound. 18 Q. Okay. Thank you. 19 Now, do you recognize what's been 20 marked as T8138? 21 A. Yes. 22 Q. And do you recall why you wrote this 23470 1 letter, sir? 2 A. We were still having ongoing 3 discussions regarding the executive bonus plan 4 with USAT. 5 Q. And this was the plan whereby money was 6 placed in a -- in an executive bonus trust with 7 the bank? 8 A. A trust account, yes. 9 Q. And even though you had asked the board 10 to recover the moneys from the trust back in 11 November, had they as of this date recovered the 12 funds? 13 A. No. 14 Q. What was the purpose, then, of writing 15 this letter? 16 A. Just to put the board of directors on 17 notice that we were taking -- I was taking 18 supervisory objection to any payments from that 19 trust to the employees listed. 20 Q. And did you view that the payments of 21 those moneys from the executive trust, if they 22 were made, would be an unsafe and unsound 23471 1 practice? 2 A. Yes. 3 Q. Now, I notice you only list seven 4 employees there. 5 A. Uh-huh. (Witness nods head 6 affirmatively.) 7 Q. Did you have any views -- well, was it 8 your understanding that the executive bonus plan 9 applied to more than seven employees? 10 A. There were other employees. 11 Q. Did you view the payments to the 12 other -- were the payments to the other employees 13 on the magnitude of those that are listed here? 14 A. No. 15 Q. Did you -- were they larger, or were 16 they smaller? 17 A. Very much smaller. 18 Q. And did you view the payment of those 19 smaller amounts to the remaining employees to be 20 an unsafe and unsound practice? 21 A. I didn't think they were material 22 enough. 23472 1 Q. And so, did you object to the -- to 2 those moneys being in the trust? 3 A. I wasn't taking -- I was -- basically, 4 regarding the rest of the people, I was taking no 5 objection. The problem was USAT couldn't get the 6 trust money back in the first place. But at that 7 time, I think there was something like $600,000 in 8 the trust account; but 475,000 of it was to these 9 individuals, which namely was the lion's size 10 share. That's who this letter was being addressed 11 to, the ones who were to be receiving a material 12 payment. 13 Q. Now, do you recall whether Mr. Gross 14 was included in this list? 15 A. I believe Mr. Gross had already left 16 the institution. Originally, he had been part of 17 the bonus plan. 18 Q. When he left the institution, as a 19 result of his leaving the institution, do you 20 recall whether his executive bonus amount was 21 recovered from the trust? 22 A. I know today there was some type of 23473 1 negotiated settlement regarding the bonus, and I 2 believe it was recovered from the trust. 3 Q. Well, do you recall that one wasn't 4 entitled to receive money under the trust unless 5 one was still at United after January 3rd, 1989? 6 A. Yeah, that's right. The provision was 7 they had to be employed on January 3rd, I think, 8 of 1989 to receive a bonus. And since he 9 resigned, he was no longer eligible for that 10 bonus. 11 Q. And do you recall, was that money then 12 recovered by USAT? 13 A. I believe it was. 14 Q. To the best of your knowledge, I take 15 it? 16 A. To the best of my knowledge, yes. 17 Q. Now, we've made reference on a number 18 of occasions to the net worth commitment that had 19 been made by -- to a net worth maintenance 20 obligation owed by UFG to USAT. 21 I would like you to take a look at 22 Tab 71 -- it's Exhibit T2013 -- and ask you if you 23474 1 recognize that document. It should be a couple of 2 documents further on in your book. And it's 3 T2013, or it may be T8070. I'm not sure. 4 MR. NICKENS: What is the second 5 number? 6 MR. RINALDI: Well, it's Tab 71; and 7 it's T2013, I believe. 8 A. The May 13th, 1988 letter. 9 Q. (BY MR. RINALDI) Yes. Do you recognize 10 that letter, sir? 11 A. Yes. 12 Q. At the time that you wrote this letter, 13 what was your understanding regarding UFG's 14 obligation with respect to the stipulation that's 15 discussed in the indented paragraph? 16 A. It was my understanding that USAT had 17 an obligation to maintain USAT's net worth. 18 Q. All right. Did you say USAT? 19 A. I'm sorry. UFG had an obligation to 20 maintain USAT's net worth. 21 Q. And did you understand that that 22 obligation was dependent upon you as the 23475 1 supervisory agent making a demand upon UFG to 2 infuse capital into USAT? 3 A. No. It was already an existing 4 obligation. 5 Q. Now, after you made the request that 6 they infuse capital that's set out in T2013, did 7 you -- you indicated that you had occasion to make 8 a subsequent request, I believe. 9 Do you recall that? 10 A. I'm sorry. Could you repeat that 11 question? 12 Q. Well, after you made this initial 13 request on May 13, 1988, I thought you had 14 indicated that you had occasion to make a 15 subsequent request. 16 A. Yes. Later, I believe, in December of 17 1988. 18 Q. Could you turn to Exhibit T2021? It's 19 Tab 73. I would ask you to -- whether you 20 recognize that document. 21 A. (Witness reviews the document.) Yes. 22 Q. Now, in the first paragraph, it 23476 1 indicates that you were making reference back to 2 the May 13th, 1988 correspondence to the 3 institution. 4 Do you see that? 5 A. Yes. 6 Q. And that's the earlier request that we 7 just looked at, which is Exhibit T2013? 8 A. Yes. 9 Q. And it indicates there that -- do you 10 recall now what happened after you made that -- 11 that initial request? 12 A. After I made the initial request, I 13 didn't receive anything in writing; but I did have 14 subsequent conversations with Mr. Berner. 15 Q. And did you anticipate that you were 16 going to receive something further from UFG 17 regarding the net worth obligation or the efforts 18 by UFG to infuse capital into USAT? 19 A. In May? 20 Q. Well, at any point during this period 21 of time. 22 A. At any point? During May, the 23477 1 institution was still looking at some type of 2 FSLIC bailout of the institution. Later, in 3 December, I was aware that UFG had some 10 to 4 $20 million in assets at the holding company. 5 Now, given that the institution was 6 materially insolvent, the December letter was more 7 of a demand for them to infuse some of that money 8 into the institution. 9 Q. Now, you indicated that they only had 10 10 or $20 million at the UFG level. 11 Was it your understanding that even if 12 they could not make up the entire deficiency, that 13 UFG still had an obligation to infuse whatever 14 assets it had into USAT? 15 A. Well -- 16 MR. VILLA: Objection, Your Honor. At 17 some point, I guess I've lost the leading question 18 objection; but it's a leading question. 19 MR. RINALDI: Fine. I'll restate the 20 question. 21 Q. (BY MR. RINALDI) Did -- 22 MR. VILLA: He's already asked the 23478 1 question of this witness. He knows where he's 2 going. He can go ahead and answer that question. 3 THE COURT: Well, maybe the witness 4 doesn't know what the question is at this point. 5 Restate the question. 6 Q. (BY MR. RINALDI) You indicated that UFG 7 only had 10 to $12 million in assets? 8 A. Uh-huh. (Witness nods head 9 affirmatively.) 10 THE COURT: That's not what you said. 11 MR. RINALDI: Did I say 12? I'm sorry. 12 Q. (BY MR. RINALDI) 10 to $20 million in 13 assets? 14 A. At or around December 1988. 15 Q. Did you have an opinion at that point 16 in time as to whether UFG had an obligation to 17 infuse money into USAT if it couldn't make up the 18 entire deficiency? 19 A. Yes. 20 Q. What was that view? 21 A. It was my view that any and all assets 22 of UFG should be used to mitigate the net worth 23479 1 deficiency at USAT. Even if that was only 2 partial, then that -- at least in my opinion, 3 that's the action they should take. 4 Q. Is that why you made the subsequent 5 request on December the 8th, knowing that UFG did 6 not have sufficient assets to make up the 7 deficiency? 8 A. Well, you have to look at it in 9 context. The May letter is basically asking them 10 to come up with a plan. At the late date of 11 December 1988 where the institution was already 12 scheduled for receivership, at this point in time 13 I was just making a demand to infuse anything they 14 had at UFG into USAT. 15 Q. Now, did you subsequently have occasion 16 later in December to make yet another demand for 17 infusion of capital? 18 A. I believe I did. 19 Q. Take a look at Tab 407. It's 20 Exhibit T8149. I'll ask you if you recognize that 21 document. 22 Now, it makes reference to three 23480 1 directives. What were the three directives you 2 were talking about here in the first paragraph? 3 A. Well, I believe there were two previous 4 pieces of correspondence in the earlier exhibits 5 you just referred to: The May 13th letter and the 6 December 8th letter. 7 Q. So, you were renewing the request you 8 had made previously? 9 A. Yes. 10 Q. I apologize. I said three. It said 11 "these." I missread. 12 Then in the next paragraph, you 13 specifically direct them to infuse $13,929,000 of 14 assets into USAT? 15 A. Yes. 16 MR. VILLA: Objection, Your Honor. It 17 misstates the document. It says "return to 18 receivable." Again, we're getting into the tax 19 issue. There are two opinions of the tax issue 20 that were submitted to Mr. Twomey. We haven't put 21 him on our witness list. I object. 22 MR. RINALDI: This document has been on 23481 1 the witness list. I just asked him did he make 2 this request. 3 A. I did make this request. 4 THE COURT: All right. Next question. 5 Q. (BY MR. RINALDI) And then in the final 6 paragraph, did you then direct UFG to infuse 7 capital into USAT? 8 A. Yes. 9 Q. And as a result of your three requests, 10 was any capital infused by USAT into -- I mean by 11 UFG into USAT? 12 A. No, they did not. 13 Q. Okay. Now, Mr. Twomey, I have a series 14 of several questions I would like to ask you about 15 your views with respect to safety and soundness as 16 a supervisory agent. 17 Did you consider it to be an unsafe and 18 unsound practice for USAT on July 1st, 1988, to 19 enter into new employment agreements with nine 20 members of senior management which increased the 21 base salary of each of the executives by the 22 amount of the previous year's bonus in view of the 23482 1 fact that USAT was failing its minimum capital 2 requirement at the time and was approaching or was 3 actually insolvent? 4 MR. VILLA: Objection, Your Honor. 5 He's not an expert witness. He expressed his 6 views. I have the document that says he's not 7 being deposed as an expert. I asked to depose him 8 on these, and the objection which I have is he's 9 not being offered as an expert witness. He's only 10 here to talk about the facts. 11 So, if that's the case, don't present 12 him as an expert. I object to this line of 13 questioning. I object to them trying to use him 14 as an expert. 15 If he's a fact witness, the question is 16 off-the-chart leading. 17 MR. NICKENS: Your Honor, my objection, 18 in addition to those stated by Mr. Villa, is that 19 the question is leading. He's simply summarizing 20 through Mr. Rinaldi's words. The only answer to 21 that could be "yes." I just don't think that's 22 appropriate. If we could hear from the witness as 23483 1 to what his views were. 2 But to summarize that at this point 3 just to put everything that they want to get into 4 the case when the witness himself is not saying 5 that is inappropriate. 6 MR. RINALDI: I can rephrase the 7 question, Your Honor. 8 MR. VILLA: Your Honor, I must disagree 9 with my co-counsel. It's not the question of 10 whether it's leading or not. This is expert 11 testimony. He has given his views as to what 12 occurred, and that's what a fact witness is 13 supposed to do. And now he's trying to put him up 14 here as an expert. And they said he is not 15 testifying as an expert. 16 Under the circumstances, let's not 17 conduct the examination as if he were an expert. 18 He's testified about his views chronologically. I 19 think he's gone through it twice yesterday and 20 today. 21 This line is inappropriate for a fact 22 witness and ought not to be permitted. 23484 1 MR. RINALDI: Mr. Villa wants to have 2 his cake and eat it, too, today. Originally, we 3 had indicated to the Court that Mr. Twomey was 4 being called as a supervisory agent; and 5 Mr. Villa, when he determined that Mr. Twomey 6 might express views that reflected his opinions 7 with respect to safety and soundness, then 8 complained that he had not been allowed to go into 9 that in the first deposition. And Your Honor 10 entered an order in which the Court directed that 11 Mr. Twomey be reproduced and that Mr. Villa could 12 examine him further. 13 Mr. Villa chose not to examine 14 Mr. Twomey any further. We made him available, 15 and Mr. Villa simply deferred. But the Court 16 ruled that given the nature of Mr. Twomey as a 17 supervisory agent who is knowledgeable on the 18 subject of safety and soundness, that it was 19 appropriate to allow them to depose him on the 20 question of his views regarding safety and 21 soundness. 22 MR. VILLA: Your Honor, I may stand 23485 1 corrected. I believe I lost that ruling. I asked 2 to take his deposition as an expert, and you ruled 3 against me. 4 MR. RINALDI: You were allowed to take 5 his deposition. I offered to bring him up to 6 Washington. 7 MR. VILLA: I don't believe so. 8 MR. RINALDI: For reasons I don't 9 recall, you were unwilling to take his deposition. 10 THE COURT: My recollection is he had 11 been deposed as a fact witness, and my 12 recollection is I ordered him to be made available 13 as an expert since he was going to be an expert. 14 But I would have to check my ruling. 15 MR. VILLA: Could we defer this line of 16 questioning at least until perhaps after the 17 break? 18 THE COURT: I think we'll adjourn until 19 1:30. 20 MR. RINALDI: Thank you, Your Honor. 21 22 . 23486 1 (Whereupon, a lunch break was taken 2 from 12:09 p.m. to 1:35 p.m.) 3 4 THE COURT: Be seated, please. We'll 5 be back on the record. 6 MR. VILLA: Your Honor, I have a 7 report. I won't divert us for long, I hope. It 8 turns out I was wrong on whether or not I had the 9 opportunity to depose Mr. Twomey further. 10 I think, however, the distinction I was 11 trying to draw is accurate. In the designation of 12 Mr. Twomey as a witness, they designated him as 13 a -- they called him a fact witness who 14 participated in the supervision and the 15 examination and that he was going to express 16 opinions which have been previously expressed in 17 documents furnished to the respondents. That's 18 what the order said. 19 That's why when he went through the 20 documents at each stage along the way and 21 expressed his opinions about the documents, you 22 didn't hear me getting up and saying, "I object to 23487 1 those opinions." 2 What I object to is what they are doing 3 now which is kind of classic expert witness 4 questioning where you lay out a big series of 5 facts and you question the expert. 6 I think it's beyond the scope of what 7 they designated him as an expert on. He was 8 designated as a so-called fact witness who was 9 going to express opinions on the documents he 10 prepared. And Your Honor, I think he's already 11 done that. 12 MR. RINALDI: Your Honor, Mr. Twomey, 13 in the course of his serving as the supervisory 14 agent for USAT, wrote a number of letters in which 15 he expressed his views regarding safety and 16 soundness to the institution. And I simply want 17 to go over with him those opinions that were 18 expressed in those letters, all of which were 19 provided to Mr. Villa and all of which he had a 20 full and adequate opportunity to examine him 21 about. 22 I think this line of questioning I have 23488 1 is four questions, and I will probably take 2 something on the order of two minutes. I think 3 that Mr. Villa fully acknowledges that he had -- 4 THE COURT: All right. I'll hear it. 5 Let's proceed. 6 Q. (BY MR. RINALDI) Mr. Twomey, in your 7 capacity as supervisory agent, did you form an 8 opinion as to whether it was an unsafe and unsound 9 practice for USAT on July 1st, 1988, to enter into 10 new employment agreements with nine members of 11 senior management which increased the base salary 12 of each of the executives by the amount of the 13 previous year's bonus when USAT was approaching 14 insolvency? 15 A. Yes, sir. 16 Q. What was your opinion in that regard, 17 sir? 18 A. I felt that that was an unsafe and 19 unsound practice by USAT. 20 Q. And is that what's reflected in the 21 letter that you sent on October 17th, 1988, to the 22 board of USAT? 23489 1 A. I believe it was a couple of letters, 2 but -- 3 Q. Take a look at Exhibit T81111. 4 A. 8111? 5 Q. T8111. Did you find it? 6 A. Okay. Yes, I found it. Okay. Yes, 7 this is one of the letters I was referring to. 8 Q. And did you form an opinion as to 9 whether it was an unsafe and unsound practice for 10 USAT on July 1st, 1988, to enter into an 11 employment agreement with nine members of senior 12 management which provided for severance benefits 13 of two times the annual salary of each individual 14 in view of the fact that such agreements were 15 entered into at a time when USAT was failing its 16 minimum capital requirement? 17 A. Yes, I did. 18 Q. What was your opinion in that regard? 19 A. Again, it was unsafe and unsound, 20 especially concerning the financial condition of 21 the institution. 22 Q. Did you formulate an opinion as to 23490 1 whether it was an unsafe and unsound practice for 2 USAT on July 1st, 1988, to enter into guaranteed 3 employment agreements of senior management which 4 had terms of three and a half years in view of the 5 fact that USAT was failing its minimum capital 6 requirement at that time? 7 A. Again, it was an unsafe and unsound 8 practice because of the financial condition of the 9 institution. 10 Q. Okay. And did you formulate an opinion 11 as to whether it was an unsafe and unsound 12 practice for USAT on October 4th, 1988, at a point 13 in time when USAT had a negative net worth of over 14 $200 million to deposit $6.6 million in an escrow 15 account to fund severance benefits provided to 16 senior management under the employment contracts 17 entered into on July 1st, 1988? 18 A. Definitely it was unsafe and unsound to 19 do that. 20 Q. I would like to move on now to a 21 different line of questioning. And if you will 22 take out your binder that's labeled No. 3, that 23491 1 should facilitate the examination. I believe most 2 of the questions will deal with the last two 3 binders that are in front of you. 4 You testified earlier, Mr. Twomey, I 5 think yesterday that you began your supervision of 6 USAT in about December of 1985; is that correct? 7 A. December 2nd, 1985, yes. 8 Q. And you were, throughout the period -- 9 through the time USAT went into receivership in 10 December of 1988, at all times the supervisory 11 agent of that institution, were you not? 12 A. Yes. 13 Q. Now, during that period of time, did 14 you come to understand what USAT's strategies were 15 with respect to the management of their various 16 investment security portfolios? 17 A. Yes. 18 Q. And did you come to an understanding as 19 to what their strategies were with respect to 20 their mortgage-backed securities investments? 21 A. Yes, I did. 22 Q. Okay. Did you also come to an 23492 1 understanding as to what their strategies were 2 with respect to their high-yield bond investments? 3 A. Yes, I did. 4 Q. Did you also come to an understanding 5 as to what USAT's strategy was with respect to its 6 equity securities portfolio? 7 A. Yes, I did. 8 Q. Okay. Can you describe for the Court 9 what you understood to be USAT's strategy with 10 respect to its mortgage-backed security 11 investments? 12 A. Yes. USAT had entered into basically 13 what was a risk-controlled arbitrage regarding 14 their mortgage-backed securities. Basically, they 15 were purchasing mortgage-backed securities; at the 16 same time, matching funding it with repo, which is 17 short-term money borrowed. And what they 18 basically did was setting up a spread where the 19 yield of the mortgage-backed securities was higher 20 than the cost of the repo money that they were 21 borrowing. And they would manage that portfolio 22 to try to maintain that spread. Now, the spread 23493 1 would not stay static. It wouldn't stay at 150 2 basis points. It would move depending on what was 3 happening with interest rates in the market. You 4 would have to actively manage a risk-controlled 5 arbitrage because interest rates would never stay 6 the same. You had to be aware that there could be 7 interest rate shocks that could adversely affect 8 you. You had to have the systems and the people 9 there to manage an RCA that knew what they were 10 doing. 11 Q. Now, you indicated that in connection 12 with this risk-controlled arbitrage, you would 13 generate a spread. 14 Is the spread sometimes referred to as 15 the yield? 16 A. No. I mean, the yield -- I would refer 17 to the yield as the interest earned by the 18 mortgage-backed securities versus the cost of the 19 liabilities. And so, the interest cost of the 20 liabilities, subtract that from the yield, and you 21 get the mortgage-backed securities. That 22 difference would be the spread. And hopefully, a 23494 1 positive spread between the two. 2 Q. When you're talking about spread, 3 you're talking about the difference between the 4 cost of funds and the assets that are being used 5 to purchase -- 6 A. Yes, I am. 7 Q. Okay. Thank you. 8 Now, you indicated that you also came 9 to an understanding as to what USAT's strategy was 10 with respect to their high-yield bond portfolio. 11 Do you recall that? 12 A. Yes. 13 Q. Can you describe for the Court just 14 briefly what your understanding was of the 15 high-yield bond portfolio? 16 A. Again, during the time I was 17 supervisory agent, USAT was purchasing what's 18 commonly referred to as junk bonds. And at the 19 same time they were funding the purchase of those 20 junk bonds or matching funding CDs, certificates 21 of deposit, savings deposits that they were taking 22 in. They were basically trying to match up the 23495 1 difference in duration between the two. 2 Relatively, if I remember right, the CD 3 money was relatively longer term than usual. But 4 basically, you still had that positive spread 5 between the two; i.e., a junk bond might be 6 yielding anywhere from 12 and a half to 14 percent 7 where maybe at that time a CD might be costing you 8 10 and a half percent. 9 So, the difference between, let's say, 10 13 and 10 and a half would give you basically a 11 2 and a half percentage spread at that time. And 12 you managed that portfolio the same, similar to 13 what you do with mortgage-backed securities. You 14 would always be looking for changes in credit 15 risk. You would be looking for changes in 16 interest rates. 17 Q. Now, in setting up these portfolios, 18 was it your understanding that the purpose for 19 entering into this strategy was to generate the 20 spread? 21 A. Basically, yes. 22 Q. And that spread was -- would then 23496 1 result in income to the institution? 2 A. It would be income enhancement to the 3 institution. 4 Q. Now, you also indicated that -- that 5 USAT had entered into a strategy with respect to 6 equity securities. 7 Do you recall that? 8 A. Yes. 9 Q. Okay. And what was your understanding 10 of the manner in which they were managing their 11 equity securities portfolio? 12 A. During that period of time, there were 13 various corporate takeovers during the 14 mid-Eighties. What they were doing, as it was 15 explained to me, is if a particular company was 16 being taken over and there's asset price, like, 17 $70 a share that's being offered or being 18 tendered, they looked for market opportunities. 19 If they saw that presently it was trading at $62 a 20 share or $65 a share, they would take a market 21 position in the stock; and then at the time of 22 settlement, they would get out. 23497 1 What would happen here is in a 2 relatively short period of time, they might 3 actually get a 10, 12, 15 percent return for maybe 4 one and a half months; but they were continuously 5 doing this with the equity portfolio. They were 6 looking for market opportunities as they viewed 7 it. And it appeared that they had the proper 8 staff in there to handle decisions about buying 9 equity securities. 10 Q. Now, with respect to the 11 mortgage-backed security portfolio, was it your 12 understanding that it was the intent of management 13 from time to time to sell mortgage-backed 14 securities out of that portfolio for the purposes 15 of generating gains to bolster profits and 16 increase capital? 17 A. No. 18 Q. And with respect to the junk bond 19 portfolio, was it your understanding that it was 20 management's intent from time to time to sell 21 assets out of the junk bond portfolio for the 22 purpose of generating gains to bolster profits and 23498 1 capital? 2 A. No. 3 Q. Now, in reaching your understanding of 4 what was the nature of this portfolio -- of the 5 various portfolios you just described, how did you 6 come to that understanding? 7 A. Well, basically through a compilation 8 of various documents that the institution had 9 submitted to the supervisory agent's office and 10 discussions with senior management and -- 11 Q. Did you also from time to time receive 12 correspondence from the institution itself 13 regarding the nature of these portfolios? 14 A. Yes. 15 Q. Do you recall from time to time issues 16 arose as to what was going on with respect to the 17 portfolios and that inquiries were made of the 18 institution? 19 A. Yes. 20 Q. And did the institution then provide 21 correspondence explaining what it is they -- what 22 it is -- what was the nature of the strategies 23499 1 they were engaged in? 2 A. Yes. 3 Q. And did you also review any securities 4 filings from time to time, or would that have been 5 done by anyone on your staff? 6 A. When you say "securities," you're 7 talking about SEC filings? 8 Q. Things like 10Ks -- 9 A. We normally wouldn't review them on an 10 ongoing basis. We were aware of them. Maybe 11 later in the review or our supervision of United, 12 we were looking at them a little more intently. 13 Q. Do you recall from time to time United, 14 as a courtesy to the Federal Home Loan Bank Board 15 and perhaps in response to a particular regulatory 16 requirement, did provide you with their securities 17 filings like their 10Ks? 18 A. Well, they probably did at our request. 19 Q. Okay. Was there any other source by 20 which you obtained information that you recall as 21 you sit here today regarding the nature of what 22 was going on in their portfolios? 23500 1 A. Well, primarily it was TFRs, thrift 2 financial reports that they would file with us. 3 It would be the examination reports. It would be 4 their correspondence. And we also reviewed their 5 CPA/independent auditor's report of the 6 institution and various other special requests 7 that were made over time for reviews and that type 8 of thing. That was about it. 9 Q. Now, did -- while you were the 10 supervisory agent, did United have occasion to 11 file any applications? 12 A. Well, they filed three or four 13 applications when I was there. 14 Q. Now, do you recall yesterday I asked 15 you whether applications were a part of the 16 supervisory process or were they a separate 17 enterprise within the Federal Home Loan Bank? 18 A. Well, actually, they are a part of the 19 supervisory process; but after April 1st, 1988, 20 there was a distinct division inside supervision 21 where we had a supervisory agent and his 22 regulatory analysts were set up just primarily to 23501 1 handle applications from our member institutions. 2 Q. But until that time, if an application 3 had been filed by USAT, would that have come 4 across the supervisory agent's desk? 5 A. It would have been handled by the line 6 agent up until that time. 7 Q. And is that something that would have 8 then been part of the supervisory file that would 9 have been available to you as the supervisory 10 agent? 11 A. Yes. 12 Q. Okay. Do you recall whether, after or 13 at or about the time you became the supervisory 14 agent for USAT, whether there were any 15 applications that were filed? 16 A. There was a -- I believe a liability 17 growth application pending. There was an 18 application pending about the time I arrived. 19 Q. Do you recall any other applications 20 other than a liability growth application? 21 A. There was a forbearance application. 22 There was a direct investment application. There 23502 1 was an application, I believe, to do with 2 subordinated debt. That's about all I can 3 remember. 4 Q. Okay. Well, let's turn, then, to 5 what's been previously marked as Exhibit A11055. 6 And I'm giving this to you as kind of a benchmark, 7 Mr. Twomey, to try to establish when you came to 8 the institution. 9 Can you describe for the Court what 10 this document is? 11 A. Yes. After I arrived, I had each of my 12 analysts review the institutions assigned to them 13 in their caseload; and I wanted to get a -- 14 basically a summary of outstanding issues so I 15 would have a feel for the size of the institution, 16 their history, and basically what were some of the 17 ongoing issues. 18 So, in December of 1985, each of the 19 analysts prepared this type of summary for me on 20 the 90 or so institutions in my caseload. 21 Q. Now, directing your attention to the 22 last two sentences in the first paragraph there, 23503 1 it says, "Due to low asset yields, United reported 2 a net operating loss for each of the quarters from 3 September 30th, 1984, through June 30th, 1985. 4 However, for the quarters ended September 30th, 5 '85 and December 31st, '85, United was 6 profitable." Then it says, "Its net worth exceeds 7 the minimum requirements as of September 30th, 8 1985." 9 Do you recall that when you came to 10 United, that there had been a problem of operating 11 losses at the institution? 12 A. Yes. 13 Q. And did that problem with respect to 14 operating losses persist during the period of time 15 that you served as supervisory agent? 16 A. Yes. 17 Q. Now, in the next paragraph, it talks 18 about United was in violation of the liability 19 growth limitations. 20 Do you see that? 21 A. Yes. 22 Q. What was the -- what does it mean when 23504 1 they talk about the liability growth limitations? 2 Can you explain what that is to the judge? 3 A. During the mid-Eighties, the Federal 4 Home Loan Bank Board adopted a regulation limiting 5 an institution from growing more than 25 percent 6 in one year. If you were 100 million, you could 7 only grow to 125 million by December 1st of the 8 following year. Even then, it was pretty much 9 spread out. You couldn't go up 10 percent in one 10 quarter and shrink back in another quarter. If 11 they project out your growth in any one quarter 12 exceeded 25 percent, they took exception. 13 Q. Was there a regulation that was passed 14 relating specifically to the question of liability 15 growth limitations? 16 A. Yes. A regulation was adopted by the 17 Bank Board. 18 Q. Approximately at what point in time was 19 that adopted, sir? 20 A. Somewhere in either late 1984 or early 21 1985. 22 Q. Okay. And you made reference a moment 23505 1 ago to a direct investment application. 2 What were you referring to when you 3 talked about direct investments? 4 A. There was another regulation adopted by 5 the Bank Board that basically said that the 6 institutions could have no more than 10 percent of 7 total assets carried as direct investments. For 8 example, if a thrift was investing in a shopping 9 center, they were actually building the shopping 10 center, that would be considered a direct 11 investment. There's no equity in the deal where a 12 borrower had borrowed the money. And we could 13 look to the security in the person's credit 14 worthiness as a comfort if there was some type of 15 crisis with the real estate. This way, the 16 institutions actually did the developing. They 17 bought their own companies. They were directly 18 involved. The limit then was 10 percent of 19 assets. And what United was, I believe -- was 20 asking to have that direct investment limitation, 21 the PSA had the authority to raise it; and they 22 were requesting it to be raised to, I think, 15 or 23506 1 18 percent. 2 Q. When you refer to the PSA, that's the 3 principal supervisory agent? 4 A. Correct. 5 Q. This was promulgated in the form of a 6 regulation, this limitation on direct investments? 7 A. Yes. 8 Q. Did both the direct investment and the 9 liability growth limitations regulations come into 10 existence at about the same time? 11 A. Yes, they did. 12 Q. And as a supervisory agent and former 13 employee of the Federal Home Loan Bank of Dallas, 14 did you come to some understanding as to what the 15 purpose was for initiating these new regulations? 16 A. Yes. 17 Q. And could you explain to the judge what 18 your understanding was? 19 A. Well, during the early Eighties, a 20 number of parties were now acquiring thrifts. For 21 example, there was a small thrift in northern 22 Texas that was relatively only 30 or 40 million in 23507 1 size; and very shortly afterwards, it was over a 2 billion dollars. What was happening with these 3 institutions, new owners were coming in and using 4 broker deposits -- they were growing the 5 institution; and at the same time, they were 6 borrowing money basically with broker deposits. 7 They were making numerous investments. And it was 8 the view of the Federal Home Loan Bank Board that 9 this may be unsafe and unsound because if you were 10 growing probably 300 percent a year or greater, 11 how could you properly underwrite those new 12 investments, the new assets that you were putting 13 on the books. 14 And it looked like they could possibly 15 put FSLIC at harm by growing too fast, not making 16 safe and sound decisions. So, at the time, the 17 finance -- the Federal Home Loan Bank Board 18 adopted regulations limiting growth unless you 19 filed a business plan and got the approval of the 20 principal supervisory agent. You had to be 21 limited in growth to 25 percent a year, no more, 22 and had to put no more than 10 percent of your 23508 1 assets in direct investments. 2 THE COURT: If the S&L had a 3 subsidiary, would these restrictions apply to 4 that? 5 THE WITNESS: They would be looked at 6 at the time they formed a subsidiary. If they 7 were setting up a finance subsidiary, it would all 8 have to be discussed in the application which the 9 PSA would have to review and sign off on. 10 Q. (BY MR. RINALDI) Now, Mister -- 11 THE COURT: So I understand -- go 12 ahead. I was just curious. 13 Q. (BY MR. RINALDI) Well, was it possible 14 through the mechanism of a finance subsidiary to 15 avoid the limitations that were imposed by the 16 liability growth provisions? 17 A. Yes. 18 Q. Okay. And how would that occur? 19 A. Again, the institution would form a 20 finance subsidiary probably just for 21 risk-controlled arbitrage, for example. And what 22 would happen is the -- on its books, the -- only 23509 1 the investment in the subsidiary, the equity of 2 that subsidiary, would be counted toward the size 3 of the institution; i.e., you could have a 4 100-million-dollar subsidiary with net worth of 5 5 percent so that would be $5 million. That 6 $5 million would be reflected on the books and 7 records of the S&L. When you came to your net 8 worth, which at that time we were requiring 9 3 percent net worth, that way you wouldn't have 10 the total financial impact of trying to increase 11 net worth by 3 million for a 100-million-dollar 12 investment. You only had to increase it 3 percent 13 of the $5 million to maintain your capital 14 requirements. 15 THE COURT: So, only the 5 million 16 would be direct investment. 17 THE WITNESS: Right. Yes, sir. 18 Q. (BY MR. RINALDI) So, if an institution 19 wanted to grow and not run afoul of the liability 20 growth limitations, one mechanism they could use 21 is to invest in a finance subsidiary? 22 A. Yes. 23510 1 Q. And were there a number of institutions 2 under your supervision that were involved in that 3 kind of activity? 4 A. There were a few. There weren't a 5 number of them. There were a few. 6 Q. Okay. Did -- did United Savings 7 Association of Texas engage in that kind of 8 activity? 9 A. I believe it did have a finance 10 subsidiary. 11 Q. Now, did that -- by investing in this 12 finance subsidiary -- strike that. 13 Now, you have described a kind of triad 14 of investment strategies at the outset of your 15 testimony: Mortgage-backed securities and the 16 risk-controlled arbitrage, a high-yield bond kind 17 of arbitrage, and then also an equity securities 18 investment strategy. 19 Do you recall those three? 20 A. Yes. 21 Q. Were there, under your supervision, any 22 other thrifts that were engaged in a similar kind 23511 1 of investment strategy that incorporated all three 2 of those strategies? 3 A. Not all three. 4 Q. Were there -- well, let's just start 5 with the high-yield bonds. 6 Were there a number of institutions 7 that were engaged in a strategy similar to USAT's 8 high-yield bond arbitrage strategy? 9 A. I can -- well, not their -- I wouldn't 10 say they had -- I can think of two other 11 institutions that had a material amount of junk 12 bonds on their books, but I would not say they had 13 an RCA set up involved with those junk bonds. 14 Q. When you say "an RCA," you mean -- 15 A. Risk-controlled arbitrage. 16 Q. You mean where they were trying to lock 17 in a spread between the cost of funds and the 18 return on the junk bonds? 19 A. Uh-huh, yes. 20 Q. And what about with respect to -- 21 THE COURT: Excuse me. I thought 22 risk-controlled arbitrage pertained to 23512 1 mortgage-backed securities. You're saying that 2 was also the junk bonds? 3 THE WITNESS: Yes. In United's case, 4 sir, they basically had CD money locked in at 5 10 and a half percent; and they used that CD money 6 as part of the risk-controlled arbitrage. They 7 matched it and went out and bought probably about 8 $500 million worth of junk bonds. And the junk 9 bonds were yielding 13, 14 percent. And the CD 10 money that they had matched against it was costing 11 them probably about 10, 10 and a half percent. 12 THE COURT: You're calling that a 13 risk-controlled arbitrage? 14 THE WITNESS: Well, that's what it was 15 represented to me. They were basically -- they 16 knew the terms of the -- each of these instruments 17 have terms. The CD has a one-year term, a 18 two-year term, a three-year term. At the same 19 time when you buy the bonds, the securities, they 20 have a set term; and they pay out a set amount. 21 The difference between that would be the spread. 22 Q. (BY MR. RINALDI) Mr. Twomey, I think 23513 1 the confusion that's probably coming up here is 2 there was no hedging with respect to the junk bond 3 portfolio, was there? 4 A. No. 5 Q. So, it was just a simple arbitrage, 6 wasn't it? 7 A. Yes. 8 Q. Now, with respect to the 9 mortgage-backed securities, they did have a 10 hedging feature, did they not? 11 A. Yes. 12 Q. So, they would have been a true 13 risk-controlled arbitrage? 14 A. Well, to properly manage that, you had 15 to have hedging techniques applied. 16 Q. I was just picking up on the judge's 17 question. I think that he was -- he was 18 questioning the use of the term "risk-controlled 19 arbitrage" in conjunction with the junk bond 20 portfolio. I was just trying to clarify whether, 21 you know, it was simply an arbitrage or whether it 22 was a risk-controlled arbitrage that included 23514 1 hedging. 2 A. Yes. 3 Q. Okay. Now -- 4 MR. RINALDI: I move the admission, 5 Your Honor, of Exhibit A11055. That's the 6 association summary report. 7 MR. VILLA: No objection. 8 THE COURT: Received. 9 Q. (BY MR. RINALDI) Do you recall, 10 Mr. Twomey, how the liability growth application 11 problem -- let me get this straight. 12 This had all occurred before you 13 arrived, had it not? 14 A. Yes. 15 Q. And do you recall, were there a number 16 of institutions that had similar liability growth 17 problems like this? 18 A. Yes. 19 Q. And had the problem been resolved at 20 the point in time when you became the supervisory 21 agent? 22 A. Pretty much, yes. 23515 1 Q. And in the association's summary in the 2 next-to-the-last paragraph, it indicates, "The 3 association was required to sign a board of 4 directors resolution stating that its total 5 liabilities as of December 31st, 1985, would not 6 exceed 125 percent of total liabilities reported 7 at December 31st, 1984." 8 Do you see that? 9 A. Yes. 10 Q. Was that the ultimate resolution that 11 they -- that they reached, that the directors 12 would promise not to violate, in effect, the 13 liability growth limitations? 14 A. Yes. 15 Q. Now, would you turn to what's been 16 previously marked as Exhibit A1055 -- I mean 17 10566. This is a letter from Mr. Robert S. 18 Bonchak to -- to Mr. Bonchak from Gerald R. 19 Williams. 20 Do you see that? 21 A. Yes. 22 Q. And who was Mr. Bonchak? 23516 1 A. He was a supervisory agent at the 2 Federal Home Loan Bank at that time. 3 MR. RINALDI: I'm sorry. It's Tab 176. 4 Q. (BY MR. RINALDI) Now, I -- now, this is 5 a document that would have been sent to the Bank 6 Board sometime before you arrived there? 7 A. Yes. 8 Q. So, you did not receive this document? 9 A. No. 10 Q. And do you recall that when you were 11 shown this at your deposition, you indicated that 12 you had no recollection of having seen it before? 13 A. That's true. 14 Q. Is this the kind of document that would 15 have been maintained by the Bank Board in the 16 supervisory file after you -- when you arrived 17 there? 18 A. Yes. 19 Q. As you sit here today, do you know 20 whether you ever actually reviewed the contents of 21 this document? 22 A. I probably did. I just don't remember 23517 1 at this point in time. 2 Q. Would it have been reviewed by the 3 supervisory analysts who received it at or about 4 the time it was written? 5 A. Yes. 6 Q. Okay. Now, I don't really want to ask 7 you any questions about the specifics of the 8 document; but it -- if you look at the first page 9 in the second paragraph, it talks about the 10 association's growth during the first half of 11 1985. And this is explaining to the Bank Board 12 why USAT had violated its liability growth 13 limitations. 14 Do you see that? 15 A. Yes. 16 Q. And in the first numbered paragraph 17 there, it describes an investment that had been 18 undertaken by USAT that contributed to it. 19 Is that the reverse repurchase 20 agreement/mortgage-backed security strategy that 21 you described a moment ago that you understood 22 USAT was engaging in? 23518 1 A. Yes. 2 Q. And then in the second paragraph, does 3 that also describe one of the strategies that you 4 have discussed earlier? 5 A. Regarding their junk bonds, yes. 6 Q. Now, if you turn into the document, it 7 talks about a program for -- at Page CN052885. 8 Do you see that? This is a -- 9 A. Okay. I'm there. 10 Q. And it talks about a program for 11 matching maturities and controlling interest rate 12 risk. 13 Do you see that? 14 A. Yes, at the very bottom of the page. 15 Q. And would you read that paragraph and 16 then over onto the next paragraph where it talks 17 about the mortgage-backed securities and long-term 18 corporate securities? 19 A. (Witness reviews the document.) Yes. 20 Q. Now, directing your attention first to 21 the mortgage-backed securities, is this then the 22 program of investment that you were describing 23519 1 earlier when I asked you about their strategy for 2 investing in mortgage-backed securities? 3 A. Yes. 4 Q. Now, what does it mean when it says 5 that they were going to purchase Fannie Maes, 6 Freddie Macs, and Ginnie Maes funded with reverse 7 repurchase agreements? 8 A. Again, they were going to borrow 9 short-term money and purchase mortgage-backed 10 securities. 11 Q. Okay. When you say "borrow short-term 12 money," what are you referring to? 13 A. Repos. Basically, they were borrowing 14 for shorter terms. I mean, the average life 15 duration of a mortgage-backed security could be 16 anywhere from 8 to 12 years where, at the same 17 time, if you're borrowing money, it's six months. 18 Q. If you were borrowing money at 19 short-term interest rates and then purchasing 20 mortgage-backed securities which have longer -- 21 A. Duration. 22 Q. -- duration, was there some risk 23520 1 involved if interest rates were to move? 2 A. Primarily, if interest rates were to 3 move up dramatically and you had to borrow again 4 to replace the maturing lines, you would borrow at 5 a higher rate and it would narrow the spread 6 between the yield on the mortgage-backed 7 securities and the cost, the interest rate expense 8 of the repo line. 9 Q. In connection with this investment 10 strategy, it indicates that they were going to use 11 interest rate swaps. 12 Do you see that? 13 A. Yes. 14 Q. And they were going to lengthen the 15 maturity and duration of the liabilities. 16 What does that mean? 17 A. Basically, you purchase interest rate 18 swaps where you're locking in your interest rate. 19 What happens would be at the end of a six-month 20 period, if interest rates move up, you basically 21 have a gain and you take that gain and you net it 22 against the cost of your purchase of the next six 23521 1 months' worth of repos. For example, if interest 2 rates were at 9 percent during the first half of 3 the year but, on July 1st, when you had to roll 4 that repo money and borrow again, interest rates 5 had now moved to 11 percent, when you get out of 6 the interest rate swaps, the gains you got out of 7 the swaps, instead of recognizing it as income, 8 you basically offset the expense for the next six 9 months. 10 So, basically you lengthen the 11 six-month money you borrowed. You basically have 12 now effectively kept it at the same rate for an 13 additional six months. It gives you more time to 14 manage your portfolio, but you also maintain the 15 proper spread that you're trying to manage between 16 the mortgage-backed securities and your repo 17 money. 18 Q. And once again, was it your 19 understanding that the generation of spread income 20 was the object of the mortgage-backed security 21 risk-controlled arbitrage strategy at USAT? 22 A. Yes. 23522 1 Q. Now, the next indented paragraph down 2 talks about long-term corporate securities were 3 purchased and matched funded with retailed 4 brokered deposits. 5 What are retailed broker deposits, sir? 6 Do you see where I'm reading from? It's the 7 second indented paragraph at the top of the page. 8 A. I believe it's talking to what's 9 commonly referred to as brokered CDs. And what 10 might happen is you might invest $100,000 to 11 Merrill Lynch and Merrill Lynch would say, "We're 12 going to get you an insured CD for that money." 13 And what will happen is, basically, Merrill Lynch 14 will take your money and sell it to USAT at a set 15 price. And now you have an insured -- 16 federally-insured investment. 17 Your $100,000 is guaranteed by full 18 faith and credit by FSLIC and the United States 19 government. And you're receiving a CD rate for a 20 jumbo rate which might be 10 percent, and you'll 21 get that for the next six months. At the end of 22 the six months, you'll get your CD back. 23523 1 What would happen would be if an 2 institution would make a decision that instead of 3 going to their depositors and maybe raising rates 4 and trying to attract more money, they would buy 5 these brokered CDs from places like Merrill Lynch 6 and bring them into the institution. Again, it's 7 just borrowed money. It's just a different form. 8 They are all insured by FSLIC on the institution's 9 books. 10 Q. What does it mean when it talks about 11 being match funded with the corporate securities? 12 A. Well, many of these jumbo CDs, brokered 13 CDs, would have much longer terms than simply six 14 months or a year. Sometimes they may be one and a 15 half years, two years, or three years. They could 16 be longer. 17 Q. When they say they were going to be 18 match funded, did that mean they were going to 19 have similar durations as the corporate securities 20 they were being used to purchase? 21 A. You would turn to Merrill Lynch and you 22 would take in $50 million worth of brokered CDs 23524 1 and then you would go to the broker and then buy 2 $50 million worth of junk bonds at the same time. 3 Q. And in this case, the object was, 4 again, to lock in a net interest spread; is that 5 correct? 6 A. Yes, sir. 7 Q. Now, I notice that in both of these 8 descriptions here, it talks about locking in a net 9 interest spread. 10 Was it really possible to lock in a net 11 interest spread? 12 A. Yes. 13 Q. Well, but as a practical matter, could 14 one really guarantee that they could have an 15 absolute locked-in spread? 16 A. There's no guarantees. 17 Q. So, when they said this, did you 18 understand that this was actually going to be 19 locked in? 20 A. Well, there's no such thing as a static 21 spread. I mean, they can print 50 reams of paper 22 projecting out that they are going to maintain a 23525 1 1 and a half percent spread between the investment 2 and the liabilities. But over time, you know, 3 credit market changes; interest rates change. You 4 have to actively manage that; and from time to 5 time, it can swing up and down. But the idea is 6 you maintain your risk-controlled arbitrage while 7 it benefits the institution. 8 Q. Okay. Now, if we drop down further on 9 the page, it says, "At June 30th, 1988 -- '85, the 10 yields and rates on the match funded program have 11 effectively locked in a net interest spread of 12 1.76 percent on an investment volume of 13 777 million which will provide annualized 14 incremental net interest income of 137 million." 15 Do you see that? 16 A. Yes. 17 Q. What does that mean? 18 MR. NICKENS: Your Honor, I'm not sure 19 where all this is going. Mr. Rinaldi started out 20 by saying he didn't want to ask the witness any 21 questions about this document, that he started out 22 by saying he had never seen or couldn't remember 23526 1 anything about it. 2 Now we're going through it paragraph by 3 paragraph in what seems to me to be the 4 presentation of expert opinions which were never 5 expressed in the papers. And we come back to 6 Mr. Villa's objection. This witness has never 7 been identified as an expert in the area of 8 mortgage-backed securities; and yet, we're going 9 through a document he never read and having him 10 say what his understanding is of that document 11 and, in the course of that, expressing expert 12 opinions. 13 As I say, a certain amount of this -- 14 if he was going to testify as to what his 15 understanding was, one could understand. If we're 16 going to go through this paragraph by paragraph, I 17 just -- I do have an objection. The objection is 18 that he is using it to both bolster an opinion 19 that he apparently can't give without it and that 20 if the opinion is there, it's one that he couldn't 21 express in this proceeding because he's never been 22 identified as a person with -- to express such an 23527 1 opinion. 2 MR. VILLA: Your Honor, Mr. Rinaldi 3 asked a question that was almost apologetic 4 because I took his deposition; and in his 5 deposition, I showed him this document. "No, 6 never saw it before, didn't see it in the file," 7 you know, on and on. So, I didn't ask him any 8 questions about the document. 9 Now he comes on the stand and, on the 10 pretext of not asking him any questions about the 11 document, we've now spent 10 minutes; and we're 12 just getting warmed up. He didn't remember the 13 document in the deposition, and Mr. Rinaldi got 14 him to acknowledge that. 15 MR. RINALDI: Your Honor, I had at the 16 outset asked him what he understood about the 17 investment strategies engaged in by USAT over the 18 three-year period of time he was a supervisory 19 agent; and he indicated to me what those 20 strategies were. I am now simply showing him the 21 document that was submitted to the Bank Board to 22 his predecessor describing those strategies to 23528 1 ascertain whether that was his understanding of 2 what USAT was engaged in in terms of its 3 risk-controlled arbitrage security program and its 4 high-yield bond program. 5 I want to make sure we all are on the 6 same page. I'm not tendering him as an expert 7 witness. He's anything but an expert witness on 8 this subject. I'm simply asking him his 9 understanding of what it is they were doing. 10 THE COURT: You can't rely on his 11 understanding from this document, though. 12 MR. RINALDI: Well, he testified that 13 this document was part of the supervisory files. 14 He also testified that it would have been 15 available to both he and his supervisory analysts. 16 He said he didn't recall ever having seen it, but 17 it was consistent with his understanding. 18 I was just trying to try to flesh out 19 what, in essence, was his understanding of what it 20 was that USAT was doing at this point in time with 21 respect to its investment portfolio. 22 I'm frankly finished with the 23529 1 examination on this subject or this document, and 2 I'm at a point where I'm going to move along to 3 some other stuff. 4 MR. NICKENS: If he's finished, I 5 withdraw my objection. 6 THE COURT: All right. Let's move on. 7 Q. (BY MR. RINALDI) Now, Mr. Twomey, would 8 you take a look at what's been previously marked 9 as -- here it is -- A11153? 10 Do you recognize this document, sir? 11 A. Yes. It's a memorandum from myself and 12 my analyst, Ginger Baugh, to Roy Green regarding 13 an application for approval by USAT to exceed the 14 threshold limits for direct investments going from 15 10 percent to 18 percent. 16 Q. And was this an application that, as 17 the supervisory analyst, you were required to pass 18 upon with respect to USAT? 19 A. As a supervisory agent, yes. 20 Q. Okay. I'm sorry. Agent. I apologize. 21 I just demoted you. 22 Now, I notice that it is -- that the 23530 1 application was submitted -- I mean that the 2 memorandum was submitted to a Louis V. Roy, the 3 supervisory agent, for his signature. 4 Do you see that? Now, who was the real 5 supervisory agent? Was it you or Mr. Roy? 6 A. I was the caseload manager for USAT. 7 You'll also see in here the initials on the front 8 page, JEH. That's Mr. Halverson, who was my boss. 9 And then Lou Roy was his boss, and Mr. Green was 10 his boss. 11 Q. What role would you have placed in the 12 preparation of this document? 13 A. I would have reviewed the -- 14 particularly his memo and probably reviewed the 15 supporting documents to it; and then working with 16 Ginger, the memorandum would be prepared and then 17 submitted on to Mr. Green. 18 Q. And in the third full paragraph, it 19 talks about United proposing to increase its level 20 of direct investment in equity securities and real 21 estate investments. 22 Do you see that? 23531 1 A. Yes. 2 Q. And in the first paragraph, it talks 3 about going from a 10 percent direct investment 4 limit to an 18 percent direct investment limit? 5 A. Yes. 6 Q. Was it your understanding, then, that 7 they were going to use that additional -- or make 8 additional investments in equity securities and 9 real estate? 10 A. Yes. 11 Q. Now, do you recall what your -- the 12 final resolution of this was in terms of -- of 13 whether it was approved or not? 14 Do you see the recommendation on the 15 last page? 16 A. That's what I'm looking at, yes. 17 Q. Take a moment to read it. We're 18 looking at OW120758. 19 A. Again, we withhold our approval -- our 20 recommendation was to withhold approval on this 21 until the net worth maintenance agreement that was 22 being negotiated between the predecessor MAXXAM 23532 1 or -- I'm not sure -- MCO and our Washington 2 office could be worked out. 3 Q. Okay. And on about Page 4 -- I'm 4 sorry -- Page 3 and 4 of the document, which are 5 Pages OW120753 and OW120754, it discusses MCO and 6 Federated. 7 Do you see that? 8 A. Yes. 9 Q. And what was the issue that had arisen 10 with respect to MCO's net worth maintenance 11 obligation? Do you recall? 12 A. MCO was negotiating on the way the net 13 worth maintenance agreement would be structured. 14 And that's -- if it could be worked out in 15 Washington, if both sides could agree on that type 16 of language, then MCO would increase its 17 investment in UFG and, therefore, become the 18 holding company for USAT. 19 Q. And it states in the middle of the 20 paragraph on the bottom of the third page of the 21 document that on December 6, 1984, MCO and 22 Federated received conditional approval from the 23533 1 Federal Home Loan Bank Board to increase their 2 joint ownership of UFG from 23.8 percent to 3 35 percent. 4 Do you see that? 5 A. Yes. 6 Q. And do you recall that, in fact, the 7 Federal Home Loan Bank Board granted their 8 request? 9 A. Yeah, they did grant this stipulation, 10 yes. 11 Q. But it was conditioned on their meeting 12 a net worth maintenance obligation or undertaking 13 that? 14 A. Yeah. It was conditioned on agreeing 15 to a net worth maintenance stipulation which they 16 hadn't at this time. 17 Q. And you indicated -- it indicates -- 18 I'm sorry -- over on the next page that -- that -- 19 at the very top, the first sentence, "Approval was 20 conditioned upon consummation of proposed 21 acquisition of shares within 120 days." 22 Do you see that? 23534 1 A. Yes. 2 Q. And, obviously, now if we're in 1986 3 and the original conditional approval was in 4 December of 1984, it had been well over a year 5 since the Bank Board had issued its ruling or 6 indicated that they had received a conditional 7 approval. 8 Do you see that? 9 A. Yes. 10 Q. Had the Bank Board's approval been 11 extended? 12 A. Yes. 13 Q. Can you describe for the Court the 14 process by which that was done? 15 A. Simply put, the institution would 16 request a supervisory agent for a 90-day 17 extension; and upon discussing it with our 18 Washington office, it just became -- the whole 19 matter was really up to a resolution between our 20 Washington Office of Securities and MCO. So, we 21 were just facilitating their continued discussions 22 by routinely extending every 90 days the whole 23535 1 stipulation. It just became very automatic. 2 Once they explained what they wanted in 3 Washington, they didn't want us to terminate it. 4 They didn't want us to cause it to go away. They 5 wanted us to keep extending it until they told us 6 otherwise. 7 Q. What role, if any, did you play in the 8 process of these negotiations? 9 A. None. 10 Q. So, you would just get a letter 11 requesting extension; or how would it work? 12 A. I would get a letter from the 13 institution requesting an extension and I believe 14 actually from a MCO. Then I would just grant the 15 extension. 16 Q. Okay. Now, in connection with the 17 application to exceed the threshold limits on 18 direct investments, do you recall whether -- well, 19 strike that. 20 Was there a requirement of the Bank 21 Board that the applicant submit some sort of 22 business plan? 23536 1 A. Normally, yes. 2 Q. And directing your attention to 3 Page OW120755, does it appear that USAT submitted 4 a business plan in connection with its application 5 to exceed the threshold limits on direct 6 investments? 7 A. Yes, they did. 8 Q. Okay. And would you turn to the next 9 page in your book. 10 MR. RINALDI: Your Honor -- 11 MR. VILLA: Next page or the next 12 exhibit? 13 MR. RINALDI: Next exhibit. I would 14 move the admission of A11153 if it's not been 15 admitted, Your Honor. 16 MR. VILLA: No objection. I don't 17 believe it's in evidence. No objection. 18 THE COURT: Received. 19 MR. RINALDI: Thank you. 20 Q. (BY MR. RINALDI) And the next document 21 in your book is A11057. And can you -- do you 22 know what this document is, sir? 23537 1 A. It's the cover letter for an 2 application to increase direct investments from 3 10 percent to 18 percent; and it was sent on 4 August 20th, 1985. It was date stamped received 5 August 21st, 1985. 6 Q. Okay. Now, does this appear to be the 7 application that was filed by USAT with respect to 8 the request to exceed the direct investment limits 9 that's discussed in your memo to Mr. Green dated 10 January the 9th, 1986? 11 A. Yes. It's the same direct 12 investment -- it's the initial direct investment 13 application. 14 Q. Now, do you recall ever having seen 15 this document at or about the time that you 16 prepared the memo which is A11153 dated 17 January 9th, 1986? 18 A. Again, I probably did review the 19 document; but I don't independently remember it 20 today. 21 Q. Okay. And then -- 22 MR. RINALDI: Your Honor, I would move 23538 1 the admission of A11057. 2 MR. VILLA: No objection. 3 THE COURT: Received. 4 Q. (BY MR. RINALDI) And then directing 5 your attention to the next document in your book, 6 which is Tab 1441; and it's Exhibit B4254. Take a 7 moment to look at that? 8 A. (Witness reviews the document.) 9 Q. Now, can you describe for the Court 10 what this document is? 11 A. This was the institution's -- USAT's 12 response to a request for additional information 13 regarding their initial direct investment 14 application that was filed earlier. 15 Q. And is this a document that you would 16 have had available to you in connection with your 17 consideration of and preparation of the 18 recommendation that you made with respect to the 19 direct investment application that's dated 20 January 9th, 1988? 21 A. Yes. 22 Q. As you sit here today, do you have any 23539 1 independent recollection of ever having looked at 2 this document or reviewed it at or about the time 3 that you prepared your recommendation regarding 4 the direct investment application? 5 A. Again, I probably did review it at the 6 time we prepared the recommendation; but I just 7 don't -- don't remember it today. 8 Q. Okay. And if we look into the document 9 in the middle of the document, it talks -- at 10 Page 4, Item 8, it talks about a proposed business 11 plan. 12 MR. NICKENS: Your Honor, Exhibit 4254 13 is a one-page document. 14 MR. RINALDI: Oh, I'm sorry. You know, 15 maybe there's a transposition of the number. This 16 looks to be Exhibit B642 and also -- 17 MR. NICKENS: That's a rather 18 stupendous transposition. 19 MR. RINALDI: Well, I think it's been 20 admitted in two different forms. I think I gave 21 you one form, and it -- maybe it's in the other 22 one. I have B642 at Tab 1441. 23540 1 MR. BLANKENSTEIN: 1441? We have 4254. 2 MR. RINALDI: Well, this is B642. 3 Right? It's not Tab 1441? How did this happen? 4 THE COURT: We'll take a short recess. 5 6 (Whereupon, a short break was taken 7 from 2:38 p.m. to 3:56 p.m.) 8 9 THE COURT: Be seated, please. We'll 10 be back on the record. 11 At the recess, there was some confusion 12 about an exhibit number. Do we have that 13 straightened out? 14 MR. RINALDI: Yes, we do, Your Honor. 15 Your Honor should have a copy of Exhibit B642. 16 Q. (BY MR. RINALDI) Do you have that in 17 front of you, Mr. Twomey? 18 THE COURT: And Exhibit B4254 is not -- 19 MR. RINALDI: That is correct. 20 THE COURT: -- the subject of anything? 21 MR. RINALDI: That is correct. They 22 turned out to be documents to the same person on 23541 1 the same date. 2 Q. (BY MR. RINALDI) Do you have 3 Exhibit B642 in front of you, sir? 4 A. Yes, I do. 5 Q. Does this appear to be an amended 6 application with respect to the -- exceeding the 7 direct investment limits? 8 A. Yes. 9 Q. Is this something that would have been 10 submitted to the Federal Home Loan Bank Board and 11 would have been available to your supervisory 12 analysts in the preparation of your recommendation 13 memorandum with respect to the application to 14 increase the threshold limits on direct investment 15 that is dated January the 9th, 1988? 16 A. Yes, it is. 17 MR. RINALDI: Your Honor, I would move 18 the admission of Exhibit B642. 19 MR. VILLA: No objection. 20 THE COURT: Received. 21 Q. (BY MR. RINALDI) Now, we discussed a 22 moment ago MCO's net worth maintenance obligation. 23542 1 Did there come a time that in 2 connection with that obligation, a proposal was 3 made to you to issue subordinated debt by United 4 Savings Association of Texas? 5 MR. EISENHART: Your Honor, I'm going 6 to object to the reference to MCO's net worth 7 maintenance obligation. That's not been the 8 testimony. The testimony is that there was 9 negotiation over whether there would be an 10 obligation. 11 THE COURT: All right. 12 MR. RINALDI: That's accurate, 13 Your Honor. I apologize. 14 THE COURT: Was that related to the 15 application for subordinated debt application? 16 MR. RINALDI: Well, I think that's what 17 we're going to get to next, Your Honor. 18 THE COURT: All right. 19 Q. (BY MR. RINALDI) Would you take a look 20 at what's been marked as T1118, which is Tab 1643? 21 A. Yes. 22 Q. Now, this is a memo written by 23543 1 Mr. Berner again; and it goes to Mr. Hurwitz and 2 Mr. Munitz and Mr. Gross and Mr. Williams dated 3 March 20th, 1986. And this recounts a meeting 4 that Mr. Berner and Mr. Bob Pozen had with 5 yourself and Jim Halverson and Ginger Baugh. 6 Do you see that? 7 A. Yes, I do. 8 Q. Do you recall meeting with Mr. Berner 9 at or about this period of time and discussing the 10 subject of issuing subordinated debt? 11 A. Yes. 12 Q. Okay. And what was the proposal that 13 was being discussed here? 14 A. Basically, as part of the MCO 15 negotiations with the Federal Home Loan Bank 16 Board, MCO was proposing to put $10 million of sub 17 debt into USAT in lieu of the net worth 18 maintenance agreement. 19 Q. When you say "put sub debt into it," 20 what do you mean by that? USAT was going to issue 21 sub debt; and a portion of that would be purchased 22 by MCO? 23544 1 A. Well, MCO, as I understood it, was 2 going to contribute $10 million to the equity of 3 USAT. 4 Q. Okay. Through the purchase of 5 subordinated debt? 6 A. Yeah. 7 Q. Now, it indicates at the bottom of the 8 page -- well, then it goes on; and it says in the 9 second full paragraph, "We," meaning Mr. Berner, 10 "told them," meaning you, "that we believed 11 MCO/Federated was willing to contribute up to 12 10 million to the equity of USAT but only upon the 13 condition that they could acquire in excess of 14 25 percent of the stock of UFG without a net worth 15 guarantee." 16 Do you see that? 17 A. Yes. 18 Q. What were they referring to to acquire 19 in excess of 25 percent of the stock of UFG 20 without a net worth guarantee? 21 A. It was a definition, it being a holding 22 company, that if you own 25 percent of the 23545 1 controlling entity of a thrift, that you became 2 the holding company. 3 Q. The reference there to "without a net 4 worth guarantee," what does that refer to? 5 A. Again, that's the ongoing negotiations 6 between the Federal Home Loan Bank Board in 7 Washington and MCO regarding their net worth 8 maintenance agreements. 9 Q. Was MCO proposing that if they put 10 $10 million of equity into USAT, by purchasing the 11 sub debt, that they would be able to acquire over 12 25 percent of UFG's assets without a net worth 13 guarantee? 14 A. That's what MCO's proposal was. Again, 15 this is still a matter that Washington had to 16 agree to. 17 Q. Now, it indicates at the bottom of the 18 page that all the regulators seemed favorably 19 disposed. 20 Do you recall being favorably disposed 21 by this proposal? 22 A. I don't remember. 23546 1 Q. Okay. Then on the next page, it 2 indicates that Mr. Berner told you that he was 3 going to get an application for the subordinated 4 note transaction on your desk by the 15th. 5 Do you see that? 6 A. Yes. 7 Q. After this conversation, did USAT 8 submit a subordinated debt application? 9 A. I believe they did. 10 Q. Now, if you look in the other binder 11 that's next to you, would you take a look at that 12 document and tell me if you recognize it? 13 Does this appear to be the application 14 that was filed by -- 15 MR. EISENHART: Your Honor, may we know 16 the document he's referring to? 17 MR. RINALDI: I'm sorry. B954. It's 18 Tab 89. 19 A. This is the application for approval of 20 sub debt? 21 Q. (BY MR. RINALDI) Yeah. 22 A. All right. 23547 1 Q. And is this a document that would have 2 been submitted to you as the supervisory agent for 3 USAT? 4 A. Yes. 5 Q. And do you recall receiving a copy of 6 this in your capacity as the supervisory agent? 7 A. Yes, in 1986. 8 Q. Okay. And in connection with 9 considering the sub debt application, was it 10 reviewed by you and your staff? 11 A. Yes. 12 Q. Now, I would like for you to turn to 13 Page 13. I'm sorry. It's Bates stamped CN152324 14 of the application. I think there's a tab on 15 that. It's -- 16 A. What page? 17 Q. I think you have it right there. Does 18 it say Page 13 at the bottom? And it's CN152324. 19 Do you have that? 20 A. I have it. 21 Q. Now, in this application, it discusses 22 USAT's management strategy. 23548 1 Do you see that? 2 A. Yes. 3 Q. And it talks about some investments. 4 And it says, "As part of its management 5 strategy" -- this is the first full paragraph on 6 Page CN152324 -- "as part of its management 7 strategy, the association has significantly 8 increased its investments in marketable equity 9 securities and corporate debt instruments. The 10 portfolio of marketable equity securities of 11 public corporations has been purchased in 12 anticipation of their future market appreciation." 13 Do you see that? 14 A. Yes. 15 Q. Now, is this the portfolio that you 16 discussed earlier that you understood USAT was 17 going to become involved in relating to equity 18 securities? 19 A. Yes, I believe so. 20 Q. It goes on and says -- now, did you 21 understand that this portfolio was going to be a 22 trading portfolio or an investment portfolio, sir? 23549 1 A. I understood that on the equities, it 2 would be relatively short duration because they 3 were taking advantage of certain market 4 opportunities. And they would buy the instrument 5 and hold it until a certain, you know, anticipated 6 market situation; and then they would then sell 7 the securities. 8 Q. Okay. And in the next sentence, it 9 says, "However, there can be no assurance that 10 such appreciation will occur or that the market 11 value of such securities shall not depreciate. 12 Such securities are carried in the association's 13 trading portfolio account." 14 Do you see that? 15 A. Yes. 16 Q. Was that consistent with your 17 understanding of the nature of this portfolio, 18 that it would be a trading portfolio? 19 A. Yes. 20 Q. And then below that and slightly 21 further on down in the paragraph, it talks about 22 "The association also invested in corporate debt 23550 1 securities which involved credit risks different 2 from those traditionally associated with thrift 3 institutions." 4 Is that the -- the junk bond portfolio 5 that we've talked about earlier? 6 A. Yes, it is. 7 Q. Now, further down on the page, it talks 8 about structured arbitrage activity. It describes 9 a structured arbitrage program utilizing 10 mortgage-backed securities. 11 Is that the portfolio or the strategy 12 that we talked about earlier that you understood 13 USAT was engaging in with respect to 14 mortgage-backed securities in a risk-controlled 15 arbitrage? 16 A. Yes, it is. 17 Q. Now, I would like you to -- starting at 18 the bottom of the page, the last sentence there, 19 it talks about "The structured arbitrage program 20 is an attempt to provide earnings with a 21 reasonable level of risk." It goes on and says, 22 "However, the success of the program depends, 23551 1 among other things, on the accuracy of certain 2 assumptions regarding prepayment of the mortgages 3 underlying the mortgage-backed securities." 4 Do you see that? 5 A. Yes. 6 Q. Do you know what they were referring to 7 when they were talking about assumptions regarding 8 prepayments of mortgages underlying the 9 mortgage-backed securities? 10 A. Basically, before you purchase a 11 mortgage-backed security, you do an analysis of 12 its -- trying to determine duration. And then you 13 look at what would happen if interest rates went 14 to 12 percent or if they went to 6 percent. If 15 they went down, it would prepay. If interest 16 rates went high and the weighted average of the 17 coupon of the mortgage-backed securities was, say, 18 8 percent, then nobody was going to prepay. 19 Q. Now, over time, were these 20 mortgage-backed securities an investment that 21 required management by the institution? 22 A. Definitely. 23552 1 Q. Okay. And why was that? 2 A. Because interest rates were always 3 changing; and as interest rates would change, it 4 would change prepayment speeds on the 5 mortgage-backed securities. And that would change 6 the value and change the duration. 7 Q. And in connection with the management 8 of the portfolio, did you expect that from time to 9 time, there would be sales out of the 10 mortgage-backed portfolio in order to balance or 11 adjust the portfolio? 12 A. As part of its maintenance, yes. 13 Q. What would be the reasons that one 14 would undertake those kinds of things? 15 A. Again, it could be as little as a 16 quarter percent move in the market rates. If you 17 had a high-yielding mortgage-backed security, that 18 may cause that to now prepay faster; and it would 19 upset the risk-controlled arbitrage. So, you 20 would have to possibly liquidate that security and 21 retire some of the repo money set against it or 22 all the repo money set against it. 23553 1 Q. Did you understand that this was 2 then -- that this was an investment portfolio? 3 A. Yes, long-term investment portfolio. 4 It was meant -- if nothing happened, if rates 5 stayed absolutely the same, then you would have 6 this -- it would last out through a certain term 7 or duration. But interest rates do not stay 8 static. So, it was constant active management of 9 the portfolio. 10 Q. And that management of the portfolio, 11 even though it might from time to time include 12 sales that resulted in profits, was consistent 13 with an investment portfolio? 14 A. It could be sales or losses, but there 15 would be sales. 16 Q. And it then goes on and talks about a 17 circumstance that -- relating to a period of 18 rapidly-changing interest rates, and the interest 19 rate spread could be reduced or become negative. 20 Do you know what that's referring to? 21 Well, there could be severe interest rate shocks. 22 And for a short period of time, you might actually 23554 1 end up with a negative spread on your arbitrage. 2 But again, if you are properly managing the risks 3 and, you know, including the liability side and 4 the asset side, eventually it should cure itself. 5 And you go on. You could always make the 6 determination that if this was no longer an 7 enhancement to your institution, you terminated 8 risk-controlled arbitrage, sell the 9 mortgage-backed securities, and pay off the debt. 10 Then it goes on and says, "As interest rates have 11 fallen since the latter part of 1985, prepayment 12 of mortgage-backed security purchases in the 13 program have apparently accelerated, requiring the 14 association to reinvest the proceeds at a lower 15 yield and resulting in a significant deterioration 16 of the interest rate spread." 17 Do you see that? 18 A. Yes. 19 Q. This is talking about the 1986 time 20 frame. 21 Did you ever learn from USAT that 22 during this time frame, that the spread in the 23555 1 mortgage-backed portfolio had actually become a 2 negative spread and that there were substantial 3 losses unrealized in the portfolio? 4 A. No. No, I hadn't. 5 Q. They didn't disclose that? 6 A. No. 7 Q. Now, if this circumstance that's 8 described here occurred where the association 9 was -- where interest rates were falling as a 10 result of prepayment and the association was 11 selling off mortgage-backed securities, would you 12 have expected that there would have been 13 potentially gains in the portfolio from the sale 14 of those securities? 15 A. Definitely if you had -- if interest 16 rates were dropping -- for example, in that 17 period, I think rates dropped relatively from 18 12 percent to almost 9 and a half percent. 19 If you started selling off your 20 12 percent coupon mortgage-backed securities when 21 the market had already gone down to 10 or 9, you 22 would make a profit. 23556 1 Q. Were those kinds of profits ones that 2 were consistent with a risk-controlled -- I mean 3 mortgage-backed security risk-controlled 4 arbitrage? 5 A. I would say yes. 6 Q. Okay. Is that because they resulted 7 from management of the portfolio? 8 A. Yes. 9 Q. Now, in that kind of circumstance, 10 if -- if you sell off securities and repurchase 11 money as retired, what do you do with the hedges 12 that remain? 13 A. Well, you would have to -- 14 MR. VILLA: Objection, Your Honor. 15 Again, I don't know. Is he an expert witness here 16 on how to do a risk-controlled arbitrage? We 17 started from the proposition that he and his 18 regulatory analysts looked at this document and 19 how he manages the mortgage-backed securities 20 portfolio. I don't know that much about MBS, but 21 I think I know he's not an expert. I object to 22 the question. 23557 1 MR. RINALDI: I'm just asking his 2 understanding. 3 MR. VILLA: Everybody has an 4 understanding, but he's not an expert. 5 MR. RINALDI: I'm not trying to qualify 6 him as an expert. 7 THE COURT: What's the purpose of this 8 testimony? 9 MR. RINALDI: I wanted to elicit from 10 him what his understanding was of the dynamics of 11 the portfolio, and I think it goes to the question 12 of was it reasonable from time to time to 13 anticipate that there would be sales out of the 14 portfolio for purposes of balancing or managing 15 the portfolio. And I was just addressing the 16 questions to, you know, what his understanding was 17 of how these portfolios were managed. 18 I'll move on to another subject, 19 Your Honor. 20 Q. (BY MR. RINALDI) Would you take a look 21 at Page 20, which is Bates stamped CN152331, 22 Page 19, and then Page 20? 23558 1 Do you see it there? 2 A. Yeah. 3 Q. Page 19 talks about a structured 4 arbitrage program. Again, it's discussing -- or 5 it would appear to be discussing the structured 6 arbitrage mortgage-backed security program that 7 had been initiated by USAT. 8 Do you see that? 9 A. Yes. 10 Q. And over on the following page, it 11 again describes the circumstance of -- at the top 12 of the page where it says, "To closely manage this 13 process, a team of professionals constantly 14 monitors the structured arbitrage program. This 15 monitoring results in periodic sales and purchases 16 of mortgage-backed securities to maintain a closer 17 balance between the overall durations of the 18 securities and the underlying interest rate 19 swaps." 20 Do you see that? 21 A. Yes. 22 Q. And then below that, it says -- what is 23559 1 your understanding of what's being described 2 there? 3 A. Basically, a risk-controlled arbitrage 4 program. 5 Q. But it's talking about the sale of 6 securities out of that portfolio. 7 Are those sales that are for the 8 purpose of managing the portfolio? 9 A. Yes. 10 Q. Okay. And it indicates further below 11 that in this instance -- would you turn now to 12 Page 87 of the application? 13 A. (Witness complies.) 14 Q. This is CN152393. I apologize. This 15 is one of those documents where, when it was Bates 16 stamped or produced, the pages were out of order. 17 So, the page that I'm interested in going to is 18 CN152393; and 87 is the page number that appears 19 at the bottom. 20 Do you see that? 21 A. Yes. 22 Q. Okay. And this goes back to the 23560 1 question of MCO's participation in the sub debt 2 application. It indicates in the first full 3 paragraph in the last sentence that in the event 4 that -- strike that. 5 It says -- well, would you read that 6 paragraph to yourself? And then I have a couple 7 of questions for you. 8 A. (Witness reviews the document.) 9 Q. Have you read it? 10 A. Yes. 11 Q. Now, was it your understanding at this 12 point in time that unless MCO could get a waiver 13 of the guarantee or the condition that required 14 them to guarantee the net worth of USAT, that it 15 was not going to go forward and purchase 16 10 million in equity through the purchase of the 17 subordinated debt? 18 A. Yes. 19 Q. Was USAT, while you were the 20 supervisory agent, ever able to obtain approval 21 for such a waiver of the condition? 22 MR. EISENHART: Your Honor, I think he 23561 1 misspoke. He said USAT. 2 MR. RINALDI: I'm sorry. 3 Q. (BY MR. RINALDI) Was MCO -- or did the 4 Federal Home Loan Bank Board every approve the 5 waiver of that condition so that MCO could go 6 forward and purchase the sub debt? 7 A. I don't think they ever resolved it. 8 Q. To your recollection, did this sub debt 9 application ever result in the issuance of 10 subordinated debt by USAT? 11 A. No, it didn't. By MCO, I believe. 12 Q. I'm sorry. What? 13 A. Never mind. I don't think this sub 14 debt application went through. 15 Q. Now, on the -- at the bottom of -- 16 you're going to have to read this one backwards. 17 At the bottom of Page 86 and the top of 18 87, there is a footnote or a Note No. 6. Would 19 you read that to yourself? 20 A. (Witness reviews the document.) 21 Q. And the note makes reference to the 22 fact that Drexel Burnham Lambert, which 23562 1 beneficially owned 488,931 shares of common stock 2 of UFG, had granted an option for 300,000 shares 3 of UFG common stock to MCO. 4 Do you see that? 5 A. Yes. 6 Q. Then it also makes reference to the 7 fact that in the event that the call option was 8 not exercised, that Drexel would be entitled to 9 a -- to a put option with respect to the same 10 shares that would be exercisable during a 11 one-month period commencing August 1st, 1988. 12 Do you recall at or about the time that 13 this application was filed learning of that 14 put/call option that's described there in the -- 15 in the application to issue subordinated debt? 16 A. Well, I know of the put/call option; 17 and I know about the 300,000 shares. Probably 18 starting with this, I would become aware of it. 19 Q. Do you recall when you received this 20 whether you actually became aware of it, or you 21 have no independent recollection? 22 A. I know I'm aware of it, and I know 23563 1 Drexel actually held more shares than 300,000 at 2 one point. 3 Q. Well, was this of concern to you? Did 4 it raise any issues with you as the supervisory 5 agent at the time you learned it? 6 A. I believe we were more concerned with 7 the amount of shares that Drexel owned in UFG than 8 any other issue at that time. 9 Q. Okay. And what was the significance of 10 Drexel's ownership of UFG that was of concern to 11 you? 12 A. One, we were interested why Drexel was 13 buying shares of UFG to begin with. And two, they 14 were approaching 10 percent of all the shares 15 outstanding from UFG. And underneath our 16 regulations, if they exceeded 10 percent, hit 17 10 percent or exceeded it, they would have been an 18 affiliated party; and certain other disclosures 19 and certain other requirements would have been 20 triggered. 21 Also, you know, we were very well aware 22 that most of the junk bond transactions were 23564 1 actually purchased through Drexel. 2 Q. Now, after the subordinated debt 3 application was issued, do you recall whether USAT 4 was required to file a business plan in connection 5 with the sub debt application? 6 A. Yeah. They would have, yes. 7 Q. And turning your attention to the next 8 document in your book, it's Exhibit A10663. It's 9 Exhibit 184 (sic). 10 Does this appear to be a copy of the -- 11 of the business plan that was submitted to USAT in 12 connection -- on August 28th, 1986, in connection 13 with the subordinated debt application? 14 A. Well, the cover memo from Art Berner 15 indicates that this is the business plan 16 forwarding it to the Federal Home Loan Bank of 17 Dallas. It probably is the one associated with -- 18 or a later one associated with this application. 19 Q. Okay. And you don't -- you're saying 20 that you're not sure if this is the same one that 21 was submitted to the Bank Board or -- 22 A. I was looking at the timing. May 1986 23565 1 and -- you know, often institutions would update 2 their business plans or include additional 3 information that we may require. But Mr. Berner 4 does say this was submitted to the Federal Home 5 Loan Bank, so ... 6 Q. This would have been something that you 7 would have seen in connection with your 8 participation as the supervisory agent at USAT? 9 A. Yes. 10 Q. Now directing your attention to 11 Exhibit B1000. It's Tab 1644. It will be in the 12 other book. You can put that one aside. 13 This is a letter from -- from 14 Mr. Berner to Neil Twomey dated May the 27th, 15 1986; and it deals with the subordinated debt 16 application. 17 A. Could you give me that tab number 18 again? 19 Q. Yes. It's Tab 1644, Exhibit B1000. 20 A. I've got it. 21 Q. Take a moment to look at that document 22 and tell me if you recognize it. 23566 1 A. (Witness reviews the document.) Okay. 2 Q. What is that document, sir? 3 A. It's simply a letter from Mr. Berner to 4 me regarding the subordinated debt issue and the 5 fact that an examination is starting at USAT; and 6 until we have some preliminary results on that 7 exam, we're not going to move forward on that 8 application. 9 Q. So, it was being held in abeyance until 10 the outcome of the 1986 exam? 11 A. Yes. 12 Q. I noticed in response to a question a 13 moment ago, I think you indicated that you thought 14 a substantial amount of high-yield bonds at USAT 15 were purchased from Drexel. 16 Do you recall responding to that? 17 A. Yes. 18 Q. Do you know what the actual amount of 19 high-yield bonds were that were purchased by USAT? 20 A. No. 21 Q. Do you know if it was a majority? 22 30 percent? 40 percent? 23567 1 A. I think it was a vast majority, like 2 90 percent. 3 Q. How do you come to that conclusion, 4 sir? 5 A. That's my recollection. The primary 6 dealer in that type of securities during the early 7 1980s was Drexel. Drexel was the primary issuer 8 of junk bonds. 9 Q. Are you talking about issued bonds or 10 bonds that were actually sold on the secondary 11 market? 12 A. I think they were the primary issuer of 13 the bonds. 14 Q. Did other enterprises, after the bonds 15 had been sold, also sell them on the secondary 16 market? 17 A. Yes, they did. 18 Q. Was it your understanding that most of 19 the bonds held by USAT were sold to them by Drexel 20 or that -- 21 A. Purchased through Drexel, yes. 22 Q. How did you come to that understanding? 23568 1 A. Based on conversations with the 2 institution, based on conversations with the 3 examiners. 4 Q. Have you ever seen any documentation to 5 that effect? 6 A. That I can remember right now, no. 7 MR. NICKENS: The witness answered 8 "no"? 9 THE REPORTER: Right. 10 Q. (BY MR. RINALDI) Now, did there come a 11 time in about May of 1986 when the Federal Home 12 Loan Bank of Dallas became concerned about United 13 Savings Association of Texas' investment in 14 high-yield bonds? 15 A. Yes. 16 Q. And what do you recall of that? 17 A. Well, basically, a couple of things. 18 Jim Halverson, who was my direct supervisor, had 19 formerly been a regional director for the FDIC. 20 He had just retired from them and came to work for 21 us. The institutions that he supervised did not 22 participate in the junk bond market. When he 23569 1 became aware, particularly with USAT, of the large 2 amount of dollars that they had already invested 3 in junk bonds, he was concerned. And on or around 4 that time, I asked John Scott from my bank to go 5 down there and review their -- their activities 6 regarding junk bonds. 7 Q. Okay. Now, would you take a look at 8 what's been marked as Tab B1007? This is a memo 9 to the file from Ginger Baugh. 10 A. Okay. 11 Q. And directing your attention to the 12 paragraph that says "purpose" and then if you go 13 down about -- to the last sentence, it says, "A 14 certain amount of concern arose following the 15 bank's discovery that United had purchased 16 10 million in Hudson private placement bonds from 17 Ivan Boeske. Concern heightened when Lou Roy 18 received information from a private source which 19 cited that United's securities transaction 20 portfolio should receive our attention." 21 Do you see that? 22 A. Yes. 23570 1 Q. Do you recall or -- do you recall what 2 that statement in Ms. Baugh's memo refers to? 3 A. Yes. We had several inquiries from 4 Washington regarding the investments contained in 5 the junk bond portfolio at USAT. 6 Q. And as a result of that, did 7 Mr. Halverson and Ms. Baugh then visit USAT to 8 discuss their high-yield bond portfolio? 9 A. Well, I know they had a meeting with 10 them. I think it was in Dallas, though. 11 Q. Does this appear to be a memo dated May 12 the 29th, 1986, memorializing a May 5th meeting of 13 1986 where Ms. Baugh and Mr. Halverson met with 14 United Savings Association of Texas 15 representatives and United Financial Group? 16 A. Yes. 17 MR. RINALDI: Your Honor, I would move 18 the admission of Exhibit B1007. 19 MR. VILLA: No objection. 20 THE COURT: Received. 21 Q. (BY MR. RINALDI) Now, if you turn to 22 the second page, it indicates in the second 23571 1 paragraph down a further discussion about the Ivan 2 Boeske bonds and then an explanation which 3 follows. Then it indicates that Mr. Halverson 4 requested that they provide a written description 5 of their bond purchases, arbitrage activity, and 6 other securities transactions common to United. 7 Do you see that? 8 A. Yes. 9 Q. And as a result of Mr. Halverson making 10 that request, did you subsequently receive such a 11 description of the bond purchases and arbitrage 12 activities of United Savings Association of Texas 13 from the institution? 14 A. Yes. I believe it was sent to 15 Mr. Halverson, but I was CC'd. 16 Q. If you would take a look at 17 Exhibit A10634. That should be about the next 18 document in your -- in your book. 19 Do you see that? 20 A. Yes. 21 Q. And is this the letter that Mr. Berner 22 sent to the Bank Board describing USAT's 23572 1 corporate -- or responding to the request for 2 information on its corporate bonds? 3 A. Yes. This is the response to 4 Mr. Halverson's request. 5 Q. It says in the second full paragraph, 6 "At our meeting, you requested amplification and 7 elaboration on a number of issues regarding USAT's 8 operation." 9 Do you see that? 10 A. Yes. 11 Q. If you turn to the second page, the 12 third paragraph down, Mr. Berner describes, in 13 part, the corporate bond strategy engaged in by 14 USAT. 15 Do you see that? 16 A. Yes. 17 Q. It says, "The association has 18 implemented this program of investing incorporate 19 bonds in order to maintain an interest rate spread 20 between the high-yield corporate bonds and 21 duration-matched long-term certificates of 22 deposit. By building in this matched spread, the 23573 1 association has been able to increase its capital 2 and profitability to what we believe a balanced 3 portfolio of corporate debt." 4 Does that describe the strategy for 5 engaging in corporate bond activity that you 6 understood USAT was entering into? 7 A. Yes. 8 Q. That's what you previously described 9 when you told that strategy to the judge at the 10 beginning of your examination this afternoon? 11 A. Yes. 12 Q. If you turn to the next page, it 13 says -- this has got Bates stamped OW152653 at the 14 bottom. 15 MR. EISENHART: Your Honor, I think we 16 have a different version of the document. 17 THE COURT: Why don't we go by the page 18 number of the exhibit? I don't know why they have 19 different imaging numbers. 20 MR. RINALDI: Well, I think what 21 happened was that these were the deposition 22 exhibits; and then when they compiled the trial 23574 1 exhibits, they may have used the same document but 2 a different version of it. 3 I did not realize that, Your Honor. 4 This came from Mr. Twomey's deposition or 5 Ms. Baugh's deposition. 6 THE COURT: Where are we on the 7 document? 8 MR. RINALDI: We're on Page 3 at the 9 very top. 10 Q. (BY MR. RINALDI) Now, it states at the 11 top of that page that one of the objectives of 12 USAT's high-yield bond arbitrage was capital 13 appreciation. 14 Do you see that? 15 A. Yes. 16 Q. And in addition to that, it indicates 17 that another objective was the maintenance of 18 interest rate spread. 19 Do you see that, as well? 20 A. Yes. 21 Q. Then if you drop further down on the 22 page, it says -- in the paragraph about -- it's 23575 1 the third full paragraph. It says, "As set forth 2 on Exhibit A, the investment in corporate 3 high-yield bonds has provided a recognized profit 4 of 27.2 million since 1984. And as of April 30th, 5 1986, the association had an unrecognized gain of 6 approximately 11.6 million. This gain is in 7 addition to the built-in interest rate spread of 8 approximately 2.50 percent, which the association 9 has maintained between the corporate debt and the 10 matched certificate of deposits." Then it says, 11 "As a result of this spread plus capital 12 appreciation, the association has been able to 13 increase its net worth through the implementation 14 of this investment program." 15 Did you understand that the intent of 16 USAT was to hold the corporate bonds in the 17 portfolio on a long-term basis to maturity? 18 A. Yes. They were matching basically 19 duration with the CDs. 20 Q. And notwithstanding that intent, did 21 you understand that as part of the management of 22 the portfolio, that from time to time there would 23576 1 be sales of such bonds executed from the 2 portfolio? 3 A. Yes. 4 Q. And what would be the purpose for 5 executing those bonds -- I mean selling those 6 bonds, as you understood it? 7 A. Well, two primarily. Some bonds could 8 be called. The second thing would be if there 9 was -- since these are unsecured business loans, 10 if the company underlying the bond was to suddenly 11 have a downturn and its credit worthiness to 12 decline, they may make a decision to sell that 13 corporate debt before it further deteriorates. 14 Q. Was there any question of industry 15 exposure or diversification that might lead to 16 sales of bonds out of the portfolio? 17 A. You would want to keep your investment 18 in any one particular company at a minimum level 19 so you wouldn't have too much exposure with one 20 company because if that one company, the main 21 company, was to suddenly have a problem, it would 22 materially affect your portfolio. 23577 1 Q. Now, when you received this letter from 2 Mr. Berner and he indicated to you that they had 3 recognized profits of 27.2 million out of that 4 portfolio over the previous -- or since 1984, did 5 that surprise you? 6 A. No. 7 Q. Did you understand that that was 8 consistent with an investment portfolio, to have 9 those kinds of gains? 10 A. Yes, I would have said so. 11 Q. Did USAT ever tell you that those 12 profits were the results of sales that had been 13 executed out of the junk bond portfolio for the 14 purposes of generating gains to bolster profits to 15 meet USAT's capital requirements? 16 A. No, they didn't. 17 Q. Did USAT ever tell you that such gains 18 had resulted from premature selling of the bonds 19 to capture capital gains to bolster profits? 20 A. No, they did not. 21 Q. Now, if you turn to Page 4 of the 22 letter, in addition -- strike that. 23578 1 Stay on Page 3. Item Roman Numeral III 2 talks about investments in equity securities. 3 Do you see that? 4 A. Yes. 5 Q. And is this the equity securities 6 program that we've been talking about that's sort 7 of the second leg of the investment triad? 8 A. Yes. 9 Q. And it talks about, at the top of 10 Page 4, "As you are aware, once a transaction is 11 announced and its terms fully disclosed, until 12 consummated, there is generally an arbitrage 13 spread between the current market value of the 14 security and the value of the disclosed but not 15 yet consummated transaction." 16 What was your understanding of what 17 Mr. Berner was referring to there when he wrote 18 that? 19 A. Simply put, that if a company was 20 acquiring another company and paying for the 21 company $60 per share and the market price might 22 be 52, 53, and the deal would be consummated 23579 1 within four months or so, that they would buy the 2 securities and hold it until the deal was tendered 3 and, therefore, get the appreciation between the 4 purchase price and the offer price. 5 Q. And then if you go further down the 6 page, it talks about gap management. 7 Do you see that? 8 A. Yes. 9 Q. And in the first paragraph under "gap 10 management," it discusses -- or it appears to 11 discuss what is the mortgage-backed security 12 portfolio. 13 Do you see that? 14 A. Yes. 15 Q. And in the next paragraph, it says -- 16 they talk about using matching techniques. It 17 says, "These matching techniques eventually result 18 in long-term assets and liabilities during 19 duration matched with a built-in spread such that 20 the association has significantly reduced the risk 21 of interest rate fluctuations." 22 Do you see that? 23580 1 A. Yes. 2 Q. What are they referring to there, sir? 3 A. Again, their risk-controlled arbitrage 4 of mortgage-backed securities. 5 Q. And they reduce the risk of interest 6 rate fluctuation by managing the portfolio? 7 A. This way, yes. 8 Q. And at the same time, you're able to 9 generate a spread? 10 A. Yes. 11 Q. Now, at the bottom of the page, it 12 states, "While utilization of these techniques has 13 resulted in the association not taking full 14 advantage of the recent dramatic decline in 15 interest rates, USAT's management believes that 16 USAT should not be in the interest rate 17 speculation business." 18 What did you understand Mr. Berner to 19 be conveying there? 20 A. That USAT wasn't sweeping through their 21 mortgage portfolio taking all the winners out and 22 cashing them in to increase profits. 23581 1 Q. Then it goes on and says, "Rather, 2 management believes that we should protect our 3 interest rate spread and reduce our gap to the 4 fullest extent possible in all interest rate 5 environments." 6 What do you understand that meant? 7 A. Again, through the risk-controlled 8 arbitrage program, they were protecting against 9 movements in interest rates; and because, 10 traditionally, savings and loans are long in fixed 11 rate and savings deposits are short-term, you can 12 put yourself into a poor position. 13 Q. Now, as a result of receiving this 14 letter, did you understand that USAT was not using 15 the mortgage-backed security portfolio as a 16 vehicle for speculation? 17 A. Well, that's what Mr. Berner told me in 18 the letter. 19 Q. And you believed him? 20 A. Yes. 21 Q. Now, after you received the letter, did 22 you still have some concern about the high-yield 23582 1 bond portfolio? 2 A. Yes, I did. 3 Q. Okay. Now, take a look at the next 4 document, which is Tab 1754. It's Exhibit B978. 5 A. (Witness reviews the document.) 6 Q. Now, do you recognize that document, 7 sir? 8 A. Yes. 9 Q. Do you need a moment to look at it? 10 A. Just a minute. 11 Q. Okay. Now, after you received 12 Mr. Berner's response dated May the 9th, 1986, did 13 you then write back to him with additional 14 questions regarding the high-yield bond portfolio? 15 If you look at Point 5 on the second 16 page. Do you see that? 17 A. Yes. 18 Q. And it makes reference to the fact that 19 "We relayed the bank's position with regard to 20 sudden investment securities." It says, "The 21 association should detail its investment security 22 activities including the extended investment 23583 1 activity in subquality securities." 2 A. Yes. 3 Q. As a result of your requesting that 4 they detail their investment security activities 5 including the extended investment activity in 6 subinvestment grade securities, did you have 7 further meetings with USAT that you recall on the 8 subject of their high-yield bond portfolio? 9 A. I believe so. 10 Q. Look at the next document. It should 11 be B4001. This is Tab 887. This is a memo to the 12 file from Ginger Baugh; and it makes reference to 13 a meeting on May the 21st, 1986. It says, 14 "Following the association's most recent meeting 15 at the bank, Mr. Art Berner from United invited 16 SA Halverson, Twomey, and Analyst Baugh to Houston 17 to observe the securities operation." 18 Do you see that? 19 A. Yes. 20 Q. And did you in the latter part of 21 May 1986 visit the securities operation in 22 Houston? 23584 1 A. Yes. 2 Q. Okay. And it indicates that, in 3 particular, you're looking at both the investment 4 in corporate debt and equity securities, as well? 5 A. Yes. 6 Q. And who was Mr. Joe Phillips, sir? 7 MR. EISENHART: Your Honor, I believe 8 Mr. Rinaldi may have misspoke. He talked about 9 visiting the association in Houston. I believe 10 the memo says that the meeting took place in 11 Dallas and that there was not time to go to 12 Houston. 13 MR. RINALDI: I'm sorry. You're 14 absolutely correct. They invited them to Houston, 15 but they came to Dallas. I apologize. 16 Q. (BY MR. RINALDI) Do you recall them 17 coming to Dallas to visit? 18 A. Yes. 19 Q. And on the next page, there's a list of 20 persons that attended the meeting. 21 Do you recall attending a meeting at 22 which these -- all of these individuals were 23585 1 present? 2 A. Yes. 3 Q. Okay. Now, it appears that about six 4 people came from USAT; is that correct? 5 A. Yes. 6 Q. And who was Joe Phillips? 7 A. I believe at that time he was the 8 person managing their junk bond portfolio. 9 Q. And then in the next paragraph, it 10 describes their junk bond portfolio. 11 Do you see that? 12 A. Yes. 13 Q. And is their description consistent 14 with what your understanding had been based upon 15 Mr. Berner's letter? 16 A. Yes, it was. 17 Q. And it indicates -- in the 18 next-to-the-last sentence in that paragraph, it 19 says, "He stated that the equity securities were 20 selected so as to extract an arbitrage spread." 21 Do you see that? 22 A. Yes. 23586 1 Q. And what did you understand him to mean 2 when he referred to an arbitrage spread with 3 respect to the equity securities? 4 A. It was simply the interest earned on 5 the securities versus the cost of the -- the 6 savings deposits they were duration matched 7 against. 8 Q. Okay. Now, in the next paragraph, it 9 talks about a statement that you made. 10 Do you recall making the comment that's 11 attributed to you in the memorandum in the 12 next-to-the-last paragraph? 13 A. Yes. 14 Q. And what was your concern as reflected 15 in that paragraph? 16 A. Well, generally, many of these junk 17 bonds were issued in a much higher rate 18 environment. And now that interest rates had 19 declined, the companies that had issued them were 20 much healthier as far as meeting earnings, et 21 cetera, because their borrowing costs had come 22 down and there was also a much better probability 23587 1 that if you had a 14, 15 percent junk bond, you 2 might want to refinance it at a lower rate. 3 Junk bonds become much riskier if 4 interest rates were to spike dramatically and then 5 cause, you know, financial problems for the 6 institution -- for the companies that issued them. 7 So, the lower the interest rates, 8 basically the safer the junk bonds are because, 9 again, one, they could be refinanced and you would 10 be paid off and, two, it's less likely the 11 companies that issued them will go into any type 12 of default. 13 Q. Now, on the next page, you also express 14 a concern in the second full paragraph with 15 respect to net operating losses. 16 Would you take a look at that and tell 17 me what you were concerned about there? 18 A. (Witness reviews the document.) Okay. 19 This is on Page 2, the third paragraph down? 20 Q. Yeah. "SA Twomey stated." 21 A. Yes. 22 Q. What was your -- what were you 23588 1 referring to when you were talking about net 2 operating losses in the association? 3 A. Again, we had reviewed their ongoing 4 financials. And again, the earnings they were 5 receiving for their assets was negative when you 6 compared it to their cost of liabilities. 7 Q. In the next sentence, it says, "He 8 discussed the fact that United had been depending 9 on gains from securities transactions and branch 10 sales to secure profits." 11 Do you see that? 12 A. Yes. 13 Q. What does that refer to? 14 A. Primarily branch sales in the prior 15 accounting period. That accounted for a large 16 amount of profit that -- 17 Q. And it indicates that they also 18 depended upon gains from securities transactions. 19 What securities were you referring to 20 there, sir? 21 A. Just what was listed on the TFR. 22 Q. What do you mean by that? 23589 1 A. The thrift financial report. In the 2 section on the report -- there's one general 3 section that refers to gains on the sale of 4 securities. 5 Q. Okay. If I provide you with a copy of 6 a sample of the thrift financial report, could you 7 explain to the Court what you're talking about? 8 A. Yes. 9 Q. Okay. 10 MR. RINALDI: I'm handing up to the 11 witness what have been previously marked as 12 Exhibit T8178 and T8177, and I'll ask the witness 13 to take a look at those two documents. 14 Q. (BY MR. RINALDI) Now, sir, first of 15 all, you've made reference on at least two and 16 perhaps three occasions to a thrift financial 17 report. 18 Perhaps you can explain to the Court 19 what exactly the thrift financial report is. 20 A. During this time frame, the 21 institutions that were insured by FSLIC were 22 required to file with the FSLIC Corporation thrift 23590 1 financial reports. And these were multi-page 2 reports which would be a statement of condition, 3 statements regarding their P&L, and other 4 miscellaneous information regarding the state of 5 their assets that would be filed basically on a 6 quarterly basis. And we relied typically on these 7 to judge for trends, shifts in the asset 8 composition of the institution, their growth, 9 their investments. 10 Particularly when we talk about 11 monitoring their operations, you would -- where 12 we're talking about the sale of investments, if 13 you would flip over to Section D that's on the 14 third page, I believe, of this -- 15 Q. And "this" being Exhibit T8177? 16 A. Yes, the thrift financial report. If 17 you looked down there, you would see non-operating 18 income and profit on sale. And then underneath 19 that, you have foreclosed property, repossessed 20 property, other real estate owned. 21 And the next line, Line 230, it says 22 "investment securities." Investment securities 23591 1 was any sales from their assets that were 2 U.S. Government securities or agency securities, 3 common or preferred stock, and other investments. 4 And they were grouped together. And any gains out 5 of that, those particular assets would be listed 6 as non-operating income; and, again, that would be 7 Line 230. 8 If there were losses on the sale of any 9 of those particular assets, they would be shown on 10 Line -- if I can read it here -- Section E, 240, I 11 believe. 12 Q. Okay. Now, you identified a number of 13 items that would be aggregated in determining what 14 were investment securities. 15 How can one determine which securities 16 come under the rubric "investment securities" for 17 purposes of Item 230 of the TFR? 18 A. Okay. For gains or losses regarding 19 non-operating income and non-operating expenses, 20 you would look to Section A of the thrift 21 financial report; and you would look at the lines 22 regarding U.S. Government agency securities -- I 23592 1 should say U.S. Government and agency securities. 2 Common stock and preferred stock, that's the next 3 line. And the next line underneath that would be 4 other investments. 5 Q. Okay. And in those boxes, would it 6 indicate whether there had been a gain or a loss 7 with respect to any of those individual 8 categories? 9 A. If there was a sale of any of the 10 assets listed in these lines, a gain or loss would 11 be reflected in the income line I mentioned 12 earlier or the expense line I mentioned earlier. 13 Q. And when you make reference to a gain 14 or a loss in connection with an investment 15 security, you identify a large number of different 16 kinds of securities that would be lumped together 17 as investment securities. 18 Do you recall that? 19 A. Yes. 20 Q. How does one ascertain what the 21 definition is of an investment security for 22 purposes of the TFR? 23593 1 A. Well, there's instructions for 2 completing a TFR, a multi-page document that the 3 Federal Home Loan Bank Board would issue and, from 4 time to time, they would amend because they add 5 different schedules and change definitions. 6 All you would have to do is go under 7 the D section, continue on until you get to the 8 line that you're concerned with regarding what the 9 definition would be. And in the case of 10 Line D230, it would be profit earned during the 11 period as a result of sale of any assets of the 12 type reported in Line A370, Line A382, or A384 13 which, again, are the lines I referred to earlier. 14 Q. And you're now reading from -- 15 A. I'm reading from your Exhibit T8178, 16 which is the Federal Home Loan Bank Board 17 instructions for the quarterly financial report. 18 Q. And you just read from Page D7? 19 A. D7 regarding Line D230. 20 Q. Okay. Now, in reference -- Line D230 21 defines or includes, under the definition of an 22 investment security, those types of securities 23594 1 identified on Line A370, A382, and A384. 2 What are those three types of 3 securities that are identified there? 4 A. Okay. A370 are U.S. Government or 5 U.S. Government agency securities. They could be 6 U.S. Treasury bonds. They could be Federal Home 7 Loan Bank System bonds. These are all government 8 securities with the implied backing of the United 9 States Government. 10 Q. And how does one ascertain that from 11 the document you have in front of you? Is that 12 what's listed on Page A11 of Exhibit T8176? 13 A. Again, there's detailed descriptions of 14 what goes on each particular line. If you look at 15 A11 and look down the line at A370, it would have 16 a complete description of the type of investment 17 securities that should be listed on A370 on the 18 thrift financial report. 19 Q. Okay. Then if you turn over to the 20 next page, A12, does that indicate the types of 21 investments that should be listed on Line A -- 22 Line A382 and Line 284? 23595 1 A. Yes. 2 Q. And 382 includes a variety of common 3 and preferred stock that are identified there? 4 A. Yes. 5 Q. And then what are the other investments 6 that are included under Line A384? 7 A. Basically, that's the catchall. Any 8 other type of securities that you may have, 9 particularly it would be the junk bonds. 10 Q. Okay. So, when you as a supervisory 11 agent were reviewing the TFR and -- what is it 12 that you could ascertain by looking at the 13 non-operating income associated with investment 14 securities? 15 A. Well, particularly, I would be looking 16 at it to see how, on an operating basis, operating 17 income versus operating expenses of the 18 institution would be doing. It's a key ratio in 19 our analysis of the institution. 20 The bottom line would still be -- at 21 the bottom of the page is net income. And you 22 would also -- if an institution was losing money 23596 1 on an operating basis but had positive net income 2 overall, you would want to see what the 3 non-operating items were to ascertain, you know, 4 what -- you know, why it happened, what was going 5 on. 6 And if -- most of the time, 7 non-operating income is a one-time-only item. 8 It's not a repeatable item. If it was repeatable, 9 it would be in operating expenses. 10 Q. If it's not repeatable, then you can't 11 depend on being able to make that again in the 12 future; and if it's being used to make up 13 operating losses, does that raise a concern as to 14 whether there is continued ability to earn 15 operating profits? 16 A. Yes, it does. 17 Q. Okay. And when you referred or when -- 18 in the meeting that is referenced in 19 Exhibit B4001, when it attributed to you that 20 United has been depending on gains from securities 21 transactions, how would you have come to that 22 understanding? 23597 1 A. Based on what I saw in the TFR. 2 Q. Okay. And that would have been based 3 upon -- in turn, based upon what you saw listed 4 under Item D230 with respect to investment 5 securities? 6 A. Yes. 7 Q. Now, apart from being able to ascertain 8 that there had been sales or profits generated by 9 the sales of investment securities, by looking at 10 the TFR, would you have known which securities 11 were sold? 12 A. No. 13 Q. So, this could have been a treasury, it 14 could have been common stock, it could have been 15 stock that was sold out of the equity arbitrage 16 portfolio, or it could have been bonds that were 17 sold out of the bond portfolio? 18 A. Yes. 19 Q. So, there was no way of knowing, from 20 looking at the TFR, what had been sold? 21 A. You don't get the detailed breakdown. 22 Q. Can you tell from looking at the TFR 23598 1 the reason why those sales were made? 2 A. No. 3 MR. RINALDI: Your Honor, I would move 4 the admission of T8177 and T8176. 5 MR. NICKENS: You mean 8178? 6 MR. RINALDI: I'm sorry. 8178. 7 MR. VILLA: No objection. 8 THE COURT: Received. 9 Q. (BY MR. RINALDI) So, when you made the 10 observation at the meeting with USAT on May the 11 22nd that United has been depending on gains from 12 securities transactions, you didn't know what 13 securities United had been selling, did you? 14 A. No, I wouldn't have. 15 Q. And you wouldn't have known what the 16 purpose for those sales was? 17 A. No. 18 Q. Then Mr. Crow says in the next 19 paragraph, "According to Mr. Crow, income from 20 securities transactions should not be considered 21 extraordinary as United had made them a part of 22 their ordinary operations." 23599 1 What did you understand that to mean? 2 A. It would appear that Mr. Crow was 3 deeming it ordinary, but the bottom line is the 4 instructions are the instructions. We couldn't 5 change that. 6 Q. So, even though he called these 7 ordinary gains, they were still, for purposes of 8 the TFR, being treated as non-operating gains? 9 A. Yes. 10 Q. Now, in the last paragraph, it says, 11 "Mr. Twomey or SA Twomey requested that United 12 provide the bank with a description of the 13 corporate debt securities purchased, including the 14 names of issues, what each is rated by S&P or 15 Moody's, the representative yield, et cetera." 16 And he also requested information on 17 how United is structuring itself in the rising 18 interest rate scenario. 19 As a result of that request, did you, 20 after that, receive submissions on a periodic 21 basis or a monthly basis from United Savings 22 Association of Texas of their -- of lists of their 23600 1 security transactions? 2 A. I believe so, yes. 3 Q. Okay. Now, if you would turn to some 4 of the -- three more exhibits ahead to Tab 1522. 5 It's document A1034. This is a memo from you to 6 John Scott dated June the 6th, 1986. 7 Do you see that? 8 A. Yes. 9 Q. Now, after you had had this meeting 10 with -- 11 MR. EISENHART: Your Honor, could we 12 have the exhibit number again? 13 MR. KEETON: 1522. 14 THE COURT: What is your Exhibit -- 15 MR. RINALDI: It's A1034. 16 MR. BLANKENSTEIN: B1034. 17 MR. RINALDI: I'm sorry. I have a 18 typographical error. Thank you. 19 Q. (BY MR. RINALDI) Now, following your 20 meeting -- following your meeting with 21 representatives of USAT that occurred on May 21st, 22 1986, that is memorialized in Ms. Baugh's 23601 1 June 2nd, 1986 memo, did you continue to have some 2 concerns about USAT's investments in high-yield 3 bonds? 4 A. Yes. 5 Q. Okay. And as a -- and did you then 6 write a memo to John Scott expressing some of 7 those concerns? 8 A. Yes. 9 Q. Now, who was Mr. Scott? 10 A. Mr. Scott at that time was the chief 11 financial officer of the Federal Home Loan Bank of 12 Dallas. 13 Q. And what is it that you were asking -- 14 does this appear to be -- that is, the 15 Exhibit B1034 -- appear to be the memo that you 16 sent to Mr. Scott? 17 A. Yes. 18 Q. And it makes reference to it having 19 come to your attention several months ago that 20 United holds 10 million in Ivan Boeske bonds. 21 Do you see that? 22 A. Yes. 23602 1 Q. Now, what was that referring to? 2 A. Again, Washington, D.C., our office up 3 there was very concerned that USAT was holding 4 these Boeske junk bonds and Mr. Boeske was under 5 investigation. They were making several inquiries 6 about how they were purchased, when, so forth, and 7 so on. And Mr. Scott related to me the entire 8 portfolio of corporate debt, was probably the best 9 person at the Federal Home Loan Bank of Dallas to 10 go there and review their policy, procedures, and 11 transactions for me. I made that request to him 12 through this memo. 13 Q. Now, it states in the memo -- you 14 recite to him that "We have been informed that 15 United routinely invests in non-investment grade 16 securities"? 17 A. Yes. 18 Q. It indicates that "77.6 percent of its 19 corporate bond portfolio are considered 20 non-investment grade securities." 21 What does that mean? 22 A. Junk bonds. 23603 1 Q. Was that of concern to you? 2 A. Yes. 3 Q. And why? 4 A. If they -- if the credit decisions to 5 buy the junk bonds wasn't made with the proper due 6 diligence, you could put the institution at risk. 7 At this time, they were purchasing large amounts 8 of junk bonds. 9 Q. So, you asked Mr. Scott to visit the 10 offices of United and review their junk bond 11 practices? 12 A. Yeah. I asked him to conduct his own 13 examination. 14 Q. Okay, what kind of review or 15 examination did Mister -- he wasn't an examiner? 16 A. No. 17 Q. And was this a formal examination that 18 was being conducted at USAT? 19 A. No. It wasn't a Bank Board 20 examination. 21 Q. Was he even employed by the Bank Board 22 at this point in time? 23604 1 A. He was employed by the Federal Home 2 Loan Bank of Dallas. 3 Q. Okay. And who was Terry Smith? 4 A. Terry Smith worked for John Scott. 5 Q. And did the two of them then review the 6 practices of USAT with respect to purchases of 7 high-yield bonds? 8 A. Yes, they did. 9 Q. Directing your attention to what's been 10 marked as Exhibit B1042. This is Tab 232. It 11 should be the next document in your book. 12 Do you recognize this memo? 13 A. Yes. 14 Q. Okay. And was this sent back to you by 15 Mr. Scott following his visit to USAT? 16 A. Yes. 17 Q. Now, in the first -- the second 18 paragraph, he describes a strategy whereby United 19 purchases less than investment grade corporate 20 debentures. It says B and BB rated bonds. 21 Do you see that? 22 A. Yes. 23605 1 Q. That's the strategy that we've been 2 talking about, is it not? 3 A. Yes. 4 Q. And it goes on to say that "The idea 5 behind the strategy was to have a dedicated 6 portfolio of bonds duration matched with the term 7 deposits to achieve a 200 basis point spread." 8 Does that mean, then, that there was a 9 2 percent differential between the cost of funds 10 and the yield of the bonds? 11 A. Yes. 12 Q. Then it goes on and it says, "While the 13 portfolio does require certain adjustments to keep 14 the durations matched." 15 What did you understand he meant by 16 that: "Adjustments to keep the portfolio duration 17 matched"? 18 A. Maintenance. I mean, based on -- you 19 know, if a particular issue might be called, 20 redeemed, you would have to rebalance, buy 21 different securities. And at the same time, you 22 could have a situation where the credit worthiness 23606 1 of a particular security goes down. You may, you 2 know, want to sell that and replace it with 3 another security. 4 Q. If that happened, there might be a sale 5 out of the portfolio? 6 A. There would be a sale out of the 7 portfolio. 8 Q. In the event of such a sale, there 9 could be a gain or perhaps a loss? 10 A. Yes. 11 Q. Then he goes on and says, "Management 12 of the bond portfolio does not involve bond 13 swapping, pickup yields, or premature selling to 14 capture capital gains currently unrealized." 15 What did you understand that he meant 16 by that? 17 A. The institution wasn't sweeping the 18 portfolio for unrealized gains. 19 Q. When you say "sweeping the portfolio," 20 do you mean selling bonds out of the portfolio for 21 the purpose of generating gains? 22 A. It might be also called cherry picking, 23607 1 the best ones to sell for the most profit. 2 Q. In order to enhance their profitability 3 and increase their capital? 4 MR. EISENHART: Your Honor, the 5 witness, I think, can do the testifying. 6 Mr. Rinaldi is simply feeding the words at this 7 point. The words are very familiar. 8 THE COURT: What's the question? 9 Q. (BY MR. RINALDI) You had made reference 10 that they weren't cherry picking the portfolio. I 11 was simply asking what you meant by that. 12 A. They weren't sweeping the portfolio for 13 profits. 14 Q. When you say "sweeping for profits," 15 what do you mean by that? 16 A. Well, I mean if there was a move in 17 interest rates and a particular junk bond was at a 18 higher market value at that point in time over its 19 historic cost -- namely, what it was purchased 20 at -- because this was an investment portfolio, 21 they carry it at what they purchased it at. If 22 the market value is materially above that, you 23608 1 might sweep the account by picking the ones with 2 the most profits and selling them so you could 3 realize a gain which would then impact your bottom 4 line. 5 Q. And based upon Mr. Scott and 6 Mr. Smith's review, it was your understanding that 7 that was not something that was a practice that 8 was engaged in by United Savings Association of 9 Texas? 10 A. Yes. 11 Q. Now, if you turn to the next page, he 12 discusses the -- Joe Phillips and Mr. Phillips' 13 qualifications. And at the bottom of the page, it 14 says, "In summary, Terry Smith and I are of the 15 opinion that United Savings is responsibly 16 managing its less than investment grade portfolio. 17 We were very impressed with Mr. Phillips and feel 18 he understands the risk attendant and is managing 19 the portfolio and is capable of managing them." 20 Did that give you some comfort as a 21 result of their review? 22 A. Yes, it did. 23609 1 Q. After you received this review or this 2 memo from Mr. Scott, did you continue to have 3 discussions with USAT regarding the high-yield 4 bond portfolio? 5 A. Well, generally, from time to time. 6 But given the assurances from Mr. Scott and 7 Mr. Smith and the fact that they were very 8 impressed with Joe Phillips, I had a high degree 9 of confidence that this portfolio was being 10 managed properly and professionally. 11 Q. Now, would you turn to Exhibit T8014? 12 This is Tab 395, and it's the letter that was sent 13 to the board of directors accompanying the 1986 14 examination report. 15 A. Yes. 16 Q. Now, did you have any input in the 17 creation of this document? 18 A. Yes. My group prepared this letter for 19 signature for Danny Thomas. 20 Q. And in the next-to-the-last paragraph, 21 it makes reference to "The matter of investment 22 portfolio" -- strike that. 23610 1 "The matter of United's investment 2 portfolio has been discussed at length during 3 recent months, and management has repeatedly 4 attempted to assure this office that the 5 investments being made were prudent. However, in 6 view of the market conditions as stated and 7 projected by market sources, we are not convinced 8 that United's investments have a tolerable amount 9 of risk." 10 Do you see that? 11 A. Yes. 12 Q. What was your concern at this point in 13 time, given the fact that United had gotten a good 14 rating by Mr. Scott? 15 A. Well, by the time this letter was sent, 16 almost a year had transpired. And Washington 17 continued to have concerns regarding the junk bond 18 portfolio at United. And because of that, with 19 regard to this letter, we were expressing our 20 continued concern. 21 Q. Now, had you during that year's time 22 had further discussions with United about how they 23611 1 were managing their portfolio? 2 A. Probably from time to time. 3 Q. Now, take a look at what's been 4 previously marked as A12164. This is another 5 letter that's addressed to you from Mr. Berner 6 dated December the 18th, 1986. 7 Do you see that? 8 A. Yes. 9 Q. Take a moment to review the letter, and 10 then I have a couple of questions for you. 11 A. (Witness reviews the document.) 12 Q. Now, it indicates in the first sentence 13 that Ginger Baugh had requested that United 14 describe the current status and outlook of the 15 association's high-yield bond portfolio. 16 Do you see that? 17 A. Yes. 18 Q. Then in the next paragraph, it makes 19 reference to "While the high-yield bond portfolio 20 has a temporary market decrease in value over the 21 last month, in our opinion, due to unsettled 22 questions rising out of the Ivan Boeske matter, 23612 1 United believes that this deterioration in market 2 value is neither permanent, nor will have a 3 negative impact on the association's performance." 4 Do you recall at about this point in 5 time that there had been a question arising about 6 Ivan Boeske that caused you to raise concern? 7 A. I can't remember the time frame, but I 8 think this is about the time Mr. Boeske was in 9 trial for various crimes. But there was an effect 10 on the entire junk bond market: Temporarily 11 depressing prices. 12 Q. Is that your best recollection of what 13 the reference is to temporary market decreases? 14 A. It is. 15 Q. And then if we look at the next page, 16 Mr. Berner makes a number of representations to 17 you regarding the nature of the portfolio. And he 18 talks about "Since inception in late 1984 through 19 September 30th, 1986, United has realized earnings 20 on the accumulated spread income from the 21 high-yield bond portfolio of approximately 22 12.8 million and has realized market gains from 23613 1 such portfolio in excess of $42 million." 2 Do you see that? 3 A. Yes. 4 Q. Did that concern you, that it had 5 realized market gains in excess of 42 million? 6 A. It would probably concern me more if 7 they said they had a loss of 42 million. 8 No, it didn't particularly concern me. 9 Q. Did you understand that those gains 10 were actually realized gains that had come from 11 the sales of securities? 12 A. Well, he didn't state that in the 13 letter. 14 Q. Now, as we go further down -- it 15 actually does say "realized gains." 16 A. I'm sorry. I didn't see it. 17 Q. That's why I asked you the question. 18 You had me confused. 19 A. I'm sorry. I'm just getting tired. 20 Q. Was the fact that there were realized 21 market gains of $42 million in the portfolio 22 during the period of 1984 through September 1986 a 23614 1 matter of concern to you? 2 A. No. 3 Q. Did you understand -- well, strike 4 that. 5 It goes on below and says, "At this 6 time when the Texas economy offers few areas of 7 profitability, United's high-yield bond portfolio 8 has been extremely successful." Then it talks 9 again about the spread that is generated and then 10 states that "The current spread between the 11 portfolio yield and United's fixed rate cost of 12 funds is now 3.46 percent." 13 Do you see that? 14 A. Yes. 15 Q. Was it still your understanding at this 16 time that this was an investment portfolio that 17 had been entered into by United for the purposes 18 of earning spread income? 19 A. Yes. Matched duration, yes. 20 Q. Now, after you received Mr. Berner's 21 letter on the 18th -- turn to Exhibit B1453. 22 That's Tab 253. This appears to be a letter from 23615 1 you back to Mr. Berner raising further questions 2 pertaining to the high-yield bond portfolio. 3 Do you see that? 4 A. Uh-huh. (Witness nods head 5 affirmatively.) 6 THE COURT: Mr. Rinaldi, are you going 7 to offer A12166? 8 MR. RINALDI: I certainly am, 9 Your Honor. I apologize. 10 MR. VILLA: No objection. 11 THE COURT: Received. 12 Q. (BY MR. RINALDI) And do you recognize 13 this document? 14 A. Yes, I do. 15 Q. Okay. And did you prepare this letter 16 or -- 17 A. I participated in the preparation. 18 Q. Now, at the bottom of the page, it 19 makes reference to Joe Phillips and his departure. 20 Do you see that? 21 A. Yes. 22 Q. Were you concerned about the fact that 23616 1 Mr. Phillips was leaving? 2 A. Yes. 3 Q. Who was Mr. Phillips? 4 A. Again, he was the person managing their 5 junk bond portfolio. 6 Q. And were you concerned -- what 7 specifically was your concern about the fact that 8 he had left? 9 A. He was a highly competent individual in 10 our opinion. John Scott had a very high -- high 11 respect for him and his abilities. And we were 12 concerned that he was leaving because we felt that 13 he was a good person hopefully doing a good job. 14 Q. When you say Mr. Scott had a high 15 regard for his capabilities, were you referring to 16 the opinions that Mr. Scott referenced in his memo 17 to you? 18 A. Yes, in the summer of '86. 19 Q. And Mr. Phillips appeared to be a 20 competent junk bond analyst; is that correct? 21 A. Very competent, yes. 22 Q. Okay. And then it goes on on the 23617 1 second page of Exhibit B1453 at the top, again 2 talking about your understanding with respect to 3 Drexel Burnham, which is considered the primary 4 vehicle nationally for high-yield bond investments 5 and then makes reference again to the Boeske case 6 and talks about repercussions. 7 Do you see that? 8 A. Yes. 9 Q. What was the concern that you had at 10 this point in time with respect to the Boeske case 11 and Drexel? 12 A. Generally, that because of Drexel's 13 involvement with Boeske, there was a possibility 14 that Drexel could be negatively impacted. And if 15 Drexel was negatively impacted, that would bring 16 into question the marketability of the junk bond 17 portfolio. 18 Q. And at the bottom of the page, you urge 19 them to carefully review their strategy with 20 regard to investments and to consider reducing the 21 investment risk even at the expense of lower 22 yields. 23618 1 What were you referring to there? 2 A. We were urging them to consider that 3 maybe they should be reducing the amount they had 4 in junk bonds if there was a question whether the 5 junk bonds would be truly marketable if something 6 was to happen to Drexel. 7 Q. Now, in response to your letter, did 8 you receive a letter back from Mr. Berner? 9 A. I believe so. 10 Q. And take a look at what's been 11 previously marked as Exhibit A12169. 12 A. 12169? 13 Q. Yeah. 14 A. This is USAT's -- 15 Q. 12169. It should be a letter to you 16 dated February 11th, 1987. And if you turn to 17 Page 3, he responds to your question regarding Joe 18 Phillips. 19 Do you see that? 20 THE COURT: I don't seem to have that 21 exhibit. 22 A. I don't have the correspondence. I 23619 1 have basically a regulatory profile of the 2 institution that was prepared. 3 THE COURT: That's what I have. 4 MR. RINALDI: 12169. 5 MR. VILLA: Can you tell us the date of 6 it? 7 MR. KEETON: February 11, '87. 8 MR. RINALDI: For once, I'm not at 9 fault, Your Honor. 10 MR. NICKENS: We don't know that. 11 12 (Discussion held off the record.) 13 14 THE COURT: You say this exhibit is in 15 under that number? 16 MR. RINALDI: I will check with -- it 17 has not been admitted. It's a new exhibit, and 18 it's A12169. And the -- and -- 19 MR. NICKENS: Since there's some 20 confusion, we might want to describe it in more 21 detail. It's a letter addressed to Mr. Twomey 22 from Mr. Berner dated February 11, 1987, bearing 23620 1 imaging numbers OW151989 through 151994. 2 MR. RINALDI: Thank you. 3 Q. (BY MR. RINALDI) And directing your 4 attention, then, to -- to OW151991, Roman 5 Numeral II, Mr. Berner addresses the question 6 of -- of the actions that were being taken by 7 United with the departure of Joe Phillips. 8 Do you see that? 9 A. Yes. 10 Q. He indicates that they currently have 11 three credit analysts investigating all credit as 12 well as reviewing all credit held in United's 13 portfolio. And then he indicates at the bottom of 14 the page that Dr. Dorsey reports to Mr. Huebsch, 15 executive vice president of the association. 16 Do you see that? 17 A. Yes. 18 Q. Now, subsequent to receiving this, did 19 USAT obtain a new high-yield bond trader -- strike 20 that. That's the wrong question. 21 Did USAT obtain a high-yield bond 22 person to manage the high-yield bond portfolio? 23621 1 A. Yes. 2 Q. Okay. And who was that? 3 A. Gene Stodart, I believe. 4 Q. And then if you turn to the next page, 5 he addresses the issue that you raised regarding 6 the effect of the Boeske situation on United's 7 portfolio. 8 Do you see that? 9 A. Yes. 10 Q. And after he -- well, after he talks 11 about Drexel's involvement and that he doesn't 12 think there will be a significant long- or 13 short-term effect on the high-yield bond market, 14 if you skip further down the page, in the 15 paragraph that begins "in this connection," do you 16 see that? 17 A. Yes. 18 Q. He says, "In this connection, we 19 discussed -- as we discussed, Charles Hurwitz 20 would appreciate meeting with you to discuss his 21 insights into the liquidity of high-yield bonds at 22 your convenience." 23622 1 Do you see that? 2 A. Yes. 3 MR. VILLA: Your Honor, at the risk of 4 interrupting a smooth-flowing examination, I want 5 to make sure that I haven't lost sight of the 6 point here. There are two -- I want to make sure 7 I'm not trying some issue by consent. 8 There are two allegations of false 9 statements. One, that we told them there was a 10 locked-in spread, and two, that we didn't tell 11 them about the Drexel option. There are 12 allegations about misstatements describing the 13 mortgage-backed securities structured arbitrage, 14 that that was misdescribed to the regulators. 15 The fourth relevant issue is the issue 16 with respect to junk bonds, simply that there were 17 junk bonds; and whether they were right or wrong, 18 they are affiliated party transactions. 19 Now, those are the four different 20 pigeonholes I can see this evidence coming in 21 under; or maybe the it's the fifth pigeonhole 22 trying to somehow get Mr. Hurwitz involved. I 23623 1 understand all that. 2 I want to make clear that I'm not 3 agreeing to try by consent here some issue about 4 misstatements on junk bonds. The allegations in 5 the Notice of Charges are, A, you didn't tell us 6 about the Drexel options, B, you told us there was 7 a locked-in spread with respect to the 8 mortgage-backed securities, and C, strict 9 liability on junk bonds, either they win or they 10 lose on the issue of whether an affiliated party 11 transaction can result in losses. 12 I want to make clear we don't agree to 13 try by consent some allegation about misstatements 14 on the junk bond portfolio by Mr. Berner, my 15 client. 16 If that's what this is being introduced 17 for now, I object to it. If it's not, then I'm 18 sorry to have made a three-minute speech to 19 nobody's avail. 20 That's not -- you're not trying to 21 introduce a statement about misstatements on junk 22 bonds? 23624 1 MR. RINALDI: No. 2 MR. VILLA: Thank you. 3 MR. RINALDI: I'm trying to establish 4 what Mr. Twomey's understanding was of the 5 investment strategy of United Savings Association 6 of Texas between the periods of 1986 and 1988 and 7 what representations were made to him and what 8 representations he relied upon in his activities 9 as the -- in his capacity as the supervisory agent 10 of the institution. 11 Q. (BY MR. RINALDI) Now, Mr. Twomey, it 12 makes reference to meeting -- a suggestion that 13 Mr. Hurwitz would appreciate meeting with you to 14 discuss his insights into the liquidity of the 15 high-yield bonds at your convenience. 16 Did you ever have occasion to take 17 Mr. Berner up on his offer and meet with 18 Mr. Hurwitz on his insights? 19 A. I cannot recall right now. I met with 20 Mr. Hurwitz a couple of times. I'm not sure how 21 it -- which times. 22 Q. Do you know why Mr. Berner was 23625 1 suggesting that you meet with Mr. Hurwitz? Was it 2 your understanding that he was a person that had a 3 great deal of knowledge in the area of junk bonds? 4 A. Mr. Hurwitz definitely had a great deal 5 of knowledge in the area of junk bonds. 6 Q. At least based on your understanding? 7 A. Based on my understanding. 8 Q. Now, in the next paragraph below, it 9 says, "United has no current or proposed 10 arrangements with Drexel or other brokers with 11 regard to the purchase or sale of high-yield 12 bonds. In fact, for the most part, United's 13 high-yield bond portfolio is designed to be an 14 investment and not a trading portfolio so that 15 long-term holdings are the expectation upon 16 acquisition." 17 Do you see that? 18 A. Yes. 19 Q. Was that your understanding of the 20 nature of United's high-yield bond portfolios? 21 A. Yes, it was. 22 Q. All right. Now, Mr. Twomey, you 23626 1 mentioned several times in your testimony 2 yesterday that following the 1986 examination 3 which was completed sometime in early -- at the 4 beginning of 1987, that in lieu of entering into 5 a -- an agreement -- a supervisory agreement, that 6 USAT and the Bank Board had agreed that there 7 would be third-party review of several areas of 8 the operations of USAT. 9 Do you recall that? 10 A. Yes. 11 Q. And one of the areas that they were 12 going to review, I believe, was United's bond 13 portfolio. 14 Do you recall that? 15 A. Yes. 16 Q. Okay. And can you describe for the 17 Court how the process was undertaken to identify 18 an entity to do the high-yield bond portfolio 19 review? 20 A. Yes. Senior management at the Federal 21 Home Loan Bank's regulatory affairs office decided 22 we needed an outside group to look at their -- the 23627 1 junk bonds at USAT. At that time, Walter Faulk, 2 who was the head of supervision working under Joe 3 Selby and Sternweiss, suggested several securities 4 firms to me, one of which was Merrill Lynch. And 5 we contacted them, and they were interested in 6 doing the review. 7 When they met with USAT, they basically 8 told USAT that their fee for doing the review was 9 $100,000. USAT objected, didn't want to pay that 10 amount of money. 11 Then we looked around again, and we 12 found another securities firm that was willing to 13 do the job. We gave them the scope. The price 14 was agreed upon. I think it was about $30,000. 15 And they went in and reviewed -- a person named 16 Lemanske went in and reviewed the portfolio; and 17 then he filed a report with us, one oral and one 18 in writing. 19 Q. Now, prior to selecting 20 Prudential-Bache to do the junk bond review, had 21 you contemplated that the scope of the third-party 22 review might be somewhat broader than just a 23628 1 review of the junk bond portfolio? 2 A. Yes. I wanted a review of the trades. 3 Q. Okay. When you say you wanted a review 4 of the trades, what do you mean? 5 A. The transactions, the purchases, the 6 sales coming in and out of the junk bond 7 portfolio. 8 Q. Okay. Quite apart from that, had you 9 also contemplated possibly reviewing the -- or 10 expanding the scope to include a review of the 11 equity arbitrage and mortgage-backed securities 12 policies and procedures? 13 A. Yes. 14 Q. Okay. And do you recall having a 15 meeting with USAT on that subject? 16 A. Yes. 17 Q. Directing your attention to what's been 18 previously marked as Exhibit A11057 -- 19 THE COURT: Mr. Rinaldi, I think we had 20 better adjourn. Are you offering A12169? 21 MR. RINALDI: Yes, I am, Your Honor. 22 MR. VILLA: No objection, Your Honor. 23629 1 THE COURT: Received. 2 Are there other matters we should 3 consider before we adjourn? 4 MR. RINALDI: None that I'm aware of. 5 MR. NICKENS: On the new schedule, 6 Your Honor, we resume at 1:30 on Tuesday. I know 7 of nothing else other than -- I assume we will 8 complete the direct on Tuesday afternoon? 9 MR. RINALDI: Yes. I think we can 10 finish him up fairly quickly on Tuesday. So, 11 Mr. Twomey -- 12 THE COURT: All right. We'll adjourn 13 until 1:30 on Tuesday. 14 15 (Whereupon at 4:44 p.m. 16 the proceedings were recessed.) 17 . 18 . 19 . 20 . 21 . 22 . 23630 1 STATE OF TEXAS COUNTY OF HARRIS 2 REPORTER'S CERTIFICATION 3 TO THE TRIAL PROCEEDINGS 4 I, Marcy Clark, the undersigned Certified 5 Shorthand Reporter in and for the State of Texas, 6 certify that the facts stated in the foregoing 7 pages are true and correct to the best of my ability. 8 I further certify that I am neither 9 attorney nor counsel for, related to nor employed 10 by, any of the parties to the action in which this 11 testimony was taken and, further, I am not a 12 relative or employee of any counsel employed by 13 the parties hereto, or financially interested in 14 the action. 15 SUBSCRIBED AND SWORN TO under my hand 16 and seal of office on this the 18th day of 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 . 23631 1 STATE OF TEXAS COUNTY OF HARRIS 2 REPORTER'S CERTIFICATION 3 TO THE TRIAL PROCEEDINGS 4 I, Shauna Foreman, the undersigned 5 Certified Shorthand Reporter in and for the 6 State of Texas, certify that the facts stated 7 in the foregoing pages are true and correct 8 to the best of my ability. 9 I further certify that I am neither 10 attorney nor counsel for, related to nor employed 11 by, any of the parties to the action in which this 12 testimony was taken and, further, I am not a 13 relative or employee of any counsel employed by 14 the parties hereto, or financially interested in 15 the action. 16 SUBSCRIBED AND SWORN TO under my hand 17 and seal of office on this the 18th day of 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