200 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 FOR 9-23-97 21 22 201 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 22 202 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 Jerry Langdon, Judge Shipe's Clerk 15 REPORTED BY: 16 Ms. Marcy Clark, CSR Ms. Erica Davis, CSR 17 18 19 20 21 22 203 1 P-R-O-C-E-E-D-I-N-G-S 2 (9:03 a.m.) 3 THE COURT: The hearing will come to 4 order. I believe we are prepared to continue with 5 the opening statements of the respondents. 6 MR. NICKENS: Yes, Your Honor. 7 THE COURT: You may proceed, 8 Mr. Nickens. 9 MR. NICKENS: Good morning, Your Honor. 10 For the record, I am J.C. Nickens; and for my 11 portion of these opening statements, on behalf of 12 the respondents, I have been asked to review 13 USAT's investments in mortgage-backed securities 14 which investments are the subjects of Claims 6 15 through 11 of the notice of charges. Your Honor, 16 as I listened to Mr. Guido yesterday, I was struck 17 by how much of the claims in the notice of charges 18 that the Enforcement has either apparently 19 abandoned altogether or substituted claims that 20 contradict those stated in the notice of charges. 21 It appears to us that in the course of 22 discovery, as we have managed to rebut the claims 204 1 of the notice of charges, the Enforcement has 2 taken our very claims and tried to put a twist on 3 them that would make them some violation for 4 presentation to Your Honor. And I will try to 5 illustrate in detail these specific points as we 6 go through them. 7 Mr. Guido yesterday expressed some 8 uncertainty over what was in dispute whereas the 9 notice of charges is quite specific that they 10 relate to USAT's use of risk-controlled arbitrage, 11 what was then popularly known as risk-controlled 12 arbitrage, and that USAT instituted three -- not 13 two -- risk-controlled arbitrage investment 14 programs using mortgage-backed securities. 15 In addition, Your Honor, USAT owned, 16 outside any risk-controlled arbitrage program, 17 substantial amounts of mortgage-backed securities 18 which fact becomes important because of the use or 19 misuse of certain documents in the case relating 20 to those securities owned outside of 21 risk-controlled arbitrage in connection with 22 Claim 4 those RCAs. 205 1 Let me very briefly address the concept 2 of risk-controlled arbitrage using mortgage-backed 3 securities. During the early to mid-Eighties, 4 various investment bankers developed these 5 products that they called RCA. The concept was to 6 develop a spread income by purchasing long-term 7 mortgage-backed securities assets by using 8 short-term borrowing, usually reverse repo 9 agreements which were secured by the MBS itself. 10 Typically, there is a spread between the -- of 11 several hundred basis points between the coupons 12 on the MBS and the rates charged by the repo 13 lenders. Hedging instruments such as swaps, caps, 14 collars, the details of which we needn't get into 15 at this point, are used to protect the arbitrage 16 against the interest rate risk of short-term rates 17 which is -- you're borrowing repricing upwards 18 while you have a fixed return as reflected by your 19 coupon on the MBS. Now, the cost of these hedges 20 reduces the spread; and in some cases, they reduce 21 the investor's opportunity that he would normally 22 have owning MBS from gaining from a reduction 206 1 in -- or from falling rates. This structure, as 2 broadly described, produced a small spread; but it 3 was quite -- or thought to be quite durable over a 4 wide range of interest rate fluctuations. The 5 RCA, therefore, depended upon leverage because the 6 spreads were small but durable. So, for example, 7 an investor could take a hundred thousand dollars, 8 to just use a number. He could, using leverage, 9 purchase a million dollars of MBS; and even though 10 his spread might be small, a hundred basis points, 11 the 10,000-dollar return on his 100,000-dollar 12 investment might be and was an acceptable return 13 given the low level of perceived risk. The RCA 14 investor -- and this is a key point as we get into 15 the facts -- was required to match the cash flows 16 because the cash flows from the MBS are uncertain 17 as to their timing. You will get your principal 18 back at par, but you don't know when. So, you 19 have to match those cash flows with the life of 20 the hedge. And to match cash flows, the tool used 21 in 1985 and which has continued in somewhat 22 different forms even till today was to match the 207 1 expected lives of the assets and the liabilities 2 which, because of the nature of the MBS, required 3 them to estimate prepayments. 4 We agree with Mr. Guido that estimating 5 prepayments is no easy task, though, in 1985, it 6 appeared far easier than it now is thought to be 7 today. That is based upon the experience of 1986. 8 In the early Eighties, economists had 9 been tracking prepayments for several decades; and 10 it was widely believed that a homeowner would have 11 no economic reason to prepay his mortgage unless 12 rates fell at least 200 basis points. That 13 assumption has been largely changed through 14 developments that have occurred since that time 15 and through the experience of 1986. 16 Now, Your Honor, by matching average 17 lives of the assets and the liabilities and making 18 adjustments to keep them matched as they changed 19 with changes in interest rates and prepayments, 20 the model predicted that the investor could 21 maintain a positive spread for the life of the 22 investment which was typically five years or less 208 1 and, accordingly, investment bankers and the 2 supporting academic literature promised that the 3 spreads on the RCA would, as I have said, be 4 durable, although they would fluctuate over 5 interest rates movements of 200 basis points and 6 more. 7 Now, I'd like to pause just a moment to 8 discuss the role of market value. The focus of 9 risk-controlled arbitrage was the maintenance of a 10 positive spread; that is, cash flow. Market 11 values which are expected to go up and down on 12 both sides of your hedge are not relevant as long 13 as the hedges are adjusted and remain in place. 14 Now, as the hedges expire, the market values can 15 be quite significant; and I'm not saying that a 16 good manager ignored market values. But the 17 evidence in this case will be that the focus was 18 on maintaining that spread because at the end of 19 the day, everyone knew that the mortgage-backed 20 securities would prepay at par, whatever had been 21 the movements in the interim. And the way one 22 handled this market value fluctuation was the use 209 1 of something called matching durations to offset 2 the changes in market values. 3 Now, durations is a technical term; has 4 many meanings it has developed. But it measured 5 the sensitivity of the financial instruments to 6 price changes -- price changes sensitivity to 7 interest rate movements which, in the case of 8 mortgage-backed securities, are largely dependent 9 upon prepayments. 10 Now, theoretically, Your Honor, one 11 could match durations such that a rise in value on 12 one side of your hedge would exactly match the 13 loss in value on the other side of the hedge. But 14 it depended upon the ability to estimate in the 15 case of mortgage-backed securities prepayments. 16 Now, let me turn to USAT's assumptions 17 in the setting up of its risk-controlled arbitrage 18 program. USAT was well aware of the duration 19 matching prepayments and other theoretical 20 underpinnings of RCAs. Before deciding to invest, 21 USAT's manager had had formal presentations from 22 at least three leading investment bankers: 210 1 Solomon Brothers, Morgan Stanley, and First 2 Boston. Respondents will introduce the evidence 3 of these presentations in order that you will be 4 able to see the conventional wisdom that existed 5 at that time and upon which they acted that 6 underlaid their investment of RCA. 7 It is not unimportant that the 8 regulators encouraged these investments. MBS was, 9 by itself, far less risky than making a 10 single-family home using deposits. And hedged MBS 11 followed the regulators' recommendations that 12 thrifts reduce their gap exposure between the 13 repricing intervals of their long-term assets and 14 the short-term obligations. 15 Now, as USAT began its first RCA and 16 before the second, USAT informed the Federal Home 17 Loan Bank of its use of RCA and informed them that 18 it had helped them reduce their gap exposure; and 19 it did. I believe that will be undisputed as the 20 facts unfold. They summarized in detail the 21 results of their studies and those of the 22 investment bankers in supporting this proposed 211 1 investment. It also, the evidence will show, 2 reported the RCA investments in its published 3 financial statements even reporting the 4 fluctuating market values of those investments. 5 Now, yesterday, an issue was made about who was 6 assigned to handle the initial RCA, Mr. Joe 7 Phillips. And as I heard Mr. Guido's comments, it 8 was to the effect that Mr. Phillips didn't know 9 what he was doing; he was improperly trained for 10 this job. Mr. Phillips, the evidence will show, 11 was an experienced fixed income portfolio manager 12 with a degree -- with an MBA degree. Contrary to 13 what you heard yesterday, Phillips did not merely 14 rely on promotional materials. He studied the 15 issue, and he had eight years of experience before 16 coming to USAT on the investment committee of a 17 large insurance company that owned MBS. He had 18 never managed an RCA, but it wasn't that he didn't 19 know mortgage-backed securities or that he was 20 some investment neophyte. Indeed, in a document 21 that was -- that you will see -- and it's a report 22 from Neil Twomey and Ginger Baugh to Roy Green, 212 1 principal supervisory agent, May 23, 1986, on the 2 specific issue of Mr. Phillips' qualifications. 3 Now, this is after the rolldown or 4 toward the end of the rolldown; and the examiners 5 are commenting as follows: "Managers directly 6 responsible for their real estate and investment 7 departments" -- now, that's Mr. Phillips, the 8 investment departments -- "are said to have strong 9 experience in their respective fields." This was 10 the conclusion of the examiners at the time with 11 regard to Mr. Phillips. 12 Now, Joe's portfolio, Your Honor, was 13 not begun in 1984. It was begun in the early 14 parts into the mid-parts of 1985. The MBS that 15 USAT opened at the beginning of that year was 16 outside and remained outside of any RCA as I 17 indicated at the beginning. The cash flows from 18 Joe's portfolios of approximately -- which was 19 approximately $490 million in MBAs, $455 million 20 notional amount with swaps was, quote, "fully 21 hedged against rising rates" meaning that payments 22 from the swaps offset any reduced spread between 213 1 the MBS coupons and the reverse repo rates as 2 interest rates generally rose. The durations 3 which have price sensitivities to changing 4 interest rates were as precisely matched as one 5 could do at the time. The portfolio was also 6 projected to be protected against falling rates 7 which, frankly, were of much less concern. 8 The history at the time, again we will 9 show, was that rates had fallen from very 10 dramatically high rates that had existed in the 11 last years of the Carter Administration and were 12 at levels where most economists were expecting a 13 rebound back to higher rates. 14 Moreover, as I indicated earlier, the 15 conventional wisdom was that rates had to fall 200 16 basis points before one would begin to experience 17 any significant prepayments because of the lack of 18 economic reasons for the homeowner to repay or 19 prepay his mortgage. 20 The structure of Joe's portfolio, Your 21 Honor, the evidence will show, was the same as the 22 one discussed in the article entitled, "The ABCs 214 1 of RCAs" published by the Federal Home Loan Bank 2 of Dallas touting these types of investments and 3 explaining them. The structure is very much the 4 same which is, in itself, a remarkable fact 5 because this document was published in the spring 6 of 1987, over a year and a half after USAT had 7 instituted its first RCA. 8 The evidence will show that Joe's 9 portfolio performed as predicted in 1985. It 10 produced a steady positive return that offset 11 USAT's operating losses from its loan portfolios 12 and from its amortization of goodwill. 13 Now, it was based upon this favorable 14 experience that at the end of 1985, USAT 15 instituted a second RCA, much like Joe's 16 portfolio; and it was called United Mortgage 17 Finance. It was set up through a subsidiary 18 because USAT itself was approaching its liability 19 growth limitations. Now, when new regulations 20 were published at the end of 1985, they came out 21 in a form that was different than USAT had 22 expected; and they disqualified the use of United 215 1 Mortgage Finance as a finance subsidiary because 2 of a technical issue involving grandfathering when 3 the reverse repos repriced. As a result, at the 4 end -- United Mortgage Finance had a very short 5 life, and it was prior to year end 1985. In order 6 to avoid the problems associated with the 7 liability growth limitations, USAT unwound most of 8 the portfolio and essentially incorporated it, the 9 remaining assets and liabilities, to the extent it 10 could, into Joe's portfolio which may be the 11 reason that Mr. Guido referred to it as two 12 portfolios, because after 1985 and the unwinding 13 of USAT Mortgage Finance, it was, in fact, two 14 portfolios. 15 Now, let me -- let me talk for a minute 16 or two about the rolldown. During the latter part 17 of 1985, the interest rates which had fluctuated 18 up and down during most of 1985 began to show a 19 decline; and prepayments increased such that in 20 the early part of 1986, Joe's portfolio, augmented 21 with the remnants of United Mortgage Finance, 22 began to experience a growing mismatch of the 216 1 portfolios' expected lives and its durations with 2 its swaps. Phillips, the evidence will show, took 3 corrective actions which was what he was supposed 4 to do by selling the higher coupon MBS and buying 5 substitute lower coupon MBS that had longer 6 average lives and durations that matched the 7 swaps. USAT's management, notably Mr. Gross, 8 questioned the economics of this strategy; and 9 there are several Jenard-o-grams cited by 10 Enforcement where he questions what -- "Is this 11 the proper thing to do?" But he, like the others, 12 became convinced after the matter was explained to 13 him that it was the only viable strategy to 14 counter the duration mismatch. 15 Enforcement cites the memos in which 16 Mr. Gross poses the question, but they fail to 17 note the unequivocal testimony from him and others 18 that he was supplied with satisfactory answers. 19 Now, unfortunately, interest rates 20 continued their decline during 1986; and 21 prepayments reached historically unprecedented 22 levels. USAT could not roll down fast enough to 217 1 maintain the duration match. From the beginning 2 of 1985 -- 1986, Your Honor, through June of 1986, 3 rates declined approximately 300 basis points. 4 But more significantly, during the last months of 5 that period -- and this is not mentioned by 6 Enforcement -- prepayments on some bonds reached 7 constant prepayment rates of 60 to 65. Now, let 8 me repeat that figure: 60 to 65. The prior 9 average, 15-year prior average for CPRs on MBS had 10 been 7 to 7 and a quarter. It got to be 60 when 11 it had had a 15-year average of 7. The 12 theoretical bases for RCAs assumed CPRs at that 13 time in the 6 to 8 range. A 60 percent CPR meant 14 that 60 percent of the mortgages under that 15 mortgage-backed security would prepay in one year 16 if that rate persisted. It was eight to nine 17 times, eight to nine times the historical average 18 for the past 15 years. USAT, like all or 19 virtually all MBS investors, failed to predict 20 these prepayment rates; and, as noted, the 21 prepayment models, whatever their differences, all 22 depended upon the historical rates. It is not 218 1 true that Mr. Phillips did not begin the rolldown 2 until rates had fallen 225 basis points. I think 3 Mr. Guido is apparently measuring rates during an 4 earlier and different time period. 5 During the six-month period in the 6 first half of 1986, Phillips rolled down with rate 7 changes of 50 to 100 basis points as his durations 8 changed; and all of that can be demonstrated with 9 the historical analysis that has been done by our 10 expert. 11 Now, let us note at this point that 12 rates in 1985 which is the period, I believe, 13 Mr. Guido must be referring to, did not free fall. 14 They went up and down, sawtooth kind of pattern. 15 The manager in the midst of these movements has to 16 make a judgment about whether they are permanent 17 or whether they are temporary. Mr. Phillips in 18 hindsight was overly cautious, but that is hardly 19 a basis, Your Honor, for a safety and soundness 20 claim against him -- and he's not charged -- but 21 certainly against directors of the parent 22 organization like Mr. Hurwitz or others like 219 1 Mr. Heubsch or Berner who were neither managers of 2 the MBS or directors. Munitz was an academic. 3 Crow was an accountant. And Gross, a real estate 4 developer, was to his credit demanding to know if 5 the strategy was correct. But most significantly, 6 the claim that Phillips was too slow to roll 7 down -- that's the one Mr. Guido told us about 8 yesterday -- is a complete total about-face from 9 paragraph 148 of the notice of charges where -- 10 and I quote -- Enforcement states, "USAT's 11 rolldown strategy made no economic sense even to 12 the portfolio managers and was done to create a 13 false impression of USAT's compliance with 14 regulatory net-worth requirements." 15 Now, that was the allegation that we 16 came in to rebut based upon the notice of charges 17 yesterday. And now, they say that the rolldown 18 was -- should have been done quicker and more 19 decisively. 20 Now, was the rolldown so obviously 21 correct that Phillips should have executed it 22 sooner and more decisively; or was it so obviously 220 1 wrong that it made no economic sense such that it 2 should have been known to the directors of this 3 institution? This is a question that Enforcement, 4 after 11 years of study, has failed to provide a 5 consistent answer. 6 Now, as a result of the rolldown, USAT 7 had large gains from the sale of its higher coupon 8 MBS. And for accounting purposes, based upon the 9 advice of its independent accountants, 10 Peat Marwick, and consistent with the arbitrage 11 concept of the investment, USAT reduced its basis 12 in the substitute MBS by the amount of the gains. 13 That is -- that had the effect of deferring the 14 recognition of gains as income. Several months 15 later, the auditors changed their minds and forced 16 USAT to recognize the gains because they believed 17 that the substitute collateral, substitute assets 18 being of a different coupon, were required to be 19 recognized even though they were substituted under 20 the accounting rules. And that required UFG to 21 restate its earnings for the first two quarters of 22 1986. 221 1 Now, much, Your Honor, of the notice of 2 charges is devoted to the claim that the RCA was 3 used to produce phantom claims. This was not 4 mentioned yesterday and is apparently abandoned 5 based upon the undisputed fact that USAT's 6 management, given an opportunity to recognize 7 gains, tried to avoid doing so in the midst of 8 charges. They didn't want to do so. They were 9 trying to maintain the arbitrage and following the 10 advice of their accountants. If they had been 11 intending to recognize gains for the use of this 12 particular instrument, surely we wouldn't have a 13 record that demonstrates their effort to avoid 14 that. As a result, Your Honor, of the rolldown 15 experience, USAT consulted again with several 16 experts relating to MBS as to how to manage the 17 portfolio after the rolldown. One option was to 18 reinvest the gains in another RCA. 19 And after considering these options 20 available to them, USAT decided to recruit a new 21 manager whose specialty was only MBS. And after 22 an extended search, USAT hired Sandy Lawrenson for 222 1 this job. Lawrenson, the evidence will show, was 2 an MIT Ph.D. who had worked as Freddie Mac's hedge 3 trader and had trained with Lou Ranieri, touted as 4 the father of the trillion-dollar mortgage-backed 5 securities market, at Solomon Brothers. No one 6 could have been more highly trained or qualified 7 for this job. From October of '86 to early 1988, 8 Lawrenson managed the remainder of Joe's portfolio 9 and set up another RCA that will be described in 10 these proceedings as United MBS. The new RCA, 11 Your Honor, the evidence will show, had nothing to 12 do as stated by Mr. Guido yesterday with USAT's 13 thrift test. It had assets that would qualify it 14 as a thrift. United MBS was structured to protect 15 against rapid prepayments as well as increasing 16 rates. In other words, they weren't going to make 17 the same mistake that they had made in Joe's 18 portfolio of protecting -- if it was a mistake -- 19 of protecting against rising rates too heavily. 20 Now, Mr. Guido -- Mr. Phillips' 21 enforcement -- well, as to this United MBS, 22 Mr. Guido said yesterday that she went naked. 223 1 Mr. Phillips', Enforcement claims, was overdressed 2 and Ms. Lawrenson underdressed even though the 3 evidence will be undisputed that she maintained 4 positive cash flows -- that is the object of the 5 RCA -- in the United MBS portfolio during all of 6 her tenure at USAT despite a large and unfavorable 7 interest rate spike in March of 1987. When USAT 8 was declared insolvent, both of the remaining RCAs 9 were liquidated producing substantial market value 10 losses which is not unexpected if you interrupt 11 the strategy in midstream. 12 Your Honor, that in a nutshell is the 13 story of USAT's MBS portfolio. Let me turn for a 14 second to the claims. In the notice of charges, 15 Enforcement claims that the RCAs were inherently 16 speculative. This is simply untrue. And there 17 was no suggestion of it either that I heard 18 yesterday or as I reread the transcript last 19 night. The facts are that RCAs were correctly 20 perceived as a less risky alternative to the 21 traditional thrift business of making mortgage 22 loans with deposits. If Enforcement is still 224 1 making this claim, you will hear from 2 Frank Fabozzi. Mr. Fabozzi is the most widely 3 published expert perhaps in the world on fixed 4 income securities and mortgage-backed securities. 5 And Mr. Fabozzi will testify that RCA was less 6 risky and less speculative than any other 7 investment -- reasonable investment alternatives 8 available to USAT. Moreover, Your Honor, you will 9 hear from Andrew Carron, again one of the 10 country's leading analysts of MBS portfolios and, 11 I will add, an expert on the thrift industry, one 12 of the early prognosticators of its problems in 13 the early Eighties. He will testify that the 14 structure of Joe's portfolio was, if anything, too 15 conservative; that is, too heavily weighted to 16 protect against rising rates. And it was fully 17 hedged against those rates which hedging is the 18 very fact, Your Honor, that made it vulnerable to 19 rapid prepayments. Mr. Carron will tell you that 20 the statistical probability of what happened with 21 rates in the first half of 1986 was less than 22 4 percent, a 4 percent probability. 225 1 And what happened to prepayments in 2 response to that 4 percent probability was 3 unfathomable. It was inconceivable in the early 4 part of 1986 that CPRs would reach 60. Carron 5 will demonstrate that the prepayments associated 6 with this 4 percent probability were historically 7 unprecedented; and Wall Street professionals took 8 a figurative bath, clothed or unclothed, even 9 though the measures they took in response to these 10 conditions were essentially the same as those 11 taken by USAT. Enforcement's claim about the 12 nature of RCA generally and the structure of 13 USAT's portfolio specifically is contrary to the 14 official positions of the Federal Home Loan Bank 15 who published articles favorable, as I indicated, 16 to the RCA as an alternative to the traditional 17 thrift practices. You will see at least half a 18 dozen such articles. Their position is contrary 19 to the reports of the examiners and the 20 independent auditors who carefully monitored 21 USAT's RCAs to determine that they were proper 22 hedges and who concluded that, although RCA had 226 1 its risk, it was not speculative; the very claim 2 that we see in the notice of charges. 3 Enforcement's second claim was that 4 USAT speculatively managed its RCAs in order, as I 5 mentioned earlier, to realize phantom gains. 6 This, too, is contrary to the facts. It will be 7 undisputed, as I mentioned, that USAT tried to 8 avoid recognizing gains from the rolldown sales 9 but the accounting treatment was forced upon them 10 by their outside auditors. 11 The evidence both from their own 12 contemporaneous publications and examination 13 reports as well as Mr. Carron will be that trading 14 activity is a necessary part of properly managing 15 the RCA and that the activity in USAT's accounts 16 were not unusual and appears, even after all of 17 these years of study and second guessing, to have 18 had an economic purpose consistent with proper 19 management of the RCA. 20 Yesterday, this claim in the notice of 21 charges was transformed into one that USAT failed 22 to minimize risk in violation of some unspecified 227 1 regulations, failed to minimize risk through the 2 RCA when it has admitted that it was less risky 3 than the traditional business of the thrift. 4 Enforcement's third claim, third and 5 final claim with regard to the RCAs, was that USAT 6 misled the regulators by telling them that Joe's 7 portfolio of matching credit regulations 8 encouraged USAT to use the ARMs and caps to reduce 9 regulatory capital requirements. The regulation 10 did not allow the credit to be taken or used for 11 assets or hedges held in a subsidiary even if the 12 institution used consolidated financial reporting 13 as did USAT. In other words, from a management 14 point of view, they regarded the institution as a 15 whole. Accordingly, USAT, with the full knowledge 16 of the examiners, transferred the ARMs; and it 17 reassigned internally the caps from United MBS to 18 USAT. And it is undisputed that that was to take 19 advantage of this regulation that had been 20 instituted by the authorities to encourage them to 21 own these kinds of instruments. In mid-1987, 22 Bruce Williams, the controller/treasurer, wrote a 228 1 memorandum that did not distinguish between the 2 transfer of ARMs and the cap reassignment. And 3 USAT claimed maturity matching credit for the 4 transfers on its September 30th thrift financial 5 report six months after the purchase of the caps. 6 In his memo -- and we have it here -- it's 7 June 17th, 1987, Williams to Mr. Gross and 8 Mr. Crow. In his memo, Williams reminded 9 management that because of the maturity matching 10 credit, USAT would appear to have improved its 11 capital position; but as an economic fact, nothing 12 had changed. It was still reported on a 13 consolidated basis. But the new regs allowed less 14 regulatory capital. Ten years later and despite 15 knowing that the caps were not, in fact, 16 transferred, Enforcement claims that the transfers 17 were sham transactions. They used Williams' memo 18 to claim that USAT management knew that the 19 transfers were a, quote, "sham." 20 Now, if I heard correctly, Mr. Guido 21 yesterday disavowed the reference to sham 22 transactions admitting that it was his 229 1 interpretation of the memo and what it said in the 2 memo. There was no sham. USAT was merely 3 following the incentives that the regulations set 4 out for them. 5 Now, yesterday, Mr. Guido proclaimed 6 the newly-coined smoke and mirrors theme to these 7 claims. Now, it's unfortunate for the rhetorical 8 flourish -- and maybe there is some document out 9 there that I'm either unaware of or have 10 forgotten. But there is no mention of smoke in 11 this memo. I have it here in my hand, and you can 12 see it. And everybody will have a chance to read 13 it. It is clear -- there is a reference to 14 mirrors, and it is clear that the reference to 15 mirrors is a comment on the regulations which 16 allowed USAT to improve its capital position with 17 no change in its economics. This memo does not 18 reflect poor management. It is good management to 19 remind one's self that the Alice in Wonderland of 20 regulatory net worth in the mid-Eighties should be 21 soberly viewed as an economic matter. Williams 22 was merely following Mr. Gross' admonition that 230 1 management had to come clean with itself and to 2 know the true effects of these regulatory gifts. 3 Now, finally with regard to the last 4 claim involving mortgage-backed securities which 5 has to do with alleged guarantees, in Claims 8 6 through 11, Enforcement makes a series of claims 7 based upon a factual assertion that these three 8 letters again that I have here constitute 9 guarantees of all of United MBS's debt. These are 10 the letters. They are one-liners. The word 11 "guarantee" doesn't appear anywhere on either the 12 letter, the face, or anything else. The three 13 letters merely promise that USAT -- and these are 14 to the repo lenders. And, in fact, I believe the 15 evidence will show that two of these repo lenders 16 never made any loans to USAT. United MBS's -- 17 they were not and are not guarantees by any 18 recognized legal definition of that term. 19 Yesterday, Mr. Guido endorsed this 20 claim with a somewhat remarkable statement that 21 the guarantees -- and I quote -- "probably even 22 meet the requirements of the applicable law" which 231 1 is Texas law. "Probably even meet." This is the 2 basis for this claim? He asserts, as has 3 Enforcement in the notice of charges, that the 4 guarantees -- that the letters are guarantees, 5 quote, "for purposes of our regulations." 6 Now, when we get back to look at his 7 expert's testimony on this matter, we'll see that 8 he said that the letters were guarantees based 9 upon his own personal definition and without 10 reference to any known legal standards or 11 regulations. 12 Now, I suggest, Your Honor, that these 13 are not guarantees and that that testimony would 14 not support any finding that they were guarantees. 15 Now, it's based upon this factual assertion that 16 OTS claims that USAT violated its liability growth 17 limitations and direct investment limitations. 18 The evidence will be that these letters were not 19 guarantees; therefore, there is no violation of 20 any regulations. But in addition, the evidence 21 will be that the investments involved were 22 mortgage-backed securities, investments which the 232 1 direct investment limitation did not purport to 2 limit in any way. Accordingly, USAT consolidated 3 United MBS's assets for direct investment purposes 4 as the records will clearly demonstrate even -- in 5 other words, Your Honor, even if the letters could 6 somehow be construed as guarantees, they would not 7 have caused a violation of USAT's direct 8 investment limitation. 9 Now, the story of USAT's MBS 10 investments, it can be daunting because of 11 unfamiliar technical language; and you probably 12 have more experience with this than anybody in the 13 room. But when the facts are fully known, they 14 will squarely contradict the Enforcement's claims 15 either as stated in the notice of charges or as I 16 would suggest to Your Honor as reinvented in the 17 opening statement yesterday. The RCA investments 18 were not speculative. They reduced USAT's risk 19 profile. They were less risky than all known 20 alternatives. USAT did not use the RCA to 21 speculate on interest rates. There were no sham 22 transactions. There were no regulatory violations 233 1 of any significance in the use of these 2 investments. The transactions were disclosed to 3 the regulators and to the examiners. The RCAs, 4 remarkably the evidence will show, despite very 5 unexpected and adverse conditions, actually 6 contributed positively as designed to USAT's 7 bottom line as measured by the accounting rules. 8 Now, there will be a lot of criticism 9 of that; but those were the rules that governed 10 USAT's activities. Those were the rules on which 11 they were required to report. And by those rules, 12 during the time that these RCAs were managed by 13 these people and by Mr. Phillips and by 14 Ms. Lawrenson, they contributed to the bottom 15 line. 16 Now, we're not happy to be here; but 17 respondents do welcome the opportunity to present 18 their evidence and all of the evidence that will 19 right the wrong that has been done to them by the 20 bringing and continued prosecution of these 21 claims. 22 I appreciate your time, Your Honor. 234 1 THE COURT: Thank you. Mr. Eisenhart? 2 MR. EISENHART: Thank you, Judge Shipe. 3 If it please the Court, my name is Frank 4 Eisenhart; and with my colleagues from Dechert, 5 Price & Rhoads and my friend, Mr. Nickens, I 6 represent MAXXAM, Inc. I'm going to address four 7 issues hopefully repeating to a minimum, if at 8 all, areas that my colleagues have already 9 covered. I want to talk about the MCO Federated 10 investment in United Saving Association of Texas 11 or USAT as I will probably call it. I want to 12 talk about the net-worth maintenance claim against 13 MAXXAM and Federated. I want to talk about OTS's 14 high-yield bond claim or, as they like to call it, 15 their junk bond claim. And I want to talk 16 generally about the issue of restitution as it 17 pertains in these proceedings. 18 Let me make just one observation, 19 though, at the outset. Representing MAXXAM, I 20 don't have a client that I can have stand up to 21 introduce to Your Honor. But this is a terribly 22 important moment in history for MAXXAM; and I 235 1 think it's important to observe at this point 2 that, like any company, MAXXAM really is composed 3 of its people. And you can't bring all of those 4 people into the courtroom; but when we talk about 5 MAXXAM, we're talking about hundreds of people, 6 hundreds of employees here in Houston, literally 7 thousands of employees around the world. Just to 8 give you one brief example of the kinds of things 9 MAXXAM does, one of the company's operations 10 through its Kaiser Aluminum Facility is in the 11 Republic of Ghana. It's one of the largest 12 employers in that country. It's one of the 13 largest contributors of foreign exchange to that 14 country. Significant amounts of its profits are 15 placed in a trust administered by the Ghananians 16 and used for development purposes in that country. 17 Why do I mention this? I'm not asking Your Honor 18 to decide this case on the basis of sympathy or on 19 some index of MAXXAM's corporate social conscious. 20 I mention it only because the amounts that the 21 government is trying to claim from MAXXAM in this 22 case are frankly enormous. While MAXXAM's a large 236 1 company today, its resources are not unlimited. 2 And the decision which Your Honor is going to make 3 in this case is literally going to affect the 4 futures, the lives, and the fortunes of a great 5 many people around the world. It's a weighty 6 responsibility, and it's one that I know Your 7 Honor takes very seriously. 8 Let me move to the subject of the 9 investment made by MCO and Federated in USAT. As 10 I said, MAXXAM is a corporation located here in 11 Houston. It was formerly known as MCO Holdings, 12 Inc. And, frankly, during the course of this 13 case, I think the terms MCO and MAXXAM are likely 14 to be used interchangeably by the lawyers on both 15 sides; but they are essentially the same company. 16 It's a publicly held corporation. Its shares are 17 traded on the American Stock Exchange; and it's 18 involved in diverse businesses including real 19 estate, forest products, and aluminum. Charles 20 Hurwitz, to whom you've heard reference already, 21 is the president, CEO, and the chairman of MAXXAM. 22 In the 1980s, MAXXAM, which was then known as MCO 237 1 Holdings, considered getting in the savings and 2 loan business. In conjunction with Federated 3 Development Company which is a business trust 4 owned by Mr. Hurwitz and others, it began to 5 acquire shares of United Financial Group which is 6 the holding company of USAT. This was an 7 investment that made a lot of sense. Mr. Hurwitz 8 and his colleagues, as you will hear, as you've 9 already heard in the opening arguments, they were 10 new to the field of finance. They knew the field 11 of real estate. And after all, those are the core 12 businesses of any savings and loan. They also 13 knew Houston. This was their home. 14 You know, OTS has tried to make 15 Mr. Hurwitz and his colleagues out to be evil 16 people who were trying to loot a savings and loan 17 for their own greedy purposes. I assure you 18 nothing could be further from the truth. MCO and 19 Federated invested substantial sums of money in 20 USAT, and they were willing to invest even more if 21 they could do it on some rational basis. They 22 were not willing to write a blank check; but they 238 1 were willing to invest substantially in their 2 money, their energy, and their talents if it could 3 be done on a rational basis. They didn't invest 4 in USAT to see this institution fail. This was a 5 considered investment by knowledgeable businessmen 6 in a major financial institution in their home 7 city. I suggest to Your Honor that that is not a 8 scenario under which anyone invests for failure. 9 They wanted it to succeed, not fail. And the fact 10 that it ultimately did fail was not going to be 11 because this institution was either looted or 12 mismanaged. 13 As you've heard already, running a 14 savings and loan in Houston or, indeed, anywhere 15 in Texas in the late 1980s was no picnic. There 16 was an observation made by Richard Pratt who is 17 the former chairman of the Federal Home Loan Bank 18 Board who is going to be one of the experts that 19 will testify in this case for the respondents. 20 Mr. Pratt said in terms of running a financial 21 institution in Houston, USAT was in the worst 22 business in the worst city in the worst state at 239 1 the worst time. USAT certainly wasn't immune to 2 the economic woes that beset its peers here in 3 Texas, but it did outlast most of them. The 4 evidence is going to show that it survived for as 5 long as it did because of the strength and the 6 innovative skills of its managers. You know, the 7 USAT regulators knew this. They knew there was a 8 good management team. It sometimes made them a 9 little nervous because, I think in the views of 10 the regulators, these weren't traditional savings 11 and loan guys. The fact is that the regulators 12 knew that the institutions here that were being 13 run by the traditional savings and loan guys were 14 failing. 15 USAT, the regulators predicted -- and 16 Your Honor will see, as Mr. Villa mentioned, the 17 cash regulatory documents that talk about these 18 things. USAT, the regulators predicted, would be 19 a survivor; and they were predicting that even in 20 1988. USAT would survive, they thought, because 21 of the strength of its management team. 22 The evidence in this case is going to 240 1 show that that management team was strong, was 2 innovative. They were not trying to loot USAT. 3 They were trying to make a heroic effort to save 4 it under awful circumstances. And the fact that 5 they ultimately did not save it is no reflection 6 on them. 7 Let me turn to the net-worth 8 maintenance claim that's been asserted against 9 MAXXAM and Federated and others to give you a 10 little background of that claim. By mid-1983, MCO 11 and Federated together owned about 22.3 percent of 12 the voting stock of USAT's holding company which 13 is United Financial Group. On June 29th, 1983, 14 mid-1983, they submitted to the Federal Home Loan 15 Bank Board an application which is known as an 16 H(e)-1 application. The purpose of that 17 application was to allow them to acquire up to 18 35 percent of USAT's voting stock; so, they wanted 19 to go from -- I think they were then at about 24 20 something percent. They wanted to go up to 35. 21 Under the law, if you own more than 25 percent of 22 the voting common stock of the savings 241 1 institution, you're deemed to control the 2 institution; and you're required to register as a 3 savings and loan holding company. They knew that; 4 and, of course, if the application was approved, 5 and they actually went over the 25 percent 6 threshold, that would have been the effect of it. 7 The bank board approved the H(e)-1 application on 8 December 6th, 1984, roughly a year and a half 9 after it was submitted. The approval resolution 10 contained a condition which ultimately -- well, 11 which was unacceptable to MCO and Federated and 12 which we have now come to know in this case as the 13 so-called net-worth maintenance condition. It 14 said that so long as MCO and Federated controlled 15 USAT which means if and when you pass that magic 16 25 percent threshold, they would be obligated to 17 contribute a pro rata share of any additional 18 infusion of capital needed to maintain the 19 net-worth of USAT at regulatory levels. The pro 20 rata share would be based on their ownership of 21 stock; that is, if you own 35 percent of the 22 stock, presumably you would be liable for 242 1 35 percent of the infusion. It also said if they 2 should eventually come to own more than 50 percent 3 of the stock, they would be liable for 100 percent 4 of any necessary capital infusion. 5 Now, MCO and Federated indicated from 6 the beginning to the Bank Board that this kind of 7 a net-worth maintenance requirement was 8 unacceptable to them. This was something they 9 simply could not live with. They were willing to 10 make a substantial investment in USAT; and they 11 made that clear to the Bank Board, too. But they 12 were simply unwilling to take on this kind of 13 broad open-ended contingent liability. The 14 evidence that Your Honor will hear will show that 15 there was a very practical reason for this 16 unwillingness. The business activities of these 17 two companies were very capital intensive, and it 18 required them to have ready access to the capital 19 markets. The advice they were receiving from Wall 20 Street from prominent investment management -- 21 investment banking firms was that this kind of an 22 open-ended net-worth maintenance obligation which, 243 1 of course, they would have to disclose, would 2 significantly hamper their access to the capital 3 markets. With this kind of a contingent liability 4 on their books, no potential lender to MCO or 5 Federated or no potential investor in those 6 companies would be able to gauge the true 7 financial health condition of the company. You 8 see this kind of a contingent liability on the 9 books. How on earth can you know what that 10 company is going to look like six months or a year 11 from now if that liability gets triggered? 12 The advice they were getting from Wall 13 Street is: You cannot agree to this. They 14 concurred with that advice, and they so advised 15 the Bank Board. They were willing to discuss and 16 did discuss over a three-year period with the Bank 17 Board alternatives to the net-worth maintenance 18 obligation. They talked about some form of 19 enhanced investment. They talked about some sort 20 of a cap on the obligation. But they never 21 wavered in the position that this broad open-ended 22 net-worth maintenance obligation was unacceptable. 244 1 There were a number of extensions for the closing 2 of the acquisition, extensions of the resolution 3 approving the acquisition. 4 Ultimately, after three years, they 5 simply arrived at loggerheads; and they advised 6 the Bank Board that they would not seek any more 7 extensions. And the resolution was -- the 8 approval resolution was allowed to expire on 9 December 22, 1987. 10 Now, even though MCO and Federated 11 never agreed to the net-worth maintenance 12 obligation and really never closed the deal that 13 was contemplated under the H(e)-1 application, OTS 14 contends that the net-worth maintenance obligation 15 was, nevertheless, triggered. And they say it was 16 triggered because MCO and Federated really did own 17 more than 25 percent of UFG stock. 18 They have advanced two theories in the 19 complaint to get them over that threshold. The 20 first one, which I'm not even sure they are 21 seriously pressing anymore, was that Mr. Gross 22 owned 112,000 shares of UFG stock. And they say 245 1 Mr. Gross was acting in concert with MCO and 2 Federated to get control and that, therefore, you 3 have to count his 112,000 shares as well. I think 4 the evidence is going to show, Your Honor, that 5 Mr. Gross acquired his 112,000 shares for 6 investment purposes and that in no fashion was he 7 acting in concert with MCO or Federated. I also 8 think that the regulations -- you will find that 9 the regulations they rely on to make this argument 10 really are not applicable, and they are trying to 11 apply retroactively a regulation that didn't exist 12 at the time the transaction took place. But as I 13 say, I'm not even sure they are pushing that 14 theory anymore. 15 The one that they do seem to still be 16 pushing, though, is their second theory that MCO 17 should be deemed to own 300,000 shares of UFG 18 stock that was actually owned by Drexel, Burnham, 19 Lambert but on which -- on which Drexel had given 20 MCO a purchase option; and this has come to be 21 known in the case as "the Drexel option." I guess 22 this is the term we now put in quotes because it 246 1 has certainly become a term of art in this case. 2 What's the evidence on the Drexel 3 option? The evidence is going to show that in 4 December 1985, Drexel and MCO entered into an 5 option agreement. Drexel gave MCO an option to 6 buy 300,000 shares of USAT's stock owned by Drexel 7 at a fixed price. The option was exercisable 8 during a 30-day period two and a half years down 9 the road; so, the option agreement was entered 10 into in December 1985. The option to MCO to 11 purchase this stock was exercisable for 30 days 12 beginning July 1, 1988. And the option contained 13 several other conditions. There was a fee paid 14 for the option itself. There was then a price to 15 be paid upon exercise. There were also certain 16 representations and warranties in the option, one 17 of which was that if MCO exercised the purchase 18 option, it represented that it had regulatory 19 approval to acquire the shares and to become a 20 savings and loan holding company. That's 21 significant because its ability to obtain that 22 regulatory approval was conditioned upon the 247 1 net-worth maintenance agreement. 2 So, even under the terms of the option, 3 in order for MCO to exercise that, it either had 4 to agree to the net-worth maintenance condition, 5 which it was not going to do, or it had to resolve 6 its differences with the Bank Board and arrive at 7 some sort of substitute arrangement. 8 The option also provided that if MCO 9 did not exercise its option during that 30-day 10 period beginning July 1, 1988, Drexel then had an 11 option to put the shares to MCO at a fixed price 12 during the next 30-day period beginning August 1. 13 It also provided that MCO's option for 14 the purchase price of the shares was secured by a 15 letter of credit. You will hear testimony from 16 respondents and others that the Drexel option was 17 a prudent means by which MCO was assuring itself 18 that it could obtain additional shares of UFG 19 stock at a reasonable price in the future if and 20 when it worked out the net-worth maintenance issue 21 with the Bank Board and was, therefore, in a 22 position to increase its investment in UFG. 248 1 The respondents are emphatic, Your 2 Honor, that under no circumstances would they or 3 could they have ever exercised the Drexel option 4 and assumed ownership of these shares unless they 5 had the Bank Board's position which means, of 6 course, that they would have to have resolved the 7 net-worth maintenance issue. If this option had 8 not been extended, as it ultimately was, and had 9 Drexel attempted to put the shares to MCO as it 10 had the right to do, I think the testimony -- I 11 know the testimony will show that MCO certainly 12 would have refused to accept them. This might 13 have left Drexel with a claim for damages against 14 MCO. And as you think about it, the purchase 15 price for the shares was roughly around $2 and a 16 half million so that Drexel's claim would have 17 been somewhere between zero and 250 million -- or 18 2.5 million -- excuse me -- depending on the -- 19 depending on the price of the shares. But they 20 simply would have refused to accept the shares 21 which, of course, they couldn't do without -- 22 without going over the 25 percent and triggering 249 1 the net-worth maintenance obligation. 2 Now, having that kind of a liability as 3 a result of refusing to accept the shares, of 4 course, was not a perfect answer; but it was far 5 preferable in their view to have that sort of a 6 damage claim than to have this open-ended 7 contingent liability that would render them -- 8 would deny them access to the capital markets and 9 could ultimately cost them, as OTS is now 10 contending it does, hundreds of millions of 11 dollars. 12 Now, I was frankly astonished 13 yesterday, Your Honor, to hear Mr. Guido stand up 14 in this courtroom and claim that the Drexel option 15 was concealed from federal regulators. I was 16 truly astonished to hear that. I have to tell 17 Your Honor, if MCO really tried to conceal this 18 option from the federal regulators, it was the 19 most inept job of concealment that has ever 20 occurred. I had somebody last night run for me a 21 list of the documents. These are not MCO 22 documents. These are disclosures to the SEC, 250 1 disclosures to the Federal Home Loan Bank Board, 2 disclosures to the Federal Home Loan Bank of 3 Dallas, or internal documents within the Federal 4 Home Loan Bank of Dallas that refer to and 5 describe the Drexel option. I don't know how 6 complete this list was because it was done kind of 7 on the hurry last night, but I find no less than 8 19 separate documents between 1985 and 1989 that 9 disclose or discuss in some way the Drexel option. 10 And how Mr. Guido could stand up in this courtroom 11 and claim that there was an attempt to conceal the 12 Drexel option from the regulators is frankly 13 astonishing to me. 14 Now, the evidence is going to show that 15 under the terms of the Drexel option, of course, 16 there was no immediate right of MCO to obtain the 17 shares. It couldn't obtain the shares for two and 18 a half years. It will show that MCO had paid, in 19 terms of the fee to acquire the option, an amount 20 to Drexel that was well less than half the cost of 21 the option of shares; and it's going to show that, 22 contractually, Drexel retained the right to vote 251 1 the shares and the right to receive all dividends 2 under the shares. 3 So, I think that what the evidence is 4 going to show is that ownership of these 300,000 5 shares clearly remained with Drexel and never 6 resided in MCO. And I believe that OTS is not 7 going to be able to establish, either under the 8 facts or the law, that these 300,000 shares were 9 ever actually owned by MCO and that, therefore, 10 they ever provided any basis for triggering the 11 net-worth maintenance obligation. 12 Now, of course, as of yesterday, we now 13 have an issue in this case as well under the 14 so-called controlling influence portion of the 15 statute which I contended unsuccessfully yesterday 16 had not been pleaded. I don't know, quite 17 frankly, what OTS is going to claim was the 18 controlling influence by MCO or Federated in the 19 affairs of USAT. I don't think that they are 20 going to be able to show that kind of controlling 21 influence on behalf of either of these defendants, 22 but we're going to have to wait and see what their 252 1 evidence is going to be on that. 2 Let me speak for a moment to the 3 high-yield bond claim or, as Mr. Guido loves to 4 put it, the junk bond claim. OTS is claiming, if 5 I understand that theory -- and I'm not really 6 sure I do -- $47 million in restitution for 7 alleged losses by United Savings Association on 8 high-yield bonds. And the OTS theory again, if I 9 understand it, is that the purchase by USAT of 10 high-yield bonds that were underwritten by Drexel 11 Burnham Lambert somehow constitutes a transaction 12 with an affiliate. They say, as I understand it, 13 that Drexel was an affiliate either because it 14 owned stock in USAT's holding company, UFG, as 15 Drexel itself owned stock in UFG, or because it 16 was acting in concert with MCO to acquire stock in 17 UFG. They say that affiliate -- transactions with 18 an affiliate under a statute require approval by 19 the regulators, and they say OTS -- OTS says USAT 20 didn't get that approval. And from this, they 21 claim that they are able to seek restitution for 22 these transactions with affiliate losses. 253 1 Well, I doubt that OTS is really going 2 to be able to prove that Drexel was an affiliate 3 of USAT. I don't think they are going to be able 4 to show that it was acting in concert with MCO or 5 MCO or Federated to obtain control. And I don't 6 really think that they are going to be able to 7 show that it was an affiliate in any other way. 8 But even if they could, even putting that 9 difficulty aside, if there was an affiliated 10 transaction between Drexel and USAT, I frankly 11 don't understand how that implicates MAXXAM or 12 Federated. The parties to that transaction are 13 USAT and Drexel. If USAT failed to get advanced 14 approval of this transaction, it seems to me that 15 that's a problem for USAT or a problem for Drexel, 16 neither of which is a defendant here. 17 Beyond that, though, the -- I want to 18 talk for a second about the amount that OTS is 19 claiming, this so-called 47 million-dollar loss 20 which frankly is pure fiction. It gets to this 21 47 million-dollar number by having an expert -- 22 and I'm putting that in quotes for the time being 254 1 because I'm not sure she really even performs the 2 function a normal expert witness performs, 3 although I assume she's going to testify here. 4 But they have this expert make up a list of every 5 Drexel underwritten bond that USAT sold for less 6 than it paid for. Buy a bond for a million 7 dollars and they sell it for $990,000, she says 8 there is a 10,000-dollar loss on that bond. 9 Well, it's obvious that in any 10 securities portfolio -- and you've heard 11 references to the securities portfolios -- if you 12 run a portfolio, you're going to sell your bonds. 13 Some, you're going to make money on. Some, you're 14 going to lose money on. They have focused only on 15 the Drexel underwritten bonds on which there was a 16 loss. I will say happily in the USAT portfolio, 17 there are a great many more bonds sold as a profit 18 than bonds sold as a loss; but they ignore the 19 ones that were sold as a profit. They then told 20 the expert -- and as she confirmed, she got these 21 instructions really from the OTS lawyers -- to 22 ignore completely any interest that was received 255 1 on the bonds during the time that USAT held them. 2 This, to me, is somewhat puzzling since I had 3 always understood, in my naive way, that interest 4 is what people buy bonds for, particularly 5 high-yield bonds. The attraction of high-yield 6 bonds, I had always understood, was that they 7 produced a high-interest yield. Their expert was 8 told to totally ignore the interest yield, and she 9 did. And by ignoring all the bonds in the 10 portfolio on which there were gains and ignoring 11 all the interest yield on all the bonds in the 12 portfolio, she comes up with a number of 13 $47 million which she says represents the losses. 14 It's remarkable -- it's been remarkable 15 to me all along that OTS would even try to bring a 16 claim related to USAT's high-yield bond portfolio. 17 I say that because the high-yield bond portfolio 18 was really one of the great success stories of 19 that institution. At a time when the Houston 20 economy didn't really offer USAT many 21 possibilities for making quality commercial 22 loans -- and after all, when you think about it, a 256 1 bond really is simply a form of a commercial 2 loan -- the high-yield bond portfolio yielded 3 millions of dollars of profits for United Savings 4 Association of Texas. It permitted the company, 5 in effect, to make good loans to well-established 6 corporations located throughout the country; 7 therefore, minimizing the effect of the poor 8 economy here in Texas. 9 Now, these weren't high-risk 10 fly-by-night borrowers which is how OTS tries to 11 characterize them. These were not junky 12 companies. I think when Your Honor looks at the 13 composition of the high-yield bond portfolio at 14 USAT, you're going to see some of the best known 15 corporate names in America. Also, the evidence is 16 going to show that these issues were carefully 17 selected and thoroughly researched before they 18 were presented to the investment committee for 19 decision. 20 Dr. Lawrence Benveniste, 21 B-E-N-V-E-N-I-S-T-E, who is a professor at the 22 Business School of the University of Minnesota 257 1 studied the USAT portfolio for us. He's going to 2 testify that not only was the portfolio highly 3 profitable but it was very carefully diversified 4 over a wide spectrum of industries. 5 And the other odd aspect of the OTS 6 claim, though, is the claim which is really 7 implicit in their theory that, somehow, the 8 regulators didn't know what was in the portfolio; 9 it didn't know that USAT was buying Drexel 10 underwritten bonds and wouldn't have approved it 11 if they knew. Well, this is simply untrue. The 12 evidence is going to show that USAT informed both 13 its state and federal regulators every month of 14 every addition to and subtraction from the 15 high-yield bond portfolio. 16 Initially, they would seek advanced 17 approval from the regulators for these. But this 18 proved unworkable; so, they asked for and received 19 permission to report after the fact. They 20 reported after the fact each month. Those letters 21 went to the Texas regulators with a copy to the 22 Federal Home Loan Bank of Dallas. Neither 258 1 regulator ever disapproved, to my knowledge, a 2 single bond purchase. 3 Now, OTS is contending now in its 4 theory here that Drexel was an affiliate of USAT; 5 but Your Honor is going to see evidence certainly 6 that nobody at the time ever thought that. As a 7 matter of fact, one regulator even referred in a 8 memo to Drexel's stock ownership in USAT and -- or 9 in UFG, and it referred to its ownership by an 10 unaffiliated third party. Now, hindsight's a 11 fascinating process; but I doubt that OTS is going 12 to be able to present any single fact bearing on 13 the issue of Drexel as an affiliate that wasn't 14 fully known to USAT's regulators at the time. And 15 if those regulators didn't think Drexel was an 16 affiliate and if those regulators didn't think 17 that these transactions that they were fully aware 18 of every month required advanced approval, I don't 19 know why, frankly, that this Court should find any 20 differently. 21 Let me turn to the subject of -- let me 22 just say one more word about high-yield bonds. 259 1 The high-yield bond portfolio was certainly no 2 secret from the regulators; and, as you've heard 3 from some of the statements made yesterday, this 4 was something the regulators looked at fairly 5 closely on a number of occasions. One of the 6 things you're going to hear is that the Federal 7 Home Loan Bank of Dallas actually at one point 8 even sent two of its own investment experts, 9 Dr. Jonathan Scott and Terry Smith, two Ph.D.s who 10 worked for the Federal Home Loan Bank of Dallas. 11 They sent them to Houston to look specifically at 12 the USAT high-yield bond portfolio and to give 13 their views on whether it was well run. I think 14 Mr. Villa quoted their report yesterday. They 15 came back, and they found that the portfolio was 16 very well managed and very well run. Well, we 17 took a deposition in this case from George Barclay 18 who's -- I think he's still the president of the 19 Federal Home Loan Bank of Dallas. And we said, 20 "Do you know these two investment experts? What 21 do you think of them?" 22 And he said, "Oh, yeah." He knew them 260 1 very well. And he said, "I'll tell you, if 2 Jonathan Scott and Terry Smith think a high-yield 3 bond program is impressive and well run" -- I 4 don't think Mr. Barclay was choosing to make a 5 pun, but he said, "That's an opinion you can take 6 to the bank. Those guys know their stuff." And 7 these were people who went firsthand hands on, 8 examined the portfolio, found it very well run. 9 You know, the purpose of bank 10 regulations is supposed to be, as I have always 11 understood it, to guide the way parties conduct 12 themselves in the real world. And as I look at 13 this high-yield bond portfolio claim, it seems to 14 me that the enforcement lawyers are trying to use 15 those regulations not in the real world but simply 16 to conjure up some technical violation in this 17 case and then say, you know, "Gotcha," 10, 15 18 years after the fact. But I think when the Court 19 hears the evidence, you're going to agree that 20 there is no substance and no merit to this 21 high-yield bond claim. 22 Let me touch for a moment on the 261 1 subject of restitution. The OTS net-worth 2 maintenance claim and its high-yield bond claim 3 and, indeed, in many of the other claims in the 4 case, OTS seeks money damages in the form of 5 restitution. I think the law is quite clear. 6 Even Mr. Retsinas now seems to agree that a claim 7 for restitution requires that the agency prove 8 either unjust enrichment or reckless disregard for 9 law or regulation. Here, OTS is claiming unjust 10 enrichment. I believe they are. And if they do 11 that, they are going to have to show that MAXXAM 12 and Federated received some benefit in connection 13 with their investment in UFG, some benefit which 14 they retained and which it would now be unjust of 15 them not to give up. I think that is how the law 16 now defines restitution in the context of these 17 cases. 18 Now, OTS has pleaded that MAXXAM and 19 Federated were unjustly enriched because they 20 retained money which they were required to infuse 21 into USAT. However, I think the cases, 22 particularly the Wachtel and the Rapaport cases, 262 1 have made it quite clear that that doesn't 2 constitute unjust enrichment in the context of a 3 net-worth maintenance claim. And I think however 4 much OTS Enforcement might disagree with those 5 cases, they have to accept the fact that their own 6 director now cites them as government law. 7 That leaves OTS really with a claim 8 that MAXXAM, Federated, and Mr. Hurwitz were 9 somehow advantaged in their other activities by 10 financial assistance that they received from 11 Drexel as a result of USAT's purchase of Drexel 12 underwritten investments. And, frankly, as I 13 understand it, that is their theory of unjust 14 enrichment at this point. 15 Now, I question whether that kind of a 16 benefit, if true, even if proved, could ever 17 support a restitution claim. But I think the fact 18 is that OTS is never going to be able to prove 19 that. They rely heavily on what we in the case 20 have come to call the Drexel connection; that 21 there was some quid pro quo arrangement; that 22 Drexel sold high-yield bonds to USAT and, in 263 1 return, MAXXAM and Federated and Mr. Hurwitz got 2 some advantage from Drexel somewhere else. It's 3 nice for lawyers to stand up and say that. But 4 it's going to be quite another thing for them to 5 prove it, and I don't think they are going to be 6 able to do it. 7 But what the evidence is going to show 8 is that when MCO and MAXXAM used Drexel as an 9 investment banker -- and they used Drexel as they 10 used other investment bankers. Drexel was well 11 paid for its services. There wasn't any back 12 scratching here. Drexel got good money when it 13 acted as an investment banker. It's also going to 14 show that payment for those services was 15 negotiated at arm's length and with a fairly high 16 degree of intensity. I think Your Honor will 17 listen to great interest when the witnesses 18 describe some of these fee negotiations. I can 19 assure you that there is no evidence that you're 20 going to hear of any quid pro quo arrangement tied 21 to USAT purchases of high-yield bonds. It's not 22 there. 264 1 Let me just make one observation in 2 conclusion, Your Honor. I think you'll recall 3 that about five years ago, I appeared before you 4 in a claim by this same agency against Mr. Kaleb 5 West down in Newport News. And when OTS Director 6 Ryan affirmed Your Honor's decision in the West 7 case, December 1992, and dismissed the charges 8 against Mr. West, he made an interesting 9 observation. He noted that many of the charges in 10 that case were quite old, and he doubted the 11 wisdom -- I think I'm almost quoting him now. He 12 doubted the wisdom of devoting OTS Enforcement 13 assets to the pursuit of such stale claims. 14 Here we are again, though, five years 15 later. We're talking about events that happened 16 10 to 15 years ago. We're going to be dealing 17 with witnesses who are struggling to recollect 18 those events. We're going to be dealing with all 19 the uncertainties about missing or incomplete 20 documents, all of those same difficulties that 21 caused Director Ryan to make that comment in the 22 West case. I have to think that if there was 265 1 really, really some wrongdoing at United Savings 2 Association of Texas, somebody would have 3 identified it and somebody would have done 4 something about it a long time before now. 5 When we see a case of this sort brought 6 10 to 15 years after the fact, I at least can't 7 help but wonder what kind of agenda is at work. 8 Is it politics? Is it politics because the 9 environmentalists think they see a way through 10 this case to get at MAXXAM's redwood trees? I 11 don't know that. We've seen some of them in the 12 courtroom. They are here watching the case. 13 Maybe that's it. Is it regulatory survival? Is 14 this an agency and enforcement division that are 15 out to prove that there is some reason for them to 16 continue to exist? I don't know. That may be 17 what this fuss is all about. 18 Thank you for your attention, Your 19 Honor. 20 THE COURT: Thank you. We'll take a 21 short recess. 22 266 1 (A short break was taken. 2 from 10:21 a.m. to 10:45.) 3 4 THE COURT: We're back on the record. 5 Mr. Keeton, you look like you're ready to go. 6 MR. KEETON: Yes, Your Honor. May it 7 please the Court. I'm here speaking for 8 Mr. Hurwitz, and the other respondents have been 9 introduced. 10 Charles, would you stand up so the 11 judge can see what a bad guy like you looks like? 12 Sit down. 13 Mr. Hurwitz, Your Honor, is 57 years 14 old, grew up in Kilgore, Texas. That's up in 15 East Texas. His parents were in the clothing 16 business. He went to the University of Oklahoma, 17 graduated, became a broker, and, as they say, the 18 rest is history except he married his high school 19 sweetheart. They have two grown sons. They are 20 grandparents. It's a close family. The Hurwitzes 21 have been very philanthropic but very private. 22 Most of the stories you've ever read about 267 1 Mr. Hurwitz, if you've read any -- and I wouldn't 2 say that was improper if you had -- would show 3 that he's a very, very private person. He is. 4 And as a result of that, they are not people and 5 he particularly is not a person to talk about all 6 the good things that they do besides the public 7 business that people know about. However, in 8 talking to Barbara the other night, I gained some 9 insight as to a bit of their philanthropy. 10 I would say, after looking at the list, 11 they have given to every major charity in this 12 town and over this country and not insubstantial 13 sums. Mrs. Hurwitz particularly, but Mr. Hurwitz 14 behind her, has been responsible recently for 15 raising over $18 million, of which some of that is 16 theirs, for the park here that this city is trying 17 to redo. It's the equivalent of our Central Park. 18 It's called Hermann Park; but it, like Central 19 Park, has fallen into disarray. They are both on 20 the board of M.D. Anderson Cancer Hospital which 21 we like to think may be the greatest cancer 22 research center hospital in the world. It's 268 1 certainly one of the most well-known ones. And 2 they have lent both their time as board members 3 and their money and treasure for that. In 4 addition to that, Mrs. Hurwitz serves on the board 5 of one of our local colleges; and, together, they 6 have endowed scholarships and created a program 7 where they bring guest speakers. 8 Not to be the least of this, there is 9 also a foundation called "Knowledge is Power" 10 which has as its mission, and which the Hurwitzes 11 support greatly, bringing down students from 12 prestigious colleges in the East such as Yale and 13 others and sending them to teach in our Fifth Ward 14 which is our most impacted and impoverished 15 minority district in this town. 16 Now, least is that in their religious 17 subjects, they have given generously -- and I will 18 not state the number, but it is huge -- to their 19 temple. None of these things are almost -- or 20 almost none of these things are known publicly 21 because that's the kind of people they are and the 22 kind of family people they are, also. The sons, I 269 1 have had the pleasure of knowing. I've seen the 2 grandkids. 3 So, it's a little different view of the 4 world to look at Mr. Hurwitz through that prism. 5 That's not going to say that's the end of this 6 case because that's not the end of this case. It 7 may not even be relevant, but I think it is when 8 it comes time to judge a man's credibility and the 9 veracity of the things he's saying. Mr. Hurwitz, 10 in the charges, has been called a corporate 11 raider; and that name had been used in stories 12 about him. 13 He is not. If you look at his history 14 of business, he purchases -- and the companies 15 that he's associated with purchase companies, 16 operates those companies -- almost exclusively 17 operates them with the people who were there 18 before the purchase, and holds those companies and 19 tries to build up the assets. There is no burn 20 and pillage, no stripping of assets, none of that. 21 Now, in December of '81, they did spot 22 an opportunity for what they thought was an asset 270 1 purchase at the time because it had been announced 2 that UFG, the holding company, had entered into an 3 agreement to sell USAT, the thrift, to a third 4 party and that UFG was going to be left with only 5 cash and land, piece of land. 6 After analyzing that situation, it 7 looked attractive. And the start of acquisition 8 of UFG shares began with the understanding and 9 certainly the thought that they were not acquiring 10 a thrift; they were acquiring an entity, UFG, that 11 would have cash and the real estate. Later on, 12 I'll address the real estate. 13 What happened? Well, it had nothing to 14 do with Mr. Hurwitz; but that transaction which 15 had been publicly announced fell through for 16 whatever reasons. And all of a sudden, Federated 17 and MAXXAM now see themselves as holders of shares 18 of UFG which also now has a hundred percent owned 19 thrift. And it's from there that this saga 20 starts. Yes, I suppose they could have sold their 21 shares right then. But after studying it 22 further -- and like many of us in Houston at the 271 1 '81/'82 time with the hope that the economy was 2 getting ready to change, it looked like an 3 interesting opportunity. So, he proceeded to 4 purchase the shares that we've been talking about. 5 I'm not going to get into the 24.9 and 6 how it goes up and down. You've heard all about 7 that. But the purchase was made. At the same 8 time, what occurred is that the board was changed 9 somewhat; and there has been the contention -- in 10 fact, we've argued about it to Your Honor about 11 this controlling influence. And while I realize 12 that term, I think, is being applied in saying 13 that Drexel is a controlling influence with MAXXAM 14 and UFG, I'm not sure how they are using that. 15 But let's look at the board of UFG as 16 it was constituted over the various years. For a 17 moment, just so that we can dispel some of the 18 indications if not implications that the board was 19 constituted by Mr. Hurwitz only, maybe with 20 Mr. Munitz, and then, sometime along the line, 21 Mr. Gross came. That's it. That's what you would 22 think if you had been sitting in here listening to 272 1 the government. 2 Now, before I get started, Your Honor, 3 I'm not putting this in as an exhibit yet because 4 out here in '88, some people go off early in '88. 5 Some come on later in '88. All these people were 6 on the board at one point or another in '88. But 7 '88 has certain problems with some of these people 8 on timing, and I know that. But I'm trying -- the 9 point I'm trying to illustrate is made without 10 worrying about those nuances. Let me -- all the 11 red -- the color, by and large, has no 12 significance, Your Honor, except two colors on 13 this board do have significance: The red and the 14 yellow. 15 The red are directors who were 16 directors of USAT prior to Federated and MAXXAM 17 getting involved in any way. And if you look at 18 the UFG chart, you will see the red predominates 19 all the way through. 20 The yellow are people who were 21 designated four places by a company called 22 PennCorp Financial, and that grows out of the 273 1 First American Financial acquisition. And I'll go 2 over those; but when the merger with First 3 American occurred, these people came on. And you 4 notice the yellow predominates all the way 5 through. 6 But let me take these people for a 7 moment because you may say, "Well, yeah. Maybe 8 all these guys are a bunch of idiots or crooks or 9 maybe they are, you know, Mr. Hurwitz' best 10 friends or something." 11 Let me tell you who they are. 12 C.E. Bentley was the president at various times 13 and chairman of USAT before the acquisition by 14 Federated and Hurwitz. And he keeps going, 15 mid-'85. 16 Mr. Coles was president and chairman of 17 USAT. He had previously been president of 18 Imperial Corporation -- I think that's the name -- 19 a large holding company of several savings and 20 loans in San Diego. Very well-known, very 21 experienced. He was virtually at retirement age 22 about the time he goes off. 274 1 Mr. L.L. Duckett is the senior partner 2 of a very well-known firm in El Campo, a 3 relatively small town 50, 60 miles from here. 4 Very respected, a business lawyer, pillar of his 5 community, a knowledgeable man who served on banks 6 as well as this S&L. And you notice he goes all 7 the way. 8 Edgar Keltner is a named partner in a 9 very prestigious Fort Worth law firm, large firm. 10 He's a business lawyer, very well-respected member 11 of the bar. He goes all the way. 12 Charles A. LeMaistre -- he will also be 13 called Dr. LeMaistre -- at this time was C.E.O and 14 president of M.D. Anderson Hospital which is, as 15 I've already said, a very large institution. 16 Prior to this, for a number of years, he had been 17 president and then chancellor of the University of 18 Texas system in Austin. He understands 19 administration. He is not -- I don't want to do 20 the Doctor a disservice. He is not a medical 21 doctor, but this is a man who understands business 22 and has been managing and running institutions. 275 1 Mr. Barry Putegnat -- I'm not sure I 2 pronounced that right -- but he is an owner and a 3 president of a large cleaning commercial -- also 4 been a director, and was at this time, of a 5 company called Daniel Industries, a large company 6 listed on the New York Stock Exchange that's an 7 oil and gas service business/manufacturer, and 8 Dorchester Gas, another large company listed on 9 the Exchange. I might add Dr. LeMaistre was on 10 the board of Enron, may still be on the board of 11 Enron, a large energy company here. 12 Now, those people go through this. 13 They weren't selected by Mr. Hurwitz. They 14 weren't selected by Federated, Mr. Gross, or 15 Mr. Munitz. They were there and they stayed there 16 and they were valuable board members. 17 The yellow -- let me take the yellow. 18 How the yellow comes about, Your Honor, is 19 PennCorp had a debt of -- I think it's like in the 20 40 million, 50 million -- that was owed to it by 21 First American Financial, the holder -- the 22 holding company for Houston First Savings which 276 1 merged with USAT. Obviously, that debt 2 transferred over. And under their loan agreement, 3 PennCorp had the right to name four members of the 4 board -- obviously, First American -- and that 5 carried through, and no one tried to cancel it 6 when the merge occurred. 7 Mr. Burton Borman goes all the way 8 through. Mr. Borman was the president and C.E.O 9 of PennCorp Corporation and has an incredibly 10 impressive resume as both a manager and a 11 financial man. He's out of California. 12 Steve Silverman was a vice president of 13 PennCorp and also associate general counsel, 14 distinguished resume. He stays all the way 15 through. Gets off sometime in '88. 16 Barry Sterling was the general counsel 17 and executive vice president, I think was his 18 title, of PennCorp. Again out of California, a 19 lawyer, but also a manager. He's executive vice 20 president of that company. He also was counsel to 21 the well-known firm of Wyman Bautzer out in LA, 22 very distinguished member of the bar with plenty 277 1 of business experience. 2 Finally, Wayne Winters had been 3 president of First American before the merger. He 4 stayed on as one of PennCorp's designees. I 5 assume without reading Mr. Borman's mind, he 6 figured, "Well, Mr. Winters knows S&L business 7 real good; and he knows it in this area." He 8 stays on the board all the way to the first of 9 '87. 10 The other board members that come on at 11 various times -- let's kind of take it by date. 12 Dr. Munitz comes on sometime in '82 and stays 13 there. 14 '83, we've got Mr. Campbell. 15 Mr. Campbell is an independent investor. He had 16 actually been a director of USAT earlier times 17 back in the Seventies; had, for whatever reason, 18 not stood for election but came back on here. He 19 also was a director and -- no, not an officer -- a 20 director of Abilene State Bank and I think one 21 other bank, an experienced financial person. 22 Nobody's lacking. 278 1 Mr. B.D. Holt, again, is like 2 Mr. Campbell. He had been on the board previously 3 and came back on. He is the owner of a large 4 company in Corpus Christi, Texas, that sells and 5 distributes heavy equipment; and he is also or was 6 a director of a Corpus Christi Bank. These are 7 people who are knowledgeable about business. It's 8 not wives and sisters or your brother-in-law. 9 Then we've got Mr. Hurwitz who comes on 10 at the same time, and we've talked about 11 Mr. Hurwitz or we will. 12 George Kozmetsky comes on in '83. He's 13 variously called Dr. Kozmetsky or Dean Kozmetsky. 14 Some mention has been made of him, but I would say 15 that everyone in the financial community in this 16 country of real sophistication knows George 17 Kozmetsky and knows him with both affection and 18 great respect. He's had a distinguished career 19 teaching, among other places, at the Harvard 20 Business School; then went into business, made a 21 tremendous amount of money. He's principally 22 associated with Teledyne, but he's been a director 279 1 of numerous companies. He then came back to the 2 University of Texas and set up the Texas Business 3 School. It is now called the Kozmetsky Business 4 School. And Dr. Kozmetsky's career and personage 5 is one most impressive. He's written widely. He 6 is known for rectitude. He is known for the 7 ethics of business. And he is known for his own 8 personal ethics. He still works seven days a 9 week, as one of his lawyers said one time during 10 this investigation, giving away his money. He and 11 his wife have already donated hundreds of millions 12 of dollars, not just promised to do it when they 13 die. And he thinks all the time at the cutting 14 edge of what is good for this country and what is 15 good to make the financial engine of our society 16 work well. But he is not a man driven by greed. 17 He is a man driven by honor. And you'll see 18 Dr. Kozmetsky on the stand. But he comes on in 19 '83 and stays on all the way to '87. Anybody that 20 tells you that Mr. Hurwitz or anybody else is 21 going to control George Kozmetsky is wrong. 22 Now, Jerry Williams comes on mid-'83 280 1 and stays on till '87. You've heard about Jerry 2 Williams. He is not a respondent here, but you 3 heard his pedigree. And he had been chief 4 operating officer at First City Bank, a man of 5 high integrity, wide experience, sophisticated. 6 There is Mr. Williams. 7 Mr. Gross comes on mid-'85. I'm not 8 going to try to repeat the statements about 9 Mr. Gross, but you've heard about him. 10 Now, that is the board of UFG. And, 11 indeed, I even tried to figure out -- for whatever 12 it's worth, it has seven members in '81, eight in 13 '82, 16 in '83, 16 in '84, 16 in '85, 13 in '86, 14 11 in '87. I think I came out with 11 in '88; 15 but, remember, I've got a few little errors there. 16 The point being this is not some board that is 17 going to do imprudent things just to help either 18 MAXXAM, Federated, Drexel, or Charles Hurwitz. 19 This is a board that is going to carry out its 20 fiduciary duties. 21 Now, very quickly, Your Honor, this 22 board, which looks very similar, is the USAT 281 1 board. It's not hard to figure out there are some 2 differences. Certain of these directors were not 3 on the USAT board: Mr. Holt, Mr. Campbell, 4 Mr. Borman, Mr. Hurwitz. Otherwise, it looks very 5 similar including the red predominating all the 6 way across, the yellow predominating all the way 7 across. And Mary Grisby probably could have been 8 put in yellow. She may not have been a nominee 9 of -- of PennCorp, but she comes out of the First 10 American acquisition. She had been the chairman 11 of the board. Later, as I think you've been 12 told -- but I will say it again -- she is actually 13 appointed to the Federal Home Loan Bank Board. 14 Now, that's what it looks like; and 15 this doesn't even come close to showing you the 16 operators underneath, all of whom were capable and 17 who are independent in the sense that they are not 18 beholden to these people other than to do a good 19 job and to carry out their duties. 20 Mr. Guido said that what happened here 21 was they stripped out the profitable assets which 22 caused a bigger loss at the end and they did it 282 1 because Mr. Hurwitz, MAXXAM, and Federated hoped 2 to benefit from the recovery if they could make 3 the institution survive. Well, I don't -- I don't 4 agree with this stripped out connotation. That 5 sounds like something imprudent or in some way 6 stripped out and put it in your pocket which they 7 didn't. But I do agree that every one of those 8 directors was trying to turn this institution 9 around and save it. That's why it survived so 10 long. 11 And while I'm on the point, I ought to 12 make this point when I mentioned stripped out. 13 You do not have cars. You don't have vacation 14 homes. You don't have airplanes. You don't have 15 money. You don't have any of the self-dealing. 16 You don't have a loan to your brother that's 17 undisclosed. You don't trade your cow for his 18 horse and everybody backs it up a hundred thousand 19 dollars like some savings and loans did. 20 None of that in this case. You have 21 people struggling at the most sophisticated and 22 highest level to do what they can best do to make 283 1 this institution survive. They failed, but that 2 is not actionable. 3 Mr. Guido says Drexel owned some shares 4 in MAXXAM. So what? MAXXAM's a publicly traded 5 company. If we all had bought shares, then we 6 might have made a lot of money. I looked it up. 7 But that's not the issue. He just says Drexel 8 bought shares in MAXXAM. MAXXAM did not buy 9 high-yield bonds from Drexel. Well, where is he 10 going with that? That's not MAXXAM's business. 11 They are not in that kind of business. So what 12 that MAXXAM didn't buy high-yield bonds from 13 Drexel? I suspect Drexel owned shares in General 14 Electric and Coca-Cola and lots of other places, 15 and they probably didn't buy high-yield bonds 16 either. The point is high-yield bonds are used by 17 certain types of financial institutions. That's 18 not MAXXAM. 19 And he said so -- since MAXXAM didn't 20 buy high-yield bonds, though, Mr. Guido in his 21 mind says, "Well, MAXXAM got USAT to buy Drexel 22 high-yield bonds." So what? They made money. 284 1 And I don't think it was quite as clear as I would 2 have liked it this morning from my brother 3 Eisenhart who said all the rest of it better than 4 I could have said it. 5 This institution bought high-yield 6 bonds from everybody: Merrill-Lynch, First 7 Boston, Solomon Brothers, on and on and on. Among 8 those were Drexel. We all know Drexel underwrote 9 a large percentage of high-yield bonds during that 10 time. But these other institutions did, too; and 11 MAXXAM -- I misstated -- USAT bought from all of 12 them, and it's that that they made money on. They 13 didn't just buy from Drexel and lose money. It 14 was a portfolio. And, indeed, one of the 15 interesting aspects of this, Your Honor, unlike a 16 lot of cases that were brought out of the Drexel 17 failure, USAT's percentage each year of high-yield 18 bonds that were underwritten by Drexel that it 19 bought was a smaller percentage than Drexel 20 actually constituted of the whole high-yield 21 market each year. 22 Now, why is that important? Because we 285 1 have seen -- all of us who have lived through this 2 S&L failure -- some of those institutions had 3 hundred percent Drexel bonds and didn't buy from 4 anybody else or it looks like they did foist off 5 dogs and cats on them. That's not here. You had 6 professionals deciding; not Mr. Hurwitz like 7 Mr. Guido said. We have professionals deciding 8 which high-yield bonds to buy. There are none of 9 them on here. They have got great pedigrees, 10 great resumes, and they made money. But anyway, 11 he says, so, since USAT bought high-yield bonds 12 from Drexel, MAXXAM didn't, Drexel owned MAXXAM. 13 Then what? 14 He then leaps the farthest leap of 15 faith I have ever seen. He says it must be that 16 Drexel then agreed to do financings for MAXXAM. 17 Let's be clear on this. MAXXAM did financings 18 with a lot of people again: First Boston, Barry 19 Stearns, Merrill-Lynch, and, yes, Drexel because 20 Drexel was good at it. But those were all head 21 up, head up. Each stood on its own, no quid pro 22 quos; and they will never prove a cent of it 286 1 because it didn't occur; not because we're tricky. 2 It did not occur. 3 Now, what happens? We go along all of 4 this -- oh, by the way, I just came to where 5 Mr. Guido said many things about Mr. Hurwitz like 6 he's running everything even though he has another 7 business, several to run. It's not like this is 8 the only thing on his plate, as you will hear. 9 But he did get good managers. He did get good 10 board members, and he did see that the right kinds 11 of policies were instituted. 12 Mr. Gui