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 TRIAL PROCEEDINGS 21 22 2 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 of: Dechert, Price & Rhoads 1500 K Street, N.W. 11 Washington, D.C. 20005-1208 (202) 626-3306 16 12 ON BEHALF OF RESPONDENT FEDERATED DEVELOPMENT CO. AND 13 CHARLES HURWITZ: 14 RICHARD P. KEETON, Esquire of: Mayor, Day, Caldwell & Keeton 15 1900 NationsBank Center, 700 Louisiana Houston, Texas 77002 16 (713) 225-7013 3 17 ON BEHALF OF RESPONDENT FEDERATED DEVELOPMENT CO., CHARLES HURWITZ, AND MAXXAM, INC.: 18 JACKS C. NICKENS, Esquire 19 of: Clements, O'Neill, Pierce & Nickens 1000 Louisiana Street, Suite 1800 20 Houston, Texas 77002 (713) 654-7608 21 22 3 1 ON BEHALF OF JENARD M. GROSS: 2 PAUL BLANKENSTEIN, Esquire MARK A. PERRY, Esquire 3 of: Gibson, Dunn & Crutcher 1050 Connecticut Avenue, N.W. 4 Washington, D.C. 20036-5303 (202) 955-8500 5 ON BEHALF OF BERNER, CROW, MUNITZ AND HUEBSCH: 6 JOHN K. VILLA, Esquire 7 MARY CLARK, Esquire PAUL DUEFFERT, Esquire 8 of: Williams & Connolly 725 Twelfth Street, N.W. 9 Washington, D.C. 20005 (202) 434-5000 10 OTS COURT: 11 HONORABLE ARTHUR L. SHIPE 12 Administrative Law Judge Office of Financial Institutions Adjudication 13 1700 G Street, N.W., 6th Floor Washington, D.C. 20552 14 REPORTED BY: 15 Ms. Marcy Clark, CSR 16 Ms. Erica Davis, CSR 17 18 19 20 21 22 4 1 P-R-O-C-E-E-D-I-N-G-S 2 (10:47 a.m.) 3 THE COURT: Good morning. Be seated. 4 The hearing will come to order. It is scheduled 5 for a hearing at this time and place. The 6 proceeding's instituted by the Office of Thrift 7 Supervision by notice of charges on December 22nd, 8 1995, OTS Order AP 95-40. The notice named as 9 respondents Maxxam, Inc., Federated Development 10 Company, Charles E. Hurwitz, Barry A. Munitz, 11 Jenard M. Gross, Arthur S. Burner, Ronald Huebsch, 12 and Michael Crow. The individual respondents are 13 identified as present, former directors or 14 officers of United Saving Association of Texas, 15 United Financial Group, and/or Maxxam. The notice 16 alleges violations of law and regulations by 17 respondents' orders requiring respondents to cease 18 and desist from the violations alleged in the 19 notice of charges, to reimburse the Federal 20 Insurance Fund for losses incurred as a result of 21 respondents' alleged violations of their statutory 22 and regulatory duties, and to reimburse the Office 5 1 of Thrift Supervision for its costs of this 2 proceeding and the underlying investigation. OTS 3 further seeks as relief an order prohibiting 4 respondents from participating in any manner in 5 the conduct of the affairs of any institution 6 specified in Section AD7A of the Federal Deposit 7 Insurance Act for exercising any voting rights in 8 such institution. Also, an order debarring 9 respondent Burner from practicing before the OTS 10 and an order for assessing civil money penalties 11 against respondents Maxxam, Federated, Hurwitz, 12 Munitz, and Gross. This hearing is being held to 13 determine whether the allegations set forth in the 14 notice are true and, if so, whether orders 15 granting the relief sought should be issued -- who 16 appears for the Office of Thrift Supervision -- 17 MR. GUIDO: -- Your Honor, Kenneth 18 Guido appearing for the Office of Thrift 19 Supervision. I'm joined by Richard Stearns who is 20 the director of enforcement, Bruce Rinaldi who is 21 the associate director of enforcement and Bryan 22 Veis who is Senior Counsel. 6 1 THE COURT: Thank you. Let's take the 2 respondents from the left to the right, okay? Who 3 appears for the respondents? 4 MR. NICKENS: Yes. Your Honor, I'm 5 J.C. Nickens with the firm of Clements, O'Neill, 6 Pierce & Nickens a Houston law firm and I have 7 filed of appearance on behalf of Mr. Hurwitz and 8 on behalf of Federated. 9 10 THE COURT: Thank you. 11 MR. EISENHART: Your Honor, my name is 12 Frank Eisenhart. I'm from the law firm of 13 Dechert, Price & Rhoads from Washington with my 14 colleagues Arthur Leibold, Bettina Lawton, 15 Jennifer Kim, and Catherine Boticelli who is not 16 in the courtroom at the moment. We represent the 17 defendant -- or respondent, Maxxam. 18 MR. KEETON: Your Honor, I'm Richard 19 Keeton with Mayor, Day, Caldwell, & Keeton along 20 with David Griffith. We represent Federated and 21 Charles Hurwitz. 22 THE COURT: Thank you. 7 1 MR. BLANKENSTEIN: Paul Blankenstein, 2 Your Honor with Gibson, Dunn & Crutcher and with 3 Mark Perry. We represent Jenard Gross. 4 MR. VILLA: I'm John Villa from 5 Williams & Connolly, Your Honor. I represent the 6 respondents Art Berner, Mike Crow, Dr. Barry 7 Munitz and Ron Huebsch. With me in the courtroom 8 today and also presenting evidence during the 9 course of the trial, Ms. Mary Clark and Mr. Paul 10 Dueffert. 11 THE COURT: Thank you. Now are these 12 others entering appearances, or have they been 13 identified? All right. Is that all the 14 appearances? 15 MR. VILLA: I believe so, Your Honor. 16 MR. STEARNS: Your Honor, for Office of 17 Thrift Supervision as the proceeding continues, 18 there may be other attorneys who will present 19 evidence in the office who are not here today. 20 THE COURT: Who have entered 21 appearances? 22 MR. STEARNS: Yes, there will be full 8 1 line of discussions. 2 THE COURT: Are there any preliminary 3 matters? 4 MR. NICKENS: Yes. Your Honor, we have 5 some preliminary matters with regard to certain 6 agreements that we have made with the OTS to 7 inform the Court and certain logistical issues and 8 I believe we also have filed four motions in 9 limine to present to the Court. 10 With regard to these logical issues and 11 the agreements that we have reached, Your Honor, 12 both sides in the case have identified 13 approximately 150 witnesses, 45 of whom appear on 14 both our lists. And many of these people will 15 have to be subpoenaed to appear here. And as 16 result of that and because of the logistical 17 problems associated with getting the people here 18 in the proper time, we have established certain 19 agreements with the OTS about notifying each other 20 as to when we expect to reach certain witnesses. 21 So, we have agreed that at the close of business 22 on each Thursday, we will try to identify for the 9 1 other side the witnesses that we expect that would 2 be called the following week and that we have an 3 agreement that in any event, that we would give 48 4 hours' notice to the other side prior to calling a 5 witness. These agreements are necessary with this 6 many people involved in order to avoid just utter 7 chaos, and we have agreed to those matters and 8 expect to strictly adhere to those agreements. 9 In addition, Your Honor, there are some 10 8,000 exhibits currently identified. We have not 11 brought them to the courtroom today. We will 12 bring them either late this afternoon, this 13 evening, or in the morning. But there are boxes 14 and boxes, as you might imagine, of these 15 exhibits. 16 I fully expect that many thousands of 17 those will never be referred to in these 18 proceedings; but, nevertheless, they are the ones 19 that each side has designated as possibly relevant 20 to be used. In order to deal with the logistics 21 of having 8,000 exhibits, we have prepared a 22 computer exhibit list that Ms. Richardson will 10 1 maintain in coordination with whoever you might 2 like. We will also provide and have provided to 3 both sides a complete set of these exhibits. Our 4 thought is that as an exhibit is referred to, that 5 we would provide you with one and the witness with 6 one. Although, if Your Honor prefers, we are 7 prepared to provide you with a complete set of 8 your own exhibits. So, we're subject to whatever 9 your instructions are in that regard, although our 10 thought was that we would give you a copy as they 11 are used and try to then, at the end of the day, 12 make sure that they get back into their folders so 13 that they are then available if they are referred 14 to at a later time. But we are subject to your 15 instructions. 16 THE COURT: A large number of them are 17 not going to be referred to at all. I think we 18 better just take them as they are referred to and 19 furnish me a copy at that time. 20 MR. NICKENS: Thank you. We have also 21 agreed that as to certain types of exhibits, 22 summary exhibits, that we will provide the other 11 1 side new exhibits that may be necessary, that we 2 would provide the other side seven days' notice of 3 our intention to use such exhibit so that they 4 could examine those summaries and underlying 5 documents that they represent and to confirm that 6 they are accurate to the best of everybody's 7 information. We are also discussions and it's 8 going to clearly be necessary to supplement at 9 times even this voluminous list, and we are 10 discussing, although we have not yet reached an 11 agreement with regard to a notice period for 12 supplemental exhibits. 13 With regard to authentication, Your 14 Honor, most of these -- almost all of these 15 documents bear some identifying numbers or labels. 16 We have provided the OTS with our identifications 17 of those. We expect to reach agreements so that 18 the source of the document that is being used will 19 be known or available if that matter should become 20 a matter of concern. The management of exhibits, 21 we expect in this number, to be a problem; but we 22 have done everything that we could think to ease 12 1 that difficulty. But there's a certain amount 2 that I expect will develop as we go along. 3 Finally, Your Honor, I expect that the 4 components who are here with the exception of 5 Mr. Munitz, not all of them are going to be able 6 to be here during the entire time of the 7 proceedings; and we will ask your permission to 8 have them excused as their needs are when they are 9 not testifying and have to take care of their 10 other business interests. 11 THE COURT: Okay. Thank you. 12 MR. NICKENS: And with that, your 13 Honor, Mr. Eisenhart, I believe, would present our 14 motion in limine. 15 THE COURT: I gather the OTS has no 16 response to what Mr. Nickens has said. 17 MR. GUIDO: That has been a long, 18 drawn-out set of negotiations, and is perfectly 19 acceptable. We do have a problem, and we are 20 negotiating the question of how much notice to 21 give either side with regard to the exhibits and 22 with regard to supplemental exhibits because, as 13 1 you can imagine with this large volume of 2 documents both sides have produced, we have tried 3 to create a combined set of documents. It's not 4 sure that all of the documents each side intended 5 to be included have been included in there, Your 6 Honor. 7 THE COURT: Mr. Eisenhart? 8 MR. EISENHART: Thank you, your Honor. 9 I'd like to address first the motion in limine 10 which Maxxam filed. This concerns the scope of 11 this hearing and particularly whether OTS will be 12 entitled to present evidence in this hearing of a 13 so-called controlling influence. 14 The background of this motion is as 15 follows: As your Honor knows, there is a 16 significant case issue in this case with respect 17 to MAXXAM, Federated, and Mr. Hurwitz as to 18 whether they have a liability to maintain the net 19 worth of the United Savings Association of Texas. 20 The so-called net-worth maintenance claim arises 21 out of a bank board resolution which contains a 22 provision in it that says for so long as MCO, 14 1 which was a party to the resolution and MAXXAM'S 2 control the United Saving Association of Texas. 3 They will be responsible to maintain a pro rata 4 share of its net worth. That is the underlying 5 undertaking that triggers the net worth 6 maintenance claim in this case. 7 In the notice of charges, the document 8 that was filed by OTS to commence these 9 proceedings in December 1995 in which defines the 10 case we have been discovering in for the last year 11 and nine months, the issue of control is tied to 12 stock ownership. They plead two theories of 13 control in there. They say that MCO and Federated 14 together exceeded the 25 percent control threshold 15 by virtue of ownership of stock by the so-called 16 Drexel option. This is option stock, stock that 17 under a call option from Drexel but which was not 18 actually owned. OTS says they will prove that we 19 were deemed to own this stock; therefore, we did 20 own it therefore the addition of this stock put us 21 over the 25 percent threshold. That's Theory No. 22 1. Theory No. 2 that was pleaded also involves 15 1 the issue of ownership of stock. It says the 2 112,000 shares of stock that were owned by 3 Mr. Gross should be attributed to Maxxam and 4 Federated under theories that I won't go into at 5 the moment and that amount should be counted along 6 with our stock for determining whether we pass the 7 25 percent threshold and if, indeed, we counted 8 those 112,000 shares, we would pass that 25 9 percent threshold. 10 Those are the two theories they have 11 pleaded in the notice of charges as to how 12 MCO/MAXXAM and Federated controlled the savings 13 institution and therefore are liable under the 14 network maintenance obligation. Recently -- when 15 I say "recently," I mean within the past two or 16 three weeks, OTS has told us in a letter that they 17 intend to allege at this trial a whole other 18 theory of control. They say they intend to prove 19 at this trial that MCO and Federated and 20 Mr. Hurwitz were deemed to be in control of the 21 institution because they exercised, quote, 22 "controlling influence" over the affairs of the 16 1 institution. Controlling influence is set out in 2 the statute as another way by which you can prove 3 control. The way this particular statute is set 4 up; and actually, if your Honor wishes, I have a 5 copy of the statute which I can hand up to you. 6 There are really four ways you can get to control. 7 The first two ways which are Section A and B both 8 involve stock ownership. Those are what they have 9 alleged in the complaint and indeed Sections A and 10 B of this statute are what they have pleaded in 11 the notice of charges as their basis for this 12 claim. 13 Subsection D of the statute refers to 14 the so-called controlling influence. And you'll 15 see I've actually highlighted a portion of that. 16 What it says is that you can be deemed to have 17 control of the savings association or other 18 company if the director determines, after 19 reasonable notice and opportunity for hearing, 20 that such person directly or indirectly exercises 21 a controlling influence over the management or 22 policies of the association. That statute and the 17 1 words "controlling influence" are nowhere pleaded 2 in the notice of charges. There is not a single 3 reference in the notice of charges in Subsection 4 D. The term "controlling influence" appears 5 nowhere in the notice of charges. Indeed, this 6 subsection is somewhat unique in that unlike the 7 other sections of the statute it specifically 8 provides for a hearing. There is actually a 9 preacher called a controlling influence hearing. 10 To our knowledge, neither the bank board or its 11 successor, OTS, has ever held a controlling 12 influence hearing; but unlike the determination of 13 stock ownership which is essentially a fact, you 14 either own the stock or you don't own the stock, 15 controlling influence obviously is something that 16 would have to determine and would be fact 17 intensive. In order to trigger a hearing such as 18 we're involved in right now which is an 19 enforcement hearing under the Federal Deposit 20 Insurance Act, there would have to be a prior 21 determination that a party actually did control 22 the institution by virtue of a controlling 18 1 influence. In other words, if they allege that 2 there's control via a controlling influence, they 3 hold a controlling influence hearing. If the 4 control is then determined, where you go from that 5 is the subject of the next proceeding. There has 6 never been a controlling influence hearing. There 7 has never been any notice that this was to be a 8 controlling influence hearing. And nowhere in the 9 charges is there a reference in the statute or a 10 reference to that term. They have told us in a 11 letter by Mr. Stearns dated September 5th that 12 they think we have always been on notice that this 13 is a controlling influence hearing and they intend 14 to introduce this sort evidence at trial. It's 15 following that letter, we filed a motion in 16 limine. 17 As your Honor knows, there are 18 provisions in the OTS procedural rules dealing 19 with amendment of pleadings to conform to the 20 evidence. The rule provides that if we don't 21 object, the pleading will be deemed amended to 22 conform to the evidence. Well, we very much 19 1 object to this so-called influence evidence. This 2 is not the case we're here to try. We believe, 3 therefore, if they were really to want to go 4 forward with the controlling influence hearing 5 over our objection, they would have to seek leave 6 to amend their complaint which they have never 7 done. Where do we go? We are here to try the 8 case that was pleaded in December 1995. They want 9 to make it a different case, and I don't think 10 they should be permitted to do so. So, we moved 11 in limine to exclude evidence going to so-called 12 controlling influence on the theory that that is 13 not a part of this case. 14 THE COURT: Thank you. Do any of the 15 other respondents wish to be heard on the motion? 16 MR. NICKENS: I think all the 17 respondents join in the motion, but I think Mr. 18 Eisenhart has stated our position. 19 THE COURT: Does the OTS have a 20 response? 21 MR. STEARNS: Yes, Your Honor. Good 22 morning, Your Honor. Richard Stearns for the OTS. 20 1 The OTS is here try precisely the case alleged in 2 the notice of charges. And that notice of charges 3 as I'm sure Your Honor's aware is replete with 4 allegations and statements of fact which allege 5 controlling influence by means of allegations that 6 respondents exercised actual control over the 7 operations, policies, and management of the United 8 Financial Group, the United Savings Association of 9 Texas. If your Honor does look at the statute, 10 you'll notice it is a statute that is designed to 11 determine when a person is deemed to have control; 12 and as Mr. Eisenhart has said, there are several 13 ways of doing so. We have alleged not only that 14 respondents acquired control through stock 15 ownership and not only they acquired control by 16 acting in concert with each other to acquire 17 stock; but they actually, in addition to their 18 acquisition of stock, exercised control over the 19 operations and management of USAT. The notice of 20 charges uses such phrases to put them on notice of 21 those allegations as actually participating in the 22 conduct of the affairs of the association. If I 21 1 can draw your Honor's attention to the early 2 sections concerning jurisdiction. In the 3 statement of who the respondents are, there are 4 allegations, for example, in paragraphs 5 and 6, 5 MAXXAM and Federated participated directly or 6 indirectly in the conduct of the affairs of UFG 7 and USAT. A further example in 15 of the notice 8 respondents in Maxxam and Federated, acting 9 through the individual components and other 10 officers, directors, employees and agents 11 participated in the conducts and affairs of USAT 12 and knowingly or recklessly participated in the 13 activities prescribed herein. Your Honor, if our 14 theories were merely acquisition of control of 15 stock ownership, there would have been no need for 16 the notice charges to then go on an as it does 17 allege actual control and the exercise of actual 18 control over the activities of the institutions. 19 The notice of charges your Honor, contains 20 numerous detail factual allegations of how the 21 respondents exercised their control over the 22 institution, allegations that put the respondents 22 1 on notice from the moment the day they received of 2 the allegations of their exercise of actual 3 control. There are allegations of almost every 4 claim with the exception of those claims that are 5 specific to the acquisition of control through 6 stock ownership as to how these respondents in 7 taking control of this institution then directed 8 the affairs of this institution. Directed the 9 affairs of the institution through failure to 10 maintain net worth of the association as they 11 controlled the UFG, directed the affairs of the 12 institution through the implementation of a 13 strategy to purchase and sell mortgage-backed 14 securities. Exercise control through transactions 15 that involved inflating maturity matching credits 16 and violations of regulations concerning 17 guarantees and direct investment rules, 18 participated in decisions of the association 19 concerning speculative real estate practices and 20 after USAT failed its net worth and participated 21 personally and directly in decisions as to the 22 payment of excessive bonuses and compensation. 23 1 Your Honor, all parties in this case 2 have done a tremendous amount of discovery. There 3 are thousands of pages of documents that have been 4 exchanged and dozens and dozens of depositions. 5 Those depositions or those documents are replete 6 in themselves with proof concerning the actual 7 exercise of control by the respondents over this 8 association Mr. Eisenhart, I think, would say 9 unless the phrase "controlling influence" appears 10 some place in the notice, there is not reasonable 11 notice. 12 The statute says reasonable notice of 13 our allegation that these individuals controlled 14 the institution. That's what the notice contains 15 in more than 100 pages. Allegations that they 16 controlled the institution. The statute also 17 provides before the director can make a 18 determination of controlling influence not only 19 must the respondents have reasonable notice, but 20 they must have an opportunity for hearing. The 21 respondents' allegation is that the agency through 22 its director has never issued regulations that 24 1 implement that part of the statute. But, in fact, 2 those regulations are part of Part 509 of 12CFR. 3 509.100 provides that any hearing to be held under 4 this subsection, Subsection A2D shall be held in 5 accordance with the rules set forth in Subpart A 6 which are the rules of uniform practice and 7 procedure that govern this proceeding we're at 8 today. And Part 509.1G specifically says that 9 those uniform rules, practice and procedure cover 10 any nonenumerated type of hearing which by statute 11 calls for an opportunity for hearing which 12 precisely what A2D provides, an opportunity for 13 hearing. In short, your Honor, there's been both 14 elements as required by the statute for purposes 15 of determining whether or not respondents 16 exercised control or exercised a controlling 17 influence, as respondents would have it, over the 18 operation and management of the association. 19 There's been reasonable notice provided to the 20 facts of the notice of charges. The notice of 21 charges cites the savings loan holding company as 22 a jurisdictional basis and there is today an 25 1 opportunity for a hearing as provided for by 2 regulations through the rules that govern this 3 procedure. 4 MR. EISENHART: Your Honor, may I 5 briefly respond? 6 THE COURT: Yes. 7 MR. EISENHART: The examples 8 Mr. Stearns gave actually underscore, in my view, 9 the seriousness of this motion. He talks, for 10 instance, about control over purchases of 11 mortgage-backed securities or control over real 12 estate transactions. My client, MAXXAM, is not 13 named in the notice of charges as having anything 14 to do with the charges pertaining to real estate 15 or anything to do with the charges pertaining to 16 mortgage-backed securities. That is not an area 17 of the case in which we are a named respondent. 18 It is not an area in the case that we have paid 19 that much attention to in the discovery in this 20 case. That's been very ably handled by some of 21 our colleagues whose clients are directly involved 22 in that. If I am now being told that MAXXAM is 26 1 going to be held liable because it exercised a 2 controlling influence over mortgage-backed 3 securities or over real estate. I can assure you, 4 your Honor, that is a very new charge. That is 5 not one I have heard before. And I would have 6 conducted myself very differently over the past 7 two years, with respect to discovery in those 8 areas had I had any inkling that MAXXAM was going 9 to be held responsible. I think the word 10 "control" is being thrown around quite a bit in 11 the complaint; but the word "control" as applied 12 to MAXXAM in this case has been always limited to 13 control via stock ownership. There has never been 14 any reference to controlling influence, and 15 there's never been any reference to the portion of 16 the statute dealing with control via controlling 17 influence. The problem we have and the prejudice 18 we face if they are allowed to go forward with 19 this new theory at this point are several. That 20 statute specifically requires adequate notice. We 21 don't believe that telling us on the 5th of 22 September, that this is now part of the case is 27 1 adequate notice. We have had no ability to 2 conduct discovery. I don't know what are the 3 so-called controlling influences we are supposed 4 to have alleged. They are not set out anywhere in 5 the notice of charges. They have not been 6 provided to me. I have no idea whether we have 7 addressed some or all of any of those so-called 8 controlling influences in the discovery of this 9 case. There are no experts in this case on either 10 who are prepared to come into court and talk about 11 controlling influence. There are experts who have 12 dealt with the issues of control. Both their 13 experts and their expert on that issue have dealt 14 with control; but they have dealt with it on the 15 context of stock ownership. There is no expert 16 that has ever addressed the subject of what is a 17 controlling influence. What is the lure? How is 18 that defined in bank word and OTS terminology? 19 Nobody has opined on that because nobody has ever 20 thought until September 5th that it was part of 21 this case. We believe that if they were to add 22 this new charge at this point, there would be 28 1 statute of limitations concerns. This is now 2 1997. We're talking about an institution that was 3 put in receivership in 1988 and events that 4 happened many years prior to that. I'd have to 5 see what they're alleging the so-called 6 controlling influence conduct to be, but I cannot 7 believe that at this late date, that wouldn't 8 raise statute of limitations concerns. There are 9 waiver and estoppel concerns that would arise. 10 These are all defenses that I would assume we 11 would plead and pursue if they were to amend their 12 complaint to set out the controlling influence 13 charge. But since they've never done that, we've 14 never had opportunity to do it. 15 Indeed, there would be an issue as to 16 whether OTS can hold a hearing now because this is 17 one of the many statutes that was changed 18 completely. When FIRREA was passed in 1989, 19 statute that they would go forward with now if 20 they were going to hold a so-called controlling 21 influence hearing is a statute that came into 22 being in 1989. The prior statute which would have 29 1 been in place when all the conduct supposedly took 2 place was repealed in 1989. I have never looked 3 at this. I don't whether they would have the 4 ability to hold a controlling influence hearing 5 now on pre-FIRREA based on pre-FIRREA conduct, but 6 the most important prejudice is that this injects 7 in this file a whole new issue that nobody has 8 looked at over the past nine months to over which 9 there are many, many implications not the least of 10 which is adequate notice and due process. And for 11 all of these reasons, I believe our motion should 12 be granted; and they should not be permitted to 13 amend their complaint; and they should not be 14 permitted to introduce this evidence. 15 MR. NICKENS: Your Honor, might I offer 16 one point of clarification? Mister Eisenhart's 17 comments might have suggested that MAXXAM wasn't 18 named in certain parts of the claim when, in fact, 19 I think they are named. But there are no 20 supporting factual allegations that would ever 21 have suggested that the controlling influence was 22 a basis for those allegations. 30 1 THE COURT: Thank you. 2 MR. STEARNS: Brief response, your 3 Honor? Very briefly, Your Honor, Mr. Nickens is 4 right. It is very clear from the face of the 5 notice, the charges that each of the respondents 6 are named in the individual claims as they are set 7 forth. Our allegations against them are in a 140 8 pages of detailed notice of charges to demonstrate 9 how the respondents exercised control over these 10 associations. Their acquisition control not 11 merely just through obtaining ownership of stock 12 or acting in concert with others' ownership of 13 stock, that's a small part of this notice of 14 charges limited to just a few of these claims. 15 All of the other claims -- more ten of them are 16 factual allegations. They are set forth in great 17 detail as to how actual control is set forth to 18 direct the operations, policies, and the 19 management of this association. Mr. Eisenhart's 20 point that he believes he was prejudiced because 21 it was something that occurred to them and they 22 did not raise affirmative defenses, really in this 31 1 case, each of the arguments he raises is a legal 2 argument which certainly can be addressed at any 3 stage of the proceedings including now. One of 4 those arguments in the statute of limitations is 5 an argument Your Honor's already ruled on with 6 respect to applicable statute of limitations. I 7 don't see that a prejudice. I see that all of the 8 facts which are the basis of this hearing have 9 been alleged and have been well-known to the 10 respondents for the discovery in this case for 11 quite some period of time. 12 THE COURT: I'm prepared to rule. I 13 deny the motion. It does not seem to me that the 14 notice can be construed as alleging the exercise 15 of control based solely on stock ownership, and I 16 see nothing inconsistent with the procedure 17 required on the 1467G3D with that being followed 18 here. It's a notice of hearing and evidence, and 19 I don't see any requirement that there be a prior 20 determination. And then you have another hearing. 21 And it seems to me granting the motion would 22 exclude evidence that pertained to many quite 32 1 explicit allegations in the notice; so, I deny the 2 motion. 3 MR. EISENHART: May I ask whether your 4 Honor will require OTS to amend its notice of 5 charges to assert this? 6 THE COURT: No. 7 MR. EISENHART: Your Honor, I want to 8 address briefly two other motions in limine; and I 9 think these will not need to detain us long. We 10 filed a motion dealing with the scope of rebuttal 11 testimony. And the genesis of that motion was, 12 quite frankly, a concern on our part that OTS 13 might be attempting to push into the so-called 14 rebuttal phase of its case evidence which more 15 properly belonged in its case-in-chief. We have 16 since taken the deposition of Mr. Oliver who was 17 one of the -- I'm sorry. I'm getting ahead of 18 myself. We have discussed this with OTS; and I 19 think at this point, we are prepared to take them 20 at their word on the notion that they are not 21 going to play fast and lose with the concept of 22 rebuttal. We still have some concerns, and we 33 1 still have some suspicions. But we think at this 2 point, we can ask the Court to defer any ruling on 3 this issue unless and until the problem arises. 4 We will be waiting to see what they actually try 5 in rebuttal and take it up then if we need to. 6 THE COURT: Thank you. I accept that. 7 And let me just say that I don't look with favor 8 on a party holding something up his sleeve so he 9 can spring it in for rebuttal. And so, I have 10 that concern, too. But, I'm taking OTS at their 11 word, also. 12 MR. STEARNS: I certainly accept 13 Mr. Eisenhart's representation. I think that is 14 an appropriate way to go, and I think it applies 15 surrebuttal, Your Honor, and I don't think there's 16 any way the Court at this beginning stage in the 17 hearing can make those determinations that they 18 have to reserve. 19 MR. EISENHART: The other half of that 20 motion dealt with what we have referred to as 21 summary witnesses. OTS identified rather late in 22 the game two witnesses, a Mr. Oliver and 34 1 Mr. Cooper whom they described as summary 2 witnesses. We have some concern that these might 3 be new expert witnesses being snuck in under the 4 guise of summary witnesses. We have taken the 5 deposition of Mr. Oliver and at least on the 6 subjects we believe they're offering and we think 7 that he is, in fact, a genuine summary witness. 8 We have no objection at this point on that basis. 9 With respect to Mr. Cooper, what we would like to 10 propose is that during the course of this 11 proceeding before he testifies, that we take the 12 deposition of Mr. Cooper. If, as is the case with 13 Mr. Oliver, he does look like a genuine summary 14 witness, there will not be an issue for the Court 15 to resolve. 16 MR. STEARNS: Mr. Cooper, Your Honor, 17 was listed at the appropriate time on our witness 18 list as an individual who will present summary 19 testimony has publicly available information 20 concerning housing conditions and market 21 conditions in Texas in the 1980's which he has 22 collected. In order to facilitate in court, he 35 1 will provide a summary testimony as to what the 2 bind of that information states. He is available 3 for deposition. We have offered him for 4 deposition. They have not yet noticed this 5 deposition, and we will certainly find time to do 6 that. 7 MR. EISENHART: We will do it, Your 8 Honor, and if there's a problem then, we will take 9 it up with the Court at that time. And I believe 10 there's a last matter to be considered and Mr. 11 Blankenstein will address that. 12 MR. BLANKENSTEIN: Your Honor, with 13 your permission I would like Mr. Perry to address 14 that last motion in limine that was filed on 15 behalf of Jim R. Gross. 16 MR. PERRY: Thank you, Your Honor. As 17 you know Mr. Gross has filed a motion in limine 18 that addresses two issues in the notice of charges 19 the. First one is the question whether the 1987 20 bonuses are properly part of this case. In the 21 13th claim for relief the OTS makes various 22 allegations regarding the compensation practices 36 1 charging that they were unsafe and unsound against 2 Mr. Gross and some of the other individual 3 respondents. 4 Nowhere in that claim or anywhere else 5 in that notice are the 1987 bonuses are mentioned. 6 The 1988 bonuses are mentioned but not the 1987 7 bonuses. In discovery their expert made -- he had 8 certain opinions regarding the 1987 bonuses. We 9 have therefore filed a motion in limine to 10 preclude them from bringing that into this case at 11 this late date because it's not in the notice of 12 charges. OTS says that all compensation practices 13 in 1988 are encompassed by the notice of charges. 14 That's not true, Your Honor. They haven't 15 alleged, for example, that Lawrence Pinell's 16 contract was unsafe and unsound. In fact, the 17 notice is specific about the three areas that they 18 do claim are unsafe and unsound. The 1987 bonus 19 is not one of them. They effectively concede that 20 they did not include it in the notice of charges 21 by asserting that respondents had ample notice in 22 this claim because their expert Alan Dermany 37 1 offered an opinion about the 1987 bonuses. Your 2 Honor, there is no authority for the proposition 3 that the litigant can amend its pleadings by 4 procuring expert testimony on an issue that is not 5 in the notice of charges itself. 6 In fact, OTS has said that it wouldn't 7 amend the notice of charges and the statute of 8 limitations clearly precludes them from doing so. 9 The 1987 bonuses were paid in January of 1988. A 10 lot more than six years, five years or whatever 11 the statute of limitation has passed since then. 12 OTS also claims that we have waived this argument 13 by not raising it apparently at the time 14 Mr. Dermany testified. Your Honor, that would not 15 have been a proper objection to Mr. Determines 16 deposition testimony. It was not appropriate at 17 the summary disposition stage because it did not 18 get rid of a claim. In fact, it is exactly what a 19 motion in limine is designed for, carved out a 20 particular small issue, not raised in the 21 pleadings in this case and just make sure that 22 it's not presented in the hearing. 38 1 The second issue, Your Honor, in our 2 motion of limine concerns the acting in concert 3 allegations. This issue is previously before Your 4 Honor in a motion for summary disposition. Our 5 position is that the notice of charges contains 6 only one allegation of fact, relating to 7 Mr. Gross' alleged acting in concert with any 8 other respondent to control UFG and that is, that 9 Mr. Gross and Mr. Hurwitz both were directors of 10 Weingarten Realty. OTS again effectively concedes 11 this point by stating that in its opposition for 12 summary disposition it raised -- and it raised for 13 the first time in that point Your Honor -- a 14 number of factual issues regarding Gross' 15 acquisition of UFG shares. Those factual issues 16 were not raised in the notice of charges and we 17 submit are not proper issues in this case. We are 18 not seeking reconsideration of your earlier 19 ruling. We understand that you have rules. As a 20 matter of law, OTS would receive but as a matter 21 of pleading in trial practice we are asking you to 22 preclude them from introducing evidence on a 39 1 theory that they have not pleaded or given us 2 notice of. 3 Your Honor, OTS investigated this case 4 for a long time. As Mr. Stearns just pointed out, 5 the notice of charges is 140 pages long and 6 contains detailed allegations. OTS chose not to 7 include in those allegations anything relating to 8 the 1987 bonuses or anything acting in concert by 9 Mr. Gross other than Weingarten. It's too late in 10 the day and the statute of limitations prevents 11 OTS from bringing new issues in at this point. 12 Thank you. 13 THE COURT: Thank you. 14 MR. RINALDI: If it please the Court, 15 Bruce Rinaldi responding for the OTS. First with 16 respect to the compensation issue and whether the 17 1987 bonuses, which were paid in 1998, are 18 included within the notice of charges. The OTS 19 asserted in the notice of charges that when it 20 became apparent that respondents could no longer 21 concede that USAT failed its minimum capital, 22 respondents caused UFG and USAT to enter into 40 1 employment agreements with exorbitant, illegal, 2 and unsafe provisions for the benefit of certain 3 individual respondents. And then we go on and we 4 talk about all of the various employment practices 5 that we're engaged in. They increase their own 6 salaries by 55 to 80 percent. They paid 7 themselves bonuses in 1980, a special bonus -- 8 THE COURT: Excuse me. What year? 9 1980? 10 MR. RINALDI: I'm sorry. '88, excuse 11 me. And we go on and we also identified 12 employment agreements that provided for lavish 13 severance benefits for over two years' 14 compensation in the event that these individuals 15 were terminated at USAT. The notice of charges 16 makes it very clear that once these individuals 17 realized what was happening, that the thrift was 18 failing and that they were going to lose their 19 jobs, they simply treated the thrift as a piggy 20 bank and started to use compensation practices as 21 a mechanism for their on personal aggrandizement. 22 Now, in that regard having alleged the general 41 1 allegations that they have done these things, 2 during did course of discovery we advised them on 3 several occasion that one of the factors which we 4 considered to be unsafe and unsound was the 5 payment of a 55 to 80 percent bonuses in the case 6 of Mr. Gross, to be perfectly honest his bonus was 7 only 55 percent and represent $167,000 but there 8 are other individuals who received much greater 9 bonuses in 1988. This was some three months after 10 they had been advised by their general counsel 11 that they were about to fail their net-worth 12 requirements. Mr. Dermany states unequivocally, 13 in his opinion, that it was unsafe and unsound for 14 them to have paid those bonuses at that time when 15 the thrift was failing its net-worth requirements. 16 This was on April the 15th that they were advised 17 of this fact; so, they've known for some five, six 18 months now that this was one of the contentions of 19 the Office of Thrift Supervision. They then 20 deposed Mr. Dermany on two different occasions and 21 he made it very explicit in his deposition that it 22 was unsafe and unsound for them to have paid these 42 1 bonuses. They now state that well, when they read 2 the notice of charges, there's not an explicit 3 statement that says this particular bonuses was 4 unsafe and unsound. It talks about other bonuses 5 that were paid. It talks about generally their 6 compensation practices, but they claim that it 7 wasn't specific enough. The fact is they've began 8 on notice for months, Your Honor, regarding this 9 bonus claim rather than at some point earlier in 10 the proceedings filing some pleading to state that 11 claims with respect to the this should be 12 stricken. They simply laid in the weeds. Now 13 they say gee, we didn't have enough notice. We 14 didn't know what was going on when clearly they 15 were on notice as much as five months ago. In 16 fact, if one reads their pleading very carefully, 17 on page 2 they say the following: OTS has 18 indicated in discovery that it intends to attempt 19 to prove that the 1987 payments were unsafe and 20 unsound. That's their own statement. Now, they 21 claim they didn't know. I think it's palpably 22 absurd to make such a claim on their behalf. The 43 1 second point they make raises the issue was 2 Mr. Gross placed on adequate notice of the fact 3 that he was acting in concert with the other 4 respondents in this case to be part of a control 5 group. The notice of charges sets out very 6 clearly on page 23 at paragraph 58 that Mr. Gross 7 acquired some 112,000 shares of UFG. Now, we did 8 not spell out the specific detail of how that 9 occurred. We said that he acquired 110,000 shares 10 of UFG and his total holdings were 112. The 11 110,000 shares were acquired by Mr. Gross with a 12 loan that was funded 100 percent by UFG that was 13 presented to him by respondents in this case. And 14 for him to acquire a portion of the company; and 15 then subsequent to that when Mr. Gross could not 16 pay off the loans that were owed to him they 17 simply forgave the debt. And in effect Mr. Gross 18 held a substantial block of stock in the company 19 throughout the whole period of this challenge here 20 today that's part of our claims today. And during 21 that period of time it is our assertion that he 22 was acting in concert with other individuals who 44 1 also held shares of UFG. The notice of charges 2 are replete with allegation that he was acting in 3 concert of all of these individuals. To state 4 that because we alleged greater detail with 5 respect to the Weingarten Realty part of the case, 6 isn't really a claim at all. They were placed by 7 notice by virtue of, one, stock ownership and; 8 two, his direct representation along with Charles 9 Hurwitz and the Weingarten board that he would be 10 deemed to be acting in concert with Mr. Hurwitz 11 and therefore part of the control group. I would 12 submit to the Court that at this point in time 13 this is not a new claim, that it's one that's 14 fully evident from the face of the notice of 15 charges and it would be inappropriate for the 16 Court to dismiss or at least restrict evidence 17 with respect to that aspect of our claim of acting 18 in concert. Thank you. 19 MR. PERRY: Very briefly, Your Honor? 20 With respect to the 1987 bonuses, I think 21 Mr. Rinaldi just admitted they are nowhere in the 22 notice of charges. He said it came up in 45 1 discovery. He says we should have filed some 2 pleading before we filed our motion in limine. He 3 didn't tell you what pleading that should have 4 been, and I don't know what pleading it should 5 have been. The only pleading I know of to 6 preclude evidence at the hearing of a theory that 7 is not raised in the notice of charges is the 8 motion in limine. We agreed on a schedule for 9 filing the notice, Court approved it and we filed 10 it on time. I'm not sure what this pleading that 11 Mr. Rinaldi has in mind is. When it came to our 12 attention, we dealt with it. And as for acting in 13 concert issue, I think Mr. Rinaldi has also 14 admitted that the facts that he just laid out for 15 Your Honor are not in the notice of charges. 16 They're in OTS's new theory, way late, about how 17 Mr. Gross allegedly acted in concert. If you look 18 in the notice of charges, it says 19 Weingarten Realty. Yes, it says he purchased UFG 20 shares. Nowhere is that connected with Mr. 21 Hurwitz, any of the other respondents, control of 22 UFG or anything else that OTS now says. It simply 46 1 isn't there, Your Honor; and we ask that it not 2 get into this case. Thank you. 3 THE COURT: I've looked at this 4 question about whether there are other factors 5 alleged pertaining to Mr. Gross' acting in 6 concert. And it seems to me that the notice does 7 put him on notice that there are other issues 8 involved. As to the '87 bonus, there were general 9 allegations and I believe the specifics have come 10 up during discovery and I believe as of this 11 moment, we're aware of what the issues are and 12 that there has been adequate notice, and I deny 13 the motion. 14 MR. NICKENS: Your Honor, we have one 15 other minor preliminary matter prior to opening 16 statements. When I first stood up today I 17 indicated that my notice of appearance was on 18 behalf of Mr. Hurwitz and Federated which it is 19 and I would ask permission from Your Honor to be 20 able to file a notice of appearance as co-counsel 21 for MAXXAM the purpose of this is to allow us to 22 allocate and assign primary responsibility for 47 1 certain witnesses in areas of expertise that we 2 have developed in the case. 3 THE COURT: Very well. Are you going 4 to file a formal notice? 5 MR. NICKENS: Yes, Your Honor I will 6 and I apologize for not having done so prior to 7 this time; but I wanted get this matter here; and 8 I will file a formal piece of paper. 9 MR. VEIS: Your Honor, we have one 10 other preliminary matter if I may. Your Honor, 11 last month we filed a motion for additional 12 Drexel-related discovery which Your Honor granted 13 ten days ago. It required that Federated and 14 MAXXAM supply to the OTS shareholder lists. Both 15 of those entities have failed to comply to Your 16 Honor's order and I would like to bring it to the 17 attention of Court and ask that it be so required. 18 In our motion, we set forth the factual matters 19 that we have discovered in the course of discovery 20 in analysis of documents. We stated in view of 21 this newly discovered information OTS requests 22 that the terms of the May 7, 1986 order be 48 1 modified and that MAXXAM be required the provide 2 to the OTS copies of its shareholders' lists for 3 all classes of stock, and records of shareholders' 4 votes, including copies of proxy cards for the 5 period January 1, 1981, to present in order that 6 OTS can seek to determine whether other 7 Milken-Drexel related partnerships or other 8 entities may be or may have been shareholders. In 9 addition to facts now known to OTS suggests a 10 pattern by Drexel and Milkens and in investing in 11 stock of companies of which they were doing 12 business, OTS requests that Federated Development 13 Company be required to provide the copies of its 14 shareholder list or the equivalent documents 15 maintained by a New York business trust and 16 records of shareholders votes including copies of 17 proxy cards for the same period. Your Honor 18 granted our motion after briefing by both sides. 19 I have copies of the responses or the productions 20 by both and MAXXAM and Federated which I would 21 like to hand up to Your Honor and discuss the 22 reason why they are inadequate. 49 1 THE COURT: With respect to these 2 documents, are these documents that I have not 3 seen? 4 MR. VEIS: Yes, Your Honor we have 5 received them they are letters dated September 6 18th, last Friday. 7 In a letter from Ms. Lawton on behalf 8 of MAXXAM to Mr. Stearns and Mr. Guido in it says: 9 In response to Mr. Law Judge Shipes September 12, 10 1997, order regarding modified discovery MAXXAM 11 Inc., hereby provides copies of sections of the 12 proxy detailed voting tabulation reflecting 13 Drexel, Burnham, Lambert Inc.'s ownership in 1984 14 and 1985 of shares of MCO Holdings, Inc. The 15 responsive documents were located during a search 16 conducted pursuant to the Judge's order under the 17 direction or Mr. Bernard L. Brickell. A copy of 18 Mr. Brickell's affidavit says: Under my direction 19 a diligent search was conducted for the 20 shareholder lifts and proxy cards for the period 21 of January 1, 1981, to December 31, 1988, that's 22 the first noncompliance because we asked for 50 1 documents to the present and Your Honor ordered 2 such documents to be produced. 3 Next paragraph: As a result of this 4 search the following items were located: 5 (A) certified stockholder list of MCO 6 Holdings, Inc., MCO, for April 18, 1984, (for 7 uncommon stock) March 20, 1987, (common and 8 preferred stock) and February 9, 1987, common and 9 preferred stock relating respectively for its 10 1984, 1987, and 1988 annual meeting of 11 shareholders; and (B) it's proxy summary report, 12 proxy detailed voting tabulation, for 1985 dated 13 January 10th, 1985; and (C) MCO's proxy cards with 14 respect to MCO's 1987 meeting of shareholders. 15 It indicates that certain documents 16 were not located. However, it then says in 17 paragraph 5: With the exception of Drexel's 18 ownership of MCO's shares, reflected in the 19 attached proxy detailed voting tabulations, none 20 of the persons or entities identified in OTS's 21 motion specifically Michael Milken, Loel Milken, 22 GLJ Partnership, Lorsend Partnership, Wilham 51 1 Financial Group Incorporated, Essex Financial, for 2 ML Associates are reflected in the certified 3 stockholders' lists, proxy summary reports, or 4 proxy cards of MCO located by MAXXAM and referred 5 in paragraph 3 above. 6 Attached are three copies of redacted 7 pages from the shareholder list indicating that at 8 various points in time, Drexel, Burnham, Lambert 9 was listed as a record shareholder. Your Honor, 10 this merely confirms what we already knew and it's 11 completely unresponsive to the motion and the 12 order. We asked for those documents in order to 13 determine whether or not there were other Drexel 14 or Milken related entities. We didn't ask them to 15 search for the entities we have identified. We 16 want to know if there are others and there 17 are/were in existence hundreds of Drexel-related 18 participants and Drexel had numerous employees. 19 Their search to the extent that a search of the 20 files was appropriate was completely unresponsive 21 and we submit they should have produced the 22 shareholder lists and proxy records in their 52 1 entirety. 2 Looking at Federated's. Federated as 3 also provided a similar set of documents. In 4 Mr. Griffith's letter the second document which I 5 handed to you it says: Please find closed 6 Federated's documents responsive to administrative 7 Law Judge Shipes September 12th, 1997, order 8 regarding modified discovery. For your 9 information there are no responsive documents 10 concerning Michael Milken, Loel Milken, GLJ 11 Partnership, Lorsend Partnership, Wilkin Financial 12 Group Inc., Essex Financial, or ML associates. 13 Attached to that letter appear to be five pages of 14 redacted shareholder lists that indicate at some 15 point in time, Drexel, Burnham, Lambert was a 16 shareholder of Federated. 17 Again this is inadequate. It simply 18 confirms that we suspected that Drexel itself 19 might own shares; but it does not answer the 20 question as to whether other Drexel-related 21 entities with Milkens through partnership, owned 22 shares. It does not answer the question as to 53 1 whether Drexel employees might own shares. 2 Your Honor, we simply ask that these 3 two respondents be required to comply with your 4 preexisting order. And I think this is not the 5 time for anybody to re-argue the basis for the 6 order. We simply just want compliance. 7 MR. EISENHART: I will speak on behalf 8 of MAXXAM. I think much of what I have to say may 9 pertain to Federated, too, but certainly Mr. 10 Griffith and Mr. Keeton could add whatever needs 11 to be added for Federated. We did get Your 12 Honor's order, and we actually thought we had 13 complied with it. The period of time for 14 discovery in this case from time of memorial has 15 been up to and including the end of 1988. For 16 every proceeding I'm aware of in this case that is 17 what the parties have agreed is the relevant 18 period of discovery and indeed I can't imagine 19 since the institution was put into receivership in 20 the end of 1988 what need they could have for 21 Maxxam's shareholder lists for 1987 and 1997, '96, 22 or '95. We treated the time period the way every 54 1 party in this case has treated every other 2 discovery request in this case as running through 3 1988. And that's what we searched for. We also 4 took their motion at what we thought was face 5 value. What they were interested in was ownership 6 by the Milkens and by the partnerships that they 7 had identified in their motion. 8 That's what we searched for, and that's 9 what Mr. Brickell's affidavit goes to. I don't, 10 frankly, know what more they want. If they have 11 some master list that they have developed of 12 Drexel-related partnerships, they can give it to 13 us. We will redo the search and if we turn up 14 anymore of those we would let them know. We 15 thought we knew the entities they were interested 16 in; but if they have some larger list, we will be 17 glad to search on the larger list as well. Beyond 18 that, I don't know what more I can say except 19 shareholder lifts are regarded by MAXXAM and by 20 many other companies as extremely sensitive 21 documents. 22 In Maxxam's case there has been at 55 1 least one fairly hotly contested shareholder 2 resolution within the past few years; and there 3 are, quite frankly, a number of people who would 4 like to get their hands on our shareholder list. 5 It is not something we give lightly access to or 6 lightly give out. If OTS has some compelling need 7 to get in and see our shareholder list themselves, 8 as distinguishing them from giving us the list and 9 having us do the search themselves, I would be 10 glad to hear what it is. If, in fact, they are 11 going to be allowed to do that, let them Your 12 Honor is going to insist that we produce the 13 shareholder list to them and allow them to do the 14 search instead of us, I would very much like to 15 get from a confidentiality order to make sure that 16 the information that is disclosed, stays in the 17 possession of OTS and is used only for the 18 purposes of this case and it goes no further. 19 We have had instances were things have 20 been leaked out to persons not involved in this 21 case and persons who have interests that are 22 really unrelated to this case but interests that 56 1 are very hostile and adverse to MAXXAM. Our 2 position is we think we have complied. We think 3 we gave them what they want to the extent that 4 it's information relevant to this case. If there 5 is something more than they have, we will be glad 6 to expand the list if they think they have some 7 compelling reasons to go beyond the year 1988, I'd 8 like to hear it. 9 MR. GRIFFITH: Your honor, Dave 10 Griffith of Federated, I was the author of the 11 letter that was read into the record. The timing 12 question for Federated is basically irrelevant. 13 We went private in '87. So, we don't have 14 shareholder lists after '88. The order that Your 15 Honor signed was documents the subject of the 16 motion. And you can read the motion and the 17 subject of it deals with the Drexel and all of the 18 various entities that they identify in this motion 19 and that's why we thought we were responding to 20 the Judge's order and this is the first time that 21 we have heard we are not. 22 MR. VEIS: Your Honor, if I may. I 57 1 think it's very clear that the documents that are 2 subject to the motion are all the shareholder 3 lists. The entities are listed because we had 4 reason to believe there might be others; and 5 that's what we wanted to search for. 6 As to the time frame Mr. Eisenhart is 7 correct that December 1988 has been considered a 8 cutoff for many of items of discovery in this 9 case, but not necessarily all. 10 Now, as to why there might be some 11 cause for need after that date, among other things 12 the Drexel, Burnham, Lambert liquidating trust did 13 not go out of business until April of this year. 14 It may well be that there were shares held then. 15 THE COURT: How would that bear on this 16 case? 17 MR. VEIS: It simply would indicate a 18 continuity of ownership. There may be 19 participants that still exist. I don't know. We 20 would be happy to agree to a confidentiality order 21 if that would decrease the concerns that 22 Mr. Eisenhart has raised provided that we are able 58 1 to use in evidence anything which we find 2 appropriate. We are willing to keep confident the 3 shareholder lists that the respondents are 4 concerned about. 5 THE COURT: You think that if you had 6 the shareholder lists, you could identify Drexel 7 employees? 8 MR. VEIS: We could, Your Honor, but it 9 would be, at this point in time, it would take 10 longer to compile a list of entities to be 11 identified than it would to simply look through 12 the lists and time is of the essence because we 13 are now at the beginning of trial. 14 THE COURT: Are you suggesting that the 15 respondents should have been able to identify 16 others or -- 17 MR. VEIS: No, Your Honor, I'm 18 suggesting that they should have given us the list 19 so that we could identify the others. 20 THE COURT: Well, I think if the 21 parties can work a confidentiality protection 22 order out, respondents should make available the 59 1 entire list. I see no reason why it should not be 2 held in confidence. 3 MR. VEIS: There is none, Your Honor. 4 THE COURT: I'll sign a protective 5 order. 6 MR. EISENHART: Your Honor, may I ask 7 the time period? Is there really a need to make 8 current lists? 9 THE COURT: I agree with the 10 respondents. I think if they owned it in '88, the 11 fact that it continued -- I don't see. I really 12 can't see. 13 MR. EISENHART: Drexel went into 14 liquidation, I believe, in 1990. 15 THE COURT: So, let's use that. 16 MR. VEIS: Thank you, Your Honor. 17 MR. EISENHART: Thank you, Your Honor. 18 MR. GUIDO: Your Honor, its five 19 minutes to noon. I don't know what you're 20 preference is. 21 THE COURT: I was thinking perhaps we 22 would adjourn for lunch and begin the next item of 60 1 business, the opening statements. 2 MR. NICKENS: Opening statements. And 3 I believe that will take the entire afternoon. 4 MR. KEETON: Your honor, on behalf of 5 Mr. Hurwitz of Federated, I want to move for a 6 continuance given your ruling on the control and 7 influence document issue. That issue is much 8 broader than I think Your Honor appreciates, it's 9 much different than the discovery, and there's 10 much discovery that would have occurred had that 11 been in the case. So, I've got to move for a 12 continuance on behalf of my clients. 13 MR. EISENHART: Your Honor, MAXXAM 14 would join in that motion. 15 MR. GUIDO: You Honor, I would like to 16 respond to that motion. 17 THE COURT: Motion denied. 18 19 (Whereupon a lunch break was taken.) 20 21 THE COURT: The hearing will come to 22 order. I believe at this time, we are going to 61 1 have opening statements. Mr. Guido? 2 MR. GUIDO: May it please the Court, my 3 name is Kenneth Guido; and I represent the Office 4 of Thrift Supervision in this proceeding. As 5 introduction to my opening statement, I thought it 6 would be important to summarize the notice of 7 charges or the claims that are set forth in the 8 notice that was filed on December 26th, 1995. The 9 first claims in the notice deal with respondents' 10 failure to maintain the net worth of United 11 Savings Association of Texas as it required as a 12 condition MCO and Federated having required 13 control of USAT and its holding company, United 14 Financial Group, and the respondents causing false 15 and misleading statements to be made regarding the 16 put call option with regard to the acquisition of 17 the stock of United Financial Group. Those are 18 claims 1 through 3 of the notice. In addition, 19 the notice alleges violations of the Control Act 20 and its applicable regulations for the failure to 21 register MCO and Federated as savings and loan 22 holding companies and failure to file annual 62 1 reports with the FSLIC savings and loan holding 2 companies. That's Claim No. 4, Your Honor. 3 Claim No. 2, Your Honor, is that the 4 respondents failed to comply with United Financial 5 Group's net worth maintenance condition that was 6 imposed as a result of a merger of United 7 Financial Group with another savings and loan 8 holding company. 9 In addition, the notice of charges 10 alleges that the respondents caused USAT to 11 purchase junk bonds from Drexel, Burnham, Lambert 12 with whom respondents were acting in concert to 13 acquire control of UFG and USAT, and it did so 14 without the prior written consent of the Federal 15 Home Loan Bank Board causing respondents to 16 violate and causing USAT to violate the affiliated 17 party regulations of 12CFR. 18 In addition, the notice of charges 19 alleges that respondents engaged in unsafe and 20 unsound practices and made false and misleading 21 statements while speculating in USAT's portfolios 22 of mortgage-backed securities. Those are claims 6 63 1 and 7, Your Honor. 2 In addition, the notice of charges 3 alleges that when the respondents could no longer 4 use accounting gains to generate profits to shore 5 up the capital of United Savings Association of 6 Texas, they engaged in sham transactions to 7 transfer caps and adjustable rate mortgages from a 8 subsidiary, United MBS, to the parent company, 9 USAT, in order to reduce the capital requirements 10 for the holding company. 11 The notice of charges also alleges that 12 the respondents caused USAT to guarantee a debt or 13 the debts of a subsidiary corporation, United MBS, 14 in violation of the applicable service corporation 15 regulations, the liability growth regulations, and 16 the direct investment regulations. So, those are 17 the claims, I believe, that are claims 9 through 18 11 in the notice of charges, Your Honor. 19 The notice of charges also alleges that 20 the respondents, in order to generate profits for 21 USAT, engaged in unsafe and unsound lending and 22 investment practices and violated the applicable 64 1 regulations in connection with speculative 2 investments in Park 410, an 80 million-dollar 3 loan, and the Norwood United Project which was a 4 30 million-dollar loan with a 9 million-dollar 5 capital contribution. The allegations in there 6 are that the respondents failed to properly 7 underwrite the loans, relied on inadequate and 8 fraud appraisals, approved disbursements prior to 9 loan approval by the board of directors, and 10 failed to comply with applicable lending 11 regulations as a result of which USAT incurred 12 losses in excess of $80 million. That's Claim 13 No. 12 in the notice of charges, Your Honor. 14 Then, finally, at a time when USAT 15 couldn't meet its minimum regulatory capital 16 requirements and when it was rapidly approaching 17 insolvency, respondents, with knowledge of both of 18 these facts, approved retroactive increases in 19 compensation, bonuses, severances, payments, and 20 debt forgiveness for themselves and other USAT 21 insiders in excess of $40 million. 22 They, therefore, caused the limited 65 1 remaining assets of USAT/UFG to be distributed 2 themselves, further depleting those assets and 3 damaging their financial condition and impairing 4 their ability to meet UFG's net worth maintenance 5 obligation. That's claim No. 12, Your Honor. 6 And before I proceed, elaborate on 7 these, Your Honor, I think it's important to put 8 this into context by looking at the financial 9 condition of United Financial Group over time and 10 the financial condition of MCO over time, Your 11 Honor. 12 In 1982, prior to acquisition of 13 control of USAT and UFG, UFG had total assets of 14 $1.8 billion, Your Honor. At the same time, MCO 15 had assets of $484 million, Your Honor. By 1987, 16 a year before USAT was closed, UFG had assets of 17 $7.1 billion, Your Honor. And MCO or MAXXAM at 18 the time -- it's not clear to me when MCO Holdings 19 became MAXXAM -- had assets of $1.4 billion 20 approximately which increased in 1988 to 21 $3.63 billion. 22 During this time period, Your Honor, 66 1 from 1984 to 1988, USAT purchased junk bonds 2 underwritten by Drexel Burnham Lambert, a total of 3 about $1.6 billion, I believe, Your Honor. In 4 1984, they bought $49 million. 1985, the amount 5 went up to $317 million. 1986, it went to 6 $772 million. 1987, it was $267 million. And 7 1988, it fell off because of the decline in the 8 thrift to $115 million. 9 During that same time period, Drexel 10 Burnham Lambert on net underwrote approximately 11 $1.8 billion in junk bond issuances by MAXXAM. 12 I believe, in addition, there are two 13 other telling facts. You've heard this morning a 14 little bit about Drexel Burnham Lambert's 15 ownership of MCO stock which, I think, is relevant 16 to issues that will come up in this proceeding; 17 but, also, you will hear in the testimony that 18 during this entire time period, MCO Holdings, 19 Federated, and the related entities other than UFG 20 and its subsidiaries purchased no junk bonds from 21 Drexel Burnham Lambert or anyone else, Your Honor. 22 Now, turning to the first and fourth 67 1 claims, MCO's net-worth maintenance obligation, 2 Your Honor, the facts will show that with the 3 assistance of Drexel, MCO Holdings and Federated 4 purchased 24.9 percent of the outstanding stock of 5 United Financial Group. It initially did so 6 through a subsidiary of Federated called -- 7 Federated Reinsurance, I think, was the name of 8 that company which it filed an application to 9 acquire something in excess of 10 percent. And it 10 sought approval of the Federal Home Loan Bank 11 Board to do so. It did receive that approval. It 12 was told that it would have to rebut a presumption 13 of control if it did so. It sought to rebut that 14 presumption. Federal Home Loan Bank Board 15 determined that it had not rebutted that 16 presumption and concluded that for purposes of the 17 regulations, Federal Reinsurance was in control. 18 Subsequent to that point in time, MCO 19 and Federated increased their purchases of stock 20 so that the amount finally reached to 21 24.9 percent, as I indicated, was purchased with 22 the assistance of Drexel. In addition, MCO and 68 1 Federated filed an application, H(e)1 application, 2 to obtain control of United Financial Group and, 3 indirectly, its hundred-percent owned subsidiary, 4 USAT. That application was approved. 5 As a condition to that application, 6 Your Honor, the bank board provided that for as 7 long as they, MCO and Federated or the applicants, 8 directly or indirectly controlled United Savings, 9 applicants shall contribute a pro rata share based 10 on their UFG holdings of any additional infusions 11 of capital in a form satisfactory to the 12 supervisory agents that may become necessary to 13 maintain its net worth at the level required by 14 the corporation's net-worth regulations. 15 At about the same time, the evidence 16 will show that Drexel's -- excuse me -- that MCO 17 Holdings sought other ways to obtain stock in UFG 18 without triggering this provision which would 19 establish control. The evidence will show that it 20 did so because it did not want to be bound by the 21 net-worth maintenance condition; and, in fact, it 22 sought repeatedly to get the bank board to change 69 1 the net-worth condition. 2 It entered into an agreement with 3 Drexel, in order to avoid the prescriptions in 4 that condition, to acquire another 790,000 shares 5 of stock of UFG in addition to the 24.9 percent 6 that it owned. And over a long period of time in 7 negotiations, it sought to draft what is referred 8 to as a "put call option" in this situation. 9 Under that agreement which was 10 eventually adopted, Drexel agreed to hold stock 11 for MCO. MCO had the right to call that stock for 12 payment of the fee which it paid at a 13 predetermined price. If that call option were not 14 exercised, Drexel negotiated and received the 15 right to put that stock to MCO. 16 The negotiations didn't stop there 17 however, Your Honor. Drexel demanded and 18 received, in addition, guarantees that it would be 19 reimbursed for any losses that it might occur; and 20 it also received a letter of credit guaranteeing 21 that if it put that stock to MCO, because of MCO's 22 failure to call the stock, that it would receive 70 1 its fee that it had contracted for and the full 2 amount of that stock. The full 790,000 shares 3 approximately, Your Honor, were not included in 4 that put call option because it turned out that 5 there were regulations of the National Association 6 of Securities Dealers that didn't allow broker 7 dealers such as Drexel to enter into such an 8 agreement. It had a limit of 150,000 shares that 9 could be covered in this situation. 10 Because of the staggered term of the 11 put and the call here, however, Your Honor, Drexel 12 and MCO were permitted to enter into an agreement 13 for 300,000 of those shares. 14 What happened to the 490,000 shares, 15 Your Honor, that were left? Drexel held them. It 16 held them during a long period of time when the 17 UFG stock prices were declining. It only sold 18 that stock after MCO announced that it was no 19 longer going to attempt, in the parlance of the 20 Federal Home Loan Bank Board, to acquire control 21 over UFG. 22 Your Honor, that put call agreement 71 1 that was entered into with Drexel imposed the 2 preponderate economic risk of ownership on MCO. 3 There was no risk whatsoever to Drexel under that 4 arrangement. Unless the third-party entity had 5 issued the letter of credit, it defaulted on its 6 obligation. But in all respects, the contract 7 shifted all risks of ownership to MCO. No other 8 party had a risk of ownership. 9 Now, one of the questions that will 10 come up in this proceeding as we go is the whole 11 question of: Why are there net-worth maintenance 12 conditions? Why did the agency require net-worth 13 maintenance conditions? 14 You will hear testimony, Your Honor, 15 that net-worth maintenance conditions were a 16 bargain between individuals that purchased savings 17 and loans and the Federal Home Loan Bank Board. 18 You will hear testimony that in the 1979/1980 time 19 period, traditional thrifts were in a great deal 20 of trouble financially because of the oil crisis 21 and the spike in interest rates that went with 22 inflationary impacts that were related to attempts 72 1 to defend the dollar during that time period. 2 You will hear testimony that there was 3 a need to get new management into savings and 4 loans to expand them into less traditional 5 activities, Your Honor. You will hear testimony 6 that Congress expanded the investment powers of 7 savings and loans at this point in time in the 8 1979/1980 time period in order to assist them in 9 becoming profitable again. 10 You will also hear, however, Your 11 Honor, testimony that when recruiting new 12 management or attempting to make savings and loans 13 available to new management and new owners, there 14 was no opportunity to get infusions of capital or 15 very little opportunities to do so because people 16 didn't want to risk their funds, putting it into 17 entities that were as severely damaged as savings 18 and loans were at that time. 19 You will hear, Your Honor, testimony 20 that the reason why net-worth conditions were 21 demanded is because the agencies wanted something 22 in return. They couldn't get people to risk their 73 1 capital as a way of assuring that they wouldn't 2 abuse their powers as managers of those thrifts 3 like they can do today. 4 So, instead, what they did is they 5 extracted net-worth maintenance conditions; and 6 they did so in a number of ways, one of which was 7 to unilaterally impose conditions in the 8 resolution as was done here stating that if 9 certain acts were undertaken on the other side, 10 that the net-worth maintenance condition would be 11 triggered. 12 But you will hear testimony, Your 13 Honor, that it was viewed as a bargain, that it 14 was something that was being extracted in exchange 15 for giving people the right to control savings and 16 loans, to expand their geographic lending areas, 17 to expand their investment powers and allow them 18 to engage in activities that traditional thrifts 19 had not been allowed to engage in at that point in 20 time. 21 Now, we believe that the statutory or 22 the acquisition of stock meets the requirements of 74 1 control, Your Honor; but we do not stop there, 2 Your Honor. You will hear testimony, Your Honor, 3 that at all relevant times, Mr. Hurwitz was the 4 controlling shareholder of a business trust named 5 Federated Development which was one of the two 6 acquirers. He was the chairman and chief 7 executive officer of that entity. He was also a 8 trustee of that entity as were two of his 9 associates, George Kozmetsky and Barry Munitz. 10 Through Federated, Hurwitz controlled MAXXAM/MCO 11 Holdings which was formerly known as McCullough 12 Oil Company. He was also its chairman and chief 13 executive officer. And he, Kozmetsky, and Munitz 14 were all directors of MCO. They also all became 15 directors of UFG. Hurwitz became the chairman of 16 the board and CEO of UFG; and Munitz was also a 17 director of USAT, positions they held as 18 representatives of MCO and Federated. 19 In fact, Barry Munitz had 20 correspondence that will be part of the record of 21 these proceedings that shows Barry Munitz has an 22 indemnification agreement with MCO because of his 75 1 serving on that, on the board of UFG at MCO's 2 behest. The board of directors' meetings of UFG, 3 which had absolutely no operations other than 4 USAT, were held simultaneously with USAT's boards. 5 The evidence will show that 6 Charles Hurwitz attended those meetings and in 7 some of those instances will show that 8 Charles Hurwitz was reporting to the board of USAT 9 on activities of USAT, that he also in some 10 instances even went so far as to second motions 11 that were made by Mr. Munitz you will find in the 12 course of this. The record of evidence will show 13 that Mr. Hurwitz, Mr. Kozmetsky, and Munitz 14 attended most of those joint board meetings. 15 The evidence will show that 16 Mr. Hurwitz -- that Mr. Munitz directed the hiring 17 of UFG and USAT senior management. The evidence 18 will show that Mr. Hurwitz and Munitz were the 19 only two UFG board members who were on what was 20 referred to as the "strategic planning committee" 21 which I will get to a little later on when I 22 explain how they transformed this thrift from a 76 1 traditional savings and loan to one that engaged 2 in what the respondents refer to as wholesale 3 activities. That strategic planning committee 4 that was so instrumental in defining the direction 5 of UFG and USAT had, as its only other members, 6 senior employees hired by either Charles Hurwitz 7 or Barry Munitz. In addition, Charles Hurwitz and 8 Barry Munitz were also members of the management 9 committees, were also senior employees that 10 Mr. Hurwitz and Mr. Munitz had hired. In 11 addition, Mr. Hurwitz and Mr. Munitz caused UFG 12 and USAT to create a joint investment committee 13 which had exactly the same members. It was 14 composed entirely of senior management that they 15 had selected; and Mr. Hurwitz and Mr. Munitz, to a 16 lesser extent, actively participated in its 17 deliberations. None of this should be a surprise 18 because in the H(e)1 application to acquire 19 control, MCO and Federated stated their intentions 20 for UFG and USAT once control had been acquired. 21 The record will show that they stated in that 22 application MCO and Federated believed that the 77 1 financial services industry is entering into a 2 period of rapid growth, diversification, and 3 change. MCO and Federated's investment in UFG 4 will enable them to participate in an increasingly 5 diversified financial services industry that, in 6 turn, UFG and USAT will benefit from MCO's 7 investment expertise in the financial markets. 8 Following that admonition, Mr. Hurwitz 9 and Mr. Munitz, acting through various UFG and 10 USAT committees, selected financial analysts to 11 help devise a new investment strategy for UFG as 12 described in the H(e)1 application. In response, 13 the strategic planning committee adopted an 14 investment strategy recommended by the analysts 15 and advocated by Charles Hurwitz that dramatically 16 changed USAT's business operations. The change, 17 as I said, caused USAT to shift away from being a 18 traditional thrift that originated residential 19 loans funded with retail deposits to a wholesale 20 strategy funded with broker deposits and, in this 21 case, reverse repo agreements. The evidence will 22 show they caused USAT's size to increase, as I 78 1 stated at the outset, from 1 -- from a 2 1.8 billion-dollar institution to one with 3 $7 billion in assets. They structured the USAT 4 committees in a way in order to dominate USAT's 5 policies and procedures. They devised its 6 strategic plan. Charles Hurwitz advocated that 7 they sell branches to generate capital to grow, 8 which they did. He advocated that they curtail 9 retail residential lending, which they did. He 10 advocated they redirect its investments into 11 high-risk junk bonds, which they did. He 12 advocated that they direct other investments into 13 corporate equity securities, which they did. He 14 advocated that they purchase mortgage-backed 15 securities funded with reverse repos, which they 16 did. 17 As a consequence of the change, the 18 evidence will show that USAT's balance sheet was 19 stripped of profitable assets in order to meet 20 regulatory capital requirements and forced the 21 failure of regulatory capital, the net effect of 22 which was to increase the losses to the Federal 79 1 Insurance Funds when the institution failed. 2 The evidence will show, Your Honor, 3 that the growth, the redirection of investment 4 activity, and the stripping of the balance sheet 5 were done by the respondents in order to survive a 6 downturn in the Texas economy, to continue their 7 investment activities as a diversified financial 8 institution, have USAT emerge as a viable entity, 9 and have respondents Hurwitz, MAXXAM, MCO, and 10 Federated benefit financially from a hope for 11 recovery. 12 The evidence, in essence, Your Honor, 13 will show that the respondents received the 14 benefit of control of a multi-billion-dollar 15 institution and deliberately redirected its 16 investments and operations which, if they had not 17 obtained deposit insurance, would have cost 18 substantial sums of money in the hundreds of 19 millions of dollars assuming that they could have 20 even gone out and raised those funds. 21 The facts will show, Your Honor, that, 22 in essence, the government conferred a 80 1 quantifiable substantial financial benefit, the 2 control of USAT, on the respondents Hurwitz, MCO, 3 and Federated -- those respondents accepted and 4 retained the benefits of control; and, in fact, 5 they vigorously exercised it -- and that those 6 respondents are seeking to avoid that -- their 7 obligation to meet the net-worth maintenance 8 condition which was the benefit that the Federal 9 Home Loan Bank Board thought it was obtaining when 10 it allowed them to obtain control. 11 Respondents' control over USAT's 12 investments, as the evidence will show, 13 facilitated their receipt of financial assistance 14 from Drexel. I indicated at the outset that 15 Drexel had underwritten 1 -- approximately 16 $1.8 billion in financing junk bonds for MCO or 17 MCO-related entities. I also pointed out the 18 evidence will show that during that time period, 19 USAT purchased $1.6 billion in junk bonds 20 underwritten by Drexel. 21 The evidence will also show, as Your 22 Honor is aware from the earlier matters that came 81 1 up today, that Drexel loaned approximately 230- to 2 250,000 shares of MCO directly in its own name. 3 The evidence will also show, as I pointed out, 4 that MCO didn't purchase any junk bonds at all 5 during this time period. But what is also 6 significant is that during the time period of 1982 7 through 1988, Drexel was also a major financier of 8 USAT's purchase of mortgage-backed securities. In 9 fact, at a time when USAT was running into 10 financial trouble, Drexel stepped in, the evidence 11 will show, and picked up the gap in the financing 12 of USAT's mortgage-backed security portfolio, Your 13 Honor. In essence, the relationship between 14 Drexel, MCO, and Federated was of mutual benefit. 15 The benefit from the MCO side will dramatically be 16 evidenced by the statements that Mr. Munitz made 17 in his interview with the FDIC when he was asked, 18 "What were Mr. Hurwitz's motivations for owning 19 USAT and continuing to keep it open?" 20 And he said, as reflected in the notes 21 of the counsel for the FDIC, "Peer group 22 pressure." 82 1 Who was going down, and who was still 2 alive? He did not want to hurt his reputation 3 among Pierce and Miliken. He was concerned about 4 a net-worth maintenance risk to MAXXAM, and USAT 5 was his ticket to ride with Drexel. The evidence 6 will show that the OTS sought to get Mr. Munitz to 7 testify to these matters; and his testimony was 8 not satisfactory so that the OTS sought a subpoena 9 enforcement or initiated a subpoena enforcement 10 action for the notes which it had sought. And he 11 would not voluntarily provide the notes that his 12 lawyers had prepared, the two of them in the room 13 with the FDIC people; and the two sets of notes 14 were then taken and combined into a recitation of 15 the facts. That subpoena enforcement action 16 failed, Your Honor, the evidence will show; but 17 the District Court observed that the FDIC's 18 attorney's testimony appeared to provide ample 19 proof of what Dr. Munitz said. And, therefore, in 20 the Court's view, there wasn't substantial need to 21 overcome the prescriptions of the attorney work 22 product document. 83 1 In either case, Your Honor, the 2 evidence -- we will attempt to introduce the 3 evidence of the two FDIC attorneys of what 4 Mr. Munitz said at that interview which we believe 5 explains the benefits to the continued operations 6 of USAT that Charles Hurwitz derived from his 7 ownership. 8 Essentially, the evidence will show 9 that USAT was important to Hurwitz in maintaining 10 his relationship with Pierce including Milken; but 11 the evidence will also show that Milken was 12 extremely dependent upon savings and loans 13 purchases of junk bonds in order to maintain a 14 market for Drexel's underwriting activities. 15 As I stated earlier, the size of this 16 symbiotic relationship, Your Honor, was 17 $1.6 billion of purchases of junk bonds by USAT 18 and the underwriting of approximately $1.8 billion 19 of junk bonds from respondents which allowed it to 20 increase from the size of an institution of about 21 $500 million to well over 300 million or to well 22 over a 3 billion-dollar institution. 84 1 Under those circumstances, Your Honor, 2 the existence of the put call -- the full extent 3 of the put call option from the regulators in 4 order to avoid any risk, that there would be the 5 imposition of a net-worth maintenance condition. 6 The evidence will also show that MAXXAM 7 and Federated and Mr. Hurwitz had another reason 8 for not having the net-worth maintenance condition 9 triggered by the put call option and obscuring the 10 full significance of the put call option from the 11 regulators, and that was that they didn't want to 12 be in a position where the federal regulators 13 could review MCO's issuance of junk bonds. 14 The evidence will show that if a 15 holding company comes within the jurisdiction of 16 the Federal Home Loan Bank Board, it then had to 17 get its approval for the issuance of debt. That 18 would have had a detrimental effect, from the 19 testimony of MCO employees, on MCO's operations; 20 and, therefore, it was something to be avoided. 21 Therefore, what happened was that MCO never sought 22 the approval of the regulators for the put call 85 1 option or asked whether or not it would trigger 2 the net-worth maintenance condition despite the 3 fact that there were opinions that had previously 4 been issued by the general counsel's office of the 5 Federal Home Loan Bank board that said when you 6 have contractual rights such as an option to 7 obtain stock in an entity and you have the 8 preponderate economic interest in that stock 9 because of that contractual relationship, you are 10 deemed to hold the voting stock for purposes of 11 the control regulations. And the opinions went on 12 further to say that if you have any question about 13 this, you should submit the issue to us for our 14 opinion. 15 We believe that by failing to notify or 16 to request an opinion by the actions that it took 17 to obscure the full significance of the put call 18 option and, particularly, the letter of credit, 19 Your Honor, that the respondents acted in reckless 20 disregard of the law. 21 Now, I'd like to move to the second 22 claim, Your Honor, which is the claim with regard 86 1 to UFG's net-worth maintenance obligation. As I 2 stated earlier at the outset, it also had a 3 net-worth maintenance obligation. That obligation 4 was imposed when it granted UFG's application to 5 acquire Houston First American Savings Association 6 and merge it into USAT and a stipulation executed 7 by the chairman of the UFG, Mr. Gross -- I'm 8 sorry. I think it was Mr. Williams at the time. 9 Excuse me, Your Honor. By failing to direct UFG 10 to make the required contributions to the 11 net-worth of USAT as required by the applicable 12 regulations, the individual respondents 13 essentially violated a written agreement entered 14 into with the Federal Home Loan Bank Board. They 15 violated a condition imposed in writing by the 16 Federal Home Loan Bank Board in connection with 17 the granting of that application and engaged in 18 unsafe and unsound practices within the meaning of 19 12 USC1818. Those violations, the failure to 20 satisfy the net-worth maintenance obligation of 21 UFG, were a reckless disregard to the law where 22 applicable regulations are ordered by the Federal 87 1 Home Loan Bank Board. The individual respondents 2 were aware of the resolution that imposed the 3 condition and the stipulation executed by the 4 chairman in October of 1983. They were aware that 5 USAT had failed to meet its regulatory capital 6 requirements as of December 31, '87. 7 As members of UFG's board of directors, 8 they received a written demand from the Federal 9 Home Loan Bank Board supervisory agent on 10 May 13th, 1988, to meet that obligation. They did 11 not respond to the request and took no steps to 12 contribute any capital to USAT at any time before 13 the association was placed into receivership. As 14 a consequence of their actions, the assets of UFG 15 were substantially depleted so that when the OTS 16 and the Federal Home Loan Bank Board, in a 17 bankruptcy proceeding that UFG had filed, finally 18 was able to perfect its claim, substantial sums of 19 monies had been dissipated. 20 One of the ways those funds was 21 dissipated, Your Honor, was the payment of excess 22 salaries, bonuses, and severance benefits that the 88 1 respondents authorized to be paid to others and to 2 themselves. I think the total amount was 3 somewhere around the range of $4 million, two of 4 which went to the respondents in this matter. We 5 believe that that evidence will demonstrate that 6 not only was respondents' failure to meet the 7 net-worth maintenance obligation of UFG in 8 reckless disregard of the law but it was also, 9 Your Honor, a flagrant attempt to unjustly enrich 10 themselves at the expense of the Federal Home Loan 11 Bank Board and the Deposit Insurance Fund. 12 Now, I'd like to move on to the fifth 13 claim, Your Honor. The fifth claim is predicated 14 upon Drexel being -- acting in concert with MCO 15 and Federated to obtain control over UFG and USAT. 16 There is no dispute between the parties, Your 17 Honor, at least as of this date, that if Drexel 18 was acting in concert with MCO and Federated to 19 obtain control, it was an affiliated party for the 20 purposes of the affiliated party regulations. 21 We believe the evidence, as I explained 22 earlier, will show that Drexel acted on MCO's 89 1 behalf to acquire stock that it put into a special 2 account to be held for MCO, that it accumulated 3 the initial stock that resulted in the acquisition 4 of 24.9 percent of UFG's stock or -- excuse me -- 5 a sizable portion of that actual stock, that it 6 held 490,000 shares of the 790,000 that it 7 acquired and held in a special account for MCO, 8 and that it put 300,000 of that into a put call 9 option that it held or entered into for MCO's 10 benefit to obtain control. 11 The evidence will show that USAT at 12 Charles Hurwitz' and Ron Heubsch's direction 13 purchased junk bonds from a number of companies 14 including a sizable portion of that portfolio that 15 was underwritten by Drexel. The total amount of 16 those purchases exceeded $1.6 billion, Your Honor. 17 As a consequence, those Drexel underwritten junk 18 bonds contained junk bonds that lost $47 million 19 for USAT. The respondents never sought approval 20 for that -- those affiliated party transactions, 21 Your Honor. And the respondents played crucial 22 roles in the management of that portfolio. In 90 1 fact, Charles Hurwitz and Ron Heubsch directed 2 that that portfolio be cherry picked for profits 3 periodically to bolster the capital of USAT into a 4 forestall regulatory takeover. That portfolio was 5 not managed as a consistent entire portfolio. 6 That portfolio was managed as specific assets to 7 be used and sold to bolster USAT's capital to 8 forestall regulatory control. 9 The evidence will show, Your Honor, 10 that the regulators never were presented with the 11 opportunity to value that acquisition of junk 12 bonds from Drexel in light of the fact that Drexel 13 was underwriting substantial amounts of junk bonds 14 for MCO to finance its takeover activities. We 15 believe that the facts will demonstrate that the 16 respondents acted in reckless disregard of the 17 requirements of the law when they initiated that 18 junk bond portfolio with Drexel, when they failed 19 to obtain the requisition regulatory approval; and 20 they did so because they did not want the 21 regulators to review those purchases in light of 22 Drexel's underwriting of junk bond purchases for 91 1 MCO. 2 Now, I'd like to move on to the 3 mortgage-backed security portfolio, Your Honor, 4 and those claims which are in claims 6 and 7. 5 There has been a great deal of dispute during the 6 period of discovery about what constituted the 7 portfolios that are at issue in this case. And I 8 think we're coming closer to agreement, but my 9 characterization of the facts in this regard may 10 still be subject to some dispute. 11 There were essentially, what it looks 12 like now, two portfolios, Your Honor, of 13 mortgage-backed securities. One was the USAT 14 portfolio or what has sometimes been referred to 15 as the "Jones portfolio." That portfolio -- the 16 purchases began in 1984. By 12/31/84, there was a 17 small portfolio of approximately $98.9 million of 18 mortgage-backed securities. It increased to about 19 616 million by 12/31/85. And then it was 20 somewhere around 1.2 to 1.3 billion by 21 November 30, 1988. 22 There were a number of representations 92 1 that were made about that portfolio, Your Honor, 2 as the evidence will show. The core of those 3 representations were that it was a risk control 4 arbitrage financed by reverse repurchase 5 agreements that repriced every 30 to 60 days. It 6 was hedged with swaps to extend the maturity of 7 the 30-day and match it with the expected duration 8 of the underlying mortgages in the mortgage-backed 9 security portfolio. And the respondents 10 committed, as required by the applicable 11 regulations, to manage this portfolio in order to 12 minimize the changes in interest rate risk. In 13 other words, they committed themselves to minimize 14 the risk of loss that could be occasioned by 15 changes in interest rates. And as Your Honor 16 knows, that is traditionally done in the savings 17 and loan industry by trying to match the duration 18 of assets and liabilities. The evidence will also 19 show, however, Your Honor, that to match the 20 duration of mortgage-backed securities and swaps 21 is no easy task. Prepayment rates are not easily 22 predicted or forecasted, and there is great room 93 1 for error. Moreover, they increase dramatically, 2 prepayment rates due, with a decline in interest 3 rates requiring careful monitoring of the 4 portfolio with someone with a great deal of 5 sophisticated knowledge of those instruments. 6 We believe that the evidence will show 7 that the respondents acted recklessly when they 8 placed a person in charge of this original 9 portfolio who had never had responsibility for 10 managing such a portfolio; that, when he was 11 hired, he was never asked any questions about 12 mortgage-backed security portfolios or his 13 knowledge thereof. And the evidence will show 14 that the only knowledge that he got about the 15 operations of mortgage security portfolios was 16 reading promotional literature distributed by 17 investment banking firms that were peddling 18 mortgage-backed securities to savings and loans. 19 The evidence will show that this manager failed to 20 appreciate the sensitivity of prepayment rates to 21 changes in interest rates. The evidence will show 22 that sometime in late 1985, for the next six 94 1 months, interest rates declined 300 basis points. 2 The evidence will also show, Your Honor, that this 3 person who was responsible for managing that 4 mortgage-backed security risk control arbitrage 5 portfolio didn't start taking any action to 6 protect that portfolio from the dramatic increase 7 in prepayment rates until interest rates had 8 dropped 2.25 percent, Your Honor, almost the 9 full -- or more than two-thirds of the full 10 3 percent that they declined. The action that he 11 took was to roll down to lower coupon 12 mortgage-backed securities, Your Honor, which the 13 evidence will show merely had the effect of 14 locking in a loss in the spread in that portfolio 15 which, as the evidence will show, one of the 16 experts hired by USAT to help explain to them what 17 had happened in that portfolio found that not only 18 did he lock in a loss but no matter what way 19 interest rates moved, Your Honor, that portfolio 20 would have generated greater losses. That's how 21 that portfolio was managed, Your Honor. 22 The evidence will show that that's in 95 1 contrast to what even the respondents' expert 2 testifies is the appropriate way to manage a 3 portfolio when you use swaps to match the duration 4 of the reverse repo agreements and the 5 mortgage-backed securities. The evidence will 6 show that even the respondents' experts state 7 that, one, if you're going to use a roll down-down 8 strategy to protect a mortgage-backed risk control 9 arbitrage portfolio from changes in prepayment 10 rates, that you must roll down every 50 point 11 basis move which was not done. The evidence will 12 also show, Your Honor, that when you roll down 13 that 50 basis points, that a responsible manager 14 of a risk control arbitrage portfolio will also 15 reinvest all of the proceeds including the profits 16 because there is a profit that will be made during 17 that first 50 basis point move. The evidence will 18 show, Your Honor, that the person managing this 19 portfolio concluded that not all of the proceeds 20 were reinvested as they should have been to 21 protect that portfolio against further losses. As 22 a consequence, we believe, Your Honor, the initial 96 1 portfolio -- the evidence will show that the 2 initial portfolio generated a negative spread, 3 that it resulted in a portfolio that would lose 4 money no matter what direction it would move in, 5 and that the respondents recklessly failed to 6 terminate that portfolio to avoid future losses 7 when interest rates moved one direction or the 8 other. 9 Now, USAT couldn't continue -- couldn't 10 not continue to purchase mortgage-backed 11 securities -- this is in June of 1986, Your 12 Honor -- because by that time, they had sold most 13 of their branches that generated retail deposits 14 to be used to generate residential mortgage loans. 15 So, they had no way to continue to operate as a 16 qualified thrift under the qualified thrift lender 17 test except by holding mortgage-backed securities 18 if they wanted to continue to invest in junk bonds 19 which we explained -- have explained the evidence 20 will show is very important to MCO, Federated, and 21 Mr. Hurwitz. They, therefore, had to purchase 22 mortgage-backed securities to continue to meet 97 1 that test and remain a thrift of the size that 2 they were to purchase junk bonds, to engage in the 3 equity arbitrage program that they had previously 4 been engaged in, and, also, as I will show, to 5 make highly risky commercial development loans in 6 order to hopefully benefit by a turnaround in the 7 market in Texas. So, what did they do? They 8 created a second portfolio, and they created a 9 portfolio which resulted in them being somewhere 10 around -- holding somewhere around -- I think it's 11 $3.3 billion in mortgage-backed securities at some 12 point in time in 1988. 13 In this case, they did go find somebody 14 who had more experience, Your Honor. They didn't 15 use Joe Phillips, the previous manager. The 16 evidence will show that they hired somebody who 17 had managed such portfolios in the past, who had 18 studied such portfolios and, I think, had a 19 doctorate from MIT. They, again, repeated their 20 representations that they were going to create 21 risk-controlled arbitrage portfolios. They were 22 going to be financed with reverse repo agreements. 98 1 They were going to be managed in a way to minimize 2 interest rate risk. They didn't say anything 3 about swaps this time because they learned 4 something from their experience with swaps, if it 5 was only that, as the evidence will show, that 6 they didn't know how to manage that kind of a 7 portfolio this portfolio manager. However, Your 8 Honor, they didn't buy any hedges to match the 9 duration of the reverse repo with the 10 mortgage-backed securities. In other words, they 11 went naked, Your Honor, to use the parlance of the 12 CFTC that I remember from my previous life. 13 In March of 1987, there was only 14 $360 million of hedges that were purchased. Why 15 did this happen, Your Honor? Well, the evidence 16 will show that the investment committee and the 17 manager of the portfolio were speculating on the 18 direction of interest rates, that they projected 19 that interest rates were either going to decline 20 or remain steady, that they were not attempting to 21 minimize the risk from interest rate changes and, 22 in fact, they were attempting to maximize that 99 1 risk, Your Honor. 2 What happened? Rates substantially 3 increased during that time period, and that 4 portfolio lost substantial sums of money. Even at 5 its height, that portfolio was not managed to 6 minimize interest rate risk. At its height, it 7 had $1.7 billion in mortgage-backed securities and 8 only 1.1 or $1.2 billion in hedges. It didn't 9 minimize the risk. 10 The evidence will show, contrary to 11 what the respondents would have this Court 12 believe, that that portfolio could have been 13 hedged against the interest rate risk that caused 14 the loss in an economic fashion. As a 15 consequence, that portfolio was operated exactly 16 contrary to the representations that were made to 17 the regulators, exactly contrary to the 18 regulations that were applicable to the operations 19 of such service or subsidiary corporations, and 20 that the two portfolios combined caused a loss of 21 $270 million to the Insurance Fund or to USAT and, 22 indirectly, the Insurance Fund. 100 1 We believe, Your Honor, the evidence 2 will show that those two portfolios were 3 recklessly managed in disregard of the law and 4 that they were continually managed in the way that 5 they were managed in order to continue to meet the 6 qualified thrift lender test and, also, to keep 7 USAT afloat so that it could engage in its other 8 activities. These activities, Your Honor, ended 9 up creating losses to the portfolios. They did 10 not end up generating enough income or accounting 11 income in order to help USAT meet its capital 12 requirements. 13 So, as a consequence, the respondents 14 came up with another scheme to keep USAT afloat. 15 It was referred to, as the evidence will show by 16 internal accountants at USAT, as smoke and 17 mirrors, I think. I, for a while, thought or 18 recall that the person who testified referred to 19 it as a sham. Well, that's the incorrect term. 20 It's my term for what happened with the maturity 21 matching credit. The term -- it may be a little 22 more polite term -- inside USAT was that they 101 1 engaged in smoke and mirrors to meet capital 2 requirements. 3 And what was the smoke and mirrors? 4 Essentially, what they did was they manipulated 5 the maturity matching credit in order to extend 6 their control. And how did they do that? The 7 evidence will show that in January of 1987, the 8 Federal Home Loan Bank Board demanded its capital 9 requirements. It phased in an increase of capital 10 requirements to 6 percent capital, but it allowed 11 a credit for what it called maturity matching 12 credit. And that was calculated based on a 13 reduction for assets that were duration matched to 14 avoid the interest rate risk which is such a 15 threat to the financial well-being of savings and 16 loans. In direct contravention of the 17 regulations, the respondents, to meet this 18 maturity matching credit test and get the full 19 benefit of it so that they could satisfy the 20 capital requirements and keep USAT afloat for 21 their other purposes, shifted $320 million of 22 variable rate mortgage-backed securities and 102 1 $710 million of caps from United MBS's books to 2 USAT's books or from United MBS's general ledger, 3 to use the technical term, to United Savings 4 Association's general ledger. What did this 5 have -- what effect did this have on United 6 mortgage-backed securities which the regulations 7 require to be duration matched which was the 8 second of the mortgage-backed portfolio? 9 Basically, it ended up undermining that match; 10 and, as a consequence, it created a situation 11 where it appeared that the interest rate risk 12 exposure to USAT had been reduced when, in 13 actuality, there had been no change and, in fact, 14 regulations that specify how subsidiary 15 corporations will be operated was violated. The 16 evidence will show that the variable rate 17 mortgage-backed securities and the caps were 18 originally on the general ledger of United MBS and 19 that they were transferred. The effect of it was 20 to reduce the capital requirement for USAT from 21 around $284 million to 184. It ended up creating 22 a situation where USAT appeared to be in 103 1 compliance with its capital requirements as 2 opposed to not in compliance. The evidence will 3 show that the respondents tried to obscure where 4 the caps were, on whose general ledger they were, 5 who owned them. The evidence will show that the 6 respondents tried to say, "Well, look. There was 7 never really any movement of these things because 8 they were always on USAT's books" because the 9 income from the caps is recorded on USAT's books. 10 Well, the evidence will show, Your 11 Honor, that USAT was filing consolidated tax 12 returns or financial statements for purposes of 13 the SEC requirements; and, as a consequence, it 14 had to take the income from the assets that were 15 owned by United MBS and record them on its books 16 because it had to, for that purpose, combine them 17 on the books. But for the purpose of the maturity 18 matching credit, those principles don't apply; and 19 the respondents who have argued with regard to -- 20 I think it's the guarantee issue which I'm coming 21 to next, that you can consolidate for one purpose 22 and not for another, should well understand that 104 1 fact. 2 But the evidence will show that what 3 happened here was, in the words of the person who 4 was responsible for doing it, smoke and mirrors, 5 Your Honor; and it was in reckless disregard of 6 the requirements of the law. 7 Now, I'd like to turn to the guarantee 8 issue, Your Honor. Do you remember earlier, I 9 said that at some point in time, USAT was having 10 trouble with the investment banking firms and 11 getting them to finance their mortgage-backed 12 security purchases through reverse repo 13 agreements? As a consequence, a number of things 14 happened, one of which was, the evidence will 15 show, that the investment banking firms sought 16 some sort of assurances that United MBS which had 17 purchased $1.8 billion worth of mortgage-backed 18 securities from them would have the capital to 19 meet its obligations or its collateral calls under 20 those agreements. 21 The evidence will show that in response 22 to that concern, that USAT made a commitment to 105 1 the issuers of those reverse repo agreements to 2 maintain the capital of United MBS at 10 percent 3 of assets that created not only the margin for the 4 collateral for those such as are required for the 5 purchase of futures contracts, called a margin; in 6 addition, also have additional capital; and that 7 there was always a deeper pocket to protect those 8 people who were financing United MBS's purchases 9 of those mortgage-backed securities. That 10 commitment was made directly to those lenders; and 11 that, we believe the evidence will show, 12 constituted a guarantee for purposes of our 13 regulations. 14 The evidence will show, in fact, that 15 it probably even meets the requirements of the 16 Texas cases that the respondents have been touting 17 for so long unsuccessfully so far in this 18 proceeding. But in either case, we believe the 19 evidence will show that by issuing those 20 commitments to maintain the capital of United MBS 21 at 10 percent of value, that the respondents acted 22 with reckless disregard of the requirements. 106 1 Now, I'd like to turn to the last two 2 claims, Your Honor. Those are those that deal 3 with the real estate lending and compensation 4 issues. The evidence with regard to the real 5 estate claims will show that at the direction of 6 Charles Hurwitz and Jenard Gross primarily, that 7 USAT entered into a few costly high-risk real 8 estate loans in order to book large loan fees and 9 did so masking losses so as to avoid having to 10 take a set of reserves against those transactions, 11 both of which dealt with raw land. The first was 12 Park 410, an 80 million-dollar transaction. It 13 was initiated by Charles Hurwitz and Jenard Gross. 14 It violated USAT's own internal lending policies. 15 It was never presented to the board of directors. 16 It would have been the largest loan, I think that 17 evidence will show, that USAT had ever issued. 18 There was no due diligence done on that property. 19 Now, it may be that the respondents 20 believed that due diligence wasn't necessary 21 because the evidence will show that in another 22 transaction, Mr. Hurwitz has testified in his 107 1 deposition that he didn't need a due diligence. 2 All he needed to do was go out there and look at 3 the property because that was better than a due 4 diligence, Your Honor. 5 There was no appraisal of the property 6 prior to the commitment of the loan. And when it 7 came in, the appraisal didn't comply with R41B, 8 the applicable regulation on what needs to be in 9 an appraisal. In addition, there was inadequate 10 capital. We believe that the underwriting for 11 that loan was in reckless disregard of the law, 12 Your Honor, as the evidence will show. 13 The Norwood loan, Your Honor, was done 14 in a similar fashion. The evidence will show that 15 there was an inadequate appraisal. There were 16 inadequate evaluations of borrowers' financials, 17 that USAT's own internal policies were violated 18 when there was no guarantee, full guarantee 19 required where its practice was to require full 20 guarantees, and that there were improper 21 disbursements. 22 We believe, Your Honor, in that case, 108 1 also, the evidence demonstrated that they acted -- 2 respondents acted in reckless disregard of the 3 law. There's not much I can say at this point in 4 time because I think you've now heard about the 5 compensation issue two times already, Your Honor. 6 And all I can say at this point in time 7 is that if reckless disregard of the law has any 8 meaning under this statute, it clearly covers 9 these compensation practices that occurred here. 10 What essentially happened here is that the 11 respondents were on notice that the thrift failed 12 to meet its regulatory capital requirements, was 13 likely to be taken over, and had a net-worth -- 14 and UFG had a net-worth maintenance obligation and 15 they ended up compensating themselves with 16 extravagant bonuses, excessive salaries after they 17 knew those facts. That is not only a clear 18 reckless disregard of the law, but it clearly is 19 unjust enrichment in violation of the net-worth 20 maintenance obligation. 21 Now, respondents in their lengthy 22 prehearing submission attempt somehow to say, 109 1 "Well, look. You know, the regulators knew all of 2 this. They knew about the wholesale strategy. 3 They knew about the option agreement. They knew 4 about the MBS trading. They knew or they had 5 views about the Austin market." 6 Well, Your Honor, the evidence will 7 show that all of that is mere smoke and mirrors. 8 With regard to the put call option, 9 yes, Your Honor, there is evidence that the 10 regulators knew something about an option. But 11 the evidence will show that many of the people who 12 viewed that option agreement -- in fact, you can 13 take a look at the enormous prehearing submissions 14 and see the quotes -- that a number of people just 15 thought it was a call option, Your Honor. They 16 didn't know there was a put to it as well which 17 transferred all of the economic risk of ownership 18 to MCO. Nowhere will you find, Your Honor, that 19 the regulators knew anything about the letter of 20 credit nor that the stock had been put into an 21 escrow account to guarantee that the transaction 22 would occur. 110 1 I don't believe, Your Honor, that 2 partial knowledge -- in light of the fact that the 3 respondents knew that they could have gone to, I 4 think, what was referred to as CASDI at that point 5 in time and may still be referred to as CASDI at 6 the OTS, corporate and securities division, I 7 think, and get an opinion from them like everyone 8 else had been doing and, in fact, exactly how the 9 respondents had done when they converted one of 10 those preferred stock -- convertible preferred 11 stocks to another convertible preferred stock to 12 avoid triggering the regulations that would have 13 counted that stock as stock owned by MCO and, 14 thereby, in itself, triggered the net-worth 15 maintenance condition. 16 They knew they could have done 17 something, and they didn't do it and that they 18 tried to avoid the issue coming up. And, in fact, 19 I think at one point in time in their prehearing 20 submission, they make the statement, "Well, 21 something was submitted to the Texas Savings and 22 Loan commissioner." And they described the Texas 111 1 Savings and Loan commissioner as the primary 2 regulator, Your Honor. Well, the Texas Savings 3 and Loan commissioner, as the evidence will show, 4 was never the primary regulator for purposes of 5 federal regulations; and that is just another 6 example of the smoke and mirrors that's been 7 presented in this proceeding so far. Another 8 example, Your Honor, that will be demonstrated by 9 the evidence, you'll find in a prehearing 10 submission that how could anyone complain about -- 11 I can't remember whether it was Park 410 or 12 Norwood -- being underwritten in a market that 13 everybody knew was a declining market because even 14 the regulators viewed it positively, that market 15 as positively -- quoting something from 16 Ginger Baugh who was a supervisory analyst with 17 the Federal Home Loan Bank Board in Dallas where 18 they say in their submission -- boldly assert that 19 she says the Austin market was a growth market. 20 Well, Your Honor, the quote that they 21 took is totally distorted. The evidence will show 22 that that quote came from a memorandum that 112 1 Ginger Baugh wrote to her superior telling -- 2 summarizing what was in a filing that was made by 3 the respondents in this case. Those are not her 4 views. Those are her summaries of someone else's 5 views, passing it on to the person who had the 6 responsibility to make a decision. 7 And lastly, Your Honor, you heard a 8 great deal; and you'll hear a great deal in 9 argument -- I don't know whether you'll ever see 10 any testimony to that effect -- about how this 11 thrift went down because of the decline in the 12 Texas economy. The Texas economy may have 13 contributed to the losses here; but what we are 14 complaining about here, Your Honor, is failure to 15 meet a net-worth maintenance obligation that the 16 respondents, MCO and Federated, agreed to. We're 17 talking about reckless operations of what is 18 called the wholesale strategy, Your Honor, which 19 the evidence will show even the respondents agree 20 as reflected in a memorandum written by respondent 21 Mr. Crow that the losses to this thrift and the 22 cost to the federal taxpayer caused by the 113 1 reckless operations of the respondents while they 2 were unjustly enriching themselves was the direct 3 result of actions that were taken by the 4 respondents in reckless disregard of the law in 5 managing all of the wholesale strategy portfolios 6 which they claim to be so proficient at managing. 7 Thank you, Your Honor. 8 THE COURT: Thank you. I will take a 9 short recess. 10 . 11 (At which time a short recess was had.) 12 . 13 THE COURT: We are ready for the 14 respondents' opening statements. Mr. Villa, are 15 you going to be the first one? 16 MR. VILLA: I am, Your Honor. 17 THE COURT: Proceed. 18 MR. VILLA: Once again for the record, 19 I'm John Villa from Williams & Connolly with 20 Mary Clark and Paul Dueffert. We represent four 21 respondents. In alphabetical order, they are 22 Art Berner, Mike Crow, Ron Heubsch, and 114 1 Barry Munitz. Let me assure you, Your Honor, 2 today, the respondents -- all the respondents here 3 have coordinated their opening so that we should 4 have very minimal repetition. I'm going to divide 5 my opening into three parts. First, I'm going to 6 talk a little bit about the four respondents so 7 you know who they are and how they fit into the 8 history of USAT. Second, I'm going to paint in 9 broad strokes the story of USAT so you understand 10 the factual context in which these issues arise. 11 And third, I'm going to lay out for you 12 what we expect to be the evidence on several of 13 the claims that are directly relevant to our 14 respondents. Let me begin first by introducing 15 the respondents. In alphabetical order, they are 16 Art Berner first. I'll ask Mr. Berner to stand up 17 so that Judge Shipe -- thank you. Mr. Berner is a 18 53 year-old resident of Houston. He's married 19 with four children. He's a shareholder, what we 20 used to call a partner in the law firm of 21 Winstead, Sechrest & Minick here in Houston. He 22 handles primarily securities and corporate law 115 1 issues. He joined United Financial Group which is 2 the holding company for USAT in October of 1985. 3 Prior to that, he had been with Inesco Oil. He 4 had risen to the rank of general counsel of Inesco 5 Oil. He had been there 15 years. When he first 6 came to UFG in October of 1985, he was not the 7 general counsel of the thrift. The general 8 counsel of the thrift was a man named Jim Pledger, 9 and Jim Pledger held that position until mid-1986. 10 Mr. Pledger left in 1986 to go to the Texas 11 Savings and Loan Commission where he's ultimately 12 become the commissioner of Texas Savings and Loans 13 and has had a very distinguished career for the 14 last decade. For approximately three and a half 15 years, Mister -- three and a half years, about 16 that, Mr. Berner was the general counsel of UFG. 17 He had a staff of five inside lawyers, and he 18 retained a number of distinguished regulatory law 19 firms in the United States. His duties evolved, 20 but I think it would be fair to say that at no 21 time during this time period was he a thrift 22 regulatory lawyer. He became more involved in 116 1 different aspects of the work and particularly in 2 1987 and 1988 in the recapitalization plans of 3 united. He held the position as general counsel 4 until December 30, 1988, at the time of the 5 receivership. After the receivership, he 6 practiced -- or he stayed for a brief time with 7 United Financial Group, and then he returned to 8 private practice in corporate and securities law 9 which is his specialty. He doesn't practice 10 thrift regulatory law either before or after this 11 time period. Mr. Berner went on the board of UFG 12 and USAT on February 11, 1988, about ten months 13 before it closed. He did so because his 14 employment contract required him to do so if he 15 were asked. And a number of the directors 16 resigned. He was asked, and he went on. 17 The second of our four respondents in 18 alphabetical order is Mr. Mike Crow. I'll ask 19 Mr. Crow to stand. Mr. Crow is a 50 year-old 20 resident of Houston. He's married with one child. 21 He graduated from Texas Tech University. He's a 22 CPA, although he's currently inactive as a CPA. 117 1 His career began with Arthur Andersen where he 2 worked for two years. After that, he went to 3 First City National Bank here in Houston, the 4 biggest commercial bank in town, and rose through 5 the ranks from the very bottom to become its chief 6 financial officer. In 1983, he received a 7 telephone call from a man named Jerry Williams who 8 was then the president of United Savings 9 Association of Texas. Mr. Williams, who's not a 10 respondent in this case, had known Mike Crow for 11 years at First City; and he asked Mike to come 12 over and work at USAT. He did so. He became the 13 chief financial officer of USAT about New Year's 14 day, 1984. He spent the first several years 15 focused on back office problems. You see, as 16 you'll hear in some detail, United was the product 17 of a merger between two significant thrifts in 18 1983; and their computer systems were wholly 19 incompatible. And consequently, that's one of the 20 reasons that Mr. Williams called Mike Crow in. He 21 spent the first several years trying to reconcile 22 the back office problems. And as time went on, he 118 1 became more involved in financial accounting and 2 planning. Like Art Berner, Mike Crow joined the 3 board of directors of UFG in February of 1988. He 4 only joined the board of directors of the holding 5 company in February of 1988 because, again, the 6 employment contract required him to do so. He 7 resigned on December 13, 1988, about three weeks 8 before the takeover, two and a half weeks before 9 the takeover. He was not a member of the 10 executive committee. After receivership, he 11 became the CFO of a real estate firm; and he now 12 is involved in a securities firm. 13 I'd like to comment on several points 14 that were made by Mr. Guido in his opening. He 15 talked about a memo involving smoke and mirrors. 16 And since Mike Crow is the only accountant here, 17 you might have the misimpression, although I don't 18 think he explicitly said it, that such a memo was 19 authored by Mike Crow. It wasn't. Likewise, at 20 the conclusion of his remarks, Mr. Guido referred, 21 I think, with perhaps rhetorical flourish to a 22 memo that was authored by Mr. Crow which -- and 119 1 then it went on and on about the degree of loss 2 that was imposed on the institution, et cetera. 3 We'll all see the memo. I think that the memo 4 that he is referring to is simply an analysis of 5 the financial impact of the October 1987 stock 6 market crash on United, and it takes it at that 7 point in time. 8 So, Your Honor, to the extent that 9 comments were made which suggested that Mr. Crow 10 had either written the smoke and mirrors memo or 11 had written some memo which suggested that he was 12 recognizing or stating that he was responsible for 13 some sort of loss, I think that probably was not 14 intended; and it certainly isn't the fact. 15 The third respondent that we represent 16 in alphabetical order, again, is Mr. Ron Heubsch. 17 Mr. Heubsch, will you stand? Thank you. 18 Mr. Heubsch is 66 years old. He's married with 19 two children. He graduated from law school, but 20 he never took the bar examination or practiced 21 law. He has been involved in investments 22 throughout his entire career. He is a technician. 120 1 He's a pure stock trader. His life is the trading 2 room. His tools are the trading screen and the 3 telephone. He was an officer of United. And when 4 I say "United," I'm almost always talking about 5 the thrift itself. And UFG's primarily involved 6 in equity arbitrage which is the buying and 7 selling of stocks once there is a publicly 8 announced takeover attempt. So, what happens is 9 when it goes out on the wires that somebody's 10 trying to take over another company, the equity 11 arbitragers analyze it, make a judgment as to 12 whether that price is likely to work. If it is, 13 they jump in, buy some stock, not a huge amount, 14 but buy some stock; and if the price rises and it 15 closes out, they make their market on -- make 16 their profit on that premium. As I said, Your 17 Honor, he was a person primarily involved in 18 equity arbitrage. He had minor involvement in 19 mortgage-backed securities and in high-yield 20 bonds, but he was not the portfolio manager for 21 either one of them. Both the equity arbitrage 22 and, to a lesser extent, the junk bond portfolios 121 1 were extremely profitable for United over its 2 career. 3 Now, in Mr. Guido's opening, he said 4 that Mr. Heubsch directed the sale of junk bonds 5 or the purchase of junk bonds from time to time. 6 The evidence in this case will be that on June 10, 7 1986, the Federal Home Loan Bank of Dallas sent 8 out a team to interview the high-yield bond 9 operations at -- the people who were running the 10 high-yield bond operations at United. And the 11 memo which will be in evidence in this case 12 identifies the, quote, "manager" of this junk bond 13 portfolio as Joe Phillips. And at the end, it 14 says, "In summary, Terry Smith and I are of the 15 opinion that United is responsibly managing its 16 investment-grade-depth portfolio. We were very 17 impressed with Mr. Phillips, and he understands 18 the risks attendant." 19 The testimony will be as well that in 20 1987, Prudential Bache sent out another team to 21 interview the people who were managing the junk 22 bond portfolio. We have in here the notes of 122 1 those interviews and the notes of his summary, and 2 they say -- and the notes are and the evidence 3 will be -- they are in March of 1988 -- quote, 4 "Stodart was very good. Young staff but well 5 supervised." And that is correct because 6 Mr. Heubsch was not the manager of the 7 mortgage-backed securities portfolio. And the 8 evidence in this case will be that documents 9 coming from the Federal Home Loan Bank of Dallas 10 is that they sent out teams to interview the 11 mortgage-backed securities portfolio managers, and 12 they weren't Ron Heubsch. He did, however, run 13 the equity arbitrage portfolio; and it was one of 14 the few really bright spots consistently in the 15 history of United. For example, in the year 1988, 16 when he was running the mortgage-backed securities 17 or the equity arbitrage portfolio, it earned 18 $52.4 million net in a period of nine months. He 19 was never a director. He was never a member of 20 the executive or strategic planning committee, and 21 the only committee he was ever on was the 22 investment committee. 123 1 The fourth of our four respondents is 2 Dr. Barry Munitz. Dr. Munitz is not here today. 3 He is 56 years old. He's married. He lives in 4 California. He was awarded a Master's and a Ph.D. 5 in Comparative Literature from Princeton 6 University. Except for the stint involved here in 7 the 1980s, a portion of the 1980s, he has been in 8 academics his entire life. He has held various 9 positions at colleges and universities throughout 10 the United States. From 1976 to 1982, he was the 11 chancellor of the University of Houston and, as 12 such, met many of the individuals here. In the 13 fall of 1982, he took a position with MCO and also 14 became a director of UFG and USAT. He held the 15 position of chairman of the executive committee. 16 He was central to establishing procedures for 17 United. He was involved in high-level personnel 18 decisions including the selection and hiring and 19 firing of key officers. In 1991, Dr. Munitz moved 20 out of this area. He became the chancellor of the 21 California State University system. He now has 22 responsibility for more than 340,000 college and 124 1 university students in California. Those 2 responsibilities will severely limit the time that 3 he can spend in this courtroom. He will be here, 4 but he will not be here every day as he would 5 like. Obviously, it's in his personal interest to 6 be here; but he does feel the obligation to the 7 California State system. He has also recently 8 been selected as the president and Chief Executive 9 Officer of the Getty Trust which, I believe, is 10 one of the largest philanthropic and charitable 11 organizations in the world. 12 Your Honor, what we have before us for 13 the next three months is an adjudicate proceeding; 14 and it is a process by which the fact finder in 15 this case, you, will decide between two competing 16 visions of history. The history that we're 17 examining in this case is the history and life of 18 USAT. OTS's vision of history is in its notice of 19 charges in Mr. Guido's opening statement. It's a 20 dark one. It accuses the respondents in this case 21 of duping the regulators into believing that 22 United was financially sound so that it could 125 1 gorge itself on Drexel junk bonds. 2 This deception, according to OTS, was 3 carried out by selling off appreciated assets. It 4 was carried out by misrepresenting the securities 5 portfolio as an investment portfolio when, in 6 fact, they argue that it's a trading portfolio. 7 This deception, they argue, was carried out by 8 misrepresenting real estate investments as loans 9 in order to book fees. The OTS claims if only the 10 regulators had known this, they would have stopped 11 these risky activities. They would have 12 intervened and shut them down. 13 The respondents will testify in this 14 case to a dramatically different vision of history 15 and, I submit, a more accurate one. The 16 respondents' recollection is that beginning in 17 1984, they began to restructure United to address 18 one -- to address problems, any one of which could 19 have been failed. There were three problems: 20 First, the catastrophic consequences of the 21 interest rate mismatches that afflicted all thrift 22 institutions during this time period; second, an 126 1 anemic Houston economy that got worse and worse; 2 and third, an immense goodwill burden. The 3 restructuring, as it's called, is sometimes 4 referred to as the wholesale strategy; and the 5 action was the sale of appreciated assets, 6 branches, loan servicing, and the redeployment of 7 those gains into other areas, other business lines 8 that are more secure than the disastrous home loan 9 portfolio that United had in 1983. 10 The respondents will testify that they 11 didn't dupe the regulators; that the regulators 12 approval was, in fact, necessary to virtually 13 every key decision. The respondents will testify 14 that the regulators were cautious about some of 15 the activities, particularly high-yield bonds, 16 and, therefore, subjected United to a series of 17 three federal examinations in 27 months. And 18 after these investigations, they appeared to be 19 generally supportive of United's management until 20 something happened in the late summer of 1988 and 21 the regulator's attitude abruptly changed. 22 Finally, the respondents will testify 127 1 in this case they didn't dupe the regulators into 2 believing that United met its minimum regulatory 3 net worth or that it had substantial net worth. 4 And, in fact, they will testify that it was the 5 regulators' position that at least since early 6 1987, the regulators said that United did not meet 7 its minimum regulatory net worth but did not take 8 supervisory action against United. Your Honor 9 will be the ultimate judge as to whose vision of 10 history is correct; and, usually, that would be a 11 credibility contest. Here, however, it's not 12 going to be. We have found a cash of documents 13 which will make your job a good deal easier. They 14 are the supervisory files of the Federal Home Loan 15 Bank of Dallas. You see, thrift supervision lends 16 itself nearly ideally to the task at hand. Thrift 17 supervision requires the periodic review of 18 financial institutions, the assessment of its 19 management. Every time a thrift files a 20 significant application, the supervisory agent, 21 who knows more about the thrift than anybody else, 22 and his analyst sit down and write these analyses 128 1 of management and of the institution, of their 2 business plan, of their future. 3 So, what we have over a two-and-a-half- 4 or three-year period of crucial time in the life 5 of probably the biggest savings and loan in Texas 6 is a series of documentary analyses like this. 7 You know, it reminds me of a turn-of-the-century 8 movie. You know those movies where they are very 9 slow, like, the series of still frames. You can 10 look at each one of them; but if you read them all 11 together, you really get a vision of what the 12 scene is. And that's what you'll get when you 13 read the supervisory comments on United for a 14 two-and-a-half-year period. And the picture that 15 emerges there is that the regulators were not 16 misled. Not at all. They understood everything 17 about United. 18 Well, why is this important to the 19 case? It's important, really, for two reasons. 20 First of all, the OTS has made as a cornerstone of 21 their case: Deception, deception. We deceived 22 the regulators into believing that United was 129 1 sound. We deceived the regulators into some 2 understanding of the thrift portfolio. So, OTS 3 has put it squarely into controversy. 4 But there is a second reason and, 5 really, a more important reason for you as the 6 fact finder in this case. It's a candid 7 contemporaneous assessment of the management of 8 United. It's really how well United did, given 9 the problems and the severe and intractable 10 situations it faced. And let me characterize -- 11 let me emphasize the word "contemporaneous 12 assessment." You've heard a lot of hearings; and 13 you know that plaintiffs can bring in experts and 14 produce experts to say, with the benefit of 15 hindsight, that management shouldn't have done 16 this and shouldn't have done that, that they 17 shouldn't have made a loan in San Antonio in 1986 18 because the economy of San Antonio went down in 19 the late Eighties, or they shouldn't have hedged a 20 mortgage-backed mortgage portfolio to 200 basis 21 points because, Lord knows afterwards, it went 22 down 300 basis points. It's easy to do that. But 130 1 if you are trying to judge what these managers 2 were doing, whether they were engaged in reckless 3 conduct in 1986 and 1987, isn't the most relevant 4 aspects of it the files of the supervisors who, 5 knowing the almost nonexistent options facing 6 these thrifts, would analyze them? That's why we 7 believe, Your Honor, as the evidence will show in 8 this case, the supervisory analysis of this 9 institution will reflect that the harsh judgments 10 that the OTS levels in their notice of charges and 11 in their opening were notably absent. 12 Let me take you back now to United in 13 1983 as it existed, and we'll roll it forward a 14 little bit so you can understand the factual 15 context of the case. United was a 16 3.4 billion-dollar thrift with its principal 17 offices in Houston, Texas. It had 90 branches 18 throughout Texas, probably the most of any 19 financial institution in Texas. It was the 20 product of a merger that we'll hear something 21 about. 22 United's holding company was UFG, a 131 1 hundred percent holding company. In the years 2 1981 and 1982, United lost $30 million. In the 3 12-month -- looking at the time period, 4 December 31st, 1983, as kind of a benchmark, 5 United had a 12-month interest rate gap which was 6 a measure of sensitivity to interest rate 7 movements which was an astounding 50 percent of 8 its assets, negative $1.65 billion, which meant 9 that United was exceptionally vulnerable to 10 interest rate movements, particularly upward. It 11 had $275 million in goodwill amortizing at 12 $18 million a year. $275 million in goodwill 13 exceeded the capital of United. This was the 14 thrift that the respondents inherited as, one by 15 one, they joined United's team. It was beset by 16 systemic and terminal problems. 17 Now, you get a dramatically different 18 vision of United if you read paragraphs 25 through 19 30 of the notice of charges. The implication 20 there is that the respondents took a conservative, 21 safe, traditional, well-run savings and loan and 22 loaded it up with -- by the way, plenty of 132 1 operating income -- and loaded it up and exposed 2 it to undue risk. This is the first instance 3 where there are two competing visions of history, 4 and you'll judge between them. 5 Let's roll United's business forward 6 over a period of three or four years just on a 7 quarter-by-quarter basis in order to do it 8 quickly. 9 First quarter of 1984, United begins 10 diversification of its business. It moves -- 11 starting to move away from home loans which have 12 been disastrous. It begins examining the idea of 13 investing in high-yield bonds. 14 Mid-year 1984, Joe Phillips is hired. 15 Joe Phillips is hired to manage the high-yield 16 bond portfolio. During the course of this case, 17 you will see a number of internal bank board 18 documents and letters from the bank board 19 extolling Joe Phillips, the same man that we heard 20 Mr. Guido so bitterly criticize as having put 21 together the mortgage-backed securities portfolio. 22 The third quarter 1984, USAT brings in 133 1 Solomon Brothers and the other Wall Street houses 2 for presentations on mortgage-backed securities. 3 Fourth quarter 1984, USAT obtains the 4 approval of the Federal Home Loan Bank of Dallas 5 to sell 20 of its 90 branches, first example of my 6 statement that the approval of the regulators was 7 needed as we go through. USAT also obtains 8 approval from the Texas Savings and Loan 9 commissioner to invest in high-yield bonds. 10 Year end 1984, USAT cuts its interest 11 rate gap in half in one year from $1.65 million to 12 $868 million. 13 First quarter 1985, Joe Phillips begins 14 building the United MBS portfolio; and that's why 15 they call it Joe's portfolio. I mean, they don't 16 call it Ron's portfolio or Charles' portfolio or 17 Barry's portfolio. It's Joe's portfolio. 18 Second quarter 1985, United begins 19 equity arbitrage. That's really Ron Heubsch's 20 forte. 21 Third quarter 1985, Art Berner joins 22 UFG. Year end 1985, interest rates start a 134 1 precipitous fall, falling more than 300 basis 2 points within a very short period of time and 3 calling -- causing mortgage-backed securities to 4 prepay. 5 Now, I'm not going to get into that 6 because we don't want to have repetitive openings. 7 Mr. Nickens is going to address that. But the 8 impact on Joe's portfolio was profound. 9 For the year end 1985, United has 10 leveled off. 11 Its net loss for the year is $3 million 12 in a difficult economy. Its interest rate gap 13 continues to improve. It files an application 14 with the Federal Home Loan Bank of Dallas for 15 another branch sale. And I will read about four 16 sentences from all of the materials that we've 17 seen, but this one is of particular importance. 18 This is in our prehearing memo because this is 19 really a distillation of the difference between 20 the two sides as to the history of United. And 21 I'm trying to set up the issues for the Court as 22 the Court examines them. United comes at the end 135 1 of 1985 and says, "We want to sell some branches 2 for profit," the same branches that Mr. Guido said 3 that, in 1987, they didn't have these branches; 4 because they had sold them all off. Here is the 5 supervisory analysis on page 7 of the supervisory 6 history section of the memo, pretrial memo that we 7 gave you. Here's what the senior supervisors 8 analyzed for United. They say, "If opportunity 9 costs are considered, the transaction unfavorably 10 impacts the current earnings picture of United. 11 However, United will realize an immediate gain of 12 6.45 -- $6.54 million." Then skipping a few 13 lines, "The increase in net worth will provide 14 United added time to restructure and increase 15 profitability." 16 You see, the government's view is that 17 we were selling off assets to deceive them about 18 the financial condition of United. Our view is 19 that we were selling appreciated assets with the 20 knowledge and agreement of the regulators because, 21 in a tough economy, there isn't much you can do. 22 You have to restructure and try to ride it out. 136 1 First quarter 1986, the Federal Home 2 Loan Bank of Dallas examines United's business 3 plan in connection with an application. This is 4 an application that requires them to look at the 5 business plan, and the business plan lays out the 6 wholesale strategy that has been so bitterly 7 criticized. After they lay out the wholesale 8 strategy, the supervisory agent and the 9 supervisory analyst say it appears reasonable. 10 Second quarter 1986, the interest rate 11 fall that we were talking about that hit Joe's 12 portfolio basically bottoms out. A federal 13 examination of United begins in May. And United 14 forms an investment committee to oversee the three 15 portfolio managers. The three portfolio managers 16 are mortgage-backed securities, Joe Phillips, 17 high-yield bonds -- you would think it was Ron 18 Heubsch from the opening but Joe Phillips -- and 19 equity arbitrage, Ron Heubsch. The federal 20 regulators send out a team to look at the 21 high-yield bonds -- that's June of 1986; that's a 22 little quote from what I just read you -- sent out 137 1 a team to look at the high-yield bond operation 2 and report back that United is responsibly 3 handling its high-yield bonds. 4 Third quarter 1986, United hires 5 Sandra -- Sandra Lawrenson as the mortgage-backed 6 securities portfolio manager. She's from Solomon 7 Brothers, and she consults with and has available 8 to her Walter Muller who, I believe, is a former 9 Ph.D. from MIT. He may also be a professor at MIT 10 at the time or former professor from MIT. 11 Fourth quarter 1986, Ms. Lawrenson 12 starts building the mortgage-backed securities 13 portfolio up again. 14 Year-end 1986, United reports a net 15 loss for the year of $36 million. Scheduled items 16 which are bad loans -- not mortgage-backed 17 securities, not high-yield bonds -- bad loans -- 18 and not the loans that we're talking about here, 19 not Park 410 -- go from $171 million scheduled 20 items to $432 million in the year 1986. So, we're 21 starting to see the -- and Mr. Blankenstein will 22 talk about it -- the second dip in the Texas 138 1 economy. 2 First and second quarters 1987, the 3 results of the 1986 federal exam come in. United 4 is told that the regulators do not believe that 5 United has met its minimum regulatory net worth. 6 They tell United that they are going to be 7 directed to sign a supervisory agreement. Then 8 the Federal Home Loan bank of Dallas reverses 9 itself. They say, "We're not going to require you 10 to sign a supervisory agreement." They say, "You 11 must agree to have your books and records examined 12 by some third outside -- third-party independent 13 auditor and your high-yield bonds looked at by 14 Prudential Bache or by Wall -- a Wall Street 15 firm." In this case, it turns out to be 16 Prudential Bache. And they say, "If you agree to 17 do that, we won't ask you to sign a supervisory 18 agreement." 19 Now, in their prehearing statement at 20 page 10 and at pages 25 through 30 of the -- or 21 paragraphs 25 through 30 of the notice of charges, 22 and said again here today, is the clear 139 1 implication that United tricked the regulators 2 into believing that it met its minimum regulatory 3 net worth and, thus, staved off regulatory 4 intervention so that it could continue buying junk 5 bonds. We tricked the regulators. This is the 6 second of the three quotes I'll read. This is on 7 page 20 of the prehearing statement from an 8 internal bank board document in mid-year 1987. 9 This is what the supervisory agent says. "After 10 receiving numerous financial reports and attending 11 several meetings with United's accountants, the 12 supervisory agent continues to believe that United 13 did fail its capital requirement as of June 30, 14 1986. In lieu of a supervisory agreement, United 15 has agreed to a third-party review of its 16 accounting systems and its investment area, 17 particularly in junk bonds." 18 We have different visions of reality, 19 different visions of history. We say we didn't 20 trick the regulators, that they decided not to ask 21 for supervisory agreements because they satisfied 22 themselves in other ways. They say we tricked the 140 1 regulators into thinking we met our minimum 2 regulatory net worth. The Court will be the 3 judge. 4 The third and fourth quarter 1986, the 5 independent analyses of Grant Thornton and 6 Prudential Bache come back. No problems. That's 7 the verdict: No problems. United is not asked to 8 sign a supervisory agreement. Another federal 9 examination of United begins and then the stock 10 market crash in October of 1987. 11 Year end 1987, USAT takes a 12 114 million-dollar charge to earnings for real 13 estate losses -- not what we're talking about 14 here: Real estate losses -- and reports a 15 118 million-dollar loss for the year 1987. It is 16 reporting below its regulatory capital 17 requirements. 18 First quarter 1988 and the next two 19 quarters are probably the two most important 20 quarters in many ways in United's history. United 21 files an application for capital forbearance and 22 for the Southwest Plan. 141 1 The capital forbearance application 2 projects a loss -- I think it was filed on 3 February 16th, 1988. It projects a loss for the 4 year 1988 at $112 million. 5 Second quarter 1988. You see, here's 6 where Thrift Supervision comes in because in the 7 second quarter of 1988, there are -- really the 8 end of the first quarter, the beginning of the 9 second quarter, there are a number of important 10 applications pending which will determine United's 11 future, the capital forbearance and the Southwest 12 Plan. So, United is subjected to almost 13 continuous assessment there. Within a period of 14 perhaps eight or nine weeks, we see half a dozen 15 assessments of United's management. Now, this is 16 after the supervisory agent, Mr. Twomey, the same 17 supervisory agent for two years now, or more than 18 two years, I guess -- all of '86, all of '87 -- 19 two and a half years. So, he knows United cold. 20 And this isn't a situation where United has just 21 reported a 118 million-dollar loss and is 22 projecting another 112 million-dollar loss. Not 142 1 much hidden. Here are the assessments from the 2 bank board's words: "Capable management staff, 3 motivated and skillful, high-caliber, and 4 well-paid for their respective expertise. 5 Jenard Gross considered in the highest esteem. 6 United's management team thought of highly. 7 Wealth of management expertise at every level. 8 United has a good management team." 9 The government's vision of history is 10 that these assessments were procured through some 11 sort of deception. Our vision of history, as 12 we'll show in this trial, is that they weren't; 13 that we told them how much we were losing but they 14 knew what the options were that were facing thrift 15 executives in Texas in 1988. 16 United is told in the second quarter of 17 1988 that in order to get into the Southwest Plan, 18 it must have a hard-driving CEO. So, it hires a 19 man called Larry Connell spelled C-o-n-n-e-l-l as 20 president. By the way, if this name seems 21 familiar to you, it's because in Friday's Wall 22 Street Journal, Mr. Connell was identified as one 143 1 of two people who were the Treasury Department's 2 nominee for the new chairman of the FDIC. I'm 3 sorry. Treasury Department's choice for the new 4 chairman of the FDIC, although it appears, 5 politically, he will not get that job. 6 But to give you an idea of the esteem 7 in which he's held in the industry and the kind of 8 person that United hired to fill the one criticism 9 that was made of their management structure, they 10 hired Larry Connell in June of 1988; and he came 11 on board in July. United is told that with the 12 hiring of Larry Connell, there would be no 13 impediments to its participation in the Southwest 14 Plan. United's applications now look like they 15 have smooth sailing ahead. They're poised to 16 overcome their obstacles. At about this time, you 17 will see evidence in the record, documentary 18 evidence from the files of the Federal Home Loan 19 Bank of Dallas, that two of the most powerful 20 legislators in Washington -- majority leader 21 Robert Bird and Congressman John Dingle of a very 22 powerful subcommittee -- intensify, shall we say, 144 1 their interest in United and particularly in 2 Charles Hurwitz. There is evidence in this record 3 that a staffer from Congressman Dingle's committee 4 calls United's supervisory agent, Neil Twomey, and 5 asks him why they would consider granting capital 6 forbearance to United in view of Hurwitz's 7 ownership. 8 The third quarter 1988, the forbearance 9 application that has been pending for the last 10 five and a half months with no action is returned 11 for, quote, "changed circumstances." 12 The third quarter 1988, Southwest Plan 13 application which looked like it was all ready to 14 go now that they hired Larry Connell -- and this 15 is what the bank board document says about the 16 Southwest Plan application, internal bank board 17 document -- quote, "The involvement of Hurwitz in 18 the proposed Southwest Plan acquisition 19 essentially negated the transaction." 20 A couple of weeks later, the Federal 21 Home Loan Bank of Dallas starts another federal 22 examination of United. This is the third in 145 1 27 months. The target of the examination -- and 2 it's in a memo; you'll see it -- is high-yield 3 bonds and equity arbitrage. That's odd. 4 High-yield bonds and equity arbitrage are 5 consistently profitable, but they are politically 6 sensitive. 7 United is first told that it will have 8 to sign a supervisory agreement the first time. 9 Then the bank board changes; and they say, "You 10 have to sign a consent-to-merge agreement." Then 11 United is told by the regulators that they will 12 permit a lot of activities under the consent 13 agreement but the one they won't permit is equity 14 arbitrage, again, United's most profitable 15 activity. 16 Fourth quarter 1988, forbearance 17 application and the Southwest Plan application 18 effectively dead. The Federal Home Loan Bank of 19 Dallas transfers United to physics to prepare for 20 receivership; and on December 13, 1988, United 21 goes into receivership. That's the history of 22 United. 146 1 Your Honor, now let me go to the third 2 of the three portions of my opening which are -- 3 which is to address some of the allegations and 4 lay out the evidence, some of the allegations that 5 are directed toward our clients. And what I'd 6 like to do for you is frame the issues and 7 describe to you what I expect the evidence to 8 show, and I will move through this rapidly. 9 First of all, the false statements 10 allegations, the notice of charges contain 11 allegations that two of our clients -- Art Berner 12 and Dr. Barry Munitz -- sent letters to the 13 Federal Home Loan Bank Board in March and November 14 of 1987 in which they omitted to tell the bank 15 board about Drexel's ownership of UFG's stock and 16 an option that MCO had to purchase 300,000 shares 17 of UFG stock from Drexel in light of the 18 documentary evidence on this point that we will 19 introduce at this trial, the beginning of which 20 I'll lay out for you today. That's an astonishing 21 allegation for a government agency to make. 22 At trial, we will give you five 147 1 Securities filings or submissions directly to 2 these regulators that explicitly describe Drexel's 3 stock ownership and the Drexel option. Five 4 separate times they told them. And if you read 5 them, it says put and call option; and it's in 13D 6 which has all the attached agreements to it. I 7 think -- I haven't looked at every agreement; but 8 it's got many, many agreements in it, two proxy 9 statements, a draft offering circular, and 10 United's business plan. If you look at pages 46 11 through 47 of our supervisory history pretrial 12 memo, we quote two of them. We could have quoted 13 all five of them, and it's not as though the 14 regulators missed them. The regulators wrote 15 about them. They had a number of internal memos. 16 Now, maybe they didn't write every word down; but 17 my Lord, how can you charge these people with 18 false statements to the regulators because they 19 didn't put in every letter, "I hereby incorporate 20 by reference all five prior Securities filings 21 that I have sent you." This is the Drexel option. 22 This is the false statement that is so prominently 148 1 featured in the notice of charges. 2 Let me turn to the last aspect which is 3 the compensation issues. Count 13 alleges -- I 4 call them counts. I'm supposed to call them 5 claims; but I know I'll slip back into counts -- 6 alleges that the compensation that the respondents 7 received constituted an unsafe and unsound 8 practice and was reckless, whatever their current 9 vision of it is. Although it cites several 10 regulations in R42, the Court will learn in the 11 course of this case, in the course of the 12 presentation of the evidence in this case, that 13 those regulations don't have any objective 14 standards. I mean, you can't look at that 15 regulation and say severance is limited to three 16 months or six months or nine months. You can't 17 say whether the benefits under an agreement can be 18 secured or not secured. There is nothing in the 19 regulation that helps you. There are no 20 guidelines for compensation. It doesn't say 21 120 percent of peer group or 110 percent of peer 22 group. The point is when you lay down a contract 149 1 like this and you lay down the regulation, you 2 can't tell whether the contract violates the 3 regulation or not. 4 So, to a large extent, management of an 5 association must be guided by how the regulators 6 have historically dealt with their other contracts 7 that may have had similar terms in them because 8 you're trying to interpret a term like "unsafe and 9 unsound practices" and you're directed to 10 regulations that have no standard. 11 So, let's go back and see what the 12 evidence is going to show about the compensation 13 practices at United. Well, the relevant history 14 starts with the president of United who's not a 15 respondent here: Jerry Williams. 1983, he had a 16 three-year contract, written contract, multi-year 17 contract. Nobody told management of United that 18 that was an unsafe and unsound practice. 19 In 1986, United hired Sandy Lawrenson. 20 You've heard about her from Solomon Brothers as 21 the portfolio manager of the mortgage-backed 22 securities. She had a written employment 150 1 agreement, multi-year contract, guaranteed 2 bonuses, the right to have the benefits secured 3 by, for example, a letter of credit. Her contract 4 is reviewed by the examiners. No criticism of the 5 Lawrenson contract ever. April of 1987, United 6 hires Gene Stodart to manage the high-yield bond 7 portfolio because Joe Phillips left. Mr. Stodart, 8 written contract, multi-year term, guaranteed 9 minimums. He has the right to have his benefits 10 secured by a letter of credit. His contract is 11 reviewed by the examiners. No criticisms ever of 12 Mr. Stodart's contract. 13 Mid-year 1987, United is starting to 14 suffer from management turnover. Senior people 15 are leaving. As a matter of fact, we'll see about 16 a half a dozen internal bank board documents from 17 them that say, "One of our primary criticisms of 18 United is senior officers are leaving." So, the 19 compensation committee of United -- UFG in this 20 case -- decides that in order to retain current 21 senior management, it must offer them the same 22 kind of contracts that the new hires are getting, 151 1 written contracts, multi-year terms, guaranteed 2 bonuses, severance two times salary. The 3 compensation committee recommends that UFG enter 4 into these contracts with a half dozen senior 5 executives; and in 1987, it does. 6 November of 1987. I'm going to call 7 these the UFG-1 contracts. There are going to be 8 four contracts: UFG-1, USAT-1, UFG-2, USAT-2. In 9 November of 1987, we heard about the bonuses. We 10 had a big fight about the bonuses this morning. 11 In November of 1987, United authorized 12 bonuses for the year 1987 -- customarily done; 13 done every year that they authorized bonuses -- 14 for 70 executives, not just the respondents, not 15 just the top tier. 70 people. Those bonuses are 16 declared and paid in January of 1988. 17 In January of 1988, the examiners come 18 in. And they look at the UFG-1 contracts, and 19 they look at the bonuses. And the examination 20 report contains no criticism of them. Remember, 21 management is trying to determine what's an unsafe 22 and unsound practice by reference to ambiguous 152 1 standards and trying to determine what based -- 2 based upon what the examiners have looked at and 3 agreed to over the years is acceptable. 4 In January 1988, the USAT compensation 5 committee concludes that it would be beneficial to 6 enter into another set of contracts. They are 7 called the USAT-1 contracts. So, now we have 8 parallel contracts: USAT-1, UFG-1 contracts. The 9 USAT-1 contracts which have many of the terms that 10 are going to be litigated here -- two years' 11 severance, guaranteed bonuses, and the like -- are 12 approved at a meeting of the board of directors of 13 United Savings Association of Texas in February of 14 1988; and the federal examiners are in attendance. 15 They sit there, and they hear the explanation of 16 the contracts. It's reflected in the meeting 17 minutes, how the contracts are explained. Still, 18 no criticism. The UFG and USAT-1 contracts are 19 described in the proxy statement; and the UFG-1 20 contract is actually attached as an exhibit to 21 United's 10K -- UFG's 10K which is sent to the 22 regulators. Still, no complaints about these 153 1 contracts. 2 In March of 1988, because of a problem 3 with the change of control provisions in the 4 contract, United determines it has to redraft 5 these contracts. It redrafts these contracts. It 6 adopts a new bonus plan and some security for the 7 severance and bonus plans and other things. It 8 hires a consulting firm called Hewitt Associates 9 to come in to help on the drafting of the 10 contracts and to determine whether the 11 compensation levels are appropriate. 12 In June of 1988, Hewitt concludes that 13 the compensation levels are appropriate. Now -- 14 and now comes an exceptionally important time on 15 the compensation issues, and I'm drawing to a 16 conclusion in my remarks. 17 In June of 1988, as I told you, United 18 negotiated and hired Larry Connell. It reached an 19 agreement to hire him in order to qualify for its 20 Southwest Plan. United -- I'm sorry. Mr. Connell 21 is offered a contract that Hewitt has been working 22 on and United's been working on, and we'll call it 154 1 the USAT-2 contract. It's the second generation 2 contract. When the supervisory agent at the 3 Federal Home Loan Bank of Dallas hears that United 4 is about to hire Larry Connell, he says, "Please 5 send me Larry Connell's contract. I'd like to 6 look at it." 7 Art Berner, one of the respondents in 8 this case, says, "Fine. I'll send you the 9 contract." He sends him the contract with a 10 letter dated June 30, 1988. It says, "Here's 11 Larry Connell's contract. Please call me if you 12 see any major problems." 13 June 30, 1988. For a period of four 14 months, there are no complaints from the 15 regulators. Mr. Connell's contract which is 16 called USAT-2, the second generation contract, is 17 used as a model for the other senior officers. 18 The contract that they sent in to the regulators 19 and didn't hear anything back about is used as a 20 model for the other senior officers. Four months 21 pass. 22 On October 27, 1988, Neil Twomey, the 155 1 supervisory agent from the Federal Home Loan Bank 2 of Dallas, sends a letter to United criticizing 3 the Connell contract and all of the other 4 contracts that are the same as the Connell 5 contract. His criticisms are multi-year contract, 6 compensation levels, trust to secure bonuses. 7 Mr. Twomey says he wants the bonus and severance 8 monies returned. He wants the contracts -- he 9 wants provisions put in the contracts, and he 10 wants the board to examine compensation levels. 11 Ten days later, the board says, "We'll 12 do it all. We'll do it all." They respond. They 13 go out; and before United closes, they propose 14 changes to all the contracts. They go out to 15 every one of the executives including all -- not 16 all the respondents are involved in this 17 particular -- in the compensation -- and get them 18 to sign waivers, three different waivers, to try 19 and go get back the money. There was money put in 20 banks to secure the bonus plans and the severance 21 plans, and they all agree to it. They all sign 22 the waivers. They are able to get back 90 percent 156 1 of the money. But one bank, Texas Commerce Bank, 2 says, you know, "We think that maybe these waivers 3 were obtained under duress; and, therefore, we 4 won't give back the $600,000," the last 600,000. 5 They communicate with Mr. Twomey on this issue. 6 And Mr. Twomey says in a letter three 7 days before United closes, "We wish you'd pay the 8 money back; but if you don't, quote, 'We request 9 that those funds remain in the trust until the 10 matter is finally resolved,'" close quote. And 11 that's exactly what happens. Texas Commerce Bank 12 hangs on to the last $600,000 until the matter is 13 finally resolved. 14 And as the Court knows, the matter was 15 resolved in this courthouse when a United States 16 District Judge held that the bonus plan was not an 17 unsafe and unsound practice. Although we're going 18 to relitigate that in this case, that's how the 19 matter was resolved. 20 After receivership, a number of the 21 executives instituted arbitration proceedings for 22 their severance rights; and they were settled for 157 1 25 cents on the dollar. That's the compensation 2 case. 3 Let me conclude with this observation, 4 Your Honor. I represent four individuals. They 5 had the ultimate misfortune of joining United 6 Savings Association of Texas. They could have 7 joined any one of the 30 largest banks and savings 8 and loans in Texas in 1986. Only two of them 9 survived. For the sin of choosing United Savings, 10 they have been investigated for eight years; and 11 they have been sued for more money than they will 12 ever in their life see. 13 The evidence in this case will show 14 that they don't deserve this; and at the end of 15 this case, I'll ask you to lift from them the 16 cloud that has hung over them for the last eight 17 years by finding that the OTS hasn't proven its 18 case and that each one of them is free to pursue 19 their careers or to retire, as the case may be, in 20 peace. Thank you. 21 THE COURT: Thank you. We'll take a 22 short break. 158 1 2 (At which time a short recess was had.) 3 4 MR. BLANKENSTEIN: Good afternoon, Your 5 Honor. It's been a long day, and let me introduce 6 myself again. My name is Paul Blankenstein; and 7 I'm with the law firm of Gibson, Dunn & Crutcher. 8 With me today is Mark Perry; and we represent 9 Jenard N. Gross, one of the respondents in this 10 proceeding. Mr. Gross is here today, and I'd like 11 to have you stand up and be introduced to the 12 Court. 13 From February of 1985 through 14 November 1988, Mr. Gross was the chief executive 15 officer and chairman of the board of directors of 16 United Savings Association of Texas. And for a 17 good part of that time, he also did double duty as 18 the president of USAT. He also served on the 19 board of directors of USAT's parent, 20 United Financial Group. You've already heard from 21 Mr. Guido who laid out the claims that OTS intends 22 to present in this case and from Mr. Villa who's 159 1 laid out part of the respondents' answer in the 2 case. Let me, on behalf of Mr. Gross, join fully 3 in what Mr. Villa has said and what the other 4 counsel -- what I know the other counsel for 5 respondents will say as they lay out the remainder 6 of that case. My part here is to describe what 7 the evidence will show with regard to two of OTS's 8 claims against the respondents. 9 First, OTS's claim that by failing to 10 make UFG comply with its net-worth maintenance 11 obligation to infuse capital into USAT, 12 respondents engaged in unsafe and unsound conduct 13 and recklessly disregarded some law or regulation 14 or prior order of the bank board. I'll also 15 address OTS's allegation that the respondents 16 engaged in unsafe and unsound lending practices 17 with respect to two loans: The Park 410 loan and 18 the Norwood loan. I'll also touch briefly upon 19 OTS's claims against Mr. Gross for civil money 20 penalties. 21 But before turning to what the evidence 22 will show on those issues, Your Honor, I'd like to 160 1 tell you a little bit about Mr. Gross, my client, 2 what sort of man he is, his life before and after 3 USAT, and how he tried, while at USAT, to meet the 4 very difficult challenges that he and his 5 colleagues confronted on a daily basis as they 6 tried to steer USAT through some of the most 7 trying times that the savings and loan industry, 8 particularly Texas thrifts, ever faced. 9 First, about Jenard Gross. He's a 10 long-time resident of Houston where he's involved 11 in a variety of business, civic, and philanthropic 12 activities. He's successful in all of those 13 areas, Your Honor, and is considered one of 14 Houston's most esteemed and leading citizens. 15 You'll hear testimony to that effect from some 16 notable Houstonians: Former Senator and Secretary 17 of the Treasury, Lloyd Bentsen; Bob Clark, 18 formerly United States Comptroller of Currency; 19 Ben Love, the retired chairman of the Texas 20 Commerce Bank; Charles Bunkin, former Secretary of 21 Energy as well as Robert Smith, head of the 22 Federal Reserve Bank in Houston with whom 161 1 Mr. Gross served during his term on the board of 2 the Houston bank when he was there from 1987 to 3 1983. All of those individuals have agreed to 4 testify as character witnesses for Mr. Gross. 5 Who's this man that can call upon all 6 these notable individuals to come to his aid in 7 this proceeding? Now 67 years old, Mr. Gross is 8 married with four children. He was born on 9 October 9th, 1929, in Nashville, Tennessee, to a 10 family of modest means. He graduated Magna Cum 11 Laude from Vanderbilt University in 1950 with a 12 Bachelor of Arts degree and a newly-minted 13 Phi Beta Kappa. 14 Like many other young men of his 15 generation, Your Honor, children of the 16 depression, Mr. Gross began to make his way in the 17 world of business. His first job after college 18 was with a furniture store as an executive 19 trainee. 20 Later, after a stint in the Army, 21 Jenard moved to Houston as a medical equipment 22 salesman for a company headquartered in Kansas 162 1 City. Looking for investment opportunities while 2 working as a medical equipment salesman, he came 3 upon a chance to invest in garden apartments in 4 real estate. Scraping together about 40,000, 5 Jenard developed an eight-unit garden apartment 6 complex here in Houston. He's still very proud of 7 that first effort. That was in 1955. 8 Mr. Gross never went back to the 9 medical equipment business. Instead, over the 10 next 40 years, with time out only when he was with 11 USAT, Mr. Gross has been a real estate developer. 12 During that time, he has built more than 14,000 13 apartment units providing quality affordable 14 housing for middle-income families in Texas and 15 the surrounding states. 16 Mr. Gross has never, however, let his 17 business activities crowd out his charitable 18 and -- his charitable and civic obligations. He's 19 carried a full plate of those, Your Honor, as 20 well. 21 Currently, Mr. Gross and his wife are 22 involved in establishing a residential school in 163 1 Houston to shelter and educate homeless children. 2 The school is scheduled to open later this year. 3 It's already received its charter from the Houston 4 School Board. Making this school a success is one 5 of Mr. Gross' top priorities. Along the same 6 lines, Mr. Gross was instrumental in establishing 7 the college scholarship program run by the Houston 8 Alumni Chapter of Phi Beta Kappa. Each year, they 9 provide 60 college scholarships to worthy high 10 school seniors in the Houston area. 11 That's a little bit of who Mr. Gross 12 is. His involvement with USAT began in the spring 13 of 1984 when he was contacted by Barry Munitz to 14 act as a consultant for USAT with respect to real 15 estate matters. Although he had no prior business 16 relationship with USAT, UFG, or Barry Munitz, he 17 did know but only socially Charles Hurwitz who was 18 then chairman of UFG. But the evidence will show 19 that it was his reputation in the real estate 20 community in Houston that led Mr. Munitz to seek 21 his advice as to how to improve USAT's real estate 22 operations. 164 1 In addition, Mr. Gross had some 2 experience as an outside director of two or three 3 savings and loans; so, he was generally familiar 4 with the type of issues that thrifts face. 5 Mr. Gross will testify that at this 6 time, USAT like every other thrift in Texas was 7 having problems with its real estate operations. 8 His task as a consultant was to identify the 9 source of the problem and provide solutions that 10 would make USAT's real estate department more 11 efficient and effective. He did that, and his 12 suggestions were implemented much to the benefit 13 of USAT. Once he finished this consulting work 14 and successfully finished this consulting work, 15 Mr. Gross was recruited by USAT to join the thrift 16 on a full-time basis. Sonny Bentley, the 17 long-time chairman of USAT, was retiring; and 18 Mr. Gross was asked to step in and fill that role. 19 He was named CEO and chairman of USAT in 20 February 1985 and, at the same time, became a 21 director of UFG, the parent holding company. 22 What did Mr. Gross face when he came to 165 1 work that first day as chairman of -- and CEO of 2 USAT? It's been pointed out that the institution 3 was the product of a merger between first -- 4 Houston First American Savings. The 5 institution -- the merged institution was then the 6 second business thrift in Texas with about 7 3.4 billion in assets including, however, 8 270 million in goodwill that was being amortized 9 at the rate of $18 million a year. What that 10 meant, Your Honor, is that USAT had earned 11 $18 million just to stay even. That was a 12 formidable task in the economic environment in 13 Texas in the 1980s. 14 By the time Mr. Gross arrived, USAT had 15 already begun shifting its business away from the 16 traditional savings and loan model. By early 17 1985, USAT had already put in place much of what 18 has been described as its wholesale strategy. 19 Much of the sale of some branches had already 20 occurred. USAT was reducing its reliance on 21 unprofitable real estate loans and was increasing 22 its involvement in commercial real estate loans 166 1 and joint ventures. United's high-yield bond and 2 mortgage-backed security programs were up and 3 running. 4 While Mr. Gross had some experience as 5 an outside director of thrifts, he was not an 6 expert in the real estate business; and he had no 7 direct involvement previously -- direct 8 involvement of running a thrift. 9 What he brought to the job of chairman 10 of USAT was his mature judgment and his vast 11 experience in -- and knowledge of the real estate 12 business in Texas, in Houston, and surrounding 13 areas. Mr. Gross anticipated -- and it was 14 understood at all levels of USAT -- that his focus 15 would be on the real estate business and that he 16 would rely on senior members of management, 17 particularly the then president of USAT, Gerald 18 Williams, for the other aspects of USAT's 19 operations. He would also rely, of course, on 20 outside consultants and advisors like 21 Peat Marwick, USAT's outside auditors. But 22 Mr. Gross was not a passive CEO. 167 1 Your Honor will undoubtedly see and 2 many memoranda authored by Mr. Gross are referred 3 to by some USAT personnel as Jenardograms. In 4 those memos, Mr. Gross often asked pointed 5 questions. He presented issues for consideration 6 and debate, and he sought explanations as to what 7 USAT was doing and why it was doing it. He wanted 8 to learn all he could about USAT operations. He 9 pushed, prodded, and asked questions. Sometimes 10 he was simply seeking information so that he would 11 have a better and deeper understanding of what -- 12 of some aspects of USAT's business. Other times, 13 he was reacting to proposals put forward by other 14 members of senior management; and still others, he 15 was just trying to correct what he thought was a 16 misstep by USAT. 17 The documentary evidence and testimony 18 from Mr. Gross and other witnesses will show that 19 Mr. Gross' management style as reflected in those 20 memos was very direct and positive. Jenard's rule 21 was, "Don't bury problems. Bring the bad news to 22 me, to the top." The message to middle managers 168 1 was to come clean. Don't hide problems as they 2 will only fester and worsen by neglect. His 3 direction to the staff at USAT was to bring 4 problems into the open where they could be 5 discussed and analyzed by senior management and 6 solutions identified and implemented before the 7 problems became unsolvable. 8 The evidence will show that's the way 9 USAT operated while Mr. Gross was in charge. 10 You'll see that in the minutes and exhibits to 11 meetings of USAT's board of directors as well as 12 those of the senior management committees. Those 13 minutes and exhibits reflect an open and candid 14 discussion of how USAT was running its business 15 and how they were trying to deal with the 16 issues -- the difficult issues that all thrifts 17 faced in the 1980s. There was no intent and there 18 was no attempt to hide anything from anyone. 19 In that regard, the other guiding rule 20 that Mr. Gross and other senior managers followed 21 while he was in charge was to tell the regulators 22 what USAT was doing and to conduct USAT's affairs 169 1 in a manner that was consistent with the rules and 2 regulations of the regulators. It wasn't always 3 easy to keep up with the ever changing and often 4 uncommunicated interpretations of what constituted 5 acceptable practices. Mr. Villa has described 6 some of that already for you with respect to the 7 compensation practices. 8 Your Honor, although the point has been 9 made and probably will be made again, let me just 10 say it on behalf of Mr. Gross. We're here only 11 because USAT did not survive the hard times of the 12 Eighties despite the hard work and best efforts of 13 Mr. Gross and the other respondents to make it 14 succeed. 15 The evidence is, Your Honor, that as 16 late as mid-1988, the regulators shared with 17 USAT's senior management the belief that USAT 18 would be a survivor of the thrift crisis that 19 beset all Texas thrifts. That didn't happen, of 20 course. Like most other financial institutions in 21 Texas, both banks and thrifts, USAT could not 22 produce enough income from its other activities to 170 1 offset the write-offs. It was forced to take the 2 result of the deterioration of the real estate 3 market. Mr. Villa's already told you some of 4 those large write-offs that USAT was required to 5 take through the years. The Texas economy went 6 through quite a roller coaster ride in the 7 Eighties. The first oil shock hit in the 8 1981/1982 period, and it had its principal impact 9 on those areas of the state like Houston that were 10 dependent on the oil economy. 11 Just as things were getting a little 12 better, as the prospects for sustained recovery 13 were improving, the second oil shock hit in 1986. 14 This time, its effects were wider and deeper than 15 before and spread throughout the state including 16 areas that previously had been protected and had 17 not been affected from -- by the recession in the 18 oil business. 19 What happened to financial institutions 20 in Texas in the 1980s as a result of the 21 deterioration of the Texas economy was 22 outstanding. The entire industry was decimated. 171 1 Some 370 Texas banks failed. Of the ten largest 2 bank holding companies, seven failed. Two were 3 forced to merge, and only one survived impact. 4 On the thrift side of the ledger, the 5 toll was as dramatic. There were 318 Texas 6 thrifts in operation in 1980. By 1992, only 64 7 were still operating. Almost all of the top 8 thrift institutions in Texas didn't survive the 9 end of the 1980s. I believe 28 of the 30 failed. 10 There is little or no mention -- there was little 11 or no mention to Mr. Guido's presentation as to 12 the effects of the Texas economy. It's passing 13 reference. 14 Mr. Guido -- with the benefit of 20/20 15 hindsight, Mr. Guido and OTS find the respondents 16 at fault for what happened to USAT. Now, 17 Mr. Villa's already told you that the tale of 18 reckless conduct and deceit laid out in the notice 19 of charges and restated by enforcement counsel 20 today will be conclusively rebutted by the 21 evidence that will be introduced not only by -- 22 that won't be true -- not only by the testimony of 172 1 the respondents and other witnesses but, also, by 2 the documentary evidence, in particular, that cage 3 of supervisory documents that Mr. Villa made 4 reference to. It will show that -- show what the 5 regulators knew about USAT's activities and when 6 they knew it, and it will defeat the -- 7 Mr. Guido's claims that USAT and the respondents 8 acted to deceive and dupe the regulators. 9 Since some of the evidence from those 10 supervisory files deals with real estate claims 11 set out in the 12th claim for relief, let me turn 12 to those claims now; and let me just try and move 13 through these issues as quickly as I can, Your 14 Honor, because I know it's been a long day. 15 But let me just give you a little 16 background about these two loans, the Park 410 and 17 Norwood. Park 410 was a 380-acre tract of 18 undeveloped land in San Antonio while Norwood was 19 a 90-acre tract in Austin, Texas. Both loans were 20 so-called ADC loans, Acquisition, Development, and 21 Construction loans. In each case, the borrowers 22 planned to develop the property by getting them 173 1 zoned, graded, put in drainage, roads built so 2 they could make the properties attractive for 3 ultimate resell to other commercial users in 4 smaller tracts. Those users, in turn, would put 5 up office buildings, retail stores, hotels, or 6 apartments as the case may be. 7 Now, Mr. Guido has told you that Park 8 410 and Norwood were high-risk speculative 9 investments supported by no legitimate business 10 reasons intended solely to allow USAT to book fees 11 to offset losses, to mask losses. 12 Let's see what the evidence really 13 says. To begin with, it was prudent, extremely 14 prudent, for USAT to make loans in places other 15 than its Houston home base in 1986. The Houston 16 economy was suffering the disastrous effects of 17 the oil shocks of the 1980s. As much as any major 18 city in Houston -- in Texas -- excuse me -- 19 Houston's economy was dependent on oil. Now, 20 having revived somewhat in 1984 and '85 from the 21 first oil shock, by 1986, the economy of Houston 22 had nose dived again. Homeowners were abandoning 174 1 their homes in droves and literally mailing their 2 keys back to USAT rather than try to meet their 3 mortgage obligations. Other parts of the real 4 estate market, the commercial real estate market, 5 weren't much better. USAT also had to move away 6 from concentrating its assets in single-family 7 mortgages which had proven so disastrous. 8 The evidence is that by 1986, as 9 Mr. Villa's pointed out, USAT had been required to 10 write down tens of millions of dollars in 11 single-family mortgage loans. The problem in 12 Houston in 1986 was not true. The economy in 13 San Antonio and in Austin was still strong. 14 Now, Mr. Guido has tried to disparage 15 what Ms. Baugh said in her May 23rd, 1986 memo 16 where she described the San Antonio and Houston 17 areas as still high-growth areas. That's what she 18 said. And whether or not she was summarizing 19 USAT's application or not, if she had reason to 20 believe that fact not to be true, one would have 21 expected her to say so. She didn't. Moreover, 22 the evidence will be that in 1986, both Houston 175 1 and San Antonio were still not affected by the oil 2 shock; and there was no expectation that they 3 would be. 4 Mr. Guido said that the Park 410 5 property was identified by Mr. Gross and 6 Mr. Hurwitz. Not true, Your Honor. The evidence 7 will show that neither man was involved in 8 bringing the property to the attention of USAT. 9 In fact, Mr. Gross wasn't even an officer of USAT 10 when the properties were first -- when the thrift 11 became interested in the Park 410 property. The 12 evidence will show that it was David Graham, one 13 of USAT's leading senior lending officers, that 14 was involved in identifying the property, 15 researching the property, doing the due diligence 16 on the property, and bringing the loan to the 17 attention of USAT's management. 18 Mr. Guido said there was no due 19 diligence at all that was done with respect to the 20 Park 410 loan. The evidence will be, Your Honor, 21 that there was ample due diligence done on the 22 loan. In fact, Your Honor, the loans were 176 1 reviewed by -- the Park 410 loan and the Norwood 2 loan were reviewed by the examiners. The Park 410 3 loan was reviewed by the examiners a few weeks 4 after it was approved and it was ready to pass. 5 In fact, the examiner in charge, Vivian Carlton, 6 noted on the write-up of the loan, "We'll pass." 7 Weakness is not material is what she said about 8 the loan. 9 As to the Norwood loan, the senior 10 supervisory agent, a Mr. Daniel A. Thomas, he 11 reviewed the loan in 1987; and he declined to 12 second-guess and didn't find fault with USAT's 13 business decision to make the loan in 1986. 14 Now, Mr. Guido also said that the loans 15 were intended to inflate USAT's financial 16 statements and that they were intended to mask 17 losses. Again, not true. The evidence will show 18 that Norwood was classified as an a loan. It 19 didn't materially affect USAT's earnings and net 20 worth. The evidence will also show that 21 consistent with USAT's regular practices, Park 410 22 was reviewed by the thrift's outside auditors, 177 1 Peat Marwick, and classified as a loan by Pete 2 Marwick in accordance with then current accounting 3 principles. 4 I think Mr. Guido mentioned lack of an 5 adequate appraisal that didn't meet the 6 requirements of R41B. Your Honor will probably 7 hear an awful lot about R41B in this case, 8 probably more than anyone other than the 9 professional appraiser would ever want to know. 10 The evidence will be, Your Honor, that R41B is far 11 from a perfect document, far from a perfect guide 12 to what it requires of appraisers, and that not 13 even the expert appraisers can agree exactly on 14 what it requires. 15 Moreover, the evidence will be, Your 16 Honor, that the appraisals of Park 410 and of 17 Norwood were performed by qualified appraisers, 18 that the appraisals that they delivered were 19 comprehensive and wholly consistent with the sort 20 of appraisals that were being issued in 1986. 21 Now, Mr. Guido also made the point that 22 with regard to Park 410, there was no appraisal -- 178 1 there was no appraisal, I think, is what he said 2 when the senior loan committee approved the loan 3 in 1986. 4 Let's provide a little different 5 picture as to what was going on. At the time the 6 loan was presented to the senior loan committee, 7 there were all representations from the appraiser 8 who, I believe, was Ed Schulz as to what the 9 appraisal would find. Those were presented to the 10 senior loan committee. The senior loan committee 11 approved the loan subject to receipt of the 12 appraisal consistent with those representations. 13 That appraisal was received two days later before 14 any monies were disbursed under the loan. Not one 15 penny went out before that appraisal was received. 16 There was a theme that went through 17 Mr. Guido's statements that these loans were not 18 consistent with USAT's internal policies. But 19 what Mr. Guido didn't tell you was that the loans 20 were entirely consistent with the standards that 21 the regulators had in existence at the time; that 22 under those standards, an ADC loan wasn't required 179 1 to be supported by any guarantees, that an ADC 2 loan could use interest reserves, and that an ADC 3 loan was appropriate even where its success 4 depended on the ultimate sale to third parties. 5 All of these loans had the characteristics 6 associated with ADC loans under the policies 7 authored by the regulators at the time. 8 If I heard Mr. Guido right, his 9 argument was that the respondents engaged in 10 unsafe and unsound practices because they followed 11 the regulations and the standards of lending that 12 were put out by the regulators in 1986. I don't 13 understand that argument. The loans were made 14 consistent with all current applicable lending 15 practices of the regulators. 16 In short, Your Honor, at the end of the 17 day, the evidence will show that the Park 410 and 18 Norwood loans were well documented, competently 19 researched, sufficiently collateralized, properly 20 accounted for, and were the product of reasonable 21 business judgments. 22 Now, why did they fail? They failed 180 1 because -- for the same reasons that thousands of 2 other commercial real estate loans failed in Texas 3 in the 1980s. Again, the second oil shock which 4 came in 1986 was far worse than the first one. It 5 spread through the entire state and engulfed areas 6 like San Antonio and Austin that had previously 7 been protected from the effects of the downturn of 8 the economy and, particularly, in the oil side of 9 the economy. When the economy of San Antonio and 10 Austin turned down because of the -- because of 11 the ramifications of that second oil shock, 12 Norwood and Park 410 bottomed out as well. They 13 went down, too. 14 Now, the other issue on my plate 15 involves the UFG net-worth maintenance agreement 16 which is the subject of the second claim in the 17 notice of charges. I'll try and avoid the word -- 18 I'll try not to say "count," Your Honor. Second 19 claim. That claim is brought against Hurwitz, 20 Munitz, Berner, and Gross, those respondents. 21 According to Mr. Guido, as directors of 22 UFG, these individuals were required to cause UFG 181 1 to meet its net-worth obligations, to infuse 2 capital into USAT. They didn't do that and, as a 3 result, are liable -- originally, it was 4 $500 million which is the statement in the notice 5 of charges. I think Mr. Guido has modified that 6 now, and it seems to be that they are liable for 7 the amount that they received in compensation as a 8 result of the failure of UFG to pay down money 9 into USAT until that claim was settled in 1995. 10 To recover any amount, whether it's $500 million 11 or $2 million, OTS has to establish that the 12 respondents' failure to cause UFG to infuse 13 capital into USAT pursuant to this net-worth 14 maintenance agreement was somehow an unsafe and 15 unsound act and, also, that the respondents were 16 either unjustly enriched or acting with reckless 17 disregard. 18 Now, the notice of charges only alleged 19 that UFG was unjustly enriched. Mr. Guido's told 20 you that the respondents were unjustly enriched by 21 the compensation they received. That's, however, 22 the subject of a separate 13th claim for relief 182 1 which is the compensation claim; and it appears 2 that Mr. Guido's having that claim serve double 3 duty with this unjust enrichment claim in 4 connection with the UFG net-worth maintenance 5 agreement. 6 Now, whether or not OTS can recover 7 from the respondents, on an unjust enrichment 8 theory, a benefit provided to the respondents by 9 UFG, not USAT, is a question of law that Your 10 Honor will have to decide at some later point. 11 But before they can recover any amount 12 of money or take any relief, they have to show 13 that the individual respondents did something 14 wrong and that what they did wrong, if they did 15 anything wrong, had some effect on the amount of 16 money that OTS eventually recovered from UFG on 17 the net-worth maintenance claim. 18 Now, in its prehearing statement, OTS 19 said very little about what the facts would show. 20 Mr. Guido -- in fact, they said nothing about what 21 the facts would show in their opening statement. 22 Mr. Guido said a little bit more. 183 1 Let me just spend a couple minutes, 2 Your Honor, outlining for you what the evidence 3 will be on the issue. In 1982, before any of the, 4 individual respondents were on the board of USAT 5 or UFG, USAT agreed to merge with Houston First 6 American. That transaction closed in April 1983. 7 As a condition of the merger, UFG was required to 8 stipulate, because the net worth of USAT, to meet 9 applicable regulatory standards and, if necessary, 10 infuse capital to do that. That stipulation 11 wasn't done by Mr. Gross who wasn't even -- had no 12 involvement of USAT -- with USAT at the time or 13 UFG. It wasn't done by Gerald Williams. It was 14 done by Sonny Bentley. 15 Now, the evidence will show that USAT 16 met its net-worth capital requirements at least 17 through the middle of 1986. In connection with an 18 examination that started in May of 1986, Vivian 19 Carlton who was then the chief examiner concluded 20 that USAT had failed its regulatory capital 21 requirements. She told Neil Twomey, the 22 Dallas-based supervisory agent in charge of the 184 1 USAT file. 2 Neil Twomey agreed that USAT didn't 3 satisfy its regulatory net-worth requirements as 4 of June 30th, 1986. That conclusion by the 5 regulators was reached in October of 1987; but no 6 demand was made on UFG by the regulators to infuse 7 capital into USAT or to do anything, Your Honor. 8 Another examination, as Mr. Villa has 9 told you, started in November of 1987; and the 10 bank board examiner, again Vivian Carlton, again 11 concluded that USAT was not in compliance with 12 regulatory capital standards as of December 31st, 13 1987. 14 But this time, USAT came to the same 15 conclusion and expressly acknowledged in its 10K 16 filed on March 28th, 1988, that it had a net-worth 17 obligation. In that 10K, UFG also expressly 18 warned that it didn't have sufficient funds to 19 meet its net-worth obligation to USAT and that it 20 certainly couldn't meet its obligations to USAT 21 and, also, its obligations to other debt holders. 22 Still, Your Honor, no demand from the regulators. 185 1 Silence from the regulators with regard to the 2 net-worth obligation. 3 In fact, UFG didn't hear from the 4 regulators on the net-worth issue until May 13th 5 of 1988 as Mr. Guido mentioned. And while he told 6 you that there was a demand made on that day, he 7 didn't tell you what the demand was. It wasn't to 8 infuse capital immediately down into USAT. That's 9 not what Mr. Neil Twomey's letter of that date 10 said. It said, "Tell us what steps you're going 11 to take -- what steps are you going to take to try 12 and deal with USAT's net-worth deficiency?" 13 Now, given what the regulators knew 14 about UFG's financial condition, what they had 15 said in their -- in their 10K that had been filed 16 a few months before, why Mr. Twomey at this point 17 decided to send a letter some two years after the 18 first time that USAT's net-worth had been found 19 deficient is an issue that the respondents will 20 disburse some more at trial. But whatever reasons 21 motivated Twomey's letter of May 13th, the truth 22 is that even in May 1988, Your Honor, the 186 1 regulators had absolutely no expectation that UFG 2 would infuse any capital into USAT at that time. 3 In fact, the evidence will show that after the 4 May 13th, 1988 letter from supervisory agent 5 Twomey, the regulators specifically approved UFG's 6 proposal to use 23.8 million of its then available 7 $34 million not to pay down to USAT but to pay off 8 the so-called Penn Corp debt. Payment of the Penn 9 Corp debt was important to the regulators because 10 a default on that debt would have caused the 11 change in control of USAT. Upon default of Penn 12 Corp, debt holders could execute on 52 percent of 13 UFG's common stock. That, in turn, would have 14 resulted in UFG losing about a 140 million-dollar 15 net operating loss carry-forward tax deduction 16 which was a violation to any chance that USAT 17 could be recapitalized. 18 Now, Mr. Guido also said that the 19 respondents acted recklessly because they didn't 20 even acknowledge Mr. Twomey's letter. Again, not 21 true, Your Honor. The evidence will show that by 22 a letter dated June 3rd, 1988, Art Berner who was 187 1 then general counsel directly responded to Neil 2 Twomey's May 13th letter. Mr. Berner told Twomey 3 that UFG couldn't advise as to its plans until it 4 heard back from the regulators on the Bank Board 5 of Dallas' decision on whether or not to allow UFG 6 to pay down the Penn Corp debt. 7 The evidence will also be, Your Honor, 8 that in conversations with Mr. Berner during this 9 period, Neil Twomey acknowledged that UFG didn't 10 have the assets to put sufficient capital into 11 USAT, that Twomey understood that UFG couldn't 12 possibly comply with any demand that it infuse 13 capital into USAT without causing a bankruptcy. 14 Twomey said that at some later point, he would 15 make an official but pro forma demand on UFG under 16 the net-worth maintenance agreement. What Twomey 17 told Mr. Berner at that time, that it was time to 18 strike to pay off the Penn Corp debt. Again, the 19 regulators were concerned about preserving UFG's 20 ability to recapitalize USAT through the use of 21 the net operating loss -- net operating loss tax 22 deduction. 188 1 Now, the regulators approved the payoff 2 of the Penn Corp debt on June 24th, 1988. They 3 were silent for another five months. It was only 4 on December 8th that the official demand to infuse 5 money into USAT that Mr. Twomey had mentioned 6 months earlier was made. The demand was also a 7 pro forma one as, by then, USAT's net-worth 8 deficiency had risen to about $380 million. 9 By the way, Your Honor, by 10 December 8th, 1988, both respondent Gross and 11 respondent Hurwitz were no longer members of UFG's 12 board. Mr. Hurwitz resigned in February of 1988, 13 and Mr. Gross resigned in November of 1988. 14 With regard to Mr. Hurwitz at least, 15 even the May 13th letter can't catch him. He 16 couldn't have acted in reckless disregard of the 17 May 13th letter since he was no longer a member of 18 UFG's board. 19 The evidence will show, also, Your 20 Honor, that in the interim between May -- the 21 letter of May 13th and the December 8th letter, 22 the respondents didn't sit on their hands. They 189 1 were actively trying to salvage USAT. They were 2 in constant contact with the regulators to try and 3 work through issues involving the Southwest Plan. 4 Among other things, they found MAXXAM which was 5 willing to infuse substantial capital into USAT 6 under that Southwest Plan. It didn't happen; and 7 the receivership was imposed, as everyone knows, 8 on December 30th, 1988. 9 After that, the receiver and UFG began 10 the negotiation of a settlement of the net-worth 11 maintenance claim. That happened in 1995 as part 12 of the UFG bankruptcy in Delaware. OTS and the 13 FDIC, the receiver, settled for $9.45 million. 14 The evidence will show, Your Honor, that the 15 amounts received by OTS in that settlement are 16 likely more than they could ever have received 17 from USAT in 1988 because, after all, it was only 18 in 1990 that Congress gave a priority in 19 bankruptcy to net-worth maintenance claims. 20 Prior to that, in 1988, the regulators, 21 whether it was FDIC or OTS, would have had to 22 share what was left of USAT's assets after USAT's 190 1 secured creditors took the first chunk. 2 Your Honor, we'll have to judge 3 whether, under these facts, OTS is entitled to any 4 relief on its net-worth maintenance claim against 5 UFG. 6 Last point, Your Honor, civil money 7 penalties against Jenard Gross. OTS seeks 8 $199,800. Mr. Guido mentioned not one word in his 9 opening remarks as to what the evidence would be 10 with regard to the acting in concert or the 11 alleged acting in concert between Mr. Gross and 12 Mr. Hurwitz with regard to Mr. Gross' purchase of 13 105 shares of UFG stock in 1985. 14 As Your Honor knows, this acting in 15 concert claim first came up in the context of 16 Weingarten Realty when OTS's claim at the time was 17 that Gross and Hurwitz were acting in concert 18 because they both served on the board of 19 Weingarten Realty. 20 Let me just talk quickly of what the 21 facts are in connection with that claim. It's 22 largely undisputed. Mr. Gross' stock purchase in 191 1 UFG all predated his service on Weingarten, on the 2 board of Weingarten Realty. Second, Mr. Gross and 3 Mr. Hurwitz were selected to the board of 4 Weingarten Realty to serve the interests of USAT 5 which had purchased the 35 percent interest in 6 Weingarten. And perhaps, most conclusively, Your 7 Honor, the regulation that OTS cited in its notice 8 of charges that created a rebuttable presumption 9 that joint service on the board of another company 10 constituted acting in concert was promulgated 11 after all of these events and specifically 12 exempted from the transaction from its operation, 13 transactions that occurred prior to its 14 announcement. We moved in our -- we moved on 15 this -- on these grounds in our Motion for Summary 16 Adjudication. 17 At that time, OTS came up with a new 18 theory; and that theory was that, well, it's no 19 longer Weingarten Realty. Now it was that 20 Mr. Gross purchased 105,000 shares of stock in 21 1985 to accommodate Mr. Hurwitz's effort to 22 increase control of UFG without officially 192 1 exceeding the 25 percent threshold. 2 Your Honor will have to judge whether 3 the evidence supports Enforcement's claim on this 4 new theory any more than it did on the Weingarten 5 Realty claim. 6 Let me just tell you very quickly what 7 the evidence will be. First, Mr. Gross had 8 previously purchased shares of UFG's stock on the 9 open market; and when an opportunity presented 10 itself to purchase an additional block of shares 11 at a market price but on favorable terms, UFG was 12 going to loan him the money to purchase the 13 shares. He took it. It was a good deal. 14 Mr. Gross will testify, Your Honor, that he 15 purchased the stock because he believed that USAT 16 would eventually be successful, that the market 17 price for the shares would go up, and that he 18 would make a profit. 19 The evidence will also be that 20 Mr. Gross was not singled out for this program. 21 It was offered to all of the senior managers of 22 UFG, and many of them took advantage of the 193 1 program. The thought was to provide these senior 2 executives with additional economic incentives so 3 they could work hard and make USAT succeed in 4 difficult economic times. It was to incentivize 5 them. It was to give them the type of economic 6 incentive that is very familiar and very 7 traditional in this business. 8 Mr. Gross was responsible, Your Honor, 9 for repayment of the note plus principal. Excuse 10 me. He was responsible for repayment of the note 11 plus interest. It's late, and I misspoke. 12 Those terms were fully disclosed in 13 UFG's public filings; and they were never, ever 14 questioned by the regulators before OTS brought 15 the claims in this case. 16 Now, Mr. Gross' obligation under the 17 note was eventually forgiven; but that was done in 18 context of a settlement of his claims under his 19 employment contract. And he gave up those claims 20 at a significant discount as part of that 21 settlement. 22 At the end of the day, Your Honor, 194 1 Mr. Gross will testify that there was no express 2 or implied agreement with Mr. Hurwitz or anyone 3 else that he would vote his shares or take any 4 other actions that would benefit MAXXAM. There 5 were no nods. There were no winks. There were no 6 smiles that things would be better for Mr. Gross 7 if he went along with MAXXAM and no warnings 8 expressed or implied that his job would be in 9 jeopardy if he didn't do what benefited MAXXAM. 10 In conclusion, Your Honor, when all is 11 said and done, the evidence will show that 12 Jenard Gross, like the other individual 13 respondents, along with the members of USAT's 14 senior management team who have been spared the 15 ordeal of being sued by their government, worked 16 hard and did what -- did the best they could in 17 extremely difficult times. 18 Most importantly to Mr. Gross, Your 19 Honor, the evidence will show that he did not try 20 and trick or fool the regulators. He's not that 21 kind of man. And there will be no evidence that 22 after a lifetime of honesty and probity in 195 1 personal and business dealings, Jenard suddenly 2 became a liar and cheat or tolerated that behavior 3 in others. 4 I'm confident like Mr. Villa, Your 5 Honor, that at the end of the case, you will 6 relieve Mr. Gross of the cloud on his honor caused 7 by the charges brought by OTS. You've been very 8 patient. I thank you for your attention. 9 THE COURT: Thank you. We have other 10 respondents' statements? 11 MR. NICKENS: Yes, Your Honor, we do. 12 THE COURT: All right. We'll adjourn 13 until 9:00 o'clock tomorrow morning. 14 MR. KEETON: Your Honor? 15 THE COURT: Excuse me. We'll be back 16 on the record. 17 MR. KEETON: Your Honor, I'm just 18 wondering. We have a witness for tomorrow 19 morning. If we can ask respondents how many 20 statements and how long they are likely to last, 21 we could have a witness here at the appropriate 22 time. 196 1 MR. NICKENS: I believe the witness is 2 Mr. Marlin. 3 MR. STEARNS: Yes. 4 MR. NICKENS: He will be available. 5 He's coming in tonight. Your Honor, we have three 6 more. I will address the issue of mortgage-backed 7 securities, and Mr. Eisenhart will address the 8 issue of the so-called Drexel connection as well 9 as the high-yield bond or junk bond portfolio. 10 And Mr. Keeton will discuss Mr. Hurwitz's role in 11 the institution. We estimate that that will take 12 approximately an hour. 13 THE COURT: All three of them? 14 MR. NICKENS: For the three of them. 15 THE COURT: All right. 16 MR. KEETON: It's going to take longer 17 than that, J.C. Be realistic. 18 MR. NICKENS: I know mine. I have 19 about 25 minutes. 20 MR. KEETON: Let's say about an hour 21 and a half, Your Honor. 22 MR. STEARNS: Your Honor, you said 197 1 convene at 9:00 a.m.; is that correct? 2 THE COURT: Yes. 3 MR. NICKENS: Mr. Marlin will be 4 available whatever time is needed tomorrow. 5 THE COURT: All right. We'll adjourn 6 at 9:00 o'clock. Thank you. 7 8 (Whereupon at 5:07 p.m. 9 the proceedings were recessed.) 10 11 12 13 14 15 16 17 18 19 20 21 22 198 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 22nd day of 17 September, 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 22 199 1 STATE OF TEXAS COUNTY OF HARRIS 2 REPORTER'S CERTIFICATION 3 TO THE TRIAL PROCEEDINGS 4 I, Erica Davis, 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 22nd day of 17 September, 1997. 18 _____________________________ ERICA DAVIS, CSR 19 Certified Shorthand Reporter In and for the State of Texas 20 Certification No. 6479 Expiration Date: 12-31-98 21 22