4903 1 UNITED STATES OF AMERICA Before the 2 OFFICE OF THRIFT SUPERVISION DEPARTMENT OF THE TREASURY 3 In the Matter of: ) 4 ) UNITED SAVING 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 10-24-97 22 4904 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 BRUCE RINALDI, Esquire RICHARD STEARNS, Esquire 5 and BRYAN VEIS, Esquire of: Office of Thrift Supervision 6 Department of the Treasury 1700 G Street, N.W. 7 Washington, D.C. 20552 (202) 906-7395 8 ON BEHALF OF RESPONDENT MAXXAM, INC.: 9 FRANK J. EISENHART, Esquire 10 CATHERINE BOTTICELLI, Esquire of: Dechert, Price & Rhoads 11 1500 K Street, N.W. Washington, D.C. 20005-1208 12 (202) 626-3306 16 13 DALE A. HEAD (in-house) Managing Counsel 14 MAXXAM, Inc. 5847 San Felipe, Suite 2600 15 Houston, Texas 77057 (713) 267-3668 16 ON BEHALF OF RESPONDENT FEDERATED DEVELOPMENT CO. AND 17 CHARLES HURWITZ: 18 RICHARD P. KEETON, Esquire of: Mayor, Day, Caldwell & Keeton 19 1900 NationsBank Center, 700 Louisiana Houston, Texas 77002 20 (713) 225-7013 21 22 4905 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 4906 1 2 EXAMINATION INDEX 3 Page 4 ALLEN DERMODY 5 Cont'd Cross-Examination by Mr. Blankenstein..4908 6 Cross-Examination by Mr. Keeton...............4937 7 Redirect-Examination by Mr. Rinaldi...........4953 8 Recross-Examination by Ms. Clark..............4983 9 Recross-Examination by Mr. Blankenstein.......4994 10 Recross-Examination by Mr. Keeton.............5005 11 JOSEPH PHILLIPS 12 Examination by Mr. Guido......................5009 13 14 15 16 17 18 19 20 21 22 4907 1 P-R-O-C-E-E-D-I-N-G-S 2 (9:00 a.m.) 3 THE COURT: Be seated, please. The 4 hearing will come to order. 5 Are there preliminary matters? 6 MR. BLANKENSTEIN: I believe there is a 7 preliminary matter. 8 MR. DUEFFERT: I'm Paul Dueffert from 9 Williams & Connolly. Last night, we learned that 10 Rex Cool is on the witness list for next, and 11 there is a pending motion to quash regarding the 12 deposition subpoena to Mr. Cool. I don't know if 13 that motion has been resolved or if the Court 14 would like to hear it this at this time. 15 THE COURT: I haven't issued anything 16 on it. I have reached a conclusion, and I am not 17 going to quash the subpoena. It just seems to me 18 that the state of an examiner is almost, by 19 definition, an expert; and I think he should be 20 deposed. 21 MR. BLANKENSTEIN: So, we will work 22 that out with OTS as far as a convenient time. 4908 1 Thank you, Your Honor. 2 THE COURT: Mr. Blankenstein, I believe 3 you had some more cross. 4 MR. BLANKENSTEIN: Yes, I did, Your 5 Honor. Thank you. 6 7 CONT'D CROSS-EXAMINATION 8 9 10 Q. (BY MR. BLANKENSTEIN) Mr. Dermody, 11 I'll try and complete my examination as quickly as 12 possible and turn you over to the tender mercies 13 of Mr. Keeton who, I believe, has some 14 cross-examination, as well. 15 Mr. Dermody, yesterday, we reviewed 16 the -- that the '87 bonuses were approved by the 17 USAT compensation committee and board of directors 18 on November 10th, 1987; is that right? 19 A. That's correct. 20 Q. The federal regulators conducted an 21 examination of USAT that began on November 16th, 22 1987; isn't that right? I think we looked at that 4909 1 document yesterday, as well. 2 A. I believe there is something about that 3 date. 4 Q. I believe you have it right there in 5 the folder. If you could just check if that's the 6 correct date. 7 A. Yes. 8 Q. In your experience as an examiner, was 9 a thorough review of the board and committee 10 minutes part of an examination conducted by the 11 Federal Home Loan Bank Board? 12 A. Yes. 13 Q. And that review would include the 14 minutes of the committee and board meetings up to 15 the date of the -- as of the date of the 16 examination? 17 A. Any minutes that were available, yes. 18 Q. So, the examiners would have reviewed 19 the compensation committee and board of directors 20 minutes approving the 1987 bonuses as a regular 21 part of the examination of USAT in 1987; is that 22 right? 4910 1 A. They would have reviewed the minutes of 2 the board meeting. Compensation committee meeting 3 would have been optional with them. 4 Q. The '87 report was presented to USAT in 5 July of 1988; is that right? 6 A. I believe that's correct. 7 Q. There was no mention in that report of 8 the bonus paid to Mr. Gross in 1987; isn't that 9 right? 10 A. I don't recall there being any mention 11 of the bonus. 12 Q. So, the regulators in the 1987 report 13 had no criticisms of USAT for increasing 14 Mr. Gross' compensation to reflect his added 15 duties as president of USAT in 1987; isn't that 16 right? 17 A. Repeat that question, please. 18 Q. There was no criticism in the 1987 19 report of the bonus paid to Mr. Gross; isn't that 20 right? 21 A. That's correct. 22 Q. The examiner in charge of the 1987 exam 4911 1 of USAT was Vivian Carlton; is that right? 2 A. I believe it was. 3 Q. Ms. Carlton was an experienced and 4 competent examiner? 5 A. To my knowledge, she was, yes. 6 Q. She was also aware of USAT's net worth 7 situation in 1987? 8 A. I think that's pretty clear since she's 9 the one that felt they were in a fatal position. 10 Q. But it didn't jump off the page to 11 Ms. Carlton, did it, that the bonus paid to 12 Mr. Gross in 1987 was an unsafe and unsound 13 practice; isn't that right? 14 A. Doesn't appear to have been something 15 that she concentrated on. 16 Q. Furthermore -- further, on what the 17 regulators didn't -- did or didn't say about the 18 compensation issues that are the subject of your 19 report, wasn't Mr. Berner in contact with 20 Mr. Twomey concerning Mr. Gross' departure from 21 USAT and UFG? 22 MR. STEARNS: Your Honor, I'm going to 4912 1 object. The witness has indicated he was not 2 personally involved in the examination of USAT at 3 this time. The question is: Was Mr. Berner in 4 touch with Mr. Twomey? It's not a question this 5 witness has indicated he has any personal 6 knowledge of. 7 THE COURT: Well, we'll find out. 8 Q. (BY MR. BLANKENSTEIN) In your review 9 of the documents, did you see any correspondence 10 between Mr. Berner and Mr. Twomey concerning 11 Mr. Gross' departure from USAT? 12 A. I recall there was some correspondence. 13 I don't remember the specific details at this 14 moment. 15 Q. I would like to show you what's already 16 been marked as T8120 and admitted into evidence. 17 It's a November 7th, 1988 letter from Art Berner 18 to Neil Twomey. 19 Can you take a look at this document, 20 sir? 21 A. Yes. If you'll give me a moment to 22 look at it, please. 4913 1 Q. Do you remember reviewing this in 2 your -- as part of your -- forming your opinions 3 about the compensation issues in this case? 4 A. Yes, I do. 5 Q. I'd like you to turn to Page -- the 6 second page, Item 4. Can you take -- can you read 7 for us Item No. 4? 8 A. Certainly. Item 4, "We are in 9 discussions with Mr. Jenard Gross for an 10 acceptable resolution to the issues you have 11 raised." 12 Q. As part of your review, did you also 13 learn that Mr. Berner sent Mr. Twomey a letter 14 forwarding to Mr. Twomey a copy of Mr. Gross' 15 separation agreement? 16 A. I don't recall that specifically. I 17 think I did review something, but I can't 18 recollect it at the moment. 19 Q. Let me show you what's been identified 20 as Exhibit B2552. Can you take a look at that 21 exhibit for a moment, Mr. Dermody? And let me 22 just state that's a November 23rd, 1988 letter 4914 1 from Art Berner to Neil Twomey. Attached to the 2 letter is a copy of Mr. Gross' separation 3 agreement. Is that correct, Mr. Dermody? 4 A. Yes, that is correct. 5 Q. Do you remember reviewing this letter 6 and the attachment as part of your review in 7 connection with your expert opinions in this case? 8 A. Yes. Upon seeing it, I recall it. 9 Q. Do you remember whether Mr. Twomey or 10 any other regulator at the time objected to the 11 loan forgiveness set forth in the separation 12 agreement as an unsafe and unsound practice? 13 A. I don't recall an objection being made 14 at this time. 15 Q. Mr. Twomey was -- Mr. Twomey was an 16 experienced examiner? 17 A. Mr. Twomey was -- yes, was experienced 18 and had an extremely large caseload, which meant 19 he had, in the vernacular, a very full plate of 20 work to do. 21 Q. Mr. Twomey was focusing on compensation 22 issues at this time, was he not? 4915 1 A. Well, I can't answer from direct 2 personal experience. I can tell you the 3 correspondence I saw indicated Mr. Twomey was 4 focusing on a large number of issues, compensation 5 being one of them, because of the correspondence 6 about some of the contracts. It's pretty clear to 7 me, though, with the volume of material that was 8 there, that this was not an exclusive -- you know, 9 exclusive use of Mr. Twomey's time. 10 Q. In your review of the record here, did 11 you determine whether or not Mr. Twomey, after he 12 received Mr. Berner's letter forwarding Mr. Gross' 13 separation agreement, corresponded with USAT about 14 compensation issues? 15 A. There was correspondence with USAT 16 about compensation issues. I don't recall exact 17 dates. I'd want to see them to be sure of the 18 exact sequence of dates. 19 Q. Let me show you what's been identified 20 as Exhibit B2604. Let me identify this as a 21 letter from Neil Twomey to the board of directors 22 of United Savings Association of Texas dated 4916 1 December 15th, 1988. 2 Do you remember reviewing this document? 3 A. Yes, I certainly do. 4 MR. BLANKENSTEIN: Your Honor, I would 5 move 2604 into evidence. 6 MR. RINALDI: No objection, Your Honor. 7 And if they haven't been moved into evidence, the 8 other documents, as well, I would agree to be 9 moved into evidence. 10 THE COURT: Are you talking about 11 B2552? 12 MR. BLANKENSTEIN: Yes. I was going to 13 move that. 14 THE WITNESS: Is 2526 already in? 15 THE COURT: Received. 16 Q. (BY MR. BLANKENSTEIN) Now, is the 17 subject matter of this letter the compensation 18 practices of USAT in 1988? 19 A. The subject matter of this letter is 20 specifically the executive bonus plan and the 21 payment of these -- the remainder of the executive 22 bonus plan to the named executives. 4917 1 Q. Those are compensation issues, correct? 2 A. That is part of the compensation issue, 3 yes. 4 Q. And there is no mention in that letter 5 dated December 15th, 1988, of Mr. Gross' 6 separation agreement as an unsafe and unsound 7 practice; is that right? 8 A. That is correct. There is no mention. 9 Q. Turning to Mr. Gross' 1988 10 compensation. I believe you testified yesterday 11 that they were not relevant to your review because 12 both reports did not take into account USAT's 13 financial condition at the time, which is in 1988; 14 is that right? 15 A. Did not take into consideration their 16 net worth failure position. I believe it did, at 17 least in the Hewitt report, list their losses. 18 Q. So, they didn't take into account the 19 solvency of UFG or USAT; is that right? 20 A. Well, I said net worth deficiency 21 status. They may still be solvent but in a net 22 worth deficiency status. So, solvency is going a 4918 1 little bit further than I went. 2 Q. Are you aware, Mr. Dermody, that OTS 3 has retained its own compensation expert in this 4 case? 5 A. Yes, I am. 6 Q. And do you know who that is? 7 A. I believe it's Graef Crystal. 8 Q. Have you reviewed Mr. Crystal's report? 9 A. I had it and I think I flipped through 10 it very, very quickly and I just do not recall it. 11 Q. Have you reviewed his deposition 12 testimony? 13 A. No, I have not reviewed his deposition 14 testimony. 15 Q. Do you remember whether Mr. Crystal 16 expressed an opinion as to what reasonable 17 compensation would have been for Mr. Gross in 18 1988? 19 A. No, I do not recall. 20 Q. If Mr. Crystal expressed the opinion 21 that Mr. Gross' reasonable compensation in 1988 22 was $500,000 taking into account -- and he took 4919 1 into account, in reaching that figure, USAT's and 2 UFG's financial condition, including their 3 insolvency, would that be relevant to your 4 opinion? 5 A. That would be a factor I would want to 6 consider, but one thing you have neglected to 7 mention is whether or not he considered the safety 8 and soundness of the way in which the contract was 9 entered into. 10 Q. I just asked you whether -- if he 11 issued an opinion taking into account the 12 financial condition of both USAT and UFG, you -- 13 that would be relevant to your opinion. 14 A. Yes, I would -- well, I would consider 15 it. 16 Q. Did you consider it at all? 17 A. Well, I said I reviewed Mr. Graef's 18 (sic) opinion. I believe the vast majority of all 19 my work I did for my analysis was prior to the 20 time of seeing much of anything of Mr. Crystal's 21 work. I did discuss it. I did look at it. So -- 22 and I did incorporate whatever I knew about 4920 1 Mr. Crystal's review in my analysis. 2 Q. But you don't -- as you sit here today, 3 you don't remember whether Mr. Crystal determined 4 a reasonable compensation figure for Mr. Gross in 5 1988? 6 A. No, I do not remember if he determined 7 a reasonable compensation figure for 1988. 8 Q. I want you to assume that Mr. Crystal 9 did, in fact, reach the conclusion that reasonable 10 compensation for Mr. Gross in 1988 would have been 11 $500,000 and that Mr. Crystal also took into 12 account the financial condition of USAT and UFG in 13 reaching that conclusion. 14 Would you still conclude that the 15 compensation paid to Mr. Gross in 1988 was the 16 result of an unsafe and unsound practice? 17 MR. STEARNS: Objection. The question 18 assumes facts that are not in evidence, Your 19 Honor. 20 MR. BLANKENSTEIN: He's an expert. 21 I've asked him to assume that to be the case. 22 THE COURT: Denied. 4921 1 A. I'm sorry. Repeat the question again 2 then, please. 3 Q. (BY MR. BLANKENSTEIN) I want you to 4 assume that Mr. Crystal, in fact, reached the 5 conclusion that Mr. Gross' reasonable compensation 6 for 1988 was $500,000 and I want you to further 7 assume that in this case, in making -- reaching 8 that conclusion, he took into account the 9 financial condition of USAT and UFG. 10 Would that change your opinion that 11 Mr. Gross' compensation in 1988 was the product of 12 an unsafe and unsound practice? 13 A. Well, I would certainly consider his 14 opinion; but I don't -- it would not change my 15 conclusion because I was looking at the safety and 16 soundness issues. And as you've described, 17 Mr. Crystal's looking at something a little bit 18 narrower. So, I don't think that would change my 19 opinion. 20 Q. And if I remember right, your opinion 21 is based upon what you called the process of 22 reaching the decision; is that correct? 4922 1 A. Well, I've said here "process"; and I 2 also recall saying in my deposition, I think, a 3 more inclusive term. I looked at the totality of 4 the circumstances, the condition of the 5 institution, the net worth compliance situation, 6 how these contracts were entered into, and what 7 types of decisions were entered. So, I don't want 8 it to seem as though I focused on any one 9 particular factor. It's the whole series of 10 factors and how they interrelate that I made the 11 decision. 12 Q. Are you adding to your testimony of 13 yesterday in connection with what you found to be 14 the process faults of USAT in reaching a decision 15 with regard to Mr. Gross' compensation in 1988? 16 A. No, not that I'm aware of. 17 Q. So, in your view, even if the $500,000 18 was a reasonable amount of compensation 19 commensurate with Mr. Gross' duties in 1988, you 20 would find the faults in the process made the 21 payment of that amount to Mr. Gross to be 22 excessive; is that right? 4923 1 A. Let -- let me -- 2 Q. Is that correct? 3 A. I can't answer that "yes" or "no." And 4 let me explain why. I've talked about the Hewitt 5 and the Wyatt reviews, and I said they said these 6 salaries were reasonable. And I pointed out that 7 there were issues dealing with safety and 8 soundness. What you've proposed to me is that if 9 Mr. Crystal again does this and says it's 10 reasonable, he's not talking about safety and 11 soundness. 12 So, given that I am concentrating on 13 safety and soundness, I think pretty consistent 14 with what I've said all along is whether or not 15 this, in a corporate setting, would be a 16 reasonable salary. I'm saying that the safety and 17 soundness issues here overtake the normal 18 corporate reasonableness test, and it's these 19 safety and soundness issues that predominate. 20 So, I think that's why the answer is 21 yes. Even if the specialist says it's a 22 reasonable salary, I'm saying it still is an 4924 1 unsafe and unsound action. 2 Q. And your opinion is based on the 3 process by which those decisions were reached; is 4 that correct? 5 A. I've said the totality of the situation 6 and the process. Yesterday, I said the process. 7 But by "process," I obviously mean what the 8 circumstances were and how it came about. 9 Q. So, your opinion is based on the 10 process and not the substance of the decision; 11 isn't that right? 12 A. Yes, I believe so. 13 Q. Let me ask you a few questions about 14 the forgiveness of Mr. Gross' note by UFG. If I 15 understand your testimony yesterday -- and correct 16 me if I'm wrong -- the USAT and UFG directors had 17 an obligation to reduce the net worth deficiency 18 of USAT by using all available assets of UFG to 19 that end; is that correct? 20 A. I'm saying that UFG had an obligation 21 to maintain a net worth and that the directors of 22 USAT, who were also directors of USAT, had this 4925 1 obligation -- I'm sorry -- directors of both 2 corporations -- had the obligation to do 3 everything that they are capable of doing to 4 maintain a net worth requirement. 5 Q. Did you review the process by which the 6 directors of USAT and UFG decided to enter into 7 the separation agreement with Mr. Gross? 8 A. You've gone through the whole series of 9 documents. I reviewed what I had available in the 10 record and documents; so, if there was more to the 11 process, I'm not aware of it. 12 Q. All right. Let's take a look quickly 13 at what the process was. Let me show you what has 14 been marked and is in evidence as T8114. 15 MR. BLANKENSTEIN: For the record, Your 16 Honor, let me just state it's an October 31st, 17 1988 letter from Jenard Gross to Art Berner. 18 THE COURT: That's in evidence? 19 MR. BLANKENSTEIN: That's in evidence, 20 I understand it, as T8114. And in our system, 21 it's at Tab 446. 22 THE COURT: Thank you. 4926 1 Q. (BY MR. BLANKENSTEIN) Mr. Dermody, 2 did you review this letter in connection with your 3 report and your testimony here yesterday and 4 today? 5 A. Yes, I did. 6 Q. And in this letter, Mr. Gross is 7 proposing a settlement of his claim of the note -- 8 excuse me -- settlement of his obligation to UFG 9 under the note he executed in 1985. And he's 10 identifying his employment claims against UFG and 11 USAT; is that right? 12 A. Yes. He's identifying those issues. 13 Q. And he's proposing that they cancel 14 those claims; is that right? 15 A. Let me reread that. Yes, he is 16 proposing that they cancel the contracts. 17 Q. And Mr. Gross identifies that his 18 claims are worth approximately -- more than 19 $1 million; is that right? 20 A. That is correct. 21 Q. And he says that his obligation to UFG 22 is about $761,000; isn't that right? 4927 1 A. Correct. 2 Q. So, he's offering to relinquish his 3 larger claim if USAT -- if UFG will forego the 4 loan; is that right? 5 A. The smaller claim, correct. 6 Q. Did USAT -- did UFG consider Mr. Gross' 7 proposal? 8 A. Apparently, they did. They reached a 9 severance agreement with him. 10 Q. And did you look at the board minutes 11 of November 7th, 1988, in connection with your 12 report and testimony? 13 A. Yes, I did. 14 MR. BLANKENSTEIN: Your Honor, I would 15 move the UFG board minutes of November 7th, 1988, 16 Exhibit A1164, into evidence. 17 MR. RINALDI: No objection, Your Honor. 18 THE COURT: Received. 19 Q. (BY MR. BLANKENSTEIN) Mr. Dermody, if 20 you could look the first paragraph. Can you tell 21 us who was present at the meeting? 22 A. Well, let me just quote from it. I 4928 1 think that would be easier. "Present at the 2 meeting were all members of the board. Also 3 present were Messrs. Robert Ott and Tom Seawell, 4 S-e-a-w-e-l-l, partners in a law firm of Arnold & 5 Porter, special counsel to the board." 6 Q. If you look down towards the -- on that 7 first page of the exhibit to the first paragraph 8 that begins with "after," do you see that? 9 A. Yes, I do. 10 Q. It shows that Mr. Gross recused -- left 11 the meeting because they were going to discuss his 12 proposal; is that right? 13 A. Yes. 14 Q. And so, he absented himself from the 15 meeting so he wouldn't vote or be part of any 16 discussion in connection with the proposal that he 17 made to UFG to resolve his loan; is that right? 18 A. That's correct. 19 Q. And that's what you said was 20 appropriate practice and wouldn't raise a safety 21 and soundness violation; is that right? 22 A. That was an appropriate practice for 4929 1 him to enter into. I've talked about the safety 2 and soundness of these transactions, and I think 3 I've said before that you cannot isolate his 4 activity at this point in time from the activities 5 he and others engaged in at an earlier stage in 6 time. 7 Q. But if I remember your testimony 8 yesterday, one of the process issues you 9 identified was that Mr. Gross was present at an 10 earlier meeting when the 1987 bonuses were 11 awarded; is that right? 12 A. That's correct. 13 Q. And he's no longer here so you don't 14 have that -- he's absented himself from this 15 meeting. So, that's not a concern? 16 A. We do not have the situation where 17 Mr. Gross is participating in this particular 18 decision. 19 Q. And if you look at the next paragraph, 20 it indicates that the board members didn't 21 immediately adopt Mr. Gross' proposal but 22 submitted it for further study; isn't that right? 4930 1 A. That's correct. 2 Q. Let's take a look at the November 15th, 3 1988 minutes of the board of United Financial 4 Group. 5 MR. BLANKENSTEIN: Your Honor, this is 6 already in evidence as T8124. 7 Q. (BY MR. BLANKENSTEIN) Did you review 8 these minutes in connection with your report and 9 testimony, Mr. Dermody? 10 A. Yes, I did. 11 Q. Were -- was this a special meeting held 12 to determine -- to decide on Mr. Gross' proposal 13 and his separation from USAT and UFG? 14 A. Well, it was a special meeting. And if 15 I recall correctly, they -- that that's 16 probably -- I think that's about the only item 17 that they did discuss. 18 Q. And Mr. Robert Ott, who was special 19 counsel to the board of directors, was present at 20 the meeting; isn't that correct? 21 A. That is correct. 22 Q. And if you look in the third paragraph 4931 1 on the first page of the exhibit, Mr. Berner again 2 reviewed for the members of the board what the 3 bidding was; isn't that right? 4 A. I'm sorry. What the bidding -- 5 Q. He reviewed the circumstances for the 6 members of the board once again? 7 A. Yes. 8 Q. What Mr. Gross' claims against the 9 institutions might be and what the claims 10 Mr. Gross might -- what the claims UFG might have 11 against Mr. Gross; is that right? 12 A. Yes, that is correct. 13 Q. And does Mr. Berner also talk about his 14 discussion with Mr. Whatley? 15 A. Yes. 16 Q. Mr. Whatley wasn't present at the 17 meeting; is that right? 18 A. No, Mr. Whatley was not present at this 19 telephone conference. 20 Q. Now, Mr. Whatley was an outside 21 independent director; isn't that right? 22 A. That's correct. 4932 1 Q. Could you read for us what Mr. Berner 2 says about his discussions with Mr. Whatley? 3 A. Yes. "Mr. Berner stated he had 4 discussed this matter at length with Mr. Whatley 5 and that Mr. Whatley was supportive of the view to 6 release Mr. Gross from his note obligation upon 7 Gross' release of the company of all further 8 obligation." 9 Q. Now, if you turn to the second page of 10 the exhibit, the first paragraph, does that speak 11 to the urgency of getting this issue resolved and 12 provide some further explanation as to why there 13 was a special meeting held on November 15th, 1988? 14 A. It talks about discussions with the 15 Federal Home Loan Bank about the Southwest Plan. 16 Q. Why don't I read it. "The Board 17 further noted that pursuant to discussions with 18 representatives of the FHLB-Dallas, until the 19 compensation and authority issues at USAT were 20 satisfactorily resolved, further participation in 21 a Southwest Plan transaction would be delayed. 22 The board believed this delay would cause 4933 1 potentially significant economic detriment to the 2 possibility of receiving additional value for 3 creditors and shareholders of the company." 4 That's an appropriate consideration for 5 the USAT and UFG directors; isn't that right? 6 A. That is an appropriate factor to 7 consider, yes. 8 Q. Now, if we go to the third paragraph, 9 Mr. Berner describes in some detail, does he not, 10 his assessment of the litigation risks involved if 11 UFG sought to enforce its claim against Mr. Gross; 12 isn't that right? 13 A. He discussed the claims and the amounts 14 of the claims. I don't believe he discussed the 15 risk or the -- how -- what was the likelihood of 16 prevailing. 17 Q. Well, let's read what he said. 18 "Mr. Berner noted that Mr. Gross would have 19 significant litigation claims against the company 20 if his economic obligations were honored. He also 21 noted that" -- 22 THE COURT: You left out "not." 4934 1 MR. BLANKENSTEIN: Excuse me. "Were 2 not honored." Pardon me, Your Honor. 3 Q. (BY MR. BLANKENSTEIN) "He noted that 4 on Mr. Gross' bonus arrangements, a termination 5 without cause would accelerate his note, would 6 also provide for a full bonus payment in an equal 7 amount. At the same time, Mr. Gross could claim 8 that he was entitled to full severance benefits 9 which could amount to over $1.2 million. In 10 addition, the cost of litigation would be 11 significant and, if the company did not prevail, 12 it was also possible that they would have to bear 13 the litigation cost of Mr. Gross. There was also 14 possible offset claims of Mr. Gross. It was noted 15 that in view of the company's current financial 16 position which appeared to negate any current need 17 to consider a bankruptcy filing, it was probable 18 that Mr. Gross would be in a position to realize 19 on any obligations which were held." 20 Isn't that right? 21 A. That is a quote from the document, yes. 22 Q. And I believe you were shown an exhibit 4935 1 yesterday. I believe T8157 -- 2 MR. BLANKENSTEIN: Is that in evidence? 3 Q. (BY MR. BLANKENSTEIN) Let me show 4 you, if I might -- 5 MR. BLANKENSTEIN: Your Honor -- this 6 is a -- the minutes of an October 13th, 1989 7 compensation committee meeting of United Financial 8 Group, Inc. 9 Q. (BY MR. BLANKENSTEIN) Did you review 10 those minutes in connection with your expert 11 report and testimony? 12 A. Yes, I did. 13 Q. And in those minutes, Mr. Robert Ott, 14 who was special counsel for the board, issues an 15 opinion that if Mr. Berner -- Mr. Berner's 16 employment claims under his contract -- if he 17 litigated them, he would be entitled to receive 18 the full amount; isn't that right? 19 A. Yes. 20 Q. And Mr. Berner's contract was identical 21 to Mr. Gross' contract; isn't that right? 22 A. No. Salaries were different. 4936 1 Q. Other than that? 2 A. Yes. I don't want to be facetious, but 3 I believe the provisions were virtually identical. 4 Q. Would you agree that in light of 5 Judge Hughes' subsequent opinion in the Texas 6 Commerce Bank case, Mr. Ott's analysis was 7 precedent? 8 A. Not in relation to the respondents that 9 I've been talking about. Certainly he predicted 10 how the result would end up for the other 11 employees. 12 Q. By the way, Mr. Dermody, when we 13 discussed Judge Hughes' opinion yesterday, I 14 believe that you said that you discounted his 15 opinion because you didn't find any reference in 16 his opinion to the fact that the moneys under the 17 executive bonus plan were disbursed prior to the 18 May 10th, 1988 meeting. 19 Did I remember that right? 20 A. I pointed out there were several 21 factors. I did not say it discounted it. I just 22 said I did not believe there were factors that 4937 1 were brought out in the record that I saw. 2 Q. Well, let's take a look at Page 850 of 3 the opinion. Why don't you take a look at the 4 left-hand column, the first full paragraph, 5 next-to-the-last sentence. Why don't you please 6 read that into the record? 7 A. "Before April 30, 1988, United paid 8 each employee 25 percent of the promised 9 additional compensation." 10 MR. BLANKENSTEIN: I have no further 11 questions. 12 THE COURT: Mr. Keeton, you have some 13 questions? 14 MR. KEETON: I do, Your Honor. I'll do 15 it from here if it's okay. I don't have that 16 much. 17 18 CROSS-EXAMINATION 19 20 21 Q. (BY MR. KEETON) Mr. Dermody, am I 22 correct that you have a law degree? 4938 1 A. You are correct. I have a law degree. 2 Q. From where? 3 A. Texas Wesleyan University, Fort Worth. 4 Q. Fort Worth? 5 A. Texas, that's correct. 6 Q. Are you a member of the Texas Bar? 7 A. Yes, I am. 8 Q. Have you ever practiced law? 9 A. No, I have not. Just got my JD 10 license. 11 Q. How recently? 12 A. Well, I passed the Bar for February. 13 So, the license was issued in early May. 14 Q. All right. I want to stick with the 15 same opinion that you just had of Judge Hughes. 16 To make it absolutely clear, yesterday, 17 you told us you did not agree with Judge Hughes 18 because you did not think Judge Hughes realized 19 when the plan was put in, when the money was put 20 in, and how it related to when the board approved 21 it. 22 Do you recall that testimony? 4939 1 A. Yes, I do. And I think it 2 mischaracterizes what I said. 3 Q. Well, we'll let the record decide that. 4 I want you to look at the opinion for now. 5 MR. STEARNS: Your Honor, I think it's 6 unfair of Mr. Keeton to phrase a question that the 7 witness says mischaracterizes his testimony and 8 then not let him answer. 9 MR. KEETON: I took it back. 10 THE COURT: Let's hear the answer. 11 Q. (BY MR. KEETON) All right. What 12 answer do you want to give? 13 A. Well, you state that I said 14 Mr. Hughes -- well, would you repeat what his -- 15 Q. I'll state it again for you. 16 A. Would you restate it? 17 Q. You said that Judge Hughes was not 18 aware, apparently, of the process that the plan 19 and the money was paid prior to the board 20 approving it and that was why you didn't agree 21 with Judge Hughes' finding? 22 A. You've just restated the question 4940 1 differently than you said the first time. 2 Q. Well, let's take it that way. Isn't 3 that what you said yesterday? 4 A. I said I didn't believe that the facts 5 were before the Court that I had reviewed in my 6 analysis. 7 Q. Well, let's look at -- and you didn't 8 bother to read the opinion or any of the record, 9 even though this opinion deals with unsafe and 10 unsound salaries, prior to your opinion. Right? 11 A. Are you asking me if I read it, or are 12 you telling me I didn't read it? I don't 13 understand what you're asking. 14 Q. Did you, before you issued your report? 15 A. Did I read Judge Hughes' opinion? Yes, 16 I did. 17 Q. Did you consider it in issuing your 18 report? 19 A. Yes, I considered it in issuing my 20 report. 21 Q. All right. Now, let's look at Page 850 22 a minute. Left-hand column, first full paragraph. 4941 1 It shows that Judge Hughes was very clearly aware 2 that, in March, the plan and trust was put into 3 effect. Right? 4 A. Aware that there was a plan -- he 5 states "United established a plan and trust in 6 March." It does not distinguish the fact that the 7 compensation committee approved it and that the 8 board did not approve it until May. 9 Q. Stay with me a minute. This is not a 10 debate. 11 A. I understand that. 12 Q. All right. Let me ask my questions, 13 and you can answer them. Drop down a little bit. 14 It's very clear in the same paragraph 15 that sometime before April 30th, the money was 16 actually deposited in the bank with the trust. 17 Right? 18 A. Correct. 19 Q. Turn over to the next page, 851, first 20 full paragraph. Judge Hughes writes "United did 21 not conceal the transfer. Members of the FHLB 22 were present at the board meeting when the 4942 1 managers discussed and ratified the plan and 2 trust. Upon United's full disclosure, the FHLB 3 did not object." 4 Now, we know that board meeting wasn't 5 until May. Right? 6 A. The board meeting where they approved 7 it was May, correct. That's correct. 8 Q. Okay. So, the judge knew all of these 9 things and, yet, when you go down further, he 10 finds under "unsafe and unsound" -- that's a 11 heading. 12 Do you see that? 13 A. Yes, I do. 14 Q. The last three sentences of that 15 paragraph say "The plan rewarded the beneficiaries 16 for standing watch as the ship slowly sank. It 17 did not reward them for running the ship onto the 18 rocks. As a legitimate business decision, the 19 trust and plan were not, quote, 'unsafe or 20 unsound,' close quote, for purposes of the federal 21 regulation. Mere allegations, however insulting, 22 will not create issues of fact." 4943 1 Now, that's what he found as a federal 2 judge. Right? 3 A. That is correct. 4 Q. Did you study the theory of collateral 5 estoppel or res judicata when you were in law 6 school? 7 A. Yes, I did. 8 Q. You think this might have some 9 application here? 10 MR. STEARNS: Objection, Your Honor. 11 Calls for a legal conclusion. 12 MR. KEETON: This man is testifying as 13 an expert. 14 MR. STEARNS: He's not testifying -- 15 excuse me. He's not testifying as a legal expert, 16 Your Honor. That's for the province of this 17 tribunal. 18 THE COURT: I'll sustain it. 19 Q. (BY MR. KEETON) One other question. 20 You said this decided it as to some employees but 21 not the upper employees. In fact, this was all 22 the employees that he was dealing with in this 4944 1 opinion, wasn't it? 2 A. If I recall correctly, some of these 3 employees were no longer involved with this 4 account. 5 Q. Well, let me try to refresh your 6 recollection. You can read it again tonight. 7 Some of them had released their claims; but, in 8 this case, they made a claim that they were 9 released under duress. So, he first had to decide 10 whether their plan was proper as to them and then 11 decide the question of duress. Right? 12 A. I believe so, yes. 13 Q. So, that means he covered all of the 14 people when he made this first finding, correct? 15 A. He covered the plan -- yes, he was 16 covering all the people. 17 Q. All right. Now, let me get some of the 18 factors that you didn't consider and be certain 19 that I'm clear. 20 You did not really challenge or consider 21 the level of the dollars involved; isn't that 22 correct? 4945 1 A. I did not address the level, that's 2 correct. 3 Q. Okay. You did not address how these 4 people's salaries compared to their peers', 5 correct? 6 A. That is correct. 7 Q. You did not address the factor that 8 possibly they had taken on significant additional 9 duties? 10 A. We have discussed that, yes. That's 11 something I didn't -- 12 Q. Did not consider? 13 A. Did not -- did not affect my safety and 14 soundness decision. 15 Q. You did not consider the individual 16 performance of each of these people to see how 17 well each or any had performed, correct? 18 A. Correct. We've already discussed that. 19 Q. You did not discuss or consider the 20 quality of these people in both their past or 21 current history since you have the ability to look 22 back at them? 4946 1 A. I did not discuss -- I did not review 2 that. 3 Q. You only say the process in '87 was 4 defective. And yesterday, you only said two 5 reasons. Let's be clear. Because Mr. Gross voted 6 for his or the other one voted for his and because 7 the net worth situation was not considered by the 8 board? 9 MR. STEARNS: Your Honor, I'll object. 10 That's a mischaracterization of an entire day's 11 worth of testimony that dealt with bonuses, 12 salary, compensation. The record will speak for 13 itself. 14 MR. KEETON: I'm talking about 15 November '87, Your Honor; and the record will -- 16 but I'm going to try to get a clear answer out of 17 this man. 18 MR. STEARNS: Your Honor, Mr. Keeton 19 can ask questions with a non-pejorative comment, 20 I'm sure. 21 MR. KEETON: I just did until you stood 22 up. 4947 1 THE COURT: Well, restate your 2 question. 3 Q. (BY MR. KEETON) Mr. Dermody, isn't it 4 true that yesterday, you said the November 1987 5 process was flawed because interested parties 6 voted on the contract and because the board didn't 7 consider the net worth situation of the 8 institution at the time they were voting? That 9 was the two bases on which the process was 10 defective? 11 A. I think that slightly mischaracterizes 12 my answer. Yes, I did say the conflict of 13 interest situation existed; but I also said it was 14 a net worth position -- a net worth failure 15 position, not just straight net worth. 16 Q. Okay. Net worth failure position. 17 They didn't consider that. Right? 18 A. I said that they did not appear to have 19 considered that, that's correct. 20 Q. And you jumped from that to saying what 21 they did was unsafe and unsound in your, quote, 22 "expert," unquote, opinion? 4948 1 A. Are you asking me? 2 Q. Yeah. Isn't that correct? 3 A. I don't think I jumped. I did an 4 analysis of the circumstances, reviewed what 5 happened, how it happened, and came to an opinion 6 that this was unsafe and unsound. 7 Q. And didn't consider any of these other 8 factors I just listed? 9 A. I said I was aware of those factors. I 10 said that they were not applicable to the safety 11 and soundness situation. 12 Q. Okay. Now, you remember how you said 13 Mr. Connell's contract was okay because they 14 needed him? 15 A. I said words to that effect. 16 Q. You've lived in Dallas, what, 14 years? 17 A. Yes, I have. 18 Q. Are you a football fan? 19 A. Not particularly. 20 Q. Follow the Dallas Cowboys at all? 21 A. As little as possible. 22 Q. Did you ever hear of a man named Jay 4949 1 Novacek? 2 A. Yes, I have. 3 Q. All-pro tight end? 4 A. I don't pay attention, as I said. I've 5 heard the name. 6 Q. He's retired. You know that, don't 7 you? 8 A. Heard something to that effect, yes. 9 Q. Dallas trying to replace him. Right? 10 A. I have to presume so. 11 Q. What do you think would happen to Emmet 12 Smith, Troy Aikman, Michael Irvin, Deion Sanders 13 if they brought a new tight end in, paid him 14 significantly more than they were making, but 15 said, "But you-all aren't winning this year; so, 16 we're going to pay him a whole lot more than you"? 17 A. You're asking my opinion of that 18 situation. I don't really care about that 19 situation. I've been discussing a financial 20 institution where people have fiduciary 21 responsibilities. I don't see the parallel in a 22 financial institution with fiduciary 4950 1 responsibilities to a baseball team -- excuse 2 me -- a football team, which is entertainment, and 3 they have no fiduciary responsibilities. 4 Q. Let's talk about a financial 5 institution. What do you think about these 6 Messrs. Gross, Munitz, Berner, Crow? How are they 7 going to feel? 8 Let's analogize. You've got to run the 9 whole institution -- Mr. Connell cannot run the 10 whole institution by himself, can he? 11 A. I don't expect him to run it by 12 himself. 13 Q. All right. And it's the board of 14 directors who's got to make those decisions to 15 balance employees who have been loyal and stayed 16 there and carried out their fiduciary duties and 17 going to continue to try to do that versus when 18 they bring in a new person. Right? 19 A. Well, it's their responsibility to make 20 these decisions. 21 Q. Exactly. Between '83 and '88, did you 22 get raises? 4951 1 A. I got a few. 2 Q. Did you ever check to see what the 3 federal deficit was doing between those years? 4 A. Not specifically. Usually rising. Has 5 it ever not? 6 Q. Pretty big, wasn't it? 7 A. Yes, it is. 8 Q. How about the institutions that you-all 9 were supposed to be regulating and evaluating? 10 How were they doing? 11 A. That's a rather broad question. Do you 12 want to specify the time period? You want to 13 specify where -- 14 Q. I'm saying '83 to '88. How were they 15 doing? 16 A. In Texas, a lot of them were doing very 17 poorly. In other parts of the country -- Ohio, 18 Indiana, some of the rural areas -- they were 19 doing exceptionally well. 20 Q. You were in Texas, weren't you? 21 A. I was in Texas. 22 Q. Do you think your raises were justified 4952 1 nonetheless? 2 A. I was working for an organization that 3 was a regulatory institution -- well, 4 quasi-governmental institution, regulatory, which 5 was profitable, making money, and had a 6 responsibility to regulate these institutions. 7 Q. Well, they were going downhill and out 8 of business; and the federal deficit was going 9 down. You were working for me as a taxpayer, 10 weren't you? 11 A. No, I was not. 12 Q. You weren't? 13 A. No, I was not. 14 Q. You don't think the taxpayer needed to 15 get his dollars? 16 A. Taxpayers -- well, to answer your 17 question without seeming like I'm trying to be 18 facetious about it, taxpayers were paying none of 19 the salary of the Federal Home Loan Bank 20 employees. Never did. 21 Now, as a treasury employee, yes, it's 22 tax dollars that fund the agency, although we 4953 1 still are fee based in our -- the agency's income 2 comes from the institutions. So, again, taxpayers 3 do not -- have not paid my salary during the time 4 period we're talking about. 5 Q. Even though the institutions during 6 that period of time were going downhill fast, 7 maybe over the cliff fast? 8 A. There were a lot -- 9 Q. You didn't think your raise was 10 unjustified, did you? 11 A. I did not think my raise was 12 unjustified, correct. 13 MR. KEETON: Thank you. 14 THE COURT: Redirect? 15 MR. RINALDI: Sure. Thank you, Your 16 Honor. 17 18 REDIRECT-EXAMINATION 19 20 21 Q. (BY MR. RINALDI) Mr. Dermody, I 22 believe you have in front of you Judge Hughes' 4954 1 opinion. And since you were recently questioned 2 on this and it's still fresh in your mind, would 3 you take a look at Pages 84 -- 849 over to 850 4 where he talks about the background? And tell me 5 if it appears anywhere -- well, let me just read 6 to you at the beginning the background. The 7 second sentence says "On December 30th, 1988, the 8 Federal Home Loan Bank Board declared United 9 insolvent. By a series of resolutions, it 10 terminated all employment contracts." 11 Now, it notes that United went insolvent 12 at the end of '88. Is there any indication in 13 this opinion as to the date that United went into 14 capital failure? 15 A. No, there is not. 16 Q. Okay. And when you formulated your 17 opinion -- and just so we understand it, going 18 back to the charts, just so I understand, the 19 matter which -- or the single most important 20 element in your analysis as reflected on the chart 21 is Item No. 4, that there is a net worth failure. 22 And that would have occurred one year prior to 4955 1 UFG -- I mean USAT being placed in receivership; 2 is that correct? 3 A. Well, in fact, it goes beyond that. 4 No. 4 is when the institution reported it. But 5 they are aware of it eight months earlier, that 6 the examiners are saying it. So, they become 7 aware of it here. It becomes clear -- they admit 8 it and announce it to the world through the proxy 9 statements of UFG and, also, through the reports 10 to us. 11 Q. And as an examiner, it was your view 12 that once they had achieved this net worth 13 deficiency, that it would have been inappropriate 14 to make large bonus payments such as those that 15 were received by Mr. Berner, Mr. Crow, Mr. Munitz, 16 and Mr. Gross? 17 A. That -- 18 Q. Now, in your -- is that correct, sir? 19 A. Yes, that is correct. 20 Q. Now, in your calculation, Mr. Keeton 21 asked you if you knew what -- well, let's take, 22 for example -- there was a list of people who 4956 1 received bonuses from the institution that were at 2 a lower level. 3 Directing your attention to T8026, which 4 is the list of bonuses, and then going over to 5 T8055, which are the salary adjustments -- 6 A. I believe -- is that the November 7 bonuses and the April salary adjustments? April 8 1988 salary adjustments? 9 Q. Yes. Now, the only four people that we 10 have been dealing with here were Mr. Gross, 11 Mr. Crow, Mr. Berner, and Mr. Munitz; is that 12 correct? 13 A. That is correct. 14 Q. And you did not consider, for example, 15 M. Jenkins who got an '87 bonus of $2,000, did 16 you? 17 A. I reviewed that. I did not consider 18 that one of the ones where I was criticizing. 19 Q. Okay. And it was your view that once 20 the institution had gone into a net worth 21 deficiency, it was inappropriate to have given a 22 bonus to Mr. Gross of $235,000; isn't that 4957 1 correct? 2 A. That is correct. 3 Q. Now, Mr. Blankenstein suggested to you 4 that one of the reasons Mr. Gross should have 5 received a bonus of that size was that he was 6 taking on all these added responsibilities. 7 Do you remember that? 8 A. Yes, I do. 9 Q. And he said that he had been appointed 10 president of USAT on January 8th of 1987? Do you 11 recall that? 12 A. Yes, I recall that. 13 Q. And that on that date, he took on many 14 more responsibilities? 15 A. Yes. 16 Q. Okay. When you reviewed the 17 supervisory record, were you able to determine -- 18 or supervisory record, the record in this case -- 19 did you determine whether Mr. Gross received any 20 additional compensation at or about the time that 21 he took on his new duties at USAT? 22 A. Yes, I did. Let me use one of the 4958 1 defendant's charts here of Mr. Gross. I thought 2 it was very appropriate it was here. The question 3 for Mr. Blankenstein was Mr. Gross -- the line of 4 questioning, I believe, was Mr. Gross was being 5 paid this bonus in compensation for him being 6 president for the year because he had no 7 compensation. Reviewing the record, he became, 8 according to the proxy statement, president 9 January 8th, 1987. '86, his salary is 250. 10 January 8th, 1987, at a board meeting, Mr. Gross' 11 salary was increased by 16 percent. It talks 12 about the resignation of the prior president. 13 Maybe I'm making an assumption that he was being 14 paid for being president, but he received a 15 16 percent pay increase the exact same day he 16 became president. So, unless I'm wrong, he's 17 being compensated for his additional duties; and 18 his bonus is, you know, as I said before, a 19 performance-based one -- a discretionary one, 20 excuse me -- a discretionary bonus. And I think 21 he already did get benefit of additional salary 22 for his additional duties. 4959 1 Q. And just so it's clear in the record, 2 would you take a look at Item No. T8011, I 3 believe? And if you'd turn to Page 2 at the 4 bottom, is that -- I believe the other ones are 5 the minutes. Is that T8011? 6 Are those the minutes of 7 January the 8th, 1987? 8 A. They are the minutes of UFG -- excuse 9 me -- categorized as minutes of UFG; but it says 10 it's a joint meeting of UFG and USAT on 11 January 8th, 1987. 12 Q. And would you turn to the second full 13 page and look at the bottom of the page and read 14 into the record what appears there? 15 A. Yes. Second full page, last paragraph. 16 "Mr. Whatley reported for the compensation 17 committee on the compensation committee meetings. 18 He stated that the committee was recommending the 19 adjustment of Jenard Gross' salary by 20 approximately 16 percent. After full discussion, 21 such recommendation was unanimously approved." 22 Q. So, Mr. Gross was given a 41,000-dollar 4960 1 raise -- 2 A. Yes. 3 Q. -- on -- 4 A. I'd like to add one more sentence 5 because this is what I discussed. "Mr. Whatley 6 also discussed the status of the resignation of 7 Gerald Williams as executive vice president of the 8 company and president and chief operating officer 9 of United Savings Association of Texas." 10 That is where I'm having the implication 11 that he was -- when he becomes president, he's 12 replacing Gerald in his duties and given the 13 salary. 14 Q. Now, Ms. Clark yesterday pointed out to 15 you that Vivian Carlton, in the course of her 1987 16 examination, had reviewed the September 9th, 1987 17 contracts between UFG and UFG's executive 18 officers. And I believe you testified that you 19 did not raise any concerns with respect to those 20 contracts when you reviewed them? 21 A. That is correct. 22 Q. Did it surprise you that Vivian Carlton 4961 1 didn't raise any concerns either? 2 A. No, it did not. 3 Q. Okay. And using this exhibit on the 4 net worth levels -- I mean -- I'm sorry -- the net 5 worth levels and UFG's reported equity, can you 6 explain to the Court why it is that it did not 7 raise a concern for you? 8 A. Well, we discussed the fact that in 9 April, the examiner said there was a net worth 10 deficiency. But the net worth deficiency I 11 discussed yesterday was, at maximum, $30 million; 12 and it was -- it was under, you know, vigorous 13 discussions whether it was even that large an 14 amount. 15 Q. In fact, I believe the institution 16 itself claimed that they had a positive net worth? 17 A. Yeah. They had a net worth excess for 18 their calculation. At September, which is when 19 the contracts were made, in fact -- I'm sorry. 20 What was the date of those? 21 Q. September 9th. 22 A. September 9th when this was done, they 4962 1 had not yet gotten the results yet. UFG still was 2 reporting a substantial amount of equity. USAT 3 did not have a net worth deficiency. USAT had -- 4 even if they had to come up with the difference -- 5 had over $40 million at the end of September. So, 6 even if there had been a deficiency at USAT, UFG 7 had the apparent ability to do this. 8 Given those circumstances that there 9 were, as we discussed, those safety and soundness 10 regulations specifically dealing with a holding 11 company or any compensation regulations of the 12 holding company, it was a normal business 13 transaction. I would see no reason to deal with 14 it at this point while they are still seemingly 15 quite solvent and capable of meeting any 16 obligations that we were discussing. 17 Q. Okay. And in addition, I believe 18 Ms. Clark pointed out to you that those pernicious 19 contracts contained two times annual compensation 20 as a severance benefit. 21 Do you recall that? 22 A. Yes, I do. 4963 1 Q. Now, do the regulations that you cited, 2 563.39, that pertain to employment contracts with 3 respect to insured depository institutions -- do 4 those regulations also apply to holding companies? 5 A. No, they do not. 6 Q. And was UFG an insured depository 7 institution? 8 A. No. It owned one, but it was not 9 covered under that regulation. 10 Q. Did it surprise you, then, that 11 Ms. Carlton did not comment upon those severance 12 provisions? 13 A. Yes. Excuse me. No, it did not 14 surprise me. 15 Q. Okay. Now, Ms. Carlton also pointed 16 out to you that at the November 10th -- in 17 connection with your review of the November 10th, 18 1987 board minutes -- those are the board minutes, 19 again, where the bonuses were approved by USAT 20 or -- I'm sorry -- were considered by the 21 compensation committee and then later approved by 22 the board, and those are the bonuses that later 4964 1 get paid on January the 4th -- that at your 2 deposition, you stated that you felt that -- 3 MR. KEETON: Your Honor, what is this? 4 Is this Mr. Rinaldi testifying? This is his 5 expert. When he starts reading from several texts 6 and then is going to pose a question, that is not 7 direct examination. 8 THE COURT: We will hear the question. 9 Q. (BY MR. RINALDI) Do you recall, sir, 10 that she asked you whether you had used the term 11 "window dressing" or "lip service"? 12 A. Yes, I do. 13 Q. And do you recall that, during your 14 deposition, you did use those terms? 15 A. Yes, I do. 16 Q. Can you explain for the Court why you 17 used those expressions in connection with the 18 issue of the November 10th, 1987 consideration of 19 the bonuses? 20 A. Okay. Let me try and do that. I used 21 the term "window dressing" or "lip service" in 22 particular discussing the consideration. If I 4965 1 recall, they were talking about the need to have 2 market-based compensation for their executives. 3 And there has been a lot of discussion as to, 4 "Well, isn't that appropriate?" 5 In looking, however, I saw nothing in 6 the compensation committee review or any of the 7 documents that dealt with that that said what the 8 market was. In fact, Mr. Whatley later the 9 following year says, you know, "Let's get a 10 compensation specialist to tell us whether we're 11 meeting the market." 12 So, at November, I see nothing that 13 tells me what is the market. How do they know 14 what the market is? There is nothing there to 15 support this bold statement, "We want to have a 16 market-based compensation." No backup whatsoever 17 of that that I could find. 18 The other portion was talking about, I 19 believe, the cost of replacing employees. They 20 said it will be very expensive to bring new 21 employees in as we lose these people. That's one 22 of the statements that people make; but I think 4966 1 that there needs to be some consideration. What 2 does it really cost us? You have to understand, 3 the institution at this time had been a wholesale 4 operation. Right about this time, we're having a 5 planning conference and they are saying, "There 6 are internal records saying -- well, you know, 7 we've been a wholesale bank. We need to change." 8 They just got through selling a lot of branches. 9 In other words, what's happened is they are 10 changing their organization. They may need to 11 lose people anyway, get rid of people. 12 The question is: What is the cost of 13 doing this? You're complaining that it's going to 14 be very expensive. There is nothing that says it 15 costs us so much per person or it's going to take 16 this much time to find people. You can't 17 quantitize and say, "We couldn't find something 18 for two weeks and it cost us this much." But 19 there is a cost of training and how much time is 20 going to be lost in this. No discussion 21 whatsoever of that. 22 So, to me, just making a bold statement 4967 1 that it's going to cost us a lot of money without 2 any kind of description of what, when, why, or how 3 seemed to be, as I said, lip service/window 4 dressing. 5 Q. And do you recall that in response to 6 Exhibit 8027, which I believe were the minutes of 7 the compensation committee of November 10th, 1987, 8 at which the bonuses were considered, that one of 9 the counsel pointed out to you that it was 10 considered in that meeting that United had 11 suffered operating losses at or about the time 12 they were considering giving the bonuses? Do you 13 see that? Do you recall that? 14 A. Yes, I recall that. 15 Q. Okay. Is there a difference between an 16 operating loss and a net worth deficiency? 17 A. Yes, there is. 18 Q. And can you explain to the Court why 19 consideration of a loss might be different than 20 consideration of a net worth deficiency? 21 A. Let me try. Let me just use this chart 22 to illustrate -- for illustrative purposes. And I 4968 1 want to use the association's determination of the 2 net worth requirement as an example. At this 3 point, the association is making money. They lose 4 money this quarter. They have an operating loss; 5 yet, by their calculation, they still exceed the 6 requirement. This quarter, they have a loss; yet, 7 they still exceed the requirement. 8 So, to me, if an institution is in 9 excess of its net worth requirement and they 10 report to the board, yes, we have an operating 11 loss, if -- and as we're talking about in here, if 12 the operating loss is something where they still 13 believe they are in excess of the net worth 14 requirement, that doesn't necessarily trigger the 15 problem of the safety and soundness issue of 16 whether or not it's appropriate to do this. 17 Operating loss may very well lead to net worth 18 deficiency, but it is not synonymous at the same 19 point in time. 20 Q. And at the point in time when these 21 bonuses were approved, was it your understanding 22 that the board had been advised that they were 4969 1 likely to fail their net worth requirement? 2 A. Certainly the members of the board 3 were. The examination staff had told them that 4 they already were in a failure position of the net 5 worth requirement. So, yes, I believe the board 6 had notice of that. 7 Q. Now, you indicated that USAT was 8 changing its business. Do you recall that? 9 A. Yes. 10 Q. And do you recall that in the beginning 11 of 1988, a decision was made by USAT to bring on 12 Mr. Larry Connell and that, ultimately, in about 13 June or July of 1988, Mr. Connell was brought on? 14 A. Yes. I recall there was a process to 15 bring him to the institution. 16 Q. And can you tell the Court what the 17 reasons were for bringing Mr. Connell back on or 18 bringing him on? 19 A. Let me try. At the time -- well, there 20 were several discussions. And I recall, for 21 instance, Mister -- as counsel has discussed, the 22 institution was concerned about their financial 4970 1 condition. I know Mr. Berner was having 2 discussions with Mr. Twomey who, I believe, on at 3 least one occasion told him that the Federal Home 4 Loan Bank staff was concerned about the operation 5 of the institution, was concerned that they needed 6 a traditional thrift operator at the institution. 7 I think Mr. Berner reported that they were 8 comfortable with the management but they felt that 9 there needed to be another operations -- 10 traditional thrift operator between Mr. Gross and 11 the rest of the management. 12 So, there was some push from the 13 regulators; and, obviously, the institution being 14 concerned about the Southwest Plan, I think as 15 we've discussed, would presumably be taken as a 16 clue to try to get somebody in there. And 17 Mr. Connell seemed to be that individual. 18 Q. Okay. And do you recall ultimately 19 whether Mr. Connell assumed duties of any other 20 individuals at the -- at the institution? 21 A. Yes. I recall that Mr. Connell 22 apparently assumed some of the duties of 4971 1 Mr. Gross. 2 Q. And then shortly thereafter, Mr. Gross 3 resigns and Mr. Connell remains on as the 4 president of the institution; isn't that correct? 5 A. I believe that's correct, yes. 6 Q. Now, there was some point raised about 7 the length of time it took Mr. Twomey to respond 8 to Mr. Berner with respect to comments on 9 Mr. Connell's contract. 10 Do you recall that? 11 A. Yes. 12 Q. Did it surprise you that it wasn't 13 until sometime in October that -- I believe 14 October -- that Mr. Twomey got back to Mr. Berner 15 and the board of directors regarding that 16 contract? 17 A. Not particularly -- no, it did not 18 really surprise me. 19 Q. Did you have occasion to review part -- 20 the record of the supervision of USAT at or about 21 that time? 22 A. Yes, I did. 4972 1 Q. And did that reveal anything about the 2 process by which USAT -- I mean the examiners 3 reviewed the compensation practices at USAT? 4 A. Yes. 5 Q. And can you explain to the Court what 6 you recall of that? 7 A. Well, I believe I recall when 8 Mr. Connell's contract was first sent in, somebody 9 reviewed it and, of course, had some criticisms of 10 it. And one of the things very clearly said was: 11 "There are policy issues here and they should go 12 to the regulatory review committee," which meant 13 that Neil would have to then present it up the 14 line of management of the organization. 15 There also was an interim exam report 16 that came in, I think, around October that had the 17 discussion of all of the contracts, not just 18 Mr. Connell's, and raised a series of concerns 19 about those contracts. If I remember correctly, I 20 think within about 10 or 15 days of that interim 21 report where there were these substantial 22 criticisms, Mr. Twomey then, in fact -- and in a 4973 1 letter we saw yesterday -- went back to the 2 institution and raised some issues about safety 3 and soundness on the contracts. 4 Q. Now, in your review of the record, were 5 you able to determine whether -- well, first of 6 all, did Mr. Berner send a copy of the Connell 7 contract to the bank board? 8 A. Yes. Mr. Berner did send Mr. Connell's 9 contract. 10 Q. And that was a contract between USAT 11 and Mr. Connell? 12 A. Yes, that is correct. 13 Q. Do you know whether Mr. Connell also 14 had a contract with UFG? 15 A. I didn't find a contract with UFG. 16 Q. Okay. And when Mr. Berner sent 17 Mr. Connell's contract in, did you find any 18 evidence that he also submitted to the bank board 19 the additional contracts that were entered into 20 with the executives of USAT on July the 1st, 1988? 21 A. No. And I looked -- tried to look for 22 it. Mr. Berner had earlier stated that there 4974 1 was -- I think when he sent the contract of 2 Mr. Connell, he talked about any contracts that 3 were done/entered into would be in compliance with 4 the regulations. I don't know if that implied he 5 was sending anything, but I looked -- I still 6 can't find anything where he sent any of the other 7 contracts. The first notice I see is when the 8 examiners say, "Here's all these contracts." 9 Q. And do you recall approximately when 10 the examiners first began to talk about the USAT 11 contracts? 12 A. I think I said just a minute ago that 13 there was an interim report around the middle of 14 October where there was a discussion of all these 15 contracts of the individuals, including 16 Mr. Connell, but also expanding it to all of the 17 other contract holders. 18 Q. And on October 20th, Mr. Twomey then 19 writes his letter to the board expressing his 20 views as to the lack of safety and soundness and 21 regulatory implications of those contracts, 22 doesn't he? 4975 1 A. Yes. I believe it was before the end 2 of October that he wrote his letter. 3 Q. Okay. To your knowledge, did 4 Mr. Twomey or anyone at the bank board approve the 5 July 1st, 1988 contracts between USAT and the 6 executives? 7 A. I have no direct personal knowledge, 8 and the record I saw indicates -- does not show an 9 approval by Mr. Twomey or anybody else of the 10 contract. 11 Q. To your knowledge, did anyone at the 12 bank board approve the contracts entered into 13 between USAT and the executives of USAT on 14 February 11th, 1988? 15 A. No. 16 Q. And, in fact, Mr. Berner had told 17 Mr. Twomey that those contracts didn't exist? 18 A. That's correct. 19 Q. Now, Mr. Blankenstein asked you a 20 number of questions regarding the safety and 21 soundness of the compromise of Mr. Gross' debt to 22 UFG. 4976 1 Do you recall that? 2 A. Yes. 3 Q. And you indicated that you had looked 4 at the totality of the circumstances surrounding 5 that. 6 Can you explain to the Court what you 7 meant or what factors you considered in looking at 8 the totality of the circumstances? 9 A. Okay. This chart might help a little 10 bit because it does show Mr. Gross' separation 11 agreement. I talked about the totality and was 12 discussing, of course, the net worth failure at 13 this point, the insolvency of the institution at 14 this point. I find it kind of interesting when I 15 was looking at Mr. Gross' contracts that I just 16 don't recall ever seeing Mr. Gross having a 17 contract in September when these people had 18 contracts. He didn't have one in February. It's 19 only in June -- June 28th with UFGI and July 1st 20 with USAT when the institution itself is now 21 reporting insolvency -- and I think everybody 22 there knew they were insolvent -- that he finally 4977 1 gets a contract. He's never had one before this. 2 He's had this compensation which we've discussed; 3 but he now gets a contract which, of course, 4 establishes his salary at this higher level 5 whereas before, it had been at the board's 6 discretion. He has a contract. He resigns four 7 months later, and it is finally accepted and 8 finalized in November. 9 So, here we have Mr. Gross in a 10 situation where he serves out -- enters into a 11 contract at the last minute where everything is 12 already falling down around their ears in a 13 sense -- falling down around their ears in a sense 14 that United Savings is insolvent. UFGI has been 15 reporting that it is insolvent since the end of 16 1987. It has had to compromise its debt. It is 17 showing little ability to pay its obligations. 18 They have entered into this contract; and now, 19 just a few months later, he's saying, "Well, 20 you-all owe me this money," as Mr. Blankenstein 21 said, a million plus dollars they owe him and, you 22 know, "I owe you 600,000. Let's compromise and 4978 1 settle this." 2 That contract only lasted five months. 3 It seems, you know -- it just struck me, as the 4 circumstances were, that this was done at the last 5 minute; and it was too late in the game to be 6 doing this. They already were in the net worth 7 situation. Their responsibility was to protect 8 the assets of UFG and USAT to avoid this net worth 9 deficiency. They are in a severely restricted 10 situation because they are in actual equity 11 failure here; and, yet, they are entering into a 12 contract and then settling it later. It just 13 struck me that -- well, not struck me. 14 My analysis was that this was an unsafe 15 and unsound process to do this in this type of 16 timetable. 17 Q. Now, you indicated that on June the -- 18 June of 1988, when Mr. Gross entered into his 19 contract, that the institution was -- had negative 20 net worth. 21 On the day that they considered 22 Mr. Gross' contract, do you recall whether they 4979 1 also considered Mr. Connell's contract? 2 A. I believe -- yeah. I believe it was 3 the same date that they considered all of these 4 contracts. 5 Q. And Mr. Connell was going to assume 6 some of the duties of Mr. Gross? 7 A. That's correct. As I just said a few 8 minutes ago, he assumed some of the 9 responsibilities of Mr. Gross and retained those 10 responsibilities when Mr. Gross left. 11 Q. And reviewing the record, you 12 indicated -- what were the reasons why Mr. Gross 13 was going to step aside and allow -- and they were 14 going to bring on Mr. Connell? 15 MR. EISENHART: Your Honor, I don't 16 want to unduly truncate Mr. Rinaldi's redirect; 17 but an awful lot of this is highly repetitive. It 18 really has very little to do with the 19 cross-examination. This witness has been on the 20 stand for quite a while. There is another witness 21 who OTS plans to put on and get off the stand 22 today who has already been waiting around for a 4980 1 day to get on. I really wonder how much longer 2 this is going to go on and if we can't eliminate 3 some of the repetitiveness here and move it along. 4 MR. STEARNS: Your Honor, I think it's 5 directly responsive to the questions asked by 6 Mr. Blankenstein concerning his client, Mr. Gross, 7 and by Mr. Keeton; and it seems to me Mr. Rinaldi 8 is moving along as rapidly as possible in these 9 areas. 10 MR. KEETON: Your Honor, I think 11 Mr. Rinaldi can protect himself. He sure doesn't 12 need Mr. Stearns -- 13 THE COURT: All right. I think we have 14 enough on that. 15 Mr. Rinaldi, how much more do you have 16 on your redirect? 17 MR. RINALDI: Perhaps two more 18 questions, Your Honor. 19 THE COURT: All right. Proceed. 20 MR. RINALDI: I'll have to make them 21 good, though, if I only have two. 22 Q. (BY MR. RINALDI) Would you take a 4981 1 look at your expert opinion? And directing your 2 attention to the last full sentence -- 3 A. Mr. Rinaldi, I don't have a copy here. 4 You didn't leave one up here. 5 Q. It should be A11048. 6 THE COURT: Mr. Rinaldi, somebody 7 should hand these documents to the witness rather 8 than have the witness go fishing through boxes to 9 find it. 10 MR. RINALDI: I'm sorry, Your Honor. I 11 apologize. I thought that he had been given a 12 copy of his opinion at the beginning of yesterday 13 and that it would have been right there. 14 Q. (BY MR. RINALDI) Yeah. Would you 15 take a look at the last sentence of Part F. 16 A. Part F summary or Part F -- 17 Q. On Page 8. 18 A. Okay. Yes. 19 Q. It is commenting on the fact that 20 Mr. Gross, Mr. Berner, and Mr. Munitz all had 21 their claims compromised. 22 Do you see that? 4982 1 A. Yes. 2 Q. And the last sentence reads "As a 3 consequence of UFG's entering into these unsafe 4 and unsound employment agreements, UFG ultimately 5 dissipated substantial assets that otherwise 6 should have been used to maintain the net worth of 7 USAT under UFG's net-worth maintenance 8 obligation." 9 Do you see that? 10 A. Yes, I do. 11 Q. Is it your opinion that the same would 12 be true with respect to Mr. Gross' employment 13 agreements and a compromise thereof? 14 A. Yes. I think -- I tried to make it 15 very clear when I was discussing the methodology 16 of his contract, and that is exactly what I'm 17 trying to say. 18 Q. Okay. And, to your knowledge, is Graef 19 Crystal a safety and soundness expert? 20 A. Not to my knowledge. 21 Q. And is safety and soundness the 22 principal basis upon which you base your opinions 4983 1 here today? 2 A. That's correct. 3 MR. RINALDI: I have no further 4 questions, Your Honor. 5 THE COURT: Ms. Clark, you have some 6 recross? 7 MS. CLARK: Yes, I do, Your Honor. 8 THE COURT: Proceed. 9 10 RECROSS-EXAMINATION 11 12 13 Q. (BY MS. CLARK) Mr. Dermody, did you 14 testify that the reason you didn't form an opinion 15 regarding the safety and soundness of the 16 September 1987 contracts was that they were UFG 17 contracts and, at the time they were entered into, 18 UFG had sufficient net worth to cover any 19 deficiency in USAT's net worth requirement? 20 Was that your testimony this morning? 21 A. Yes. My testimony was the information 22 that appeared to be available at that time was 4984 1 that -- 2 Q. I'm sorry. Do you recall that there 3 was considerable discussion at your deposition 4 about the reason why you did not form an opinion 5 on the safety and soundness of the September 1987 6 contracts and you did not give that explanation at 7 that time? 8 A. Yes, I recall. At the time we were 9 discussing the deposition, I believe the questions 10 were: "You didn't review it?" 11 No, I hadn't been asked to review it. 12 Subsequently, my discussion today is I went back 13 and looked. And would I be interested in it? No. 14 And these are the reasons why I would not be 15 interested. 16 Q. In fact, you had reviewed the 17 September 1987 contracts prior to the time of your 18 deposition; isn't that true? 19 A. I had looked at them, yes. 20 Q. And you had formed no opinion that they 21 were unsafe and unsound, correct? 22 A. That's correct. I still have not 4985 1 formed that opinion that they are unsafe and 2 unsound. 3 Q. And when you were asked why you didn't 4 form an opinion that they were unsafe and unsound 5 at your deposition, your testimony was, in 6 substance, that the story in your view started 7 later. The story began with USAT's net worth 8 deficiency which you dated to October of 1987 at 9 that time, correct? 10 A. That's correct. 11 Q. But, in fact, your date for the net 12 worth deficiency is September of 1987 on your 13 chart. It's No. 2 on your chart, correct? 14 A. No. My Chart No. 2 says the 15 examination staff informed them in April there was 16 a deficiency. And I've said that -- what I was 17 talking about is at the time of September, they 18 didn't know about this deficiency. I mean, they 19 knew the examiners were saying this; but they 20 weren't aware of it. It's only after December 21 that they retroactively seem to admit that there 22 is a September 30th and December 31st deficiency. 4986 1 So, you know, I don't see that there 2 was any knowledge -- other than the examiners, 3 which they were contesting strenuously, that there 4 was any deficiency -- knowledge of any deficiency 5 other than that examiners' criticism and 6 discussion at the time of these contracts. 7 Q. So, in your view, if the examiners had 8 advised USAT of the net worth deficiency but they 9 themselves did not agree with it, they were free 10 to go ahead and increase salaries and award 11 bonuses without violating any safety and soundness 12 rules; isn't that correct? 13 A. I think that with the examiners putting 14 them on notice, they should have been seriously 15 concerned about this. They were contesting this 16 very clearly; and I want to give them the benefit 17 of the doubt in saying if they were right, at that 18 point in time, then it would be an appropriate 19 action to take to give these bonuses and salaries. 20 And I'm not saying it was unsafe and unsound at 21 the time in September when they did it. 22 Q. Okay. And how about November? On 4987 1 November 10th, which is prior to the time that 2 you've just testified they admitted their net 3 worth deficiency. 4 A. November 10th is different because 5 there we have No. 3 where management themselves -- 6 not just the examiners saying "you failed" and 7 there is an argument. 8 Management itself is saying, "By golly, 9 in two days, we may fail." October 29th, 10 Mr. Berner's memo: "Two days, we may fail" or a 11 strong implication that if it's not then, it's 12 going to happen right afterwards. 13 So, by November 10th, it's no longer the 14 examiners telling us we're going to disagree. We 15 know that we're really on the verge and we're 16 right there and probably past that point. 17 Q. So, there is a possibility at that 18 time; and that's the important thing for you? 19 A. Not just a possibility. It's the 20 knowledge. Their own internal projection is that 21 they are there. No longer just a possibility. 22 Q. Is there any doubt in your mind from 4988 1 reviewing the documents that Vivian Carlton had 2 formed a conclusion that there was a net worth 3 deficiency by the time she reviewed the 4 September 1987 contracts? 5 A. No, there is no doubt that she had 6 formed the conclusion of a net worth deficiency. 7 Q. Now, I think you testified that it 8 didn't surprise you that she did not detect a 9 safety and soundness problem with the UFG 10 contracts that she reviewed, the September 1987, 11 UFG contracts, because Section 563.39 does not 12 apply to holding company contracts. 13 Was that the reason why you did not 14 consider it significant that she review those 15 contracts and did not cite them for safety and 16 soundness problems? 17 A. Yes. 18 Q. Now, do you recall that the examination 19 work papers that we reviewed yesterday at, I 20 believe, Exhibit A11032 also contained a copy of a 21 contract with Dominic Bruno? 22 A. Yes, I recall that there was a copy of 4989 1 Mr. Bruno's contract. 2 Q. And do you recall with which company 3 that contract was entered into? 4 A. I believe it was USAT. 5 Q. And do you recall that it had a 6 provision for the securing of the compensation 7 arrangements under that contract? 8 A. Yes, I do. 9 Q. And that Vivian Carlton did not cite 10 that USAT contract for safety and soundness 11 problems even though it appears that she had no 12 doubt in her mind that USAT was failing its net 13 worth requirement at that time? 14 A. Correct. And I think there is a very 15 good reason, which I've already discussed. That 16 is, in their announcement of Mr. Bruno's hiring at 17 the institution, they are talking about a 18 substantial portfolio they have that he's going to 19 manage. He's going to be the man to come in and 20 manage this. They are already talking about how 21 we're having problems with how we're running the 22 institution. They are bringing in a man from the 4990 1 outside, and this is a key difference between him 2 and the insiders I've talked about. He is an 3 outsider, as is Larry Connell, who's brought in. 4 They are going to have to pay the going rate in 5 the sense to get an outsider coming in. The only 6 way they can get somebody to come in -- an 7 important distinction. And yes, they may have had 8 to pay that. And from a safety and soundness 9 point of view, you may argue it has the same 10 features; but the distinction is who is involved 11 in doing this, where the person comes from. 12 Again, the totality of the circumstances. 13 Q. And do you see any indication 14 whatsoever in the examination records that you 15 have reviewed that Vivian Carlton made that 16 distinction in her mind when she did not cite the 17 Bruno contract and the Laurenson contract and the 18 other contracts for safety and soundness problems? 19 A. I saw nothing that tells why. I'm 20 describing to you why I would -- why I did not -- 21 was not surprised. 22 Q. So, you're just speculating about that 4991 1 subject, correct? 2 A. I'm answering a question -- 3 MR. STEARNS: Your Honor, the question 4 asks for speculation because it asks what is in 5 Ms. Carlton's mind, and he's testified frequently 6 he was not a participant in the supervision of the 7 institution at that time. I think we're far 8 beyond the scope of redirect at this point. 9 THE COURT: I believe the question was 10 did he see anything that indicated that 11 Ms. Carlton had considered the distinction. 12 MR. STEARNS: I believe that was the 13 prior question, but her final question was: 14 "You're just speculating, aren't you?" 15 THE COURT: Well -- 16 MS. CLARK: I'll move on, Your Honor. 17 I think the answer to that question is obvious. 18 Q. (BY MS. CLARK) Do you recall 19 reviewing the minutes of the February 11th, 1988 20 board meeting attended by Vivian Carlton where the 21 February '88 USAT contracts were approved? 22 A. Yes, I do. 4992 1 Q. And those were contracts with USAT; 2 isn't that correct? 3 A. The question was the USAT -- pardon me. 4 They were USAT contracts, correct. 5 Q. And do you recall that the minutes 6 state that "Mr. Berner discussed in detail the 7 views of the compensation committee concerning 8 employment contracts to be entered into between 9 the company and certain executive officers." Went 10 on to say "It was noted that these contracts were 11 identical to contracts entered into by UFGI and 12 would be effective -- only be effective if UFGI 13 could not perform under such contracts." And then 14 went on to discuss the reasons why the 15 compensation committee had decided to enter into 16 these contracts. I'm reading from Exhibit A1141 17 which has already been admitted in evidence. 18 A. I'm sorry. It was a long question. 19 Would you repeat the part you're asking? Do I 20 recall -- 21 Q. Do you recall that the minutes 22 described the discussion at the February board 4993 1 meeting? 2 A. Yes. From what you've read, yes, I 3 recall a discussion like that. 4 Q. And again, you saw no indication in the 5 record that you have reviewed in the case that 6 Vivian Carlton ever raised any questions 7 concerning the safety and soundness of the 8 February contracts with USAT which were described 9 at the meeting as identical to the UFGI contracts 10 that she had previously reviewed? Is that -- 11 A. Yes. 12 Q. My question is: Have you seen anything 13 in the record to indicate that she raised a 14 problem with those contracts? 15 A. My answer is: No, I did not see 16 anything. 17 MS. CLARK: Thank you. 18 THE COURT: Mr. Blankenstein? 19 MR. BLANKENSTEIN: Just a few quick 20 questions, Your Honor. 21 22 4994 1 2 RECROSS-EXAMINATION 3 4 5 Q. (BY MR. BLANKENSTEIN) Didn't 6 Mr. Gross have a contract in February of 1988 7 which gave him severance rights should he be 8 terminated for less than cause? 9 A. I just said I don't recall -- when up 10 here, I said I don't recall him having that 11 February '88 contract. 12 Q. Isn't that February '88 contract one of 13 the contracts that you, in your report, determined 14 was unsafe and unsound and now you don't remember 15 the terms of that contract? Is that your 16 testimony, sir? 17 A. We've been through a lot of contracts 18 today. My testimony was the February contracts 19 were unsafe and unsound, that's correct. 20 Q. You testified -- I think in connection 21 with Mr. Rinaldi's questions -- that Mr. Gross' 22 salary increase from $250,000 in 1986 base salary 4995 1 to $291,656 in 1987 base salary was to reflect the 2 fact that he became the president of USAT in 3 January of '87; is that right? 4 A. I said that that -- from the view of 5 the record, that appears to be what it was for. 6 Q. That was an assumption you made; is 7 that right? 8 A. I said that. 9 Q. And did you go back to look to see 10 whether Mr. Gross' base salary had been regularly 11 increased before he assumed the duties of 12 president? 13 A. I had looked at his compensation, and I 14 believe his compensation had been increased from 15 1985. 16 Q. From 1985 -- his base salary had been 17 increased from 1985? 18 A. 1985 to 1986, that is correct. 19 Q. And he didn't assume any new duties in 20 that regard, did he? 21 A. I wasn't aware of any duties. 22 Q. Why don't you take a look at what's 4996 1 been marked as A3013 which is -- 2 MR. BLANKENSTEIN: I believe it's 3 already in evidence, Your Honor. 4 A. This is the -- 5 Q. (BY MR. BLANKENSTEIN) 1986 proxy 6 statement. 7 A. Uh-huh. 8 Q. What does it state for Mr. Gross' total 9 cash compensation? 10 A. Mr. Jenard Gross' total cash 11 compensation: $266,846. 12 Q. I'd like you to look at Footnote No. 1 13 which talks about directors' fees; is that right? 14 A. Yes. 15 Q. And how much in directors' fees did he 16 receive during that year? 17 A. $45,650. 18 Q. And if we -- quick math. That means 19 his base salary -- if we assume that was no 20 compensation, no bonus in that -- was $220,000; is 21 that right? 22 A. That is correct. 4997 1 Q. And what would a 15 percent raise get 2 you to? $250,000? Isn't -- 3 A. 250,000, that's correct. 4 MR. RINALDI: I believe it's a 5 16 percent raise. 6 MR. BLANKENSTEIN: Excuse me. I guess 7 we missed by a percentage point. 8 Q. (BY MR. BLANKENSTEIN) Is that 9 assumption you made -- you made many assumptions 10 in this case -- isn't that right -- when you 11 reviewed the record? 12 A. I had made some assumptions based on 13 the record, yes. 14 Q. Are any of the assumptions that you 15 made better founded than the one that you just 16 made with regard to Mr. Gross' salary? 17 MR. STEARNS: Your Honor, I object. 18 It's argumentative. 19 THE COURT: Sustained. 20 MR. BLANKENSTEIN: I withdraw the 21 question. 22 THE COURT: Could I ask you a couple of 4998 1 questions on this conflict of interest? 2 THE WITNESS: Certainly, Your Honor. 3 I'd be happy to try and answer them for you. 4 THE COURT: Doesn't the -- to start out 5 with, don't the regulations require the board of 6 directors to set the officers' salaries? 7 THE WITNESS: Yes, it does. 8 THE COURT: So, how would they do 9 that -- if they are also officers, how would that 10 work ideally? 11 THE WITNESS: Well, I think the agency 12 just recently changed their conflict of interest; 13 and I think it clarifies that. And basically, it 14 says you should not participate in a discussion 15 and you should not be a party to the vote of the 16 situation, recognizing that you just can't 17 completely extinguish your responsibility as a 18 director. But as an officer, we generally -- 19 well, we generally see in institutions that the 20 officers are not the majority of the board of 21 directors. 22 At the time we had some of these 4999 1 transactions, it was the outside majority that did 2 these things. So, we're saying it's an inherent 3 conflict for you to do this; but we recognize that 4 there is a way that you can, in fact, remove 5 yourself somewhat so that you don't taint the 6 process so that other individuals -- unrelated 7 individuals can make these decisions. And, in 8 fact, you see that they did this in some -- we 9 talked about it in some of the decisions later in 10 time. They did -- 11 THE COURT: I thought you were critical 12 of that. 13 THE WITNESS: I was critical of that 14 because it was -- all it was was a bunch of 15 insiders and, you know, four -- the five of us up 16 here are all voting contracts for each other and 17 we all work together all the time and we've been 18 through this whole thing together and we just 19 simply say, "Okay. Well, I'll vote for you and 20 then, when it's my turn, you vote for me" and 21 everything else. 22 So, there is a series of these 5000 1 transactions. What I'm trying to point out in 2 this is we start out with outsiders approving 3 contracts and insiders participating. I said 4 there is a conflict for them to be involved there. 5 But as Mr. Blankenstein said, it may not have made 6 any difference if the decision was made when they 7 voted no. Later, we have all of these insiders 8 voting this -- on these contracts. There was no 9 independent determination. Mr. Whatley was 10 involved in this thing. He seemed to be doing 11 anything they recommended. Every recommendation I 12 see to Mr. Whatley seems to be approved. So, we 13 have the insiders effectively controlling this 14 thing and voting themselves. And I think I 15 pointed out, they get the largest percentage of 16 this. They get the biggest chunk of everything. 17 THE COURT: So -- 18 THE WITNESS: Everybody gets a little 19 piece; but they get the 30, 40 percent of 20 everything that gets disbursed. 21 THE COURT: It would not be sufficient, 22 then, for the concerned officer to recuse himself 5001 1 when the board considers his if he participates 2 when somebody else gets theirs? 3 THE WITNESS: When it's the same small 4 group of individuals. If we have a board of nine 5 people and there's two officers on the board, 6 you're not going to have anything where they are 7 going to be directly influenced with their vote, 8 what happens. Grant that. But when we have a 9 board of virtually all insiders, there is nobody 10 else left, then you're in a situation where they 11 are effectively just patting each other on the 12 back, scratching each other's back for this thing. 13 THE COURT: If that was the 14 circumstance, then how would they operate? 15 Presumably the other board members had gone. Is 16 that what you're saying? 17 THE WITNESS: Yeah. The other board 18 members had left. 19 THE COURT: So, in order to have a 20 legally-functioning body, they had to function in 21 some manner. How would they? 22 THE WITNESS: Absolutely. I think at 5002 1 one point in time, one of the things I said was 2 they have a fiduciary responsibility to the 3 institution, as the board of directors, to the 4 stockholders. But they are in a time in which we 5 have this insider group of directors. They are -- 6 their net worth requirement eventually just failed 7 completely. They are insolvent. They also have a 8 responsibility to the, at that time, FSLIC, 9 insurance corporation, because it became 10 effectively the largest debtor of the institution. 11 It was -- in the event of its insolvency, the 12 FSLIC would assume all of the insureds' savings 13 deposits, which was the very largest obligation by 14 far as a group. 15 So, here is the largest debtor which 16 they have an obligation to protect the assets for. 17 It made sense to do -- as they did in 18 Mr. Connell's case, to go say, "Is it okay if we 19 do this?" At least by not getting an objection 20 from the regulators by the time they accomplish 21 this, it's, like, okay. Our largest party at the 22 table is not going to object to it on this issue. 5003 1 I'm not objecting now of Mr. Connell's contract. 2 At that stage, going through and saying, "Okay. 3 Here's what we propose to do" -- as they knew well 4 how to do -- and saying, "Okay. You're the 5 largest party on the table. Do you have an 6 objection to us doing these types of things?" 7 Yes, they are ultimately responsible as the 8 directors but they also have to look at the 9 fiduciary responsibility they have to stockholders 10 when they are insolvent, the stockholders have got 11 nothing. Who is next? The largest debtor, the 12 FSLIC. 13 So, I'm saying that by the time we get 14 into 1988 when their insolvency is there, they 15 should be talking to the FSLIC and saying -- 16 getting permission for these things or at least 17 getting acquiescence. They did none of that 18 except on Larry Connell, the one outsider, and 19 Bruno. The outsiders they bring in -- Bruno they 20 didn't ask us about, but Connell they asked us 21 about. They go through the process. They know 22 how to do it. They didn't do anything for the 5004 1 insiders. In fact, they hid the ball in a sense 2 by not telling us. I'm not saying that they 3 intentionally tried to hide everything. I'm just 4 saying Berner said, no, we don't have any 5 contracts. And later, we're going to modify these 6 contracts but they don't send them in and say 7 there is going to be a problem at the very time 8 when they should be. 9 THE COURT: Thank you. Mr. Keeton? 10 MR. KEETON: I'll keep it within the 11 two-minute warning, Your Honor. 12 Q. (BY MR. KEETON) You criticize the 13 note -- 14 MR. STEARNS: Your Honor, are we going 15 to do another round of questioning? 16 MR. KEETON: Wait a minute. The judge 17 asked questions just as this man sat down. I get 18 to -- I have a defendant that I represent. 19 MR. STEARNS: I'm just asking if we're 20 going to have another round of questions. 21 THE COURT: Well, I'll hear -- you've 22 got two minutes. Let's proceed. 5005 1 MR. RINALDI: These claims don't even 2 implicate your defendants. 3 MR. KEETON: Let me put it this way, 4 Bruce, since you're talking off the record about 5 these claims. Everything in this case affects my 6 client. 7 THE COURT: Asks your questions, 8 Mr. Keeton, please. 9 10 11 12 13 14 RECROSS-EXAMINATION 15 16 17 Q. (BY MR. KEETON) You said at the 18 November board meeting they gave lip service to 19 knowing the market. 20 Do you remember who the compensation 21 committee was? 22 A. A member of -- two of them: 5006 1 Mr. Whatley and Mr. Silverman. 2 Q. Do you know anything about their 3 business backgrounds? 4 A. I saw that Mr. Silverman was an 5 attorney on the West Coast. 6 Q. You also see he was executive vice 7 president of a major financial company on other 8 boards and senior counsel to Wyman Bautser, one of 9 the national law firms? 10 A. I don't recall all of that, but -- 11 Q. How about Mr. Whatley? You just threw 12 a rock at him. You said it looks like he just 13 went along with anything they wanted. That man 14 sat on the stand here before you did -- 15 A. That's correct. 16 Q. -- 10 years after the fact. Do you 17 know how many boards and companies he's run, major 18 ones? 19 A. I know he was involved with several, 20 and I also don't believe any of them were also 21 financial institutions. They were major 22 corporations, I believe. 5007 1 Q. How about Mr. Keltner? 2 A. I don't recall Mr. Keltner's 3 background. 4 Q. Do you know he had been chairman of an 5 S&L? He's a senior partner still practicing in 6 Fort Worth with a major law firm. 7 A. I'm sorry. Yes, you mentioned that. I 8 do recall that Mr. Keltner was -- 9 Q. And then by the time he got to the 10 board, we also added Dr. Kozmetsky. You know who 11 he is? 12 A. No, I don't recall now. 13 Q. All right. Well, the judge has heard 14 him. I think they would know what a market was. 15 Now, in '88, by the time that you get down to 16 where Mr. Whatley wants somebody, most of these 17 people have left. And it's probably proper for 18 Mr. Whatley to get backup, but to criticize these 19 people in '87 when you don't know anything about 20 their background I think -- 21 THE COURT: Mr. Keeton, do you have a 22 question? 5008 1 MR. KEETON: That's it, Your Honor. 2 THE COURT: All right. 3 MR. KEETON: Oh, wait. Yes. I do have 4 one more. 5 Q. (BY MR. KEETON) Did you say you have 6 a policy now that let's a board that is all 7 insiders vote on their salaries one at a time with 8 them recusing? 9 A. No, I did not say that. I said that 10 the conflict of interest regulation had been 11 modified, and I don't have it in front of me so I 12 can't detail all of it; but I know that at least 13 part of it is that individuals should recuse 14 themselves, not participate in the discussion and 15 not vote. I did not discuss it in the context of 16 completely insider board of directors. 17 Q. Okay. 18 A. Nor did I intend to. 19 MR. KEETON: Thank you. 20 THE COURT: All right. Thank you, 21 Mr. Dermody. You may step down. We'll take a 22 short recess. 5009 1 2 (A short break was taken 3 at 10:48 a.m.) 4 5 THE COURT: Be seated, please. We'll 6 be back on the record. The OTS is calling another 7 witness? 8 MR. GUIDO: Yes, Your Honor. The OTS 9 calls Mr. Joe Phillips. 10 11 12 JOSEPH PHILLIPS, 13 14 called as a witness and having been first duly 15 sworn, testified as follows: 16 17 THE COURT: Be seated, please. 18 19 EXAMINATION 20 21 22 Q. (BY MR. GUIDO) Would you state your 5010 1 full name for the record, please? 2 A. Joseph H. Phillips. 3 MR. GUIDO: Your Honor, before I 4 proceed with this witness, in the interest of 5 moving things along, I would like to move into the 6 record three packets of documents that each party 7 will be relying upon at some point in time in the 8 proceedings. 9 This witness will not be asked about all 10 of these documents, but this seems to be the 11 appropriate time to introduce the documents into 12 the record. One category of documents are 13 documents of what's referred to as the asset 14 liability committee. 15 The second are the investment committee 16 minutes for the relevant time period that he was 17 employed at USAT. 18 And the third are the performance 19 reports which we are introducing in their totality 20 at this point in time, Your Honor, so that when 21 the parties make reference to them as we go 22 forward, the documents are in the record. 5011 1 The asset liability minutes are A1607 2 that starts January 10th, 1985, and it runs 3 through July 28th, 1988, which is A1642. 4 The second, Your Honor, are the 5 investment committee minutes for the time period 6 April 24th, 1986, through October 1, 1986, and 7 those are Exhibit Nos. A1388 through A1411. 8 And the third packet, Your Honor, are 9 the performance reports that cover the time period 10 of December 31, 1984, through December 1986, Your 11 Honor. This is not the complete set of 12 performance reports. I misspoke. These are 13 Exhibits A5001 through A5017, Your Honor. 14 MR. EISENHART: Your Honor, may I have 15 the ending date of those again? 16 MR. GUIDO: December 31, '86. Thank 17 you. I move the admission of the three packets of 18 document, Your Honor. 19 MR. NICKENS: Your Honor, no objection. 20 To clarify the record, I assume that what 21 Mr. Guido meant was with regard to the asset 22 liability committee minutes, that they begin at 5012 1 A1607 and continue consecutively through A1642 and 2 the same with regard to the performance reports. 3 That is, they begin at A5001 and continue 4 consecutively through 5017. And that the 5 investment committee minutes are A1388 and 6 continue consecutively through 1411? 7 MR. GUIDO: That's correct. Those are 8 the A category of documents that the respondents 9 have produced to the OTS as the category of 10 documents. 11 THE COURT: These numbers run 12 consecutively? 13 MR. GUIDO: They run consecutively as 14 far as I know, Your Honor, as I received them. 15 THE COURT: All right. No objection. 16 Received. 17 Q. (BY MR. GUIDO) Now, where did you 18 receive your college education? 19 A. At Texas A&M University. 20 Q. And what years was that? 21 A. 1972. 22 Q. 1972 you received a degree -- 5013 1 A. That's correct. 2 Q. -- from Texas A&M? 3 A. That's correct. 4 Q. What was that degree? 5 A. A bachelor of business administration. 6 Q. And did you have any specialization in 7 that degree? 8 A. In finance. 9 Q. Business finance? 10 A. Yes. 11 Q. And did you do any post-graduate work? 12 A. I also studied for and received a 13 master of business administration from Texas A&M 14 University in 1973. 15 Q. Okay. And did you have any 16 specialization in that degree? 17 A. It was also finance. 18 Q. And did you have any other degrees 19 after that? 20 A. No academic degrees. 21 Q. Now, can you tell us something about 22 your employment background? Where did you go to 5014 1 work after graduation? 2 A. I entered the military and served three 3 years and, upon leaving the military, I went to 4 work here in Houston at American General 5 Corporation, 1976. 6 Q. And what were you hired to do there? 7 A. I was a private placement assistant. 8 Later, the director of private placements. 9 Q. What is the private placement area at 10 American General? 11 A. It consisted of financial analysis and 12 the monitoring of privately placed investment 13 portfolios that were in place at the company and 14 those that were acquired later. 15 Q. What do you mean by "private placement 16 portfolios"? 17 A. These were securities that were 18 directly placed under some exemption to securities 19 laws, primarily to insurance companies. 20 Q. And you evaluated those placements on 21 behalf of American General? Is that -- 22 A. That's correct. 5015 1 Q. And for how long did you do that? 2 A. I was there eight years. 3 Q. And what year was it that you left? 4 A. 1984. 5 Q. And then where did you go? 6 A. I was with Southmark Financial, which 7 is a subsidiary of Southmark Corporation. 8 Q. And what was your position there? 9 A. I was an analyst and portfolio manager. 10 Q. What kind of a portfolio? 11 A. That portfolio consisted of US treasury 12 securities and corporate bonds. 13 Q. Was that high-yield bonds? 14 A. Yes, it was. 15 Q. Now, with regard to the portfolios that 16 you were reviewing at American General, were those 17 similar to that? 18 A. Yes. 19 Q. Were they corporate bonds, high-yield 20 corporate bonds? 21 A. Yes, they were. 22 Q. Now, when did you leave Southmark? 5016 1 A. In July of 1984. 2 Q. Who did you work for at Southmark? 3 A. I worked for Jim Sullivan. 4 Q. Who was Mr. Sullivan? 5 A. He was a colleague of mine at American 6 General who had left and started this subsidiary 7 under Southmark to manage corporate assets, as 8 well as other kinds of investments they might 9 undertake. 10 Q. So, these were investments for 11 Southmark that you were -- he was managing? 12 A. For Southmark or its subsidiaries. 13 Q. Okay. And at American General, were 14 those assets that were managed for American 15 General or evaluated for American General? 16 A. Yes, that's correct. 17 Q. Not for clients of either of the 18 entities? 19 A. Yes. Not for clients. 20 Q. Now, how did you come into contact with 21 the people at United Savings Association of Texas? 22 A. I was introduced by Jim Sullivan. 5017 1 Q. Who did he introduce you to? 2 A. He introduced me to Charles Hurwitz and 3 Ron Huebsch. 4 Q. And when was that? 5 A. That would have been in August of 1984. 6 Q. Did he indicate to you before he had 7 introduced you to them that they were looking for 8 someone with your background? 9 A. He suggested at the time that they 10 might be looking for -- to develop a team of 11 investment people and that he, too, might -- the 12 two of us might go there at the same time. 13 Q. Why were you looking for an alternative 14 position at the time? 15 A. Well, our position at Southmark had 16 been abolished and we had -- the operation had 17 been shut down and we were looking for work. 18 Q. Why was the operation shut down? 19 A. Well, Mr. Sullivan was our primary 20 contact with Southmark. We were located in 21 Houston. That company was in Dallas. He was 22 dismissed and his staff was disbanded. 5018 1 Q. And why was he dismissed? 2 A. I'm not sure. 3 Q. Did it have anything to do with the 4 performance of the portfolio? 5 A. It could have been a factor. 6 Q. What do you mean "it could have been"? 7 A. He had a number of issues with people 8 within Southmark that -- interpersonal 9 relationships. He had difficulties getting along 10 with certain people in Southmark. He didn't have 11 a great deal of support. 12 Q. And how had the portfolio performed at 13 the time he was dismissed? 14 A. It had performed poorly. 15 Q. Now, did you meet with Mr. Hurwitz and 16 Mr. Huebsch after Mr. Sullivan suggested that you 17 might meet with them? 18 A. Yes. I recall that the two of us met 19 with them and that sometime later, I was called 20 and asked to return alone. 21 Q. And who called you to come back to 22 meet? 5019 1 A. It would have been Ron Huebsch. 2 Q. And in your discussions with Mr. 3 Huebsch, what position did you discuss with him? 4 A. I discussed with him the position of an 5 investment manager. 6 Q. Did you -- what investments did you 7 discuss with him? 8 A. I discussed investments in high-yield 9 bonds. 10 Q. Junk bonds? 11 A. That's correct. 12 Q. Did you discuss any other investments? 13 A. No. 14 Q. Now, in your meetings with Mr. Hurwitz, 15 what investments did you discuss with him? 16 A. I discussed high-yield bonds. It was 17 the same meeting. It was only one meeting with 18 the two of them present. 19 Q. Uh-huh. So, you discussed the same 20 sorts of things. Did they indicate to you what 21 they were looking for in terms of investments in 22 high-yield bonds? 5020 1 A. They were looking for a person to 2 manage an investment portfolio in high-yield 3 bonds. 4 Q. Did they indicate to you how high 5 that -- the size of the portfolio that they were 6 looking for someone to manage? 7 A. No, they did not. 8 Q. Did they indicate that it was sizable? 9 A. No, they did not. 10 Q. Did they indicate on whose behalf they 11 wanted someone to manage the portfolio? 12 A. I was aware that it was for United 13 Savings. I don't know if they mentioned it. 14 Q. How were you aware that it was for 15 United Savings? 16 A. Through discussions with Jim Sullivan. 17 Q. And what did he tell you about the USAT 18 high-yield bond portfolio? 19 A. He didn't know anything about it. 20 Q. But he indicated to you that it was for 21 USAT? 22 A. Yes. 5021 1 Q. Now, what was their reaction to the 2 interview that you had with Mr. Huebsch and 3 Mr. Hurwitz? 4 A. I was asked to meet with Jerry Williams 5 and others at the United Savings offices sometime 6 later. 7 Q. Did they indicate to you why they 8 wanted you to do that? 9 MR. KEETON: Your Honor, I object. He 10 keeps saying "they," and the witness has already 11 testified it's only Mr. Huebsch that called him 12 back. 13 MR. GUIDO: He indicated that he met 14 with Mr. Huebsch and Mr. Hurwitz. I will clarify 15 that. 16 MR. KEETON: Okay. Thank you. 17 Q. (BY MR. GUIDO) Did Mr. Huebsch and 18 Mr. Hurwitz tell you why they wanted you to meet 19 with Jerry Williams or Michael Crow? 20 MR. KEETON: I object. That's not the 21 witness' testimony. 22 THE COURT: Well, let's have the 5022 1 answer. 2 A. It was my understanding that 3 Mr. Williams was the president of the association 4 and that I would have to meet with him in order 5 for this interview process to be complete. 6 THE COURT: Who asked you to do that? 7 THE WITNESS: I believe I was called 8 directly by Mister -- by Mr. Williams. 9 Q. (BY MR. GUIDO) Now, what position did 10 Mr. Huebsch hold at USAT at that time? 11 A. None that I know of. 12 Q. What position did Mr. Hurwitz hold at 13 USAT at that time? 14 A. None. 15 Q. For whom did Mr. Huebsch work at that 16 time? 17 A. Mr. Huebsch worked for Federated 18 Development Company, which is one of Mr. Hurwitz's 19 company's. 20 Q. And who did Mr. Hurwitz work for at 21 that time? 22 A. I don't know. 5023 1 Q. Now, when did you start at USAT? 2 A. I began work in September 1984. 3 Q. September 1984? 4 A. That's correct. 5 Q. I'd like you to take a look at a series 6 of documents starting with B355. It's a letter 7 dated July 23, 1984, to Mr. L.A. Anderson and it 8 is -- and also Exhibit B356 -- B356, which is a 9 letter from Mr. Anderson to Mr. Bentley dated 10 July 24, 1984; Exhibit B370, which is a letter 11 dated September 20th, 1984, to C.E. Bentley; 12 exhibit -- those three exhibits. They are Tabs 13 160 through 162. And also, Exhibit B371, which is 14 dated September 24th, 1984, and it's a memorandum 15 from Joe Phillips to Gerald Williams. And that's 16 Tab No. 163. 17 Have you had a chance to look at that 18 packet of documents, Mr. Phillips? 19 A. I have seen part of the documents in 20 Exhibit B355, certain schedules that are attached 21 to the letter. I had not seen the letter on top 22 before. 5024 1 Q. Do those documents describe high-yield 2 bonds or junk bonds that were held by United 3 Savings Association of Texas upon your arrival? 4 A. The securities described here were 5 purchased or held upon my arrival. 6 Q. Okay. 7 A. Purchased prior to or held upon my 8 arrival. 9 Q. Do you know who purchased those 10 securities? 11 A. I do not. 12 Q. Okay. Did you discuss any of those 13 securities with Mr. Huebsch when you met with him 14 before being hired? 15 A. I did not discuss any of these with him 16 before being hired. 17 Q. Did you discuss with Mr. Hurwitz any of 18 these securities prior to being hired? 19 A. No, I did not. 20 Q. When you met with Mr. Huebsch and 21 Mr. Hurwitz, did they indicate to you who had -- 22 that USAT had had junk bonds on its portfolio? 5025 1 A. Yes, they did. 2 Q. Did they tell you how they had gotten 3 in that portfolio? 4 A. No, they did not. 5 Q. Now, you then, at least as of 6 September 24th, 1984, became employed by United 7 Savings Association of Texas as reflected in 8 Exhibit B371? That is Tab No. 163. Is that 9 correct? 10 A. Yes, that's correct. 11 Q. Now, did you discuss with Mr. Huebsch 12 any of those junk bonds that are listed in that 13 attachment to that exhibit? 14 A. I recall preparing these schedules and 15 these attachments and discussing them with Mr. 16 Huebsch and others. 17 Q. Did -- how did you learn about the 18 existence of these securities in USAT's portfolio? 19 A. I understood that some securities were 20 held before I arrived and that when I got there, I 21 was shown reports or schedules that contained 22 listings of these holdings. 5026 1 Q. Who showed you those listings? 2 A. Ron Huebsch. 3 Q. And where was Ron Huebsch employed at 4 that time? 5 A. He was with the -- with the Federated 6 companies. 7 Q. Now, when did he become an officer or 8 an employee of United Savings Association or 9 United Financial Group? 10 A. I don't know the exact date, but it was 11 sometime after my arrival. 12 Q. Okay. Was it some months after your 13 arrival? 14 A. Yes. 15 Q. Now, who did Mr. Huebsch report to at 16 the time you became an employee of USAT? 17 A. He reported to Mr. Hurwitz. 18 Q. Now, take a look at Exhibit B398 and 19 Exhibit B405. Those are Tabs 164 and 165. B398 20 is a letter from Mr. Bentley to Mr. Bowman dated 21 December 6th, 1984. And B405 is a memorandum from 22 you to a number of people dated December 12th, 5027 1 1984. 2 Now, that lists a number of purchases 3 of fixed rate corporate documents, B398. Do you 4 see that? 5 A. Yes, I do. 6 Q. Did you initiate those purchases? 7 A. I initiated some of these purchases. 8 Q. Okay. And did anyone else initiate 9 others of those purchases? 10 A. Yes. 11 Q. Which ones? 12 A. The floating rate issues on the third 13 page of Exhibit B398. 14 Q. That is the Occidental Petroleum, Ba, 15 MDC Corp., B, Mesa Petroleum, Baa, I think is what 16 that says, Coastal Corp., Kaufman & Broad, 17 Continental Illinois, LTV Corporation? 18 A. Yes, that's correct. 19 Q. Who initiated those? 20 A. I don't know. 21 Q. You don't know? 22 MR. EISENHART: Your Honor, I think 5028 1 there is some confusion. I'm sure it's 2 inadvertent. Mr. Guido's original question was 3 premised on this letter reporting securities 4 purchased, and he then asked the witness if he had 5 been involved in the securities that were 6 purchased. The witness then referred him to a 7 portfolio listed on the third page, which I'm not 8 sure did contain securities purchased versus those 9 already owned. I think there is some confusion. 10 Q. (BY MR. GUIDO) When you made a 11 reference to the third page, were those securities 12 that were purchased after you arrived at USAT? 13 A. This third page is a listing of 14 holdings, and the fixed rate issues at the bottom 15 are those that I would have purchased. 16 Q. Okay. And the ones at the top of the 17 page, were those purchased after you arrived at 18 USAT? 19 A. They were not. 20 Q. Okay. They were previously in the 21 portfolio? 22 A. Yes, that's correct. 5029 1 Q. Now, with regard to those on the third 2 page that were purchased, did you make the 3 decision to purchase those without approval of the 4 specific purchases from anyone else? 5 A. I don't recall that I acted without any 6 approval. I discussed these routinely with both 7 Ron Huebsch and with Mr. Williams at United. 8 Q. Okay. 9 A. And, I would add, Mr. Crow. 10 Q. So, is it your testimony that prior to 11 initiating these transactions, you discussed them 12 with Mr. Williams, Mr. Crow, and Mr. Huebsch? 13 A. Yes. 14 Q. And where was Mr. Huebsch employed at 15 that time? 16 A. Mr. Huebsch was employed at Federated. 17 Q. Now, look at the letter dated 18 December 12th, Exhibit B405. It's a memorandum 19 from you to distribution and it lists -- you see 20 the distribution list? It lists Mr. Huebsch. 21 Do you see that? 22 A. Yes. 5030 1 Q. Where was Mr. Huebsch employed at that 2 time? 3 A. I said I'm not sure when Mr. Huebsch 4 became an officer, but it's very likely he was 5 still employed exclusively at Federated at this 6 time. 7 Q. Now, what was the issue that prompted 8 this -- the preparation of this memorandum? 9 A. The management of United Savings 10 believed that approval by the state commissioner 11 was required before purchase of these securities. 12 Q. Now, is this a recordation of your 13 discussions with Mr. Anderson? 14 A. Yes, it is. 15 Q. And it purports to report that you 16 described your junk bond program with him. 17 Did you discuss the junk bond program 18 with Mr. Anderson as reflected in that memorandum? 19 A. Yes, I did. 20 Q. And what did you tell him that program 21 was? 22 A. I told him that we would invest in 5031 1 high-yield corporate bonds that I would select and 2 evaluate for value, and that we would fund those 3 purchases with liabilities of matching duration. 4 Q. What did you mean by you would "fund 5 them with matching duration"? 6 A. The association had begun a program of 7 selling longer term CDs that were longer than the 8 maturities typically offered. And these had 9 maturities long enough to create duration or 10 interest rate sensitivity that would match those 11 of these corporate bonds. 12 Q. Now, how did you know what the duration 13 of the corporate bond was? Were these a fixed 14 duration corporate bond? 15 A. Well, they had a duration that was 16 calculated periodically and it was not a fixed 17 duration because it would change with market 18 prices. It would change with yields. It would 19 change with the passage of time. We'd calculate 20 these at the outset, and we'd calculate them every 21 time we made a report. 22 Q. Was that calculated off the maturity 5032 1 date of those bonds? 2 A. The maturity date is a variable in the 3 calculation. 4 Q. Okay. 5 A. But it's not by any means tied to the 6 maturity of the issue. 7 Q. Now, this -- look at the discussion 8 section. It says you presented him with a list of 9 non-liquidity portfolio and "a sample of the asset 10 liability matching analysis that I proposed for us 11 internally." 12 Do you see that? 13 MR. NICKENS: "For use internally." 14 MR. GUIDO: Oh, "for use internally." 15 Excuse me. 16 Q. (BY MR. GUIDO) Do you see that 17 sentence? 18 A. Yes. 19 Q. What was the asset liability matching 20 analysis that you proposed for USAT internally 21 that's referred to there? 22 A. There's not an example attached to 5033 1 this, but it would consist of a schedule in which 2 the durations of all of the CDs were calculated 3 and summarized. And then below that, there would 4 be a list of the bonds and their durations which 5 would be calculated and summarized, extended into 6 dollars, and then those two numbers would be 7 offset to calculate the degree of match or 8 mismatch. 9 Q. Now, the next sentence says "I told 10 Mr. Anderson that we would manage the maturity 11 matching as well as the spread on this new 12 business component." 13 Do you see that? 14 A. Yes. 15 Q. Can you tell us what you told him you 16 would do in terms of managing the maturity 17 matching? 18 A. I told him that we would prepare a 19 report similar to the one I presented him, and we 20 would prepare it periodically to determine whether 21 these assets and liabilities had remained matched 22 through the passage of time or through changes in 5034 1 interest rates. 2 Q. Okay. And what did you mean when you 3 said that you would manage the spread on this new 4 business component? What did that refer to? 5 A. The portfolio objective was to earn a 6 protected spread, a spread protected by this match 7 so that interest rate movements would not affect 8 the return potential of the portfolio over time. 9 And in so doing, we would keep the portfolio 10 balanced as the durations might change or shift 11 and that the spread would be the objective. 12 Q. So that you would look to the yield, 13 the net interest spread between the cost of funds, 14 the CDs, and these high-yield bonds? 15 A. That's correct. 16 Q. And that's what you would attempt to 17 manage? 18 A. Yes. 19 Q. Okay. And that's what you would look 20 to to determine whether or not you needed to 21 adjust the portfolio for changes in circumstances? 22 A. No, that's not correct. I wouldn't 5035 1 look to the spread for the adjustment. I would 2 look to the match of the durations extended into 3 dollar amounts to see if they were equal or close. 4 Q. All right. But all with a eye toward 5 maintaining the spread that you had initially 6 established as your target? 7 A. That's correct. 8 Q. Now, who did you report to the first 9 six months in which you were employed by USAT to 10 manage its junk bond portfolio? 11 A. I reported directly to Gerald Williams. 12 Q. Now, did you informally report to 13 anyone else? 14 A. I consulted on virtually everything 15 with Ron Huebsch. 16 Q. What do you mean you consulted with Ron 17 Huebsch? 18 A. He had set up a trading room in the 19 offices of Federated Development and we had hired 20 a trader to monitor all secondary market offerings 21 and pricing and to inform us of new issues. And 22 he had an office adjacent to that and was very 5036 1 well-informed as to securities markets. And so, 2 it was a very valuable consultation. 3 Q. Where -- that was in the MCO building? 4 Is that -- 5 A. That's correct. 6 Q. And where was that located in 7 relationship to Mr. Hurwitz's office? 8 A. It was at the opposite end of the 9 floor, of the suite I should say. 10 Q. Did it have a common entryway? 11 A. Yes, it did. 12 Q. Did it have a common anteroom? 13 A. Yes. 14 Q. Physically, how far was that trading 15 room from Mr. Hurwitz' office? 16 A. It would have been the equivalent of 17 five or six office spaces approximately. I don't 18 know how many feet. 19 Q. Five or six doors down? 20 A. Yes. 21 Q. Now, did you also have an office in 22 that trading facility? 5037 1 A. I had an office in that suite. 2 Q. Okay. Were you employed by MCO? 3 A. No, I was not. 4 Q. Were you employed by Federated? 5 A. No. 6 Q. Did you manage any portfolios for MCO? 7 A. No, I did not. 8 Q. Did you manage any portfolios for 9 Federated? 10 A. No. 11 Q. How much time did you spend in that 12 office? 13 A. I spent approximately a third of my 14 time in those offices. 15 Q. And what was it that you did while you 16 were in those offices? 17 A. While I was there, I would review the 18 trader's logs to see what she had been shown that 19 day, to understand what new issues might be coming 20 to market, speaking with Mr. Huebsch about the 21 market, and reviewing strategy with him. 22 Q. Now, you mentioned a trader's log. 5038 1 What was that trader? 2 A. The trader was named Lauren Jordan. 3 Q. And what was her responsibility? 4 A. She received phone calls from the -- 5 from the bond dealers and she recorded securities 6 offerings and bids and would post prices, market 7 value prices on securities we held and generally 8 keep us informed as to what was going on in the 9 securities markets. 10 Q. By whom was she employed? 11 A. She was employed by United Savings. 12 Q. Okay. And she was housed at MCO? 13 A. That's correct. 14 Q. And the log that she kept, that was of 15 junk bonds, was it not? 16 A. Yes, it was. 17 Q. Now, did MCO purchase junk bonds? 18 A. No, they did not. 19 Q. Did Federated purchase junk bonds? 20 A. No. 21 Q. Did any of their subsidiaries, other 22 than UFG or subsidiaries of UFG, purchase junk 5039 1 bonds? 2 A. Not that I know of. 3 Q. Now, take a look at the document T4061, 4 which is a memo from Ron Huebsch to Gerald 5 Williams dated March 29th, 1984. It is Bates 6 stamped T4061 -- I mean Exhibit No. T4061. 7 MS. BOTTICELLI: Have these already 8 been introduced? 9 MR. GUIDO: These have already been 10 introduced. That's why I said "tab number." I 11 didn't say the tab number? It's Tab No. 173. 12 Q. (BY MR. GUIDO) At some point in time, 13 did you shift the office that you had at USAT over 14 and combine it with the office that you had in the 15 MCO building in the trading room? 16 A. Yes, I did. 17 Q. And was that part of what was referred 18 to as the investment facility? 19 A. I haven't heard that term used. 20 Q. Okay. What term had you heard used in 21 reference to the investment department? 22 A. I don't believe I heard it 5040 1 characterized as any department. We worked for 2 United, and we used the trading room facilities in 3 the MCO building. 4 Q. Was that referred to as the trading 5 floor? 6 A. I recall more often that it was 7 referred to as the trading room. 8 Q. And is that the same room, after you 9 moved your other office over to the MCO building, 10 that existed at the time that you had offices in 11 both places? 12 A. Yes, I believe it was. 13 Q. And was it still a room that was 14 located in what you referred to as Charles 15 Hurwitz' suite? 16 A. Yes. 17 Q. And is it a room that shared an 18 anteroom with the other offices in Charles 19 Hurwitz' suite? 20 A. Yes. 21 Q. Who were the people working out of that 22 trading room at the time you moved your second 5041 1 office into that suite? 2 A. By that time, Ms. Jordan was there. 3 Ms. Jacobs, who was a trading assistant, was 4 there. Clint Carlson was an equity trader and 5 investor -- investment officer, and he also was 6 there. 7 Q. Now, did anyone have responsibility for 8 trading the junk bonds in the secondary market? 9 A. Yes. 10 Q. Who was that? 11 A. Ms. Jordan. 12 Q. And what was your responsibility? 13 A. I would select and evaluate the 14 offerings and from time to time, of course, give 15 her an order to execute and purchase or sell 16 securities. 17 Q. Was your responsibility to evaluate 18 initial offerings? 19 A. Yes, it was. 20 Q. As opposed to evaluate securities, junk 21 bonds, that were in the secondary market? 22 A. No, not as opposed to. In addition to. 5042 1 Q. Okay. Whose responsibility was it to 2 make recommendations to purchase securities in the 3 secondary market? 4 A. Mine. 5 Q. And whose responsibility was it to make 6 recommendations to purchase initial public 7 offerings of junk bonds? 8 A. That was also mine. 9 Q. Now, whose approval was necessary 10 before you could initiate a purchase of an initial 11 public offering? 12 MR. EISENHART: Your Honor, may we know 13 the point in time in which we're talking? 14 MR. GUIDO: We're talking about post 15 the combination of the two offices. I'm sorry. 16 THE COURT: Do we have a date for that? 17 Q. (BY MR. GUIDO) Do you have a date for 18 that, Mr. Phillips? 19 A. No, I don't. 20 Q. Was that sometime in early 1985? 21 A. I don't recall when they consolidated 22 the offices. 5043 1 Q. When you say "consolidated the 2 offices," when USAT also moved all of its other 3 offices over to the MCO building? Is that what 4 you mean? 5 A. Yes, that's what I mean. 6 Q. So, it's whatever that date was is what 7 you're talking about? 8 A. Yes. 9 Q. Now, at that point in time, to whom did 10 you make the recommendation? 11 A. Prior to the creation of the committee 12 that was later formed, I would make 13 recommendations to Messrs. Huebsch, Williams, and 14 Crow routinely. And it was less formal at the 15 outset and we later developed a fact sheet format 16 for distributing the information. 17 Q. Okay. When you say "the committee," 18 are you referring to the investment committee? 19 A. Yes. 20 Q. Was the investment committee created 21 sometime around April of 1986, to your knowledge? 22 A. I don't recall the date. 5044 1 Q. Did the investment committee have 2 minutes of its meetings from the point in time 3 that it was created? 4 A. Yes, it did. 5 Q. So, whatever the date of the first 6 investment committee minutes are, that would be 7 the date that the investment committee was 8 created? 9 A. Yes. 10 Q. When you made your recommendations to 11 this informal committee, did that also include 12 Charles Hurwitz? 13 A. He might be aware of what I was looking 14 at and discussing. It would not routinely include 15 him for approval. 16 Q. But there were times in which you did 17 discuss junk bond purchases with him prior to them 18 being initiated? 19 A. I'm sure I did. He was often on the 20 premises. 21 Q. How often did he visit the trading 22 room? 5045 1 A. Since it was in his suite, he was 2 there -- he would walk in once a day at least, 3 look at information services and monitors to see 4 what the markets were doing. 5 Q. Did he ever discuss any matters with 6 any of the individuals in that suite? 7 A. I'm not sure what you mean by 8 "matters." 9 Q. Did he discuss investments with any of 10 you? 11 A. Yes. 12 Q. Were there some times that he was there 13 more than half a dozen times a day? 14 A. Yes. 15 Q. Would you say that he was there 16 frequently? 17 A. He was there frequently. 18 Q. Now, did you have any discussions with 19 Barry Munitz with regard to investments prior to 20 the creation of the investment committee? 21 A. No. I would say I did not. 22 Q. Now, where were Barry Munitz' offices? 5046 1 A. He had an office adjacent to 2 Mr. Hurwitz's office. 3 Q. So, he was in the same suite, as well? 4 A. Yes, that's correct. 5 Q. Now -- and where did Mr. Huebsch have 6 an office? 7 A. Mr. Huebsch's office was next door to 8 the room that was developed into the trading room. 9 Q. Okay. Now, other than the people that 10 you mentioned who were the traders with yourself 11 and Mr. Huebsch, Mr. Munitz, Mr. Hurwitz, who else 12 was housed in that suite or officed in that suite? 13 A. Mr. Hurwitz had an office manager and 14 two or three bookkeepers that worked in that area. 15 Q. Anyone else? 16 A. No. 17 Q. Where was Jerry Williams? 18 A. Mr. Williams' offices were at United 19 Savings, either at the Harwin location or in the 20 MCO building on a different floor when they moved 21 there. 22 Q. Okay. How many floors away was he? 5047 1 A. I don't recall. 2 Q. Now, during the period of time that you 3 managed the junk bond portfolio, what percentage 4 of the junk bonds were initial public offerings? 5 A. I don't recall the percentage, but it 6 was a substantial proportion. 7 Q. More than 70 percent? 8 A. It could have been as much as 60 or 9 70 -- 10 MR. EISENHART: Your Honor, I'm not 11 sure what he's talking about here. Is he talking 12 about the market as a whole or the bonds that were 13 being purchased by USAT? 14 MR. GUIDO: I'm talking about -- I 15 thought the question was clear. The question is: 16 What percentage of the high-yield bonds that were 17 purchased by USAT were purchased as initial public 18 offerings? Is that clear enough? 19 MR. EISENHART: That's perfectly clear, 20 Your Honor. I didn't hear the qualifying clause 21 the first time. 22 A. That proportion could have been as high 5048 1 as 60 or 70 percent. 2 Q. (BY MR. GUIDO) Now, what portion of 3 initial public offerings, during the period of 4 time that you were there, were underwritten by 5 Drexel Burnham Lambert? 6 A. A very large proportion. 7 Q. And what do you mean by "large 8 proportion"? 9 A. Substantially more than 50 percent, but 10 I don't know the exact percent. 11 Q. So, more than 50 percent of the initial 12 public offerings were Drexel Burnham Lambert? 13 A. Yes. 14 Q. Now, did Charles Hurwitz, when you 15 discussed with him the purchase of junk bonds 16 prior to initiating the purchase, express his 17 views regarding your proposal? 18 A. Well, I did not routinely discuss them 19 with him. But he would express views as to 20 positions we held or positions we might intend to 21 buy. 22 Q. How often did he do that? 5049 1 A. Infrequently. 2 Q. Okay. Now, did he ever express his 3 objection to any purchases that had been made? 4 A. Yes, he did. 5 Q. Was one of those with regard to an 6 entity called Minstar? 7 A. Yes. 8 Q. And what was his objection with regard 9 to Minstar's acquisition? 10 A. He characterized it as somewhat of a 11 blind pool that was not a real business company. 12 Q. And did he object to any other 13 purchases that had been made? 14 A. He objected to the investment in one of 15 the new Atlantic City casino bonds that was 16 created, but I don't know which one. 17 Q. Did he indicate why he objected to 18 that? 19 A. He didn't think that it represented 20 good value. 21 Q. Now, with regard to those two 22 situations, was Mr. Hurwitz an officer of USAT at 5050 1 the time? 2 A. He was not. 3 Q. Did Mr. Hurwitz ever convey to you 4 conversations that he had had with Michael Milken 5 regarding offerings that Drexel Burnham Lambert 6 had underwritten? 7 A. Yes, he did. 8 Q. Can you tell us what those 9 conversations or conversation was? 10 A. I recall one in which he called 11 Mr. Hurwitz directly and, in effect, complained 12 about a new securities offering that we were 13 declining to participate in. 14 Q. When you say "he," who are you 15 referring to? 16 A. Michael Milken called Mr. Hurwitz. 17 Q. And how do you know that he had called 18 Mr. Hurwitz? 19 A. Mr. Hurwitz told me so. 20 Q. So, Mr. Hurwitz conveyed to you the 21 conversation that he had had with Michael Milken? 22 A. Yes. 5051 1 Q. And he indicated that Michael Milken 2 said what? 3 A. He had said that we should purchase 4 this bond and it would -- that it would be a 5 mistake. We weren't looking at it correctly, and 6 we should purchase it. 7 Q. Did anyone ever tell you that Michael 8 Milken was going to have that conversation? 9 A. I recall that the salesman may have 10 told me in advance. 11 Q. What was the context of that? 12 A. The salesman told me that Michael 13 Milken was annoyed that we weren't buying the bond 14 and that he was going to call Charles. 15 Q. Was that in a conversation in which the 16 salesman was attempting to convince you to 17 purchase the bond? 18 A. No, I don't think so. I spoke to the 19 salesman quite regularly. He would have known 20 before then that we weren't going to purchase it. 21 Q. And who was that salesman? 22 A. That was David Birdman. 5052 1 Q. Okay. And what was his role with 2 regard to USAT's dealings with Drexel Burnham 3 Lambert? 4 A. He was the salesman of Drexel assigned 5 to our account. 6 Q. And where was he located? 7 A. He was located in their Los Angeles 8 offices. 9 Q. Was he your -- or USAT's customer rep? 10 A. Yes. 11 Q. Do you know to whom he reported? 12 A. He reported to Michael Milken. 13 Q. Now -- 14 THE COURT: Mr. Guido, it's about time 15 to break for lunch. I wanted to raise a point. 16 Earlier, counsel had indicated that we would 17 complete this witness today. 18 Is that still your intent? 19 MR. GUIDO: Well, Your Honor, that was 20 based on the assumption that we were going to 21 start at 9:00 o'clock. I am going to try and 22 collapse this testimony as much as possible. I 5053 1 don't know whether or not I can do that. 2 Mr. Nickens indicates that he needs three hours to 3 complete this witness. 4 MR. NICKENS: Your Honor -- 5 MR. GUIDO: It's not optimistic that we 6 will complete this witness today. 7 MR. NICKENS: When we raised this with 8 you yesterday, we were trying to make arrangements 9 so that we could finish Mr. Phillips today because 10 he has been in town waiting. However, it is plain 11 to me that we are not going to finish him today 12 within the time constraints that we have and so 13 that he would unfortunately have to come back on 14 Monday. 15 And I wanted to raise with you whether 16 we ought to revisit the question of the 17 scheduling. My expectation is -- and based on my 18 conversations with Mr. Guido -- is that he will 19 finish somewhere around 3:30 or 4:00 o'clock this 20 afternoon. Obviously, we would not finish. It 21 makes a difference to some people traveling as to 22 whether we quit at 4:00 or whether we quit at 5054 1 5:00. I believe that Washington flights are sort 2 of on that schedule. And so, you know, I don't -- 3 I'm -- I will happily take up whenever Mr. Guido 4 finishes and go as far as I can or, if we want to 5 stop at the end of Mr. Guido's examination, 6 assuming it occurs at about that time frame, 7 that's okay with us, as well. 8 THE COURT: Well, that was a thought in 9 my mind, that perhaps if we're not going to finish 10 with him today, I would like to conclude a little 11 earlier. We obviously have a lot of documents and 12 we may have a lot of off-the-record work to do 13 even after we adjourn. So, it would be my thought 14 we would quit a little earlier than I had 15 indicated yesterday. 16 MR. NICKENS: Okay. 17 THE COURT: If Mr. Guido -- 18 MR. GUIDO: Your Honor, I mean, I just 19 have to come back on Monday, but that -- and 20 Mr. Phillips does, but that's fine. 21 THE COURT: It looks like you will 22 anyway. If we can finish him today, I would go 5055 1 beyond that; but I don't think we will, and I 2 expect that we should quit then. 3 MR. GUIDO: Thank you. 4 THE COURT: We'll adjourn until 1:30. 5 6 (Luncheon recess taken at 11:45 a.m.) 7 8 THE COURT: Be seated, please. We'll 9 be back on the record. 10 MR. STEARNS: Your Honor, Mr. Guido is 11 out of the courtroom. Here he is. 12 (1:33 p.m.) 13 Q. (BY MR. GUIDO) Mr. Phillips, how were 14 you presented with initial offerings of the junk 15 bonds that you purchased for United Savings 16 Association of Texas? 17 A. We were typically notified by telephone 18 by our salesman that a new issue would be brought 19 to market. Very often, a road show would be 20 scheduled for the Houston investment community; 21 and that would take place at some restaurant or 22 public place where the company issuing the 5056 1 securities would present itself and the structure 2 of the transaction and give people a chance to ask 3 questions about the company and then take their 4 prospectuses and decide whether to purchase them. 5 Q. Now, did you receive the calls from the 6 salesmen that -- 7 A. Yes, I did. 8 Q. Did anyone else? 9 A. It's very possible our trader would 10 have been notified of these same meetings simply 11 because she spoke to the same salesmen regarding 12 the market. 13 Q. Did you have discussions with Mr. 14 Huebsch about the road shows that you had been 15 invited to? 16 A. Yes. 17 Q. Did you have discussions with 18 Mr. Hurwitz about the road shows you had been 19 invited to? 20 A. Yes. 21 Q. Now, in those discussions, did you 22 discuss the companies that were making the 5057 1 presentations in those road shows? 2 A. Yes. 3 Q. In those discussions, did you have 4 discussions about the underwriters that were doing 5 the underwriting for the companies that were 6 making the presentations in those road shows? 7 A. It was always known who the underwriter 8 was; so, I don't think there was ever anything to 9 discuss. It was typically known who was bringing 10 the deal to market. 11 Q. Now, before you attended the road 12 shows, did you receive any materials from the 13 salesmen? 14 A. Sometimes the preliminary prospectuses 15 would arrive before the road show. Very often, 16 they would be distributed at that time. 17 Q. Now, when you received the prospectuses 18 for those initial offerings, did you have copies 19 made and distributed? 20 A. No. 21 Q. No? You just kept them yourself? 22 A. That's correct. 5058 1 Q. And you didn't share those prospectuses 2 with anyone? 3 A. No. I would provide them upon request 4 if anyone asked me about them. 5 Q. Did Mr. Huebsch ask you about them? 6 A. I don't recall a specific instance, but 7 it's possible that he may have wanted to look at 8 one. 9 Q. Did you prepare summaries of those 10 prospectuses when you received them? 11 A. Yes. 12 Q. Did you circulate those? 13 A. Yes. 14 Q. To whom did you circulate those prior 15 to the creation of the investment committee? 16 A. Mr. Williams, Mr. Crow. Mr. Huebsch 17 would have seen those. 18 Q. Was Mr. Hurwitz one of the people you 19 circulated them to? 20 A. I would not have routinely circulated 21 them to him. 22 Q. Okay. Now, when the investment 5059 1 committee was formed, did you circulate that 2 information to the members of the investment 3 committee? 4 A. Yes. 5 Q. And do you recall who the members of 6 the investment committee were? 7 A. That list would have included 8 Mr. Williams, Mr. Crow, Mr. Huebsch, Bruce 9 Williams. I believe that's all. 10 Q. Was Mr. Munitz on the investment 11 committee? 12 A. I don't recall. 13 Q. Was Mr. Hurwitz? 14 A. I believe he was not. 15 Q. Did he attend the investment committee 16 meetings? 17 A. Yes, he did. 18 Q. But you don't know whether he was 19 formally or not a member of the committee? 20 A. I believe that he was not a member. 21 Q. If the minutes of the board of 22 directors indicate that he was a member of the 5060 1 investment committee, would you have any reason to 2 dispute their accuracy? 3 A. No. 4 Q. Was Mr. Hurwitz a member of the UFG 5 investment committee? 6 A. I don't know that there was such a 7 committee. 8 Q. Now, do you know Art Bilger? 9 A. I know who he is. 10 Q. And who is he? 11 A. He was -- at the time I knew him, he 12 was an investment banker. 13 Q. Did you know any of the entities that 14 he was preparing underwritings for? 15 A. No. 16 Q. Do you know where he was employed? 17 A. He was employed at Drexel. 18 Q. Do you know whether or not Art Bilger 19 had done any underwriting for MCO or MAXXAM? 20 A. I did not know. 21 Q. Did you ever see him at MCO? 22 A. No. 5061 1 Q. Did you ever meet him? 2 A. I believe I did meet him. I believe I 3 did meet him one time. 4 Q. Do you recall when you met him? 5 A. It would have been at the Drexel 6 high-yield bond conference. 7 Q. Who invited you to that? 8 A. My salesman. 9 Q. What year was that? 10 A. I attended -- I attended in '84, '85, 11 and '86. 12 Q. And it would have been at one of those 13 meetings? Is that when you met Art Bilger? 14 A. Yes. 15 Q. Who introduced you to him? 16 A. I don't know. 17 Q. Were you with anyone when you met Art 18 Bilger? 19 A. I don't think so. 20 Q. Had you known him before that? 21 A. No. 22 Q. How did you meet him, then? 5062 1 A. I was introduced -- I was introduced to 2 him at that conference by someone. 3 Q. Was it someone from USAT? 4 A. I would expect it would be someone from 5 Drexel. 6 Q. From Drexel? 7 A. Yes. 8 Q. Do you recall how they described him? 9 A. I already knew that he was an 10 investment banker. I don't think anyone described 11 him to me. 12 Q. How did you know he was an investment 13 banker? 14 A. He had introduced a presenter at the 15 conference earlier, and that's what the investment 16 bankers did. 17 Q. Did you ever meet him in any road 18 shows? 19 A. I feel that he must have conducted road 20 shows during the Drexel high-yield offerings. I 21 don't recall whether I attended one that he 22 conducted. 5063 1 Q. Now, were junk bonds sold out of the 2 USAT portfolio to generate gains? 3 A. Yes. 4 Q. Why was that? 5 A. Well, there were two reasons primarily. 6 One is in the ordinary course of managing an 7 actively managed portfolio, there would be reasons 8 to take realized gains. We might determine the 9 security was overvalued or that its credit 10 position may be weakening and there were reasons 11 to get out of it. 12 There were also occasions in which we 13 were asked to realize gains for reporting 14 purposes. 15 Q. Look at -- let me show you -- I want to 16 show you three documents. One is Exhibit 4192 17 which is dated April 6th, 1986. It's a memo from 18 Mike Crow to Jenard Gross and Gerald Williams. 19 The second is Exhibit T4302 dated November 13th, 20 1986, to Bruce Williams from Mike Crow. 21 MR. EISENHART: Your Honor, may I ask 22 counsel if he has copies for us of Exhibit T4192 5064 1 because it was not on the list that was provided 2 to us. 3 Q. (BY MR. GUIDO) I'd like you to take a 4 look at T4302. It says in the -- "We had a 5 discussion at the investment committee on selling 6 junk bonds for profits for purposes of quarterly 7 earnings." 8 Do you see that sentence? 9 A. Yes, I do. 10 Q. It says "Ron Huebsch made an 11 impassioned plea to get the word now if we are 12 going to need a lot of profits because the market 13 is favorable right now in getting out of these -- 14 out of some bonds, taking a profit, and having a 15 chance of getting back into some good yielding 16 stuff." 17 Is that what you were referring to with 18 regard to the taking of gains to generate profits 19 for quarterly earnings purposes? 20 MR. EISENHART: Your Honor, if the 21 reference to that is to this memo, I believe this 22 memo was written at a time when Mr. Phillips was 5065 1 not at USAT. The situation being referred to here 2 what Mr. Guido is talking about. 3 MR. GUIDO: I think the witness 4 testified about a generic category, and I'm asking 5 him whether or not this describes the type of 6 generic activity that he was testifying about. I 7 think that's perfectly appropriate. 8 MR. EISENHART: If that's the question, 9 Your Honor, that's a different question. I'll 10 withdraw the objection. 11 MR. GUIDO: That was the question. 12 Q. (BY MR. GUIDO) Mr. Phillips? 13 A. This is of the type of transactions 14 that I described, yes. 15 Q. Now, look at the second memo, T4192. 16 Look at that paragraph. It says "In the spirit of 17 bad news to the top, this is something I'm sure 18 you're aware of but I thought I would remind you. 19 It appears that several of the gains that we had 20 counted on to bolster second quarter profits may 21 be deferred/not occur: One, branch sale to 22 Merabank; two, consumer loan to Security Pacific; 5066 1 three, sale of Weingarten stock." 2 And then it says in the last paragraph 3 "I am unaware of any significant opportunities to 4 take additional bond profits, as we did in the 5 first quarter, or any pending real estate sales 6 which would produce a profit." 7 Do you recall whether, in April of '86, 8 there were no bond profits, junk bond profits to 9 be taken to generate gains? 10 A. No, I don't recall. 11 Q. Now when were you instructed to take 12 gains out of the junk bond portfolio? 13 A. I recall being instructed to do so at 14 the end of the calendar years '84 and '85. 15 Q. Did the memorandum that I referred to 16 that was dated November 13th, T4302, refresh your 17 recollection that you were also requested to do so 18 at quarter's end? 19 A. This memorandum suggests that, given 20 the time period, it was for a year-end reporting 21 period. 22 Q. Why does "year end" stick in your mind, 5067 1 Mr. Phillips? 2 A. Because the request to realize gains 3 coming at year end comes at a particularly 4 difficult time in securities markets. In many 5 cases, those markets have slowed down. Many 6 people are off for the holidays, and there's not a 7 lot of liquidity and trading in those markets at 8 that time. 9 Q. Did you find it difficult to trade the 10 securities appropriately at those times? 11 A. It was quite challenging because there 12 were a number of tasks to undertake in a short 13 period of time. You had to identify the security 14 that might be one suitable for sale. At the same 15 time, identify a replacement security to keep the 16 portfolio invested and make all these prices and 17 amounts of securities sold work out. There was 18 quite a lot to do in a short period of time during 19 a period in which it was difficult to execute. 20 Q. Now, these were periods of time, would 21 you characterize, as not being terribly liquid? 22 Would that be fair? 5068 1 A. Yes. 2 Q. Okay. And what happens at the time 3 when a market is not highly liquid? 4 A. It's quite difficult to find a lot of 5 product to buy, and it's not always difficult to 6 find bids for what you're selling. 7 Q. So, what happens to the bid-ask spread 8 in illiquid markets? 9 A. Typically, that spread might vary, 10 might widen. 11 Q. So, you get less when you want to sell 12 than you might in a more liquid market? 13 A. You might. 14 Q. And you pay more than you might pay in 15 a more liquid market if you're buying? 16 A. You might, yes. 17 Q. I'd like to hand you Exhibit 5251? 18 MR. NICKENS: Your Honor, are we going 19 to introduce -- 20 MR. GUIDO: I'm sorry. I move 4302 and 21 4192. 22 MR. NICKENS: No objection to 4192. My 5069 1 copy of 4302 is five copies of the same document. 2 MR. GUIDO: I only have one document. 3 MR. NICKENS: No objection. 4 THE COURT: Received. That's T4302 and 5 T4192. 6 Q. (BY MR. GUIDO) Now, I'd like you to 7 take a look at T4251, Mr. Phillips. 8 MR. GUIDO: This is a document that, 9 Your Honor, has an underlining on the first page 10 of the document which I believe may have occurred 11 after the document had been produced to one of the 12 government agencies. And so, with Mr. Nickens' 13 standing objection, we will substitute this if we 14 can find a document without that. But we 15 stipulate that that document -- that underlining 16 is not necessarily a document that had the 17 underlining prior to the time of coming into the 18 government's hands. 19 MR. NICKENS: Based on that 20 understanding, no objection. 21 THE COURT: All right. Received. 22 T4251 is received. 5070 1 Q. (BY MR. GUIDO) That is a memorandum 2 that sets out -- at the beginning, it says "An 3 attached schedule presents our best estimate of 4 gains that will be needed for quarterly earnings." 5 Do you see that? 6 A. Yes, I do. 7 Q. Now, when you were notified to find 8 gains in the junk bond portfolio for purposes of 9 sale, were you given a target or some sort of a 10 number that you were to try and achieve? 11 A. Yes. 12 Q. Okay. Is this document a sample of the 13 kind of document that you would receive that would 14 give you a target? 15 A. No. The instructions I would have 16 received would have been verbal. 17 Q. Okay. So, you didn't receive any 18 document itself? 19 A. I don't remember seeing a document like 20 this before. 21 Q. Take a look at the second page of that 22 document. See where it says "gains to alleviate 5071 1 deficit" in the middle of the page? 2 A. Yes. 3 Q. It talks about liquidity, Freddie Mac 4 stock, mortgage-backed securities, and junk bonds. 5 Would you receive, when you received 6 the instructions to take gains, a dollar figure as 7 a target? 8 A. Yes. 9 Q. Okay. Does this document refresh your 10 recollection that not only were you instructed to 11 take gains at year end, but to do so on a 12 quarterly basis? 13 A. Yes, it does. 14 Q. And what does it refresh your 15 recollection were the facts? 16 A. That for this expected -- for this 17 period, the expected earnings would require some 18 gains to be realized in high-yield bonds in order 19 to be achieved. 20 Q. Now, I'd like to direct your attention 21 to one of the performance reports which is A5017. 22 I think it's a performance report for 5072 1 December 1986, which would be the last one in the 2 packet. And I direct your attention to the 3 Schedule DJ, "Gain on Sale of Investment 4 Securities." 5 Have you -- when you were at USAT, did 6 you receive any of the performance reports? 7 A. Yes, I did. 8 Q. And can you tell us what their purpose 9 was? 10 A. They were an internal management 11 document that -- 12 Q. And what were they intended to be used 13 for? 14 A. They were discussed in meetings by 15 subject matter area to discuss the performance of 16 different business activities of the association. 17 Q. And did you provide any information to 18 be included in those performance reports? 19 A. No, I did not. 20 Q. Where did the information come from 21 that was included in those performance reports? 22 A. This information would have been 5073 1 developed from the books and records of the 2 association and the accounting entries made in the 3 treasury department. 4 Q. Now, this schedule -- see the schedule 5 at the top of the page on DJ? 6 A. Yes. 7 Q. It makes reference to a number of 8 entities through -- starting with Colt Industries 9 through Mark IV Industries. 10 Do you see those entries? 11 A. Yes, I do. 12 Q. Were those high-yield bonds? 13 A. Yes, they are. 14 Q. And then it has a column with the 15 amount. Is that the face amount of the bonds? 16 A. The schedule would reflect the face 17 amount of the bonds sold. 18 Q. And then the column under "gain or 19 loss," would that reflect the profit or loss that 20 was made on the sale of those bonds? 21 MR. EISENHART: Your Honor, may I ask 22 what page counsel's on here? 5074 1 MR. GUIDO: DJ. Schedule DJ. 2 MR. EISENHART: Thank you. 3 A. Yes, it would. 4 Q. (BY MR. GUIDO) Now, then when you get 5 down to the second schedule, that schedule 6 indicates year-to-date figures, January through 7 December, and then a total. Right? 8 A. Yes. 9 Q. And for that year, it shows a total of 10 $82,672,000. Do you see that? 11 A. Yes, I do. 12 Q. And when you go through that schedule, 13 do you notice anything with regard to the sizes of 14 the profits on a monthly basis? 15 A. The amounts are larger with -- 16 corresponding with months that are at the end of 17 the calendar quarter. 18 Q. Now, what is it that happens at the end 19 of the calendar quarter that would make that 20 significant for accounting purposes? 21 A. Well, that's when the results would be 22 reported. 5075 1 Q. The 10Qs, if it's a publicly-traded 2 company? 3 A. Yes. 4 Q. Now, did the Federal Home Loan Bank 5 Board staff, supervisory staff, raise questions 6 about the propriety of USAT investing in 7 high-yield junk bonds? 8 A. Yes, I believe they did. 9 Q. And did you have occasion to meet with 10 any representatives of the Federal Home Loan Bank 11 Board to alleviate their concerns about USAT's 12 investment in junk bonds? 13 A. I met with examiners, and I met with 14 some other individuals that expressly discussed 15 high-yield bonds. 16 Q. Do you recall who those individuals 17 were? 18 A. No, I don't. 19 Q. I'd like you to take a look at the Tab 20 232, which is B1042. It's a memorandum from 21 Jonathan Scott to Neil Twomey dated June 12th, 22 1986. It's Exhibit B1042 dated June 12th, 1986, 5076 1 from Jonathan Scott to Neil Twomey. 2 Do you have that document before you? 3 A. Yes, I do. 4 Q. Now, read the first paragraph. It says 5 "On Tuesday, June 10th, 1986, Terry Smith and I 6 met with Michael Crow, Bruce Williams, Joe 7 Phillips, and Art Berner of United Savings to 8 discuss their corporate bond portfolio." 9 Do you see that? 10 A. Yes. 11 Q. Is that referring to the junk bond or 12 high-yield bond portfolio? 13 A. Yes, it is. 14 Q. Do you recall attending that meeting? 15 A. I don't recall it expressly, no. 16 Q. Now, in the second paragraph, it says 17 "In September of 1984, United conceived the 18 strategy of purchasing less than investment grade 19 corporate debentures (B and BB rated bonds) 20 financed with term deposits issued through 21 brokers. The idea behind the strategy was to have 22 a dedicated portfolio of bonds duration matched 5077 1 with term deposits to achieve a 200 basis point 2 spread." 3 Do you see that? 4 A. Yes. 5 Q. And it says "The term CDs financing 6 this portfolio range from seven to ten years 7 straight coupons to six- to ten-year series with a 8 total all-in cost of 11.6 percent." 9 Then it says "While the portfolio does 10 require certain adjustments to keep the durations 11 matched, the management of the bond portfolio does 12 not involve bond swapping to pick up yields or 13 premature selling to capture capital gains 14 currently unrealized. In as much as the emphasis 15 of the portfolio is on maintaining the spread, any 16 unrealized gains or losses on the bonds themselves 17 are not of significant concern to United because 18 (in theory) an offsetting gain or loss in the term 19 deposits should exist." 20 Do you see that? 21 A. Yes. 22 Q. Who provided that information to 5078 1 Jonathan Scott at that meeting on June 10th? 2 A. The persons attending that meeting 3 would have described the investment program to 4 them, and they would have developed this from 5 that. 6 Q. Does that accurately describe the 7 information that the representatives of USAT 8 provided to the regulators or to Jonathan Scott? 9 A. I don't recall exactly what we 10 provided -- 11 Q. Okay. 12 A. -- to them. 13 Q. Does the second sentence, "The idea 14 behind the strategy was to have a dedicated 15 portfolio of bonds duration matched with the term 16 deposits to achieve a 200 basis point spread," was 17 that the stated policy of the portfolio? 18 A. The idea of dedicated portfolio that 19 was matched was the policy. We did not have a 20 spread target in mind. This is about what we 21 could achieve. 22 Q. Was the management of the bond 5079 1 portfolio intended to involve bond swapping to 2 pick up yields or premature selling to capture 3 capital gains currently unrealized? 4 A. The management style that we used would 5 contemplate some trading of securities that might 6 be -- that might include bond swapping or some 7 sale which I would not characterize as premature. 8 Q. I mean, it says -- did the concept 9 behind the portfolio at the outset entail bond 10 swapping in order to pick up yields? 11 A. Yes, I would say that it did. 12 Q. Did it involve selling to capture gains 13 currently unrealized? Talking about the initial 14 concept. 15 A. In my initial concept, we did suggest 16 that this portfolio would be actively managed and 17 that these techniques are part of that set of 18 things you do. 19 Q. I mean, they are things that were done. 20 Right? 21 MR. EISENHART: Your Honor, to the 22 extent Mr. Guido is intending to refer to the 5080 1 memo, he has left out a fairly important word, 2 which is the memo talks about "premature selling." 3 Q. (BY MR. GUIDO) Did the initial 4 contemplation of the portfolio entail premature 5 selling to capture capital gains? 6 A. I would say, yes, it did. 7 Q. It did? 8 A. (Witness nods head affirmatively.) 9 Q. Now -- 10 THE COURT: What do you mean by 11 "premature"? 12 THE WITNESS: "Premature" is not a word 13 I would use in this -- in discussing a bond. If 14 he means somehow earlier -- earlier than maturity, 15 he may characterize it as premature. It's not a 16 word we use. 17 THE COURT: So, "premature" means 18 before the bond -- 19 THE WITNESS: Before it matures, if 20 that's what he means. 21 Q. (BY MR. GUIDO) Now -- so, what you're 22 saying is this memo doesn't accurately reflect 5081 1 what the portfolio was intended to be? 2 A. With respect to that sentence, I would 3 say it's not accurate. 4 Q. It clearly doesn't conform to what 5 happened, does it? 6 A. That's correct. It does not. 7 Q. Now, let's go back to B405, which I 8 asked you about before, which was December 14th, 9 1984, a memo from you to be distributed to various 10 people. It says "I told Mr. Anderson" -- see 11 under "discussion" -- "that we would manage the 12 maturity matching as well as the spread on this 13 new business component." 14 Do you see that? 15 A. Yes, I do. 16 Q. And I think when I asked you questions 17 about that at the outset of your testimony, you 18 indicated that that entailed some active 19 management of the portfolio. 20 Do you recall that? 21 A. Yes. 22 Q. And one of the -- is one of the ways to 5082 1 actively manage a portfolio for duration matching 2 to sell a security when you ascertain that its 3 duration may have shifted? 4 A. Yes, it is. 5 Q. And purchase another one with the 6 initial duration that you were looking for. 7 Right? 8 A. Yes. 9 Q. And does active management include 10 selling securities when you ascertain that the 11 credit risk that you initially assumed when you 12 purchased it has now increased and that, 13 therefore, you don't want to bear that additional 14 credit risk? 15 MR. EISENHART: Your Honor, I object to 16 the leading questions. We have counsel testifying 17 now. 18 THE COURT: I'll deny the objection. 19 MR. GUIDO: I don't think the question 20 was leading, Your Honor. 21 THE COURT: All right. That's fine. 22 A. I'm sorry. Can you repeat what you 5083 1 said? 2 Q. (BY MR. GUIDO) Did the active 3 management that you told Mr. Anderson about, that 4 you've testified about previously, include the 5 sale of junk bonds when you decided that the 6 credit risk had changed to a point beyond which 7 you were willing to bear? 8 A. It would include that, yes. 9 Q. Now, the memorandum doesn't -- on 10 December 12th, 1984, doesn't talk about sales of 11 high-yield securities to generate gains at 12 quarter's end, does it? 13 A. It does not. 14 Q. Did you tell Mr. Anderson that that was 15 contemplated in the program for matched -- 16 maturity matched junk bonds with the CD program? 17 MR. NICKENS: Your Honor, is Mr. Guido 18 referring to just this document or to any time? 19 MR. GUIDO: Just this document. 20 MR. NICKENS: I think the record should 21 be clear on that. 22 A. No, I do not. 5084 1 Q. (BY MR. GUIDO) Now, you met with 2 Jonathan Scott and Terry Smith. Did you tell them 3 that the strategy of purchasing less than 4 investment grade corporate securities financed 5 with term deposits issued through brokers would 6 entail the selling of junk bonds at quarter's end 7 to generate gains? 8 A. No. 9 Q. Was the sale of junk bonds at quarter's 10 end consistent with the representations that are 11 made -- purported to be made as reflected in 12 Exhibit B405 and B1042? 13 A. Exhibit B1042 is written by them and 14 has a representation that they are making. I 15 don't remember making any representation that we 16 would not sell securities from time to time. I 17 don't remember discussing any particular program 18 to sell at quarter's end. 19 Q. You don't recall any mention of that? 20 A. No. 21 Q. And so, the sale -- is your testimony 22 that the sale that captured capital gains at 5085 1 quarter's end was not consistent with what was 2 purported to be the policy as reflected in B1042? 3 A. I'm not sure I follow the question 4 exactly. Consistent with the policies that are in 5 here? 6 Q. Well, look at the paragraph. It seems 7 to be pretty simple. June 12th, 1986. Jonathan 8 Smith is reporting on a conversation that he and 9 Terry Smith had with representatives of United 10 Savings. And he says that "The management of the 11 bond portfolio does not involve bond swapping to 12 pick up yields or premature selling to capture 13 capital gains." 14 My question is: Was the sale of junk 15 bonds at quarter's end to generate capital or 16 earnings consistent with that statement, in your 17 view? 18 A. It is not consistent with that 19 statement. 20 Q. Now, you were -- there are a number of 21 documents that have been put into the record 22 regarding notices to Mr. Anderson from USAT with 5086 1 regard to activity that occurred in the 2 mortgage-backed -- I mean in the junk bond 3 portfolio. 4 Those are -- the ones that you signed 5 are Exhibits B1075, B1148, B1219, B1236, B1265, 6 B1321, B1359. They are dated June 6th, July 31, 7 September 15, September 14, October 20, 8 November 19 -- I'm sorry. It stops at 9 October 20th, B1265. 10 Do you have those? 11 A. I don't have those. 12 Q. Let me show you my sets. They are all 13 the same text letter so that you can just look the 14 first one, which is B1075 which is dated June 15 30th. And it's a letter from you to Mr. L.A. 16 Anderson. I'd like you to take a look at the text 17 of that. 18 MR. EISENHART: The one I have dated 19 June 30th is actually B1074, I think. 20 MR. GUIDO: June 30, 1986? 21 MR. EISENHART: I'm looking -- I'm 22 looking at two. One's dated -- 1074 and 1075, and 5087 1 they are both dated June 30, 1986. The 2 difference, I think, is one shows a copy to 3 Ginger Baugh at the Federal Home Loan Bank of 4 Dallas. I think that's 1075. 5 MR. GUIDO: That's right. 6 MR. EISENHART: Okay. We're on the 7 same -- 8 MR. GUIDO: I mean, I'm just using the 9 document that the respondents have put on the 10 exhibit list. 11 MR. EISENHART: It's fine, Your Honor. 12 There are two of them here. I had the -- it's the 13 same document, just slightly different. 14 MR. GUIDO: Thank you for bringing that 15 to my attention. 16 MR. EISENHART: You're welcome. 17 Q. (BY MR. GUIDO) The -- do you know who 18 provided you with the text of that letter, 19 Mr. Phillips? 20 A. I believe that I wrote this letter. 21 Q. You wrote the letter? 22 A. (Witness nods head affirmatively.) 5088 1 Q. And you used the text going forward in 2 submitting the information to the Texas Savings 3 and Loan Department? 4 A. Yes. 5 Q. Now, this letter says "During the month 6 of June, the association experienced excess 7 liquidity and purchased the non-liquidity 8 securities shown on Enclosure 1." 9 What does "excess liquidity" refer to? 10 A. Excess liquidity would have been that 11 amount of money that was in excess of amounts 12 required to be held for short-term liquidity 13 needs. Those funds were required to be invested 14 in short-term maturity, high-quality instruments. 15 Q. Now, the second sentence says "Market 16 conditions during the month presented 17 opportunities to realize gains or preserve 18 capital." 19 Do you see that? 20 A. Yes. 21 Q. Now, what does that refer to in terms 22 of "market conditions"? 5089 1 A. This would mean that the market was 2 valued in such a way that certain securities had 3 gains in them that could optimally be realized for 4 the variety of reasons I described in active 5 management. 6 Q. And what are those again? 7 A. A security that we felt was overvalued 8 for its credit quality or one that we felt had 9 begun to deteriorate in credit quality or one that 10 we expected might, we would want to avoid losses. 11 Q. Now, did you ever notify the Texas 12 Savings and Loan Department that you had been 13 instructed to make sales out of the junk bond 14 portfolio in order to generate gains at quarter's 15 end? 16 A. No. 17 Q. Now, I'd like to show you an exhibit 18 that I've marked as Exhibit A10690. It is a 19 memorandum from Michael Crow to Art Berner. 20 MR. GUIDO: And I'd like to move the 21 admission of A10690, Your Honor. 22 MR. NICKENS: No objection. 5090 1 THE COURT: Received. 2 Q. (BY MR. GUIDO) Did at some point in 3 time Peat Marwick, the outside auditors, raise a 4 question that you're aware of with regard to the 5 turnover in the high-yield bond portfolio? 6 A. Not that I'm aware of. 7 Q. Now, this memorandum is dated 8 November 7th. Is that after you left USAT? 9 A. It is approximately when I left. I'm 10 not sure of the exact date. 11 Q. Did anyone ever discuss with you the 12 need to adopt the policy by the investment 13 committee relating to junk bonds? 14 A. No, they did not. 15 Q. I'd like you to turn to Page 2 where it 16 sets out the policy or the proposed policy. It 17 says "It is the policy of United Savings 18 Association of Texas to invest in corporate debt 19 securities as market opportunities exist. The 20 objective of such investments is to spread income 21 over an extended period of time. In general, the 22 portfolio will be match funded with long-term 5091 1 CDs." 2 Do you see that? 3 A. Yes. 4 Q. Was that the original intention for the 5 junk bond portfolio? 6 A. Yes. 7 Q. Okay. Then it says "Sales of such 8 securities will be executed from time to time as 9 changes in the credit quality of the particular 10 security exists." 11 Do you see that phrase? 12 A. Yes, I do. 13 Q. And is that what you were describing 14 about the sale of securities if there is a credit 15 quality question? 16 A. That's one of the instances. 17 Q. And then it says "An opportunity to 18 upgrade credit with a similar yield is present." 19 Do you see that? 20 A. Yes. 21 Q. Is that the other policy that you 22 described? 5092 1 A. Yes. In effect, it is. 2 Q. And it says "To adjust the portfolio 3 for industry exposure." 4 Is that another way of saying an 5 industry credit risk? 6 A. I would read that as an intention to 7 provide appropriate diversification among 8 industries. 9 Q. Was the intention of the portfolio at 10 the outset an intention to maintain a certain 11 spread income between the cost of funds inherent 12 in the long-term CDs and the return that was paid 13 on the mortgage-backed -- I mean on the junk 14 bonds? 15 A. It was the intention to realize the 16 spread, not a certain spread. 17 Q. And was the intention to manage the 18 portfolio so as to maintain the spread? 19 A. Yes. 20 Q. Now, I'd like you to take a look at 21 T4320, which is a memorandum from Doug Hansen to 22 Charles Hurwitz, Jenard Gross, Barry Munitz, Jerry 5093 1 Williams, Mike Crow, Art Berner, and Bruce 2 Williams. 3 Are those the members of the -- the 4 names I just read, are those the people who sat in 5 on the investment committee that you participated 6 in at USAT? 7 A. I'm not sure who was a member in this 8 group. Some here were very likely not members. 9 It's also possible -- 10 Q. Were those the people that attended the 11 meetings? 12 A. It's possible that from time to time 13 others here did attend the meetings. 14 Q. You see Item No. 8? 15 MR. NICKENS: Your Honor, are we going 16 to offer the document? 17 MR. GUIDO: I'm sorry. I offer T4320. 18 MR. NICKENS: I have no objection, Your 19 Honor, other than to point out that this meeting 20 occurred after this witness left the employment of 21 USAT. 22 THE COURT: Received. 5094 1 Q. (BY MR. GUIDO) You see the entry 2 "high-yield bonds"? 3 A. Yes, I do. 4 Q. It says "In quarter 1-'87, we should 5 grow with some bonds. 250 million phase-in. Need 6 to look at bond and CD zeros. Need to decide 7 duration of funding. (Economic spread to date has 8 been 323 basis points). This has been reduced to 9 228 on an accounting basis due to profit taking." 10 Do you see that? 11 A. Yes, I do. 12 Q. Does that indicate that the spread had 13 been narrowed because of the sales to generate 14 quarter's end profits, to your knowledge? 15 MR. NICKENS: Your Honor, he's asking 16 him to interpret a report of a meeting which he 17 didn't attend. Now, there may be a way to ask the 18 question in such a way as to get this witness' 19 information, but for him to ask what the person 20 who wrote this at a meeting he didn't attend seems 21 improper. 22 THE COURT: All right. Restate your 5095 1 question. 2 MR. GUIDO: I'll rephrase the question. 3 Q. (BY MR. GUIDO) This covers a quarter 4 in which you were still employed at USAT, does it 5 not? 6 A. Yes. 7 Q. Okay. And it's reporting on the 8 performance in that quarter, is it not? 9 A. It seems to be reporting on a variety 10 of topics related to how the quarter might end. 11 Q. Okay. Now, do you recall ever seeing 12 any figures that indicated that because of the 13 gains that had been taken out of USAT's junk bond 14 portfolio at quarter's end to generate earnings 15 had the effect of reducing the spread that was 16 earned on that portfolio? 17 A. No, I don't. 18 Q. Was the spread or the yield on the junk 19 bond portfolio that you set out to earn at the 20 outset of the creation of the portfolio maintained 21 over the life of the time that you managed that 22 portfolio? 5096 1 MR. NICKENS: Your Honor, I object to 2 the form of the question. The witness has 3 testified they did not set out to maintain a 4 yield. He's testified quite clearly on several 5 occasions that they took the yield that was there 6 and not some particular yield. Mr. Guido's asked 7 that several times. The witness has said "no," 8 and now he's brought it into the question as if it 9 were a fact when it has been denied. 10 THE COURT: Your question was whether 11 they maintained the spread as they set out to do 12 and, as Mr. Nickens points out -- 13 MR. GUIDO: I'll rephrase the question, 14 Your Honor. 15 THE COURT: All right. 16 Q. (BY MR. GUIDO) Was the spread that 17 was maintained in that portfolio at the end a 18 narrower spread than at the outset when you 19 created the junk bond portfolio? 20 A. I don't recall that it was. 21 Q. You don't recall one way or the other? 22 A. No. 5097 1 Q. Now, let's move on to the second 2 category of information. And I will move the -- 3 these documents out of your way so that they are 4 not cluttered. Why don't you hand me those 5 documents and I'll have them put down. 6 Now, when did you first learn that USAT 7 was going to invest in mortgage-backed 8 risk-controlled arbitrage portfolios? 9 A. We discussed investment in 10 mortgage-backed securities, not necessarily in the 11 context of risk-controlled arbitrage, I believe at 12 the end of -- at the end of 1984. 13 Q. And who first raised that with you? 14 A. I remember Ron Huebsch bringing it to 15 my attention. 16 Q. And what did he tell you? 17 A. That we were going to be investing in 18 mortgage-backed securities. 19 Q. And where was he employed at that time? 20 A. At Federated Development. 21 Q. So, he wasn't an employee of USAT at 22 the time? 5098 1 A. No, he was not. 2 Q. Okay. Did you ask him where he got 3 that information? 4 A. No. 5 Q. Did he tell you whether or not he had 6 discussed it with anyone? 7 A. I don't recall that he did. 8 Q. Did he indicate to you what the reasons 9 for the investment was at the time? 10 A. No. 11 Q. Did he indicate to you that there were 12 any policy reasons that were behind the motivation 13 to invest in high-yield bonds? 14 A. No. 15 Q. I mean in mortgage-backed securities. 16 A. He did not. 17 Q. Did he mention to you the qualified 18 thrift lender test? 19 A. I'm aware of the test. I don't believe 20 he mentioned it. 21 Q. He didn't mention it to you? 22 A. I don't recall that he mentioned it. 5099 1 Q. What did you do after he mentioned to 2 you that USAT was going to invest in 3 mortgage-backed securities? 4 A. We undertook to discuss ways that we 5 might do so, structures how the portfolio might 6 work. 7 Q. But you never discussed the reasons? 8 A. I don't recall discussing the reasons 9 with him. 10 Q. Did you ever discuss the reasons with 11 anyone? 12 A. I had an understanding of this 13 qualified thrift test and didn't feel that I 14 needed to discuss it with anyone. 15 Q. And what was your understanding of the 16 qualified thrift lender test? 17 A. That it was -- for public policy 18 reasons, savings and loan associations were 19 expected to make loans to the housing markets; and 20 this was a way to do that. 21 Q. This was a way to meet the test. Is 22 that what you're testifying to? 5100 1 A. Yes. 2 Q. And that you knew that at the time? 3 A. Yes. 4 Q. How did you know that? 5 A. I don't remember how I knew it. 6 Q. And what is your understanding of what 7 the requirements are of the qualified thrift 8 lender test? What were they at the time? 9 A. I don't remember exactly at this point 10 what they were, but it involved investing a high 11 proportion of assets in home loans and receiving a 12 kind of accounting treatment for it that might 13 include -- it might include a taxation. It might 14 include something to do with bad debts and 15 write-offs, things like that. 16 Q. Did it have anything to do with whether 17 or not the charter could be maintained? 18 A. I don't know that. 19 Q. But you knew that it was a prerequisite 20 to operate in the way USAT wanted to operate? 21 A. I believe that it was a prerequisite 22 that all savings and loan associations faced. 5101 1 Q. Okay. And was one of the ways of 2 satisfying that test to originate single-family 3 mortgages? 4 A. I believe so, yes. 5 Q. Did USAT at that time or had USAT at 6 that time sold off its branches? 7 A. This would coincide with that time of 8 that branch sale. 9 Q. Were you aware of that at the time? 10 A. Yes. 11 Q. Was this also at a time when USAT had 12 cut back drastically its origination of 13 single-family mortgages? 14 A. I'm not aware of that. 15 Q. Were you aware at the time that the 16 creation of a mortgage-backed security portfolio 17 was necessary to meet the qualified thrift lender 18 test? 19 A. No, I was not. I assumed that it was 20 part of the growth of the organization that was 21 planned. 22 Q. Now, I want to show you Exhibit 11022, 5102 1 which is the charts from the -- Mr. Hargett's 2 testimony regarding the growth of the USAT 3 portfolio over time. 4 Do you have that? I direct your 5 attention to Page 4 of the document. Do you see 6 that? 7 A. Yes, I do. 8 Q. Column A is the portfolio over time. 9 See the entry for December 1984? It says 10 $98 million? 11 A. Yes. 12 Q. Do you recall the purchase of those 13 mortgage-backed securities? 14 A. I don't recall this explicit purchase, 15 but I know that we began at about that time. 16 Q. Okay. Look at the portfolio between 17 December 1984 and July of 1984. 18 Does that approximate what your 19 understanding was of the size of the portfolio? 20 MR. NICKENS: He must mean July of 21 1985, Your Honor. You said July 1984. 22 MR. GUIDO: I'm sorry. I said 5103 1 December '84 through July of 1985. Excuse me. I 2 misspoke. 3 Q. (BY MR. GUIDO) Do you see that? 4 A. Yes, I do. 5 Q. Does that approximate what you 6 understood the growth to be during that time 7 period in the mortgage-backed security portfolio 8 that you were putting together for USAT? 9 A. Yes, it does. 10 Q. Now, taking July 1985 through December 11 of 1985, does that approximate the size of the 12 mortgage-backed security portfolio that you were 13 putting together for USAT? 14 A. I don't remember these figures exactly. 15 Q. Okay. Now, see the column "USAT 16 Mortgage Finance"? 17 A. Yes. 18 Q. Does that approximate your 19 understanding of the size of the mortgage-backed 20 securities in that portfolio? 21 A. Yes, it does. 22 Q. Now, at -- can you tell us what 5104 1 happened with that USAT Mortgage Finance 2 subsidiary? It shows that there is a 3 500-million-dollar balance for November 1985 and 4 then by March '86, it turns out to be zero. One, 5 why was it created in the first place? Let's 6 start there. 7 A. This subsidiary was created because 8 there was, I believe, a time frame during which 9 this could be added to the size of the institution 10 without violating some provision for -- to allow 11 for growth. And that it was assembled in 12 anticipation of the passage of some date. 13 Q. And then it was dissolved when? 14 A. It was dissolved very shortly 15 afterwards because there was some clarification or 16 at least an interpretation that this growth would 17 not have been allowed. 18 Q. And what was it that happened that 19 resulted in that conclusion? 20 A. I don't know. 21 Q. You don't know? But the regulation 22 changed, as far as you knew? 5105 1 A. Either that or the association's 2 interpretation of the regulation changed. 3 Q. Now, let's go back to the first trades. 4 You said it was sometime in late 1984 was when the 5 portfolio began to build up. 6 MR. NICKENS: Your Honor, I would ask 7 for some clarification as to what portfolio. We 8 have talked in the record about the 9 risk-controlled arbitrage portfolio as opposed to 10 a portfolio of mortgage-backed securities that the 11 institution owned that were not a part of that 12 arbitrage. And unless there is some clarity as 13 to -- or distinction there, we're going to have a 14 problem with the record as to whether or not the 15 witness is answering a different question than is 16 being posed by Mr. Guido in this case. 17 MR. GUIDO: Your Honor, I've never 18 talked about different portfolios. I think -- and 19 I can get you the document on the liability growth 20 application that Gerald Williams testified about. 21 But he testified that they were creating a 22 risk-controlled arbitrage portfolio. There has 5106 1 never been any testimony, so far that I have heard 2 in this case, that there was a risk-controlled 3 arbitrage portfolio and then there was something 4 else. 5 MR. NICKENS: There was -- 6 MR. GUIDO: I'm going to ask this 7 witness questions about the buildup of the 8 portfolio. If Mr. Nickens wants to ask him 9 clarifying questions about that, he's perfectly 10 free to do so. I will, as I go through this 11 testimony, clarify when the portfolio was hedged 12 and when it was not, Your Honor. And whether or 13 not that was part of the representations or part 14 of the intentions of the individuals that were 15 supervising Mr. Phillips' operations is a question 16 to be left to further determination. But what I'm 17 trying to do -- 18 THE COURT: So, we have a dispute as to 19 whether or not there were accounts that were not 20 intended to be hedged? 21 MR. GUIDO: That's correct, and were 22 represented to the regulators as not to be hedged, 5107 1 Your Honor. And that's an issue in the 2 litigation. So -- but I will, as far as I can 3 based on my knowledge of the facts, Your Honor, 4 try and make a distinction between when something 5 was hedged and when something was not hedged, Your 6 Honor. 7 But -- and Mr. Nickens can make 8 whatever legal conclusions he wants to about that, 9 but I do believe that my questions will make it 10 clear when the portfolio was hedged and when it 11 was not. This witness is about to testify about 12 the origins of that, and he will testify about 13 whether it was hedged or wasn't hedged at the 14 outset and when it became hedged after the 15 initial -- 16 THE COURT: So, you're contending there 17 was only one portfolio? Is that what you're 18 saying? 19 MR. GUIDO: Your Honor, that's what it 20 appears to be. And the witness is going to, I 21 think, explain that as we go through the 22 testimony. 5108 1 THE COURT: All right. 2 MR. NICKENS: Your Honor, it's -- there 3 is a deliberate effort to create some confusion 4 here. It is absolutely clear from the documents 5 that USAT owned mortgage-backed securities that 6 were not a part of the risk-controlled arbitrage. 7 Indeed, it is absolutely clear that as to this 8 June date, this 769 million is about $300 million 9 more than was in the risk-controlled arbitrage. 10 And the witnesses that -- Mr. Hargett's testimony 11 was that he simply took these figures from a 12 Coopers & Lybrand document created for a different 13 purpose. And this witness, it's been ten years 14 ago and he's showing him a document and asking 15 him, you know, is this the approximate number when 16 he knows -- he knows, because we have recently 17 reviewed the documents, both sides, and we know 18 that there is about $300 million that is not in 19 the portfolio as of that time. 20 MR. GUIDO: Your Honor, that -- 21 THE COURT: All right. We've made the 22 issue. We'll go on to -- I think we'll just have 5109 1 to proceed with the questions. I can't handle the 2 dispute on the basis of an objection. 3 MR. GUIDO: Your Honor, there is no 4 doubt there are various points in time there were 5 modifications to the portfolio. I think that 6 Ms. Laurenson testified that there is a 7 speculative portfolio. I recall that testimony. 8 There will be points. I will clarify as we go 9 through these specific facts. I was not going to 10 leave off with this witness saying "That's my 11 understanding of generally what the portfolio was 12 that I was managing." And if Mr. Nickens will 13 allow me to proceed, I think I can help clarify 14 that. 15 THE COURT: You may proceed. Let's go. 16 MR. GUIDO: Thank you. 17 Q. (BY MR. GUIDO) Now, when you -- after 18 you had your first discussion with Mr. Huebsch, 19 did you sit down with him and discuss what you 20 would do when you purchased the portfolio? 21 A. Yes. 22 Q. Did you sit down with anyone else? 5110 1 A. I don't recall discussing it with 2 anyone else. 3 Q. So, it was with Mr. Huebsch that -- the 4 two of you sat down and you discussed the concept 5 of investing in mortgage-backed securities? 6 A. Yes. 7 Q. Did you discuss the concept of 8 investing in mortgage-backed securities without 9 hedging the interest rate risk that was attendant 10 to them? 11 A. We discussed the kinds of risk that can 12 originate in mortgage-backed securities and 13 discussed which of those risks provided the return 14 and which of those risks had to be hedged. 15 Q. And which of those risks did you 16 identify? 17 A. We identified the risk from changes in 18 market value price, and we identified the risk 19 that would be created by a mismatch in the funding 20 of the asset. 21 Q. What's that typically referred to as? 22 A. If the asset was financed with a 5111 1 liability that was considerably shorter than the 2 life of the asset. 3 Q. Okay. And so, you discussed that 4 issue? 5 A. Yes. 6 Q. And when you meant the life of the 7 liability was considerably shorter than the asset, 8 do you mean the life of the liability or the date 9 at which it repriced, its interest rate changed? 10 A. It would mean the date at which it 11 repriced. It was assumed that even if such 12 liabilities matured, they could be rolled over. 13 Q. So, you discussed the duration mismatch 14 between the source of funding and the expected 15 life of the mortgage-backed security portfolio? 16 A. Yes. 17 Q. And did you discuss with him at that 18 time whether that was a risk that the institution 19 was willing to bear? 20 A. Yes. 21 Q. And what did you conclude? 22 A. We determined that hedging the market 5112 1 value of a security was not the appropriate risk 2 and that to develop a portfolio that was funded 3 with short-term liabilities and then hedging that 4 mismatch was the appropriate structure to 5 undertake. 6 Q. So, you, in your discussions with Mr. 7 Huebsch, decided to create a portfolio that was 8 funded with short-term deposits, deposits that 9 repriced at a short term, invest them in 10 mortgage-backed securities which had a longer 11 term, a fixed term, and to create or to purchase 12 some sort of a hedge instrument to correct for 13 that mismatch? 14 A. Yes. 15 Q. Or mitigate the effect of that 16 mismatch? 17 A. Yes. 18 Q. Is that what is typically known as a 19 risk-controlled arbitrage? 20 A. That is what came to be known as a 21 risk-controlled arbitrage. 22 Q. Now, you then made your initial 5113 1 purchases, did you not? 2 A. Yes. 3 Q. Those weren't hedged, were they? 4 A. We made one initial purchase, that I 5 recall, that was -- that was not hedged; and it 6 led to the discussion of which risk was 7 appropriate to hedge. It was not explicitly 8 financed with an individual liability. It was 9 purchased from the general funds of the 10 association. And so, there was no express 11 offsetting liability to it. 12 Q. Okay. So that you didn't have the 13 problem of the short-term repricing of that, did 14 you? 15 A. No, not expressly. There was nothing 16 really to link it to. 17 Q. Okay. Did you discuss with Mr. Huebsch 18 at the outset what size of a portfolio you were 19 shooting for? 20 A. No. 21 Q. Did you discuss with him the other 22 risks that one encounters with a mortgage-backed 5114 1 security portfolio? 2 A. We discussed every aspect of investing 3 in mortgage-backed securities. I'm not sure 4 exactly what you mean. 5 Q. Well, let me move on to another area 6 and we'll come back to that. 7 Did you and Mr. Huebsch have 8 discussions with anyone else prior to the -- 9 making the initial purchases in the 10 mortgage-backed securities portfolio? 11 A. We discussed which securities might be 12 the most appropriate for use, and we would consult 13 with different bond dealers for that input. We 14 could see prices and categories of the types of 15 agencies that issued, whether it was Fannie Mae or 16 Ginnie Mae and the different characteristics of 17 payment that they had and how their yields and 18 prices behaved because of their structures. 19 Q. Now, who were the people that you met 20 with from the brokerage houses? Do you recall? 21 A. They would have been our usual salesmen 22 from those Wall Street firms that called on us 5115 1 regularly. 2 Q. And did you -- after you gathered that 3 information, did you and Mr. Huebsch sit down and 4 decide what sort of structure you would have for 5 the mortgage-backed security portfolio at USAT? 6 A. Yes. But at that time, I'm sure the 7 discussion would have included other people. 8 Q. Okay. So, after your preliminary 9 discussions that you and Mr. Huebsch had, you then 10 included other people or other people were 11 included in the conversations? 12 A. Yes. 13 Q. And prior to the point in time where 14 you talked structure? 15 A. That's correct. 16 Q. Now, who were those people? 17 A. The kinds of people that would have 18 been included in such a discussion, given their 19 functions, would have been Mr. Crow, Gerald 20 Williams. It's possible that we discussed it with 21 the treasurer. 22 Q. What about Mr. Gross? 5116 1 A. It's very likely Mr. Gross was present 2 when we discussed these matters. 3 Q. What about Mr. Munitz? 4 A. I couldn't be sure that he was. 5 Q. What about Mr. Berner? 6 A. I don't recall that Mr. Berner was 7 there at the time. 8 Q. What do you mean, "there at the time"? 9 A. I don't think he was employed at United 10 at that time. 11 Q. Okay. And what about Mr. Hurwitz? 12 A. I would not have expected him to be 13 there. 14 Q. The question was: Was he there? 15 A. I don't think so. 16 Q. But you don't recall? 17 A. I don't recall. 18 Q. Now, these were your initial 19 discussions about the structure of the 20 mortgage-backed security portfolio. And so, it 21 included Mr. Crow, Williams, and who else did you 22 say? 5117 1 A. Very possibly Mr. Gross. 2 Q. Okay. And yourself and Mr. Huebsch? 3 A. Yes. 4 Q. Was Mr. Huebsch employed by USAT at the 5 time? 6 A. I don't know at that time. 7 Q. Now, when you discussed the structures, 8 what alternative structures did you discuss? 9 A. Whether or not to assemble a portfolio 10 with the market value of the securities hedged 11 against market risk or whether to have a 12 short-funded portfolio of securities without a 13 hedge on market risk but, rather, hedging the 14 short funding risk. 15 Q. Is that what is known in the accounting 16 literature as whether or not you should have an 17 asset hedge as opposed to a liability hedge? 18 A. Yes. 19 Q. Okay. And were you at that point in 20 time discussing the accounting issue? 21 A. No. 22 Q. Okay. And you concluded that it was 5118 1 more feasible to have a liability hedge as opposed 2 to an asset hedge? Is that what your testimony 3 is? 4 A. Yes. 5 Q. And was that because you concluded that 6 you could find a hedge instrument that operated 7 more closely to mirror the movements in the 8 liability hedge than you could to find a hedge 9 instrument that would mirror the movements in the 10 mortgage-backed security asset? 11 A. No. 12 Q. No? What was it? 13 A. The reason is because the kind of hedge 14 that would reflect movement in the asset value 15 would essentially extinguish all the return from 16 that security. 17 Q. Now, what kind of instrument were you 18 thinking about when you thought about that? 19 A. Interest rate futures contracts. 20 Q. Interest rate futures contracts. Now, 21 the interest rate futures contracts were on what 22 instruments? 5119 1 A. They were on treasury notes, bonds, and 2 bills. And from time to time, there were 3 experiments with futures contracts on 4 mortgage-backed securities. 5 Q. There wasn't a market in futures 6 contracts of mortgage-backed securities at that 7 time, was there? 8 A. I'm not sure exactly which time, but 9 there was an attempt to develop a contract on 10 Ginnie Mae securities at least twice. And in 11 either case, the contract was not successful. 12 Q. Now -- so, those instruments that were 13 available were futures contracts on bonds -- 14 treasury bonds, treasury notes, and treasury 15 bills. Right? 16 A. That's correct. 17 Q. And bonds being 30-year instruments, 18 notes being 10-year, and bills being, what, 60 19 days? Six months? 20 A. I'm not sure that -- those characterize 21 the general maturity bands that those instruments 22 covered. I'm not sure that they are precisely 5120 1 those maturities, but that's essentially the 2 range. 3 Q. But that's essentially the range. Now, 4 do any of those treasury instruments have a 5 prepayment option in them? 6 A. No. 7 Q. Mortgage-backed securities, do they 8 have a prepayment option embedded in them? 9 A. Yes, they do. 10 Q. And does the existence of a prepayment 11 option make a mortgage-backed security operate 12 differently than a treasury bond, note, or bill 13 when interest rates change? 14 A. Yes, it does. 15 Q. And doesn't it do so dramatically? 16 A. It may, yes. 17 Q. Now, was that the reason that you 18 decided not to have an asset hedged? 19 A. No. 20 Q. Did you consider that at the time? 21 MR. NICKENS: Your Honor, I'm not sure 22 what that refers to. Did he consider what? 5121 1 Q. (BY MR. GUIDO) Did you consider that 2 the mortgage-backed security behaved differently 3 when interest rates changed than either a treasury 4 bond, note, or bill? 5 A. Yes, we did. 6 Q. But that isn't the reason that you 7 chose not to select that instrument as a hedging 8 instrument on the asset side? 9 A. Yes, that is not the reason. 10 Q. And what was the reason again? 11 A. Because a hedge that would have 12 protected the market value from any loss or 13 movement would have left you with a short-term 14 rate that you would earn that would be lower than 15 most market short-term rates. In effect, it would 16 remove virtually all the return from the security. 17 Q. So, it was the cost that led you not to 18 look at those instruments as instruments to hedge 19 the asset side of the balance sheet? 20 MR. KEETON: Your Honor, he's asked 21 this question eight ways. He's had the answer 22 given to him seven times. He's now said, "So, it 5122 1 is this" and he has totally rephrased in an 2 improper way the witness' answer. Can't we move 3 on to another area? 4 MR. GUIDO: Your Honor, I think that 5 this is very important, foundational facts. 6 MR. KEETON: It may be germane, Your 7 Honor, but we don't need it eight times. 8 THE COURT: What are you trying to 9 elicit now? 10 MR. GUIDO: Your Honor, I'll move on. 11 Q. (BY MR. GUIDO) Did you consider, at 12 the time you were creating the structure, other 13 hedging instruments? 14 A. I'm sorry. Other than what? 15 Q. Other than the futures contracts on the 16 asset side. 17 A. Yes. 18 Q. Did you look at other instruments? 19 A. Yes, we did. 20 Q. Did you look at an instrument to hedge 21 the liability side? 22 A. Yes, we did. 5123 1 Q. Okay. What did you look at? 2 A. We looked at options. We looked at 3 shorter-term futures contracts, and we looked at 4 interest rate swaps. 5 Q. Okay. So, you looked at swaps, 6 options, and what else did you say? 7 A. Futures contracts on short-term 8 securities. 9 Q. Okay. And what short-term securities? 10 A. The treasury bill or the -- or the 11 Eurodollar contract. 12 Q. Now, what sort of options contracts did 13 you look at? 14 A. We looked at interest rate caps and 15 interest rate collars. 16 Q. Can you define a cap for us? 17 A. An interest rate cap is an option 18 strategy that limits exposure to rising rates at 19 some point, after which you don't have any effect 20 from rising rates. 21 Q. So that at some point in time, you get 22 paid money that offsets any increase in interest 5124 1 rates? 2 A. That's correct. 3 Q. And if you're talking about that in 4 terms of an option, what kind of option is that? 5 A. That would be a series of put options. 6 Q. Now -- and that would protect you 7 against rising interest rates? 8 A. That's correct. 9 Q. So, if you bought a put option, your 10 testimony is it would protect you against rising 11 interest rates? 12 A. A put option on the appropriate 13 instrument, yes. 14 Q. Okay. And what do you mean, "the 15 appropriate instrument"? 16 A. It would have to be against some 17 fixed-income security that would -- that would be 18 affected by rising or falling rates. 19 Q. You're not talking about an option on 20 an oil contract, are you? 21 A. That's correct. I'm not. 22 Q. You're talking about a contract on a 5125 1 financial instrument such as a treasury bill, 2 bond, or note. Right? 3 A. Yes. 4 Q. Now, with regard to declining interest 5 rates, did you consider any options to protect 6 against that risk? 7 A. Yes. We considered call options, and 8 we considered interest rate collars. 9 Q. Now, why were you concerned about 10 declining interest rates as a risk? 11 A. Well, Ron Huebsch had experience in 12 call writing and was knowledgeable of those 13 markets and felt that we should consider call 14 writing as a way of hedging. I suggested that it 15 was not appropriate because it only provided 16 protection to the extent of the option premium and 17 it was not a hedge instrument that would carry you 18 through large moves in the market. 19 Q. Well, if you have short-term 20 liabilities funding mortgage-backed securities, 21 which is what you were looking at at the time. 22 Right? 5126 1 A. That's correct. 2 Q. Why would you bother to hedge or even 3 contemplate hedging a decline in interest rates? 4 Wouldn't that result in the bond price going up? 5 A. Well, the use of the call option was to 6 be short, to write the option, and, therefore, 7 benefit from a falling market. I guess I answered 8 that incorrectly. That would be a falling market 9 hedge, and I suggested that was not appropriate. 10 So, at that point, until we structured 11 this portfolio, we had not considered a falling 12 rate option as a risk. 13 Q. Because it wasn't a risk at that point 14 in time? 15 A. We had not created that risk, yes. 16 Q. It wasn't until you put on the swap 17 that you created that risk, wasn't it? 18 A. That's correct. 19 Q. Now, did you consider any other hedge 20 instruments at the time you were considering 21 purchasing mortgage-backed securities? 22 A. No. 5127 1 Q. Now, did you discuss what type of 2 mortgage-backed securities you would purchase for 3 that portfolio? 4 A. Yes. 5 Q. Okay. And what were those discussions 6 about? 7 A. There were discussions regarding which 8 agency security we would use, whether the three 9 government-related industries are, in some cases, 10 considered private-label mortgage-backed 11 securities. We considered approximately what 12 coupon level we would purchase, what relationship 13 to par value, the prices we would pay. 14 Q. Did you -- when you discussed the 15 prices you would pay, did you discuss whether or 16 not you would buy seasoned mortgage-backed 17 securities? 18 A. We did discuss that. 19 Q. And what did you discuss about that? 20 A. We discussed the characteristics of 21 seasoned securities compared to newly-produced 22 originated securities. 5128 1 Q. And what did you discuss with regard to 2 the differences between newly-created 3 mortgage-backed securities and seasoned 4 securities? 5 A. The most important characteristic was 6 the behavior the security would have or the loans 7 underlying the security would have with respect to 8 prepayment. 9 Q. And what is it about the seasoned 10 mortgage-backed security that -- or what is the 11 difference between the prepayment characteristics 12 of a seasoned mortgage-backed security and one 13 that is recently created? 14 A. The most recently-created securities 15 would have loans in them, depending on the average 16 coupon of the loans and the age of them, that 17 would -- the most recent ones would be subject to 18 somewhat less prepayment because people are less 19 likely, often, to refinance very shortly after 20 taking out a loan. And the prepayment behavior of 21 the more seasoned one would be somewhat more 22 stable and in line with historic trends because 5129 1 these things have been observed for some time. 2 Q. So, what's the difference? I thought 3 you said there was a difference. 4 A. I said that the seasoned one would have 5 a more well-behaved pattern of prepayment while 6 the new one is unlikely to prepay and would have a 7 less predictable pattern for some period of time. 8 Q. Now, did you discuss other differences 9 in terms of your choice of the type of 10 mortgage-backed security that you would buy? 11 A. I don't remember everything that I've 12 just mentioned, but I mentioned the coupon, new 13 production versus seasoned, and the relationship 14 to its price to par. Those would be the most 15 important characteristics, I believe. 16 Q. Now, did -- if you have seasoned and 17 newly-originated mortgage-backed securities of the 18 same size pools, is one going to be priced 19 relatively higher than the other? 20 A. In some cases, they may be. 21 Q. Why is it only in some cases if they 22 are the same in all other respects? 5130 1 A. It would depend on the market and the 2 demand for different characteristics in the bonds. 3 Q. Okay. So that the market -- what 4 you're saying is it may not reflect the 5 differences in the prepayment assumptions 6 underlying those two instruments? 7 A. I thought your question had to do 8 solely with seasoned or new production. 9 Q. It did. And I think that you testified 10 that one has different prepayment characteristics 11 than the other. Right? 12 A. Yes. 13 Q. And aren't prepayment characteristics 14 one of the major factors that determines the 15 value, market value of the mortgage-backed 16 security? 17 A. Yes, they are. 18 Q. So, which one will be relatively higher 19 priced than the other? 20 A. Very often, the seasoned issues will be 21 higher priced. 22 Q. And is that because they have a higher 5131 1 prepayment risk? 2 A. It's because they have a better 3 understood prepayment pattern. 4 Q. Now, when we're talking about relative 5 price between the two, are we talking about the 6 relative differences that those two prices have in 7 relationship to treasuries? 8 A. No. I recall that we would have quoted 9 those in dollar prices. 10 Q. Now, you indicated that the coupon was 11 one of the factors that you talked about in terms 12 of what type of security. 13 Can you tell us what it is that you 14 considered with regard to the coupons that was 15 relevant to your decision of which coupon to pick 16 to include in the mortgage-backed security 17 portfolio? 18 A. Well, typically, the interest rate on 19 the loans underlying these bonds will have some 20 relationship to the coupon and that loans with 21 higher interest rates would be more likely to 22 prepay in times of lower rates and, thus, that 5132 1 would be a consideration in the choice. 2 Q. Now, what were the types of coupons 3 that were referred to in the literature at the 4 time that you had available to you when you were 5 selecting your mortgage-backed security coupon to 6 be included in USAT's portfolio? 7 A. There was a range of coupons available 8 depending on when the securities were originated 9 and when the loans were pooled and put into them. 10 Q. Now, was there something called a 11 premium coupon? 12 A. Yes. 13 Q. Okay. And what was that? Let's say 14 interest rates are at 10 percent. What was a 15 premium coupon? 16 A. A premium coupon would be that coupon 17 on a bond trading at a premium price, a price 18 above par, the reason for which would be a higher 19 coupon than current market rates. 20 Q. So, for example, a 12 percent coupon 21 would be -- in a 10 percent market would be a 22 premium coupon? 5133 1 A. Yes. 2 Q. And what was one that was at 3 10 percent? What was that referred to as? 4 A. That would be referred to as a current 5 coupon. 6 Q. Or an at-the-money coupon? 7 A. We used the term current. At-the-money 8 means something else to me. 9 Q. Okay. And then what happens if it was 10 an 8 percent coupon? 11 A. Well, a bond with an 8 percent coupon 12 would be trading at a discount in that market 13 environment. 14 Q. So, that would be called a discounted 15 bond? 16 A. Yes. 17 Q. Now, did you discuss the spread income 18 that you were going to try and achieve in this 19 mortgage-backed security structure that you were 20 setting up? 21 A. We discussed that as the goal. 22 Q. Okay. And what was the goal? 5134 1 A. The goal was to match off the risk -- 2 I'm sorry -- to match off the duration of the 3 mortgage-backed security with its liability. 4 Q. Did you have any specific spread that 5 you were attempting to achieve? 6 A. We didn't have a target to achieve. We 7 had some idea what spreads could be achieved, 8 given the shape of the -- of the yield curve and 9 how such transactions could be brought about. 10 Q. Okay. Now, what was that range that 11 was available to you at the time? 12 A. I believe it was on the order of 150 13 basis points, 1.5 percentage points. 14 Q. But you also just testified that you 15 could have bought different coupons. Right? 16 A. Well, I meant in the hedged structure, 17 that would be what was left. 18 Q. And what hedged structure are you 19 talking about? 20 A. Well, the hedged structure that we 21 ended up using. 22 Q. Okay. And what was that? 5135 1 A. That was to use interest rate swaps to 2 hedge the short funding risk. 3 Q. Okay. And then to use -- and the short 4 funding risk being the reverse repos that were 5 used to purchase the mortgage-backed securities? 6 A. Yes. 7 Q. Okay. Is that what came to be known as 8 the risk-controlled arbitrage? 9 A. Yes. 10 Q. Okay. Were there any mortgage backs 11 that were held by USAT that you didn't manage? 12 A. Yes, I believe there were. 13 Q. Okay. And where were they? 14 A. There were securities that were held 15 before I arrived. I'm not sure what you mean by 16 "where they were." They were in the association's 17 accounts. 18 Q. So, there were mortgage-backed 19 securities that were there when you arrived in 20 September of 1984? 21 A. Yes. 22 Q. Is that this 98-million-dollar figure 5136 1 that's on this exhibit that I've just shown you? 2 A. It may be. I have not seen this 3 schedule before. So, I'm not sure of all the 4 numbers here; but that could be that, yes. 5 Q. Were those instruments that were held 6 in subsidiaries of USAT at the time? 7 A. I don't know. 8 Q. Do you know how they were funded? 9 A. No. 10 Q. Do you know what their size was? 11 A. Other than what you've presented me 12 here, no. 13 Q. Okay. So, you don't know? Do you know 14 who managed those? 15 A. I don't have any recollection that they 16 were actively managed in any particular way. 17 Q. Were those held in any special pools 18 that were subject to indenture agreements? 19 A. I don't know. 20 Q. You don't know? Well, how large was 21 the portfolio that you managed under this -- what 22 became known as a risk-controlled arbitrage? 5137 1 A. I believe that it approached 2 $650 million. 3 Q. In 1986? 4 A. I think by the time we accumulated it, 5 it was in 1985. 6 Q. Okay. You're talking 1985. What about 7 in 1986? How large did it get? 8 A. I don't think that it grew after we 9 initially accumulated it. 10 Q. So, it was just one portfolio? 11 A. Yes. 12 Q. Were there other portfolios of 13 mortgage-backed securities? 14 A. There were securities in the financing 15 subsidiary that we discussed a moment ago. 16 Q. Okay. Any others? 17 A. I believe there was -- there certainly 18 were securities in -- that served as collateral on 19 a floating rate preferred stock issue that the 20 association later sold. 21 Q. Is that what became referred to as a 22 DART? 5138 1 A. I don't know the acronym, but it was an 2 adjustable rate preferred stock. 3 Q. Okay. 4 THE COURT: Mr. Guido, can you continue 5 on Monday? 6 MR. GUIDO: Yes, Your Honor. 7 THE COURT: We'll adjourn until 8 10:00 o'clock on Monday morning. 9 10 (Whereupon at 3:16 p.m. 11 the proceedings were recessed.) 12 13 14 15 16 17 18 19 20 21 22 5139 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 24th day of 17 October, 1997. 18 ____________________________ MARCY CLARK, CSR 19 Certified Shorthand Reporter In and for the State of Texas 20 Certification No. 4935 Expiration Date: 12-31-97 21 22 5140 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 24th day of 18 October, 1997. 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