IN THE UNITED STATES DISTRICT COURT

FOR THE SOUTHERN DISTRICT OF TEXAS

HOUSTON DIVISION

 

 

FEDERAL DEPOSIT INSURANCE )

CORPORATION as manager of the )

FSLIC resolution Fund, )

)

Plaintiff, ) Civil Action No. H-95-3956 )

v. )

)

CHARLES E. HURWITZ, )

)

Defendant. )

 

H-95-3956

 

COMPLAINT AND JURY DEMAND

 

The Federal Deposit Insurance Corporation as manager of the FSLIC Resolution Fund ("FDIC") alleges the following as its Complaint against the Defendant Charles E. Hurwitz ("Hurwitz").

 

 

INTRODUCTION

 

1. This is an action by the FDIC against Charles E. Hurwitz, who dominated and controlled United Savings Association of Texas ("USAT" or "Association") as a controlling shareholder, de facto senior officer and director and controlling person. The claims against Hurwitz are for his own actionable conduct and for aiding and abetting the conduct of others who served as officers or directors of USAT. All of the claims arise from conduct after January 1, 1987 and before December 31, 1988. Count 1 sets forth claims against Hurwitz arising from the failure of the Board of Directors of USAT to ensure that the net worth maintenance obligations of its parent corporation United Financial Group, Inc. ("UFG") and of its controlling shareholders MCO Holdings, Inc. ("MCO" now known as MAXXAM) and Federated Development Corporation (Federated") were enforced. Count II sets forth claims against Hurwitz for losses on transactions in a portfolio of mortgage backed securities that was known as "Joe's Portfolio." Count III sets forth claims against Hurwitz for losses incurred by USAT through United MBS Corporation ("UMBS").

 

 

JURISDICTION AND VENUE

 

2. Jurisdiction is proper in the court pursuant to 26 U.S.C. 1345 and 12 U.S.C. 81819.

 

3. Venue is proper in this District because the claims asserted arise from actions which occurred in this District.

 

PARTIES

 

A. The Plaintiff

 

4. Prior to December 30, 1988, USAT was a state chartered savings and loan association with its principal office located in Houston, Texas, the deposits of which were insured by the Federal Savings and Loan Insurance Corporation ("FSLIC"). All of USAT's stock was held by the Association's first tier holding company, United Financial Group, Inc. ("UFG"). On December 30, 1988 the Federal Home Loan Bank Board ("Bank Board") determined that USAT was insolvent. The Commissioner of the Department of Savings and Loans of the State of Texas gave his written approval that a ground specified in 12 U.S.C. 1464(d)(6)(A) for the appointment of a receiver for USAT existed. Pursuant to 12 U.S.C. 1729(c)(1)(B), the Bank Board appointed FSLIC as the sole receiver for USAT for the purpose of liquidation.

5. The bank Board found that USAT was not a going concern, that USAT could not be sold to a third party without financial assistance form the FSLIC, that the proceeds that could be realized from liquidation of USAT's assets were insufficient to satisfy USAT's secured and deposit liabilities and that no amount remained for payment of USAT's general creditors, subordinated debt holders or stockholders, such that their claims were worthless.

6. Upon the appointment of a receiver, USAT was in "default" within the meaning of 12 U.S.C. 1724(d). Under 12 U.S.C. 1728(b), the default of USAT triggered FSLIC's obligation to make "payment of each insured account" at USAT "as soon as possible," either in cash or by making available an insured, "transferred account" at a new institution in the same community.

7. FSLIC satisfied its obligation to the depositors of USAT by making available insured accounts at a newly-chartered federal savings and loan association ("the Acquiring Association"). The Acquiring Association stated that it "was unwilling to assume (USAT's) assets, having concluded that the value of such assets is less than the amount of the liabilities to be assumed." The Acquiring Association therefore required as a condition to agreeing to assume the secured and deposit liabilities of USAT that FSLIC in its corporate capacity enter into an Assistance Agreement pursuant to which FSLIC agreed to protect the Acquiring Association against the losses inherent in the assets of USAT, including the losses which are the subject of this complaint. FSLIC's Analysis and Evaluation Division concluded that the cost of the financial assistance required to protect the Acquiring Association from the losses already inherent in USAT's assets in the hands of USAT's receiver exceeded $1 billion.

 

8. Under federal law and 12 U.S.C. 1729(b), when FSLIC satisfies its insurance obligation by making available insured accounts to a depositor of a failed savings and loan association, FSLIC is subrogated to the rights of the depositor and acquired the depositor's claim against the receiver for the failed institution. 12 U.S.C. 1823(g). After FSLIC provided assistance to USAT's Acquiring Association, FSLIC in its corporate capacity was subrogated to the rights of USAT's depositors against FSLIC as receiver and FSLIC as receive was not relieved of that liability. FSLIC as receiver for USAT continued to have a substantial loss for which it was entitled to seek recovery from liable parties, including Hurwitz.

 

9. Because, both before and after the transaction with the Acquiring Association, FSLIC as receiver for USAT held assets which were worth substantially less than USAT's liabilities, as a result of the conduct of Hurwitz, FSLIC as receiver had incurred losses and was entitled to pursue claims against Hurwitz to recover those losses. On December 30, 1988, FSLIC as receiver for USAT and FSLIC in its corporate capacity entered into a Receiver's Agreement pursuant to which FSLIC as receiver for USAT transferred to FSLIC in its corporate capacity all of the claims against Hurwitz which are the subject of this complaint. The agreement acknowledges the "insufficiency of (USAT's) assets to provide for the assumption of USAT's secured and deposit liabilities" and the fact that FSLIC "will be required to bear and to pay" the "substantial losses and costs" inherent in USAT's assets.

10. On August 9, 1989 Congress enacted the Financial Institution Reform, Recovery and Enforcement Act of 1989 ("FIRREA"). Section 401 of FIRREA abolished the FSLIC, FDIC, as manager of the FSLIC, including the right to assert the claims stated in this complaint.

 

B. Charles E. Hurwitz

11. Charles E. Hurwitz ("Hurwitz"), was the controlling force of USAT, UFG, MCO and Federated. He was the controlling shareholder of Federated which, in turn, was the controlling shareholder of MCO. Through MCO and Federated, which held significant stock ownership in UFG, Hurwitz was a controlling shareholder of UFG and USAT. He was the Chairman of the Board and Chief Executive Officer of UFG, MCO and Federated. He also served as UFG's President and was a member of UFG's Executive Committee and the UFG/USAT Strategic Planning Committee. Hurwitz was also a

de facto director and senior officer of USAT and voluntarily assumed the responsibilities of an officer and director of the institution. He functioned as an active member of the USAT Board, if not its de facto chairman. He directed and controlled USAT's investment activity; he regularly attended Board and Committee meetings; he selected USAT officers and directors; he controlled and dominated virtually all of USAT's activities. No significant decision concerning USAT's affairs was undertaken without his approval.

 

BACKGROUND

 

12. In early 1982 Hurwitz began to acquire UFG shares through MCO and Federated. In August, 1982 UFG agreed to merge with First American Financial of Texas, which owned Houston First American Savings. The Bank Board approved the merger effective April 29, 1983 and First American's insured subsidiary was merged into USAT. As part of the acquisition and merger process and as part of MCO and Federated's efforts to increase their control over USAT, UFG, MCO and Federated were subject to net worth maintenance obligations for the benefit of USAT.

 

A. The Drexel Connection

 

13. In 1984, Hurwitz began to engage in substantial reciprocal business arrangements with Drexel Burnham Lambert, Inc. 'Drexel.' Drexel assisted Hurwitz's takeover activities and USAT invested heavily in Drexel underwritten junk bonds. From 1984 through 1988, Hurwitz purchased a substantial volume of Drexel underwritten junk bonds and other brokered securities. Drexel, in turn, provided substantial financing for Hurwitz takeover activities.

14. By keeping USAT open and free from regulatory intervention, Hurwitz was able to continue these reciprocal business arrangements with Drexel. On information and belief, many of USAT's actions to maintain net worth at artificially high levels were undertaken to avoid regulatory intervention and to ensure that USAT eventually became the eighth largest purchaser of Drexel-underwritten junk bonds among all savings and loans nationwide.

 

B. The Deteriorating State of USAT

 

15. Under Hurwitz's control, the financial condition of USAT steadily deteriorated. As the institution's financial health plummeted, Hurwitz, senior officers and USAT Board members serving at Hurwitz's request undertook greater and greater risks until both the officers and Board members became entirely indifferent to losses the institution might incur. Rather than recognize USAT's problems and confront them constructively, Hurwitz: (a) dramatically increased the liabilities of the Association in violation of federal law, (B) gambled on large, cumbersome real estate projects with no realistic chance of success, and (c) invested in complex financial instruments which the officers understood poorly and which resulted in staggering losses to the Association.

16. To "keep the doors open," to forestall regulatory intervention and to insulate UFG, MCO and Federated from the need to make capital contributions to USAT, Hurwitz and his colleagues covered up the true state of the Association by a pattern of deceptive financial reporting and balance sheet manipulation. Gains were taken on certain securities transactions, while losses were left imbedded in the portfolio; subsidiaries were used to skirt liability restrictions; losses on real estate investments were repeatedly understated; maturity matching credits were improperly constructed. The effect was to keep USAT operating despite its desperate condition, incurring ever increasing losses for which the insurance fund ultimately paid more than $1.5 billion. Moreover, by failing to honor UFG, MCO and Federated's net worth maintenance obligations, significant wealth was preserved by Hurwitz and his colleagues for distribution to themselves or for other investment opportunities.

17. Hurwitz and members of USAT's Board were fully aware of this debacle as it progressed. From 1984 through 1986 the directors of USAT and Hurwitz were advised of significant problems at the Association by regulators and outside auditors. They took no steps, however, to protect the institution. Thus:

 

- The Board as a whole was advised early in

USAT's history of significant problems in the

Association's real estate portfolio. In January

1985, the entire Board was advised by Texas regulators that (a) scheduled items had grown

dangerously and exceeded the Association's

net worth, (b) the appraisal practices at USAT were suspect, and (c) "significant" increases in

loss reserves would be forthcoming. In February

1985, the Board acknowledged the problems and

"promised" to monitor such matters more closely.

 

- From 1984 through 1986, the Board and the

Audit Committee of the Board were repeatedly

advised by the Association's outside auditors that the ADC lending was a significant problem at the

Association and that the Association's appraisal

practices were deficient.

 

- Throughout 1985 and 1986 Board packets

forwarded to members of the Board for quarterly

meetings clearly indicated the growing danger

that ADC lending posed to the institution and the

rapidly rising rate of foreclosures in the portfolio.

 

- Throughout 1986 the Board was advised from

Performance Reports made to the Board, from

reports by Peat Marwick or from the investment

Committee's deliberations (Board members

received copies of Investment Committee minutes)

that the significant increase in securities trading

had created serious internal control problems and

that the MBS portfolio was seriously distressed.

 

- Board members were advised in February 1986,

that the income of UFG was plummeting and that

the accounting gains taken from MBS trading may

not reflect "real" results.

 

- The April 1986 Texas Examination and the May

1986 FHLB Examination report that the institution

had significant securities investment problems and

a staggering substandard assets problem.

 

- - -

18. The claims against Hurwitz set forth below must be

 

viewed against this background. By January 1, 1987 it was readily

 

apparent to Hurwitz and the USAT directors that the Association had

 

very serious financial problems. Indeed, its viability was in doubt.

 

 

 

 

 

 

COUNT I

 

(Net Worth Maintenance:

Breach of the Duty of Loyalty

From January 1, 1987 through December 30, 1988)

 

19. The FDIC realleges and incorporates by reference herein,

 

the allegations of paragraphs 2 through 18.

 

20. In 1983, the UFG was required, as a condition of its merger and acquisition to enter into an agreement to maintain the net worth of USAT within federal requirements. Resolution

No. 83-252 of the FHLBB, imposed the following terms, among others, on UFG in connection with its acquisition and control of USAT:

 

(T)he subject acquisition (is) hereby approved,

provided that the following conditions are complied

with in a manner satisfactory to the (FHLBB's)

Supervisory Agent at the Federal Home Bank of

Little Rock ("Supervisory Agent"):

 

6. Applicant shall stipulate to the (Federal Savings

and Loan Insurance Corporation) that as long as it

controls the Resulting Association (United Savings),

Applicant shall cause the net worth of the Resulting

Association to be maintained at a level consistent with

that required by Section 563.13(b) of the Rules and

Regulations for Insurance of Accounts, as now, and

hereafter in effect, of institutions insured 20 years or

longer and, as necessary, will infuse sufficient

additional equity capital, in a form satisfactory to the

Supervisory Agent, to effect compliance with such

requirement.

 

 

 

21. At its meeting on April 27, 1983, the Board of Directors of USAT authorized the delivery to the Bank Board of any and all certificates or instruments to carry out the terms of the acquisition of the financial institution. On October 31, 1983, the USAT's general counsel transmitted to the Federal Home Loan Bank of Dallas a commitment, signed by the Chairman of the Board of UFG, agreeing that UFG would maintain the capital of USAT at the specific minimum level. The commitment states:

 

(The) Chairman of United Financial Group, Inc., (does)

hereby stipulate that as long as United Financial Group,

Inc. controls United Savings Association of Texas, it will

cause the net worth of United Savings to be maintained

at a level consistent with that required by Section

563.13(b) of the Rules and Regulations for Insurance of

Accounts, as now or hereafter in effect, of institutions

insured 20 years or longer, and, as necessary, will

infuse sufficient additional equity capital, in a form

satisfactory to the Supervisory Agent, to effect

compliance with such requirement.

 

22. On June 29, 1985, MCO and Federated filed an application with the Bank Board for approval to acquire control of USAT through the acquisition of up to 35% of UFG's shares. On December 6, 1984, the Bank Board granted conditional approval of the application of MCO and Federated to acquire control of USAT. The condition the Bank Board imposed on MCO's and Federated's acquisition of control was that;

 

for so long as they directly or indirectly control United

Savings, (MCO and Federated) shall contribute a pro rate

share based on their UFG holdings, of any additional

infusion of capital ... that may become necessary for

the insured institution to maintain its net worth at the

level required by the Corporation's Net Worth Regulation.

 

23. MCO and Federated acted jointly through Hurwitz in their efforts to control UFG and USAT. In 1985, MCO, through an option agreement with Drexel, acquired control of additional stock in UFG that caused the total holdings of MCO and Federated in UFG to exceed the 25% control threshold under federal law. As a result, the net worth maintenance obligation of the Board's resolution became applicable to MCO and Federated. Hurwitz, MCO and Federated did not disclose the impact of the agreement with Drexel to federal regulators in an effort to avoid the net worth maintenance obligation.

 

24. Hurwitz, as a controlling shareholder and a de facto member of the Board of USAT and as a member of the Boards of UFG, MCO and Federated was aware of UFG, MCO and Federated's obligation to maintain the regulatory net worth of USAT.

 

25. By virtue of his position as a de facto senior officer and member of the Board of USAT and a controlling shareholder of USAT, Hurwitz owed to USAT fiduciary duties, including, in particular, the duty of loyalty. Hurwitz also served as Chairman and a member of UFG, MCO and Federated's Board of Directors. Hurwitz had an affirmative obligation to protect the interests of USAT, even when to do so would be contrary to the interests of UFG, MCO and Federated.

 

 

26. By December 31, 1987, and continuing throughout 1988, USAT's reported regulatory capital did not meet minimum standards. USAT's actual regulatory capital fell below minimum standards throughout 1987, but Hurwitz failed to report the true financial condition of the Association. USAT's regulatory capital deficiency resulted, in substantial measure, from the gross mismanagement of USAT for which Hurwitz was responsible. On May 13, 1988, the Bank Board formally advised USAT and UFG that USAT did not meet its regulatory capital requirements as of December 31,. 1987. The bank Board directed UFG and UFG's Board to infuse capital sufficient to meet those requirements. UFG refused to abide by the written commitment to maintain USAT's regulatory capital shortfall. Hurwitz took no steps to encourage or compel UFG, MCO or Federated to honor their net worth maintenance obligations although he had the power to do so. On December 30, 1988, the Bank Board reiterated its request. Again, UFG, MCO and Federated refused to abide by their obligations; Hurwitz and the other members of USAT's Board stood by and did nothing. As of December 30, 1988 USAT's reported capital was $534 million less than the stipulated minimum.

 

27. From the time USAT's regulatory capital fell below the required level in 1987 and at the time of the initial demand to infuse capital into USAT, UFG, MCO and Federated would have been able to contribute very substantial amounts to USAT. As part of his duty of loyalty to USAT, Hurwitz had an obligation to cause UFG, MCO and Federated to make such contributions and to report the net worth of USAT accurately so that such contributions would be made in a timely fashion. Hurwitz was in a position to compel such a result as Chief Executive Officer and Chairman of the Board of UFG, MCO and Federated. Nonetheless, he intentionally refused to do so, thereby breaching his duty of loyalty to USAT.

 

28. Hurwitz knew that USAT would not meet its regulatory net worth requirements long before the Bank Board's demands in 1988. Repeatedly he was advised of USAT's regulatory net worth problems. For example, following the 1986 federal examination, federal regulators advised the USAT Board that a significant regulatory capital shortfall was likely given the understatement of losses in the real estate portfolio. Repeatedly through 1986 Hurwitz was advised of on-going and significant operational losses. He knew in the early autumn of 1986 that USAT's operational losses for the year were estimated to be approximately $77 million. It was clear by January 1, 1987 that USAT would not meet its regulatory net worth requirements and its regulatory net worth was dropping rapidly. Notwithstanding his knowledge, Hurwitz failed to report the true net worth of USAT; continued to take actions that aggravated USAT's losses and further decreased its net worth and took no steps to ensure that UFG did not dissipate its assets or otherwise compromise its obligations to USAT. Had he taken appropriate steps, UFG, MCO and Federated would have been required to make net worth maintenance payments to USAT, and UFG, MCO and Federated would have been in a position to contribute significant additional sums towards their net worth maintenance obligations.

 

29. As a result of Hurwitz's breach of his duty of loyalty, USAT was deprived of substantial infusions of capital that UFG, MCO and Federated were obligated to make. As a result, USAT was significantly damaged

COUNT II

(Joe's Portfolio: Gross Negligence

Aiding and Abetting Gross Negligence

Breach of Fiduciary Duty of Loyalty

From January 1, 1987 through December 30, 1988)

 

A. Parties, Jurisdiction and Venue

 

30. The FDIC realleges and incorporates by reference the allegations of paragraphs 2 through 18.

 

B. The "Roll Down" of Joe's Portfolio

 

31. In 1985, USAT made substantial investments in mortgaged backed securities ("MBS") in what became known as "Joe's Portfolio," referring to Joe Phillips, USAT's junk bond analyst who had responsibility for managing USAT's investments. USAT acquired MBSs funding then with reverse repurchase agreements, and entered into interest rate swap agreements to lengthen the maturity and duration of the reverse repurchase liabilities. USAT's description of the program in an October 28, 1985 letter to USAT's Principal Supervisory Agent at the FHLB of Dallas noted that the asset/liability match "virtually locks in a spread between Unit's asset yield and funding cost." This investment strategy was undertaken with Hurwitz's full knowledge, encouragement and direction.

 

32. Hurwitz, USAT officers and Board members relied excessively on representations and presentations by broker dealers in establishing Joe's Portfolio. They did little or no due diligence on their own. They had little or no appreciation of the complexity of the instruments they acquired. Worse, the institution itself had no procedures or policies with respect to such securities, and few, if any, internal controls over such investment activity.

 

33. As a result, Joe's Portfolio was seriously flawed from the beginning. The interest rate swaps locked in a funding cost of approximately 11%, which generated a positive spread when compared with the original MBSs in the portfolio having a yield of slightly over 12%. But the home mortgagors underlying the MBSs were subject to prepayment at the option of the mortgagors. The possible impact of such prepayments was never considered by USAT though it was commonly known to be a key factor in evaluating MBS risk. Shortly after USAT acquired the MBSs for Joe's portfolio, interest rates plunged, with the five year treasury rate falling from 10.88% in April, 1985 to 7.14% in April, 1986, giving homeowners an incentive to refinance their mortgages. As a result, USAT found that the MBSs were prepaying at a much fast rate than had originally been estimated, depriving USAT of the high yielding assets which were needed to cover the 11% funding cost on the interest rate swaps.

 

 

34. USAT reacted to the accelerating prepayments by selling the high yielding MBSs at a gain before they prepaid and purchasing replacement MBSs at current coupon rates. USAT contends that the theory of this "roll down" strategy was to acquire more stable MBSs that would be less likely to prepay, eroding the assets in the portfolio. However, even if this was the reason for USAT's initial sales of MBSs, it continued to buy and sell MBSs from Joe's Portfolio thereafter, solely for the purpose of claiming short-term profits. Ultimately, USAT ended up with a portfolio of MBSs yielding less than the locked in funding cost on the interest rate swaps. The interest rate swap agreements, which were designed to fix USAT's funding costs for the portfolio at about 11%, exposed USAT to enormous losses after short term interest rates declined substantially from their levels in late 1985. Under the agreements, USAT was required to make periodic payments under the contract at much lower current short term interest rates. Huge losses began to mount quickly.

 

35. In early 1986, senior officers questioned whether the gains on sales of MBS were true gains in light of the replacement of existing MBS with lower coupon MBS which did not cover the cost of the interest rate swap agreements. Numerous internal memoranda indicated that by mid-1986 Hurwitz and other officers and Board members knew that Joe's Portfolio had turned into a major problem. The portfolio had locked in a dangerous negative spread. By early August, the Board was advised that net interest income fell considerably short of expectations because of the reduced spread on mortgaged backed securities. By November and December performance reports reviewed by the Investment Committee and presented to the Board posted losses for October and November of $7.2 million and $16.5 million respectively.

 

36. By the fall of 1986, Hurwitz and the officers and Board members knew that the interest rate swap agreements from Joe's portfolio were a serious threat to USAT. A September 23, 1986 memorandum reveals that a consultant was retained by USAT to propose a strategy "to alleviate the damaging effects of our current swap positions." The consultant advised USAT that it could reverse or offset the swaps and, if it took that action. USAT would "no longer have a negative carry of approximately 500 basis points." USAT rejected those options as "obviously unworkable" because they would require "booking a loss up front," thereby acknowledging the failure of Joe's portfolio and the fictitious nature of MBS gains USAT reported from the roll down strategy. The resulting losses on Joe's portfolio would have reduced USAT's net worth and increased the probability that UFG, MCO and Federated would be required to perform under their net worth maintenance obligations.

 

37. The costs of the swap agreements increased substantially during 1986 as short term interest rates declined. By December, 1986, USAT was paying $3,654,233 under the agreements for one month alone. Losses under the swaps for the entire year totaled $34,907,036. Yet USAT did not terminate the agreements.

 

38. Rather than reduce the risk to USAT by selling the MBS, paying off the financing liabilities with the proceeds and closing out the interest rate swaps, USAT continued Joe's Portfolio, continued to buy and sell MBSs and exposed USAT to further risk of loss. Hurwitz adopted this approach in order to book artificial gains on MBS sales without recognizing the losses associated with closing out the interest rate swaps. These losses would have threatened Hurwitz's continued control of the institution and would have obligated UFG, MCO and Federated to infuse additional capital into USAT. A November 24, 1986 memorandum from senior officer Bruce Williams indicated that as of November 19th, the unrealized mark-to-market losses on the interest rate swap agreements was $122 million.

 

39. By January 1987, the problems with Joe's Portfolio were unmistakably evident. The analysis of the results and risks of the portfolio during 1988 clearly demonstrated those problems. Indeed, Hurwitz was told on January 22, 1987 that "our swaps were not properly designed ..." In January 1987, the full array of information available to Hurwitz demonstrated that it was imperative that USAT act to liquidate the portfolio, recognize the growing losses imbedded in it and free USAT from further risks posed by maintaining the portfolio.

 

40. Despite Hurwitz's knowledge that the gains from he 1986 roll down were not real and that replacing higher coupon MBS with lower yielding securities exposed USAT to a risk of loss if interest rates increased, USAT continued to buy and sell MBS in early 1987. Hurwitz, through the investment Committee, authorized the sale of MBS from Joe's Portfolio, the reporting of artificial gains, and the acquisition of new replacement MBS for the portfolio despite the growing crises. Hurwitz knew that these actions exposed USAT to large losses if interest rates increased. The January 21, 1987 Investment Committee minutes and exhibits indicate that "if rates were to rise 100 B.P., the MBS portfolio would lose over $80 million of its current value... far in excess of the appreciation of the swap position...," resulting in an additional net loss of $47 million. Despite this knowledge, Hurwitz failed to terminate Joe's Portfolio.

41. In April, 1987 and again in September, 1987, interest rates increased substantially and the losses Hurwitz knew would occur actually were incurred. The MBSs in Joe's Portfolio suffered a massive decline in value.

42. The failure to terminate Joe's Portfolio in 1987 was grossly negligent. It was consciously indifferent to the effects of this deteriorating portfolio on USAT's viability. As the controlling person of USAT and a de facto member of USAT's Board of Directors, Hurwitz and other members of the Board owed a duty of care and a duty of loyalty to USAT. The failure to terminate or otherwise address the problems in the portfolio was a breach of these duties.

43. The failure to confront the problems of Joe's Portfolio in January 1987, or any time thereafter, was principally motivated by a desire to avoid the recognition of losses at whatever the cost. Closing out the portfolio and the interest rate swaps would have resulted in the recognition of significant losses, stricter regulatory supervision and calls on UFG, MCO and Federated to perform under their net worth maintenance obligations. Hurwitz wished to avoid this even though it was in the Association's best interest to do so. By maintaining USAT's regulatory net worth artificially high, Hurwitz believed he would protect UFG, MCO and Federated and preserve his ability to conduct business through his other entities. This would also make it possible for him to continue to develop his relationship with Drexel and would improve his chances of obtaining Drexel funds for his own takeover activities.

44. As a result of Hurwitz's gross negligence and conscious indifference to the interests of USAT, his aiding and abetting of the gross negligence and conscious indifference of other USAT officers and directors, and his breach of his duty of loyalty to USAT. USAT incurred substantial damages.

 

COUNT III

(United MBS: Gross Negligence

Aiding and Abetting Gross Negligence

Breach of Duty of Loyalty

From January 1, 1987 Through December 30, 1988)

A. Parties, Jurisdiction and Venue

 

45. The FDIC realleges and incorporates by reference herein the allegations of paragraphs 2 through 18.

 

B. The Formation and Operation of UMBS

 

46. Notwithstanding the problems associated with Joe's Portfolio, sharp criticisms of USAT's activities by federal regulators, and an Association crippled by huge losses in real estate portfolio, USAT approved the formation of UMBS. USAT exercised complete control over the entity. Hurwitz was active in the affairs of the investment Committee which approved UMBS investments and played a significant role in developing the UMBS gamble.

47. Initially UMBS acquired substantial amounts of mortgage backed securities, gambling that interest rates would continue to fall and the value of the portfolio would rise. Subsequently, UMBS put in place substantial positions in derivatives that would move counter to the mortgage backed securities, apparently intending to report short term "profits" by selling MBS or derivatives, depending on which showed profits when interest rates moved. As with Joe's Portfolio, the mortgage backed securities were financed by reverse repurchase agreements. Using the high leverage associated with such financing, USAT sought to report quick profits -- ignoring the fact that such leverage and the use of derivatives meant that in real economic terms, losses were likely to grow at least as rapidly as reported profits.

48. It was a grossly negligent and reckless gamble given the condition of USAT. The institution was in no condition to embark on such an endeavor, a fact known to Hurwitz and the other members of USAT's Board:

 

- In June 1986, an internal memorandum apprised

Hurwitz that operating income was significantly

negative.

 

- A July 1986 memorandum to Hurwitz noted that

USAT was losing $4.5 million per month excluding

extraordinary gains and that special gains

opportunities were close to exhaustion.

 

- In September, Hurwitz was advised that with no

change in interest rates USAT would lose $40 to

$60 million in each of the next three years.

 

- In November, 1986 Gerald Williams advised

Hurwitz that USAT's base operation was losing

money at a rate of $77 million per year -- up

from $40 million per year twelve months

earlier.

 

49. Indeed, by late 1986, USAT appeared to be in serious jeopardy. Nonetheless, gambling that large profits could be achieved, Hurwitz proceeded with the high risk UMBS investment. In November, 1986, USAT began to fund a $100 million equity investment in UMBS to begin securities acquisitions. In March, 1987, USAT increased its investment by another $50 million, although losses had begun to grow significantly. In May, another $30 million was added despite losses of even greater magnitude.

50. USAT retained consultants in 1986 to provide advice about leveraged investments in MBS of the type contemplated for UMBS. Hurwitz knew that the risks of such investments were enormous unless adequate "hedges" were used. One of USAT's consultants wrote in August, 1986 that "if an appropriate hedging strategy is being followed, the decrease in the value of the mortgages will be fully offset by the hedging vehicle, with no resulting economic loss to the investor."

51. Hurwitz knew that hedging vehicles were available to prevent massive losses on the assets in MBS investment programs. A Statement of Purpose for the UMBS subsidiary, which USAT provided to its outside auditors, described such hedging. But despite this knowledge, the writings of USAT's 1986 consultant and the Statement of Purpose, Hurwitz had USAT proceed with investments in UMBS after January 1, 1987 that were not properly hedged against asset loss. What hedges there were, were not adequate to protect the institution. On information and belief, Hurwitz rejected an adequate hedging program in favor of a purely speculative series of bets on interest rate movements.

52. The results were disastrous. It was evident very quickly that this portfolio, like Joe's Portfolio, was performing poorly. Interest rates rose in March and April 1987 and again in September and October 1987 and the value of the UMBS portfolio dropped by $125 million. What hedge protection there was had little impact. As mark to market losses grew dramatically, senior officers at USAT finally acknowledged in May, 1987 that USAT had "an almost black box lack of understanding of these securities." Most remarkably, the growth of losses and this lack of understanding did not moderate Hurwitz's willingness to risk USAT's funds. $80 million was pumped into UMBS after it was evident that the gamble was lost in 1987. Indeed, $30 million was invested after USAT's acknowledgment that it did not understand these instruments.

53. The decision to establish and operate UMBS was motivated not by the best interests of USAT but, again, by the interests of Charles Hurwitz. The UMBS high risk gamble was designed, in part, to generate enough profits quickly to preserve Hurwitz's ability to operate USAT as an indirect funding base for takeover activities. After the gamble failed in 1987, Hurwitz and other officers and Board members refused to recognize the losses imbedded in the portfolio. They did so, again, to maintain control of USAT and to avoid calls on UFG, MCO and Federated to perform under their net worth maintenance obligations.

54. USAT incurred substantial losses from UMBS investments made after January 1, 1987, including the costs of funding those investments. Hurwitz's conduct was grossly negligent and a breach of his duty of loyalty to USAT. By the conduct described above, Hurwitz also aided and abetted other officers and directors in their breach of their duties of care and loyalty.

 

PRAYER FOR RELIEF AND JURY DEMAND

WHEREFORE, FDIC as Manager of the FSLIC Resolution Fund requests that judgment be entered in its favor and against Charles E. Hurwitz for damages in excess of $250 million and requests a jury trial pursuant to Rule 38 of the Federal Rules of Civil Procedure.

 

Dated: August 2, 1995 Respectfully submitted,

HOPKINS & SUTTER

 

By______________________

Lori B. Bellows

State Bar No. 02107501

1717 Main Street, Ste. 3700

Dallas, TX 75201

(214) 653-2100

(214) 653-2255 (FAX)

 

Attorneys for Plaintiff

FEDERAL DEPOSIT

INSURANCE CORPORATION,

as Manager of the FSLIC

Resolution Fund

 

OF COUNSEL:

 

Jeffrey Ross Williams

Robert J. DeHenzel, Jr.

Federal Deposit Insurance Corporation

1717 H Street, N.W.

Washington, D.C. 20006

(202) 736-0648

(202) 736-0685

 

Robert W. Patterson

John L. Rogers

F. Thomas Hecht

Lori B. Bellows

Hopkins & Sutter

Three First National Plaza

Suite 4100

Chicago, IL 60602

(312) 558-6600

 

 

 

 

 

 

 

 

 

 

 

 

 

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