3943 1 UNITED STATES OF AMERICA Before the 2 OFFICE OF THRIFT SUPERVISION DEPARTMENT OF THE TREASURY 3 In the Matter of: ) 4 ) UNITED SAVING ASSOCIATION OF ) 5 TEXAS, Houston, Texas, and ) ) 6 UNITED FINANCIAL GROUP, INC., ) Houston, Texas, a Savings ) 7 and Loan Holding Company ) ) OTS Order 8 MAXXAM, INC., Houston, Texas, ) No. AP 95-40 a Diversified Savings and ) Date: 9 Loan Holding Company ) Dec. 26, 1995 ) 10 FEDERATED DEVELOPMENT CO., ) a New York Business Trust, ) 11 ) CHARLES E. HURWITZ, ) 12 Institution-Affiliated Party ) and Present and Former Director ) 13 of United Savings Association ) of Texas, United Financial Group,) 14 and/or MAXXAM, Inc.; and ) ) 15 BARRY A. MUNITZ, JENARD M. GROSS,) ARTHUR S. BERNER, RONALD HUEBSCH,) 16 and MICHAEL CROW, Present and ) Former Directors and/or Officers ) 17 of United Savings Association of ) Texas, United Financial Group, ) 18 and/or MAXXAM, Inc., ) ) 19 Respondents. ) 20 21 TRIAL PROCEEDINGS FOR 10-21-97 22 3944 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 (Not present) 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 DALE A. HEAD (in-house) 13 Managing Counsel MAXXAM, Inc. 14 5847 San Felipe, Suite 2600 Houston, Texas 77057 15 (713) 267-3668 16 ON BEHALF OF RESPONDENT FEDERATED DEVELOPMENT CO. AND CHARLES HURWITZ: 17 RICHARD P. KEETON, Esquire 18 of: Mayor, Day, Caldwell & Keeton 1900 NationsBank Center, 700 Louisiana 19 Houston, Texas 77002 (713) 225-7013 20 21 22 3945 1 ON BEHALF OF RESPONDENT FEDERATED DEVELOPMENT CO., CHARLES HURWITZ, AND MAXXAM, INC.: 2 JACKS C. NICKENS, Esquire 3 of: Clements, O'Neill, Pierce & Nickens 1000 Louisiana Street, Suite 1800 4 Houston, Texas 77002 (713) 654-7608 5 ON BEHALF OF JENARD M. GROSS: 6 PAUL BLANKENSTEIN, Esquire 7 MARK A. PERRY, Esquire of: Gibson, Dunn & Crutcher 8 1050 Connecticut Avenue, N.W. Washington, D.C. 20036-5303 9 (202) 955-8500 10 ON BEHALF OF BERNER, CROW, MUNITZ AND HUEBSCH: 11 JOHN K. VILLA, Esquire MARY CLARK, Esquire 12 PAUL DUEFFERT, Esquire of: Williams & Connolly 13 725 Twelfth Street, N.W. Washington, D.C. 20005 14 (202) 434-5000 15 OTS COURT: 16 HONORABLE ARTHUR L. SHIPE Administrative Law Judge 17 Office of Financial Institutions Adjudication 1700 G Street, N.W., 6th Floor 18 Washington, D.C. 20552 Jerry Langdon, Judge Shipe's Clerk 19 REPORTED BY: 20 Ms. Marcy Clark, CSR 21 Ms. Shauna Foreman, CSR 22 3946 1 2 EXAMINATION INDEX 3 Page 4 SANDRA ORR 5 Cross-Examination by Mr. Nickens.........3947 6 Redirect-Examination by Mr. Guido........4118 7 Recross-Examination by Mr. Nickens.......4176 8 Redirect-Examination by Mr. Guido........4182 9 JAMES WHATLEY 10 Examination by Mr. Rinaldi...............4185 11 12 13 14 15 16 17 18 19 20 21 22 3947 1 P-R-O-C-E-E-D-I-N-G-S 2 (9:00 a.m.) 3 THE COURT: Be seated, please. The 4 hearing will come to order. I believe at the 5 conclusion of yesterday's hearing, the direct 6 examination was complete. 7 MR. GUIDO: Yes, Your Honor. 8 THE COURT: Mr. Nickens, you're going 9 to cross examine? 10 MR. NICKENS: Yes, sir. Thank you. 11 12 CROSS-EXAMINATION 13 14 15 Q. (BY MR. NICKENS) Ms. Orr, how are you 16 doing this morning? 17 A. Fine. 18 Q. Good. I'd like to ask you some 19 additional questions to those that Mr. Guido asked 20 you yesterday, and why don't we start at the 21 beginning with regard to your being hired at 22 United Savings. 3948 1 Given what you have told us Mr. Ranieri 2 told you, why did you decide to go to United 3 Savings? 4 A. I hated living in New York. There were 5 box people living in front of my apartment 6 building. Everywhere you went, there was filth 7 and stench. It was horrible. 8 Q. And you were asked some questions 9 yesterday about the process of your being hired, 10 and I believe you indicated you came down -- you 11 were interviewed in New York; is that correct? 12 A. Yes. 13 Q. After having been contacted by a 14 headhunter? 15 A. Yes. 16 Q. And then you came to Houston and were 17 interviewed; is that right? 18 A. Yes. 19 Q. Let me show you a document -- you were 20 asked some questions about who interviewed you, 21 and I want to show you a document indicating an 22 interview schedule. And it is B1115. 3949 1 MR. NICKENS: Your Honor, we offer 2 B1115. 3 MR. GUIDO: No objection, Your Honor. 4 THE COURT: Received. 5 Q. (BY MR. NICKENS) I'm going to show 6 you another document of the same subject that has 7 been marked as B1127. 8 MR. NICKENS: And, Your Honor, we offer 9 B1127. 10 MR. GUIDO: No objection, Your Honor. 11 THE COURT: Received. 12 Q. (BY MR. NICKENS) Now, Ms. Orr, 13 looking at B1115, at least who was indicated that 14 were scheduled to interview you? 15 A. Mike Crow, Bruce Williams, 16 Jenard Gross, Jerry Williams, Barry Munitz, Ron 17 Huebsch, and Mike Crow. 18 Q. And do you have any different 19 recollection with regard -- I realize it's a long 20 time ago, but I do this for the record. 21 Do you have any different recollections 22 as to who you may have talked to other than set 3950 1 out on the schedule? 2 A. I have no recollection. 3 Q. Now, this -- B1115 indicates that 4 another person was being interviewed a couple of 5 days before you. 6 Do you see that? 7 A. Yes. 8 Q. And that was Muhamed Sacirbey. Do you 9 know Mr. Sacirbey? 10 A. No. 11 Q. And his resume is attached. You see 12 that? 13 A. Yes. 14 Q. And with regard to B1127, are you aware 15 that Mr. Muller was also interviewing for this 16 position? 17 A. No. 18 Q. And do you know Mr. Muller? 19 A. Yes. 20 Q. Tell the Court who Mr. Muller is. 21 A. He was a Ph.D. student that we hired to 22 do some computer modeling at United. I knew him 3951 1 from MIT and from Freddie Mac. 2 Q. And again, his interview schedule as 3 well as Mr. Sacirbey's is set out in 1115 and 4 1127? 5 A. (Witness nods head affirmatively.) 6 Q. Now, thereafter, you received an offer 7 of employment, did you not? 8 A. Yes. 9 Q. Let me ask you to take a look at B1158. 10 B1158 is Mr. Crow's letter addressed to you dated 11 August 4th, 1986, correct? 12 A. Yes. 13 MR. NICKENS: Your Honor, we offer 14 B1158. 15 MR. GUIDO: No objection, Your Honor. 16 THE COURT: Received. 17 Q. (BY MR. NICKENS) In the second 18 paragraph, Mr. Crow describes an offer of 19 compensation where he indicates that they were 20 offering to pay you $100,000 a year, a 21 25,000-dollar sign on bonus, and a guaranteed 22 bonus payment of $50,000 and an option to purchase 3952 1 5,000 shares of UFG at the market price on the 2 date the options are granted. 3 Do you see that? 4 A. Yes. 5 Q. Now, the actual terms of your 6 compensation were significantly better than that, 7 were they not? 8 A. Yes. 9 Q. And if we look at what was introduced 10 yesterday as Exhibit A10669 -- what's the date? -- 11 at Tab 328. Mr. Guido asked you some questions 12 about this, and this is the agreement on which 13 your compensation was ultimately based? 14 A. I think it followed this pretty 15 closely. 16 Q. And -- I'm sorry. I didn't mean to cut 17 you off. 18 A. That's okay. I believe it followed 19 this fairly closely. 20 Q. And on -- if I could draw your 21 attention to the second page with regard to 22 Paragraph 5, "United agrees that your salary plus 3953 1 bonuses for the period January 1, '87, to 2 January 1, '89, will be no less than $600,000." 3 And No. 6, "United will arrange to guarantee its 4 obligations under this agreement in a manner 5 acceptable to you." 6 Now, how did it come about that your 7 compensation was so much better than the original 8 offer? 9 A. I told them I wouldn't go down there 10 for the first offer. It was less than I was 11 making at Salomon Brothers. 12 Q. And it was these terms that brought you 13 to United Savings? 14 A. Yes. 15 Q. Were they competitive terms as you 16 understood it at the time? 17 A. Yes. I had received a job offer at 18 that same level from a place in Boston about two 19 years previously when I was at Freddie Mac. 20 Q. With regard to your employment at 21 Freddie Mac, tell the Court what you did at 22 Freddie Mac. 3954 1 A. Whatever new thing came up, basically, 2 they would ask me to look at. There was the basic 3 hedging of the entire acquisition program for all 4 sorts of different mortgages. They had a pipeline 5 of about $5 billion worth of mortgages that were 6 being purchased in various loan purchase programs 7 that they felt they wanted to mitigate the risk in 8 institution. So, we would set up positions that 9 were short mortgage securities or short treasuries 10 or we'd buy put options on various instruments 11 that would mimic what the asset should look like 12 that we were going to eventually sell. 13 Q. And the size of the portfolio was 14 approximately $5 billion? 15 A. Yes. 16 Q. And you were the director of hedging? 17 A. Yes. 18 Q. And with regard to those hedging 19 instruments, how frequently, if at all, would you 20 turn over those instruments? 21 A. Well, by turning over -- I mean, you're 22 always extending your hedges out in time and 3955 1 you're always rolling your old contracts into new 2 contracts. So, it would probably end up looking 3 like about two and a half times. 4 Q. On an annualized basis? 5 A. On turn rate on an annualized basis, 6 yeah. 7 Q. Then you went to work for Salomon 8 Brothers. Tell the Court what you did at Salomon 9 Brothers and, if you would, compare it to the 10 position that you had with Freddie Mac. 11 A. It was slightly different because I was 12 selling hedge instruments to customers in addition 13 to doing some mortgage portfolio management. They 14 had a relationship with Pru Home Savings where 15 they were also originating a pipeline of 16 mortgages, pricing loans, to originate them every 17 day, 15-year mortgages, 30-year mortgages, 18 adjustable rate mortgages. 19 So, I would do the pricing for the 20 Pru Home origination, their joint venture. I 21 would hedge the origination. I would sell 22 interest rate swaps, caps to customers. Just sort 3956 1 of whatever involved ancillary mortgage activity 2 at Sali, I would do. 3 Q. And did that also involve turnover with 4 regard to your hedging instruments? 5 A. Certainly. 6 Q. Was that any particular surprise -- 7 A. No. 8 Q. -- that you would have turnover? 9 A. No. By definition, because the 10 contracts to hedge only last a certain period of 11 time and it's generally less than a year, if you 12 are selling short Ginnie Mae 10 and a half hedging 13 30-year residential loan that you've purchased 14 against asset value decrease if you're hedging 15 that, then you can't just continuously short that 16 Ginnie Mae 10 and a half for five years. That 17 would be very expensive. So, you short it for 18 however far out the liquid market is, which is 19 only several months. So, you have to keep rolling 20 these contracts until you actually sell the asset 21 that you're hedging. 22 Q. The -- let me turn to a slightly 3957 1 different subject, Ms. Orr. 2 How would you characterize the level of 3 sophistication with regard to mortgage-backed 4 securities that existed at Freddie Mac and at 5 Salomon Brothers while you were there in the 6 period, let's say, '84 through '86? 7 A. People were just beginning to figure 8 out that mortgages didn't all prepay at a set 9 rate. The assumption all along had been that 10 30-year mortgages prepaid in 12 years, roughly 11 over a 12-year period. Prepaid in 12, they called 12 it. And the 15-year mortgages, let's say, would 13 prepay in seven. 14 So, they had set rates which about 15 equated to 6 percent CPRs on mortgages as a whole 16 that mortgages just didn't move outside that range 17 significantly. So, because people were not aware 18 of their prepayment options, banks did not make 19 them aware of them. They weren't -- they didn't 20 want to prepay their own loans. So -- 21 Q. Now, what changed that perception of 22 things? 3958 1 A. Much more competition in the mortgage 2 market, violent rate moves. You know, when you 3 didn't have rates moving much prior to the Reagan 4 administration, you had rates between, say, I 5 don't know, 13 and 10 roughly. The Reagan 6 administration was the first time when rates 7 significantly moved down. So, that was when you 8 had the huge movements in rates. It made people 9 aware "I don't have to stay in a 10 percent 10 mortgage. I can get an 8 percent." 11 Q. And to be clear about this, this is the 12 perception that persisted at Salomon Brothers and 13 Freddie Mac? 14 A. Salomon Brothers, they were just 15 beginning to do prepayment models when I got 16 there, I believe. And Freddie Mac -- certainly 17 when I was at Freddie Mac, we had the entire range 18 of the street available to us. There wasn't a day 19 when somebody from First Boston or Goldman or 20 Sali, you know, was down in our office. Michael 21 Waldman was continuously there. Lou Ranieri was 22 there. 3959 1 So, we had access to all the best 2 research on the street. We saw them developing 3 these models. They just weren't there. They 4 weren't highly developed. They weren't available 5 to customers. They weren't used by the street at 6 that point because they were still so raw. And 7 then when I got to Sali, they were beginning. 8 Sali was beginning to use it. I mean, I remember 9 talking to Michael Waldman about his developing 10 the prepayment model when I was at Sali, and it 11 was still very rough. 12 Q. Now, how did -- again, talking about 13 the level of sophistication, how did your 14 experience at Freddie Mac and Salomon Brothers 15 compare with the situation at USAT? 16 A. Well, they were all -- it was the same 17 instruments I was trading. I was familiar with 18 all the instruments that I was using. It was 19 different. Well, in terms of the level of 20 expertise in prepayments, it had probably gotten 21 slightly better, but not a lot. 22 Q. And the street contacts were still 3960 1 available to you? 2 A. Yes. 3 Q. Did you handle your job in any 4 significant way different realizing that some 5 years had passed where, you know, knowledge was 6 increasing? 7 A. I put more variance in prepayments, I'm 8 sure, when I was at USAT than earlier. 9 Q. Now, did you know Mr. Phillips? 10 A. I knew him, yes. 11 Q. And he stayed there for several months 12 after you went? 13 A. Yes. 14 Q. And he was working on the high-yield or 15 junk bond portfolio? 16 A. Yes. 17 Q. And was he on the investment committee 18 making reports at the same time you were? 19 A. I'd have to look at a document to see 20 that; but, yes, he sat in on everything and he was 21 there for the transition. 22 Q. And, of course, you had reviewed the -- 3961 1 his work when you came and looked at the 2 portfolio? 3 A. Yes. 4 Q. What was your impression of 5 Mr. Phillips with regard to mortgage-backed 6 securities? 7 A. He was very bright. He had an 8 accounting background. He understood what 9 happened. He thought things were set up a certain 10 way with Peat Marwick, and it turned out that 11 Peat Marwick didn't want him to take the 12 conservative approach. And the way that they 13 rolled down coupons in the mortgage portfolio, the 14 best economic and, as far as I'm concerned, the 15 right approach would have been to do exactly as he 16 did which would be to amortize the gains over the 17 remaining life of the asset. However, there's 18 some reason that they don't want you to do that. 19 So, he was caught in a very bad situation. But 20 he's a very bright person, understood what was 21 going on, and I respected him. 22 Q. With specific reference to the 3962 1 availability of OAS models, you mentioned that 2 yesterday, that you had looked at some OAS models 3 at some point in time while you were at USAT; is 4 that correct? 5 A. Yes. Yes. 6 Q. And what were the -- what was your 7 perception of the OAS models at that point in 8 time? We're talking about 1987. 9 A. I don't know anybody that traded off of 10 them. You know, at best, they were very broad 11 indicators when there was something that you 12 should or shouldn't buy. If every other thing 13 fell in place as to whether you should do 14 something, then you would look at that maybe. But 15 they have so many assumptions in them that were so 16 rough at that time that the street laughed about 17 them basically. 18 Q. Now, you indicated that when you came 19 to USAT, they had been speaking to Smith Breeden? 20 A. Yes. 21 Q. Who was Smith Breeden? Explain to the 22 Court who was Smith Breeden? 3963 1 A. Charles Hurwitz' son had some courses 2 at -- I guess it was North Carolina where Doug 3 Breeden was teaching and thought he was really 4 bright and he had a consulting firm for setting up 5 portfolios at thrifts that were actively traded to 6 produce sort of an option effect. It was just a 7 very active trading. It was a day trading, 8 basically, to simulate an option. When the market 9 would rise, you'd be buying into a rising market. 10 When the market would fall, you'd be selling into 11 a declining market. This was a strategy a number 12 of thrifts took. Franklin Savings and Ottawa used 13 them with disastrous results. 14 Q. Did USAT ultimately use any Smith 15 Breeden model for its risk-controlled arbitrage? 16 A. No. 17 Q. How did they differ? 18 A. I didn't think that Peat Marwick would 19 let us pursue that kind of trading, the day-to-day 20 rebalancing, because it was basically a macro 21 hedge it would be called. And I didn't think that 22 the accountants could handle that, and it 3964 1 turned -- they can't. 2 Q. Now, let me ask you to take a look at a 3 document that we have marked as B1258. B1258 is a 4 letter addressed to you at United Savings dated 5 October 13th signed by Michael Giarla on the 6 letterhead of Smith Breeden Associates; is that 7 correct? 8 A. Yes. 9 MR. NICKENS: Your Honor, we offer 10 B1258. 11 MR. GUIDO: No objection, Your Honor. 12 THE COURT: Received. 13 Q. (BY MR. NICKENS) Now, what was the 14 occasion for your receiving this analysis from 15 Smith Breeden? 16 A. I'm not sure. I don't remember. 17 Q. Well, let me draw your attention to a 18 couple of things in the document, if we might. 19 The third paragraph indicates that "Document No. 2 20 is a paper written by Doug Breeden and myself 21 which is an introduction to hedging from an 22 asset-based perspective. The paper is written for 3965 1 a somewhat unsophisticated reader, quote, 'in 2 terms of hedging,' and I'm sure you will find it 3 rather boring. I have included it in order to 4 complete the package." 5 So, he was complimenting you on your 6 level of sophistication with regard to the hedging 7 activities? 8 A. He was trying to get business. 9 Q. Well, that's undoubtedly true, but 10 would it be fair to say that he was complimenting 11 the level of your sophistication? 12 A. Yes. 13 Q. And if you look at the second page, he 14 indicates "I would also like to discuss with you 15 or with Mike Crow the issue of how the trading of 16 mortgages futures and options will be handled." 17 Then let me ask you to turn over to 18 Page 4 which is actually at US3002046, and it's 19 several pages into the document. It's about seven 20 pages into the document. 21 MR. GUIDO: My copy stops at 2041 and 22 jumps to 2117. 3966 1 MR. NICKENS: Yes. Your Honor, it 2 looks like -- what page does it stop at? Okay. 3 Your Honor, there's some -- in the copying 4 process, we've either misplaced these pages -- 5 just let me ask you to take a look at this. And 6 we'll get the copying situation fixed, Your Honor. 7 This is just -- 8 Q. (BY MR. NICKENS) At what's been 9 marked as Bates marked US3002044 -- and this is 10 the hedging program for savings and loan 11 association by Mike Giarla, Smith Breeden 12 Associates, October of 1985. Mr. Giarla writes, 13 "The choice of the interest rate futures contract 14 to be used for the hedge should be based upon the 15 correlation of the interest rate futures contracts 16 movements with the movements in the interest rates 17 to be hedged." 18 Did you use correlation analysis? 19 A. Yes. 20 Q. And how was it used at USAT, the 21 correlation analysis? 22 A. We used it to correlate the Eurodollar 3967 1 futures positions with the financing rates. 2 Q. Now, this correlation being a 3 mathematical model? 4 A. It's not a mathematical model. It's an 5 R squared. Basically it's a statistic. 6 Q. Using regression analysis? 7 A. Yes. 8 Q. And -- to establish a statistical 9 relationship between two variables and how they 10 move? 11 A. Yes. 12 Q. And one being the price of the futures 13 and the other being the price of the instrument 14 being hedged? 15 A. Yes. 16 Q. Was that the most sophisticated method 17 at the time for doing this hedging analysis? 18 A. That was really just a check for the 19 accountants. It was something that Peat Marwick 20 required and we did. It really didn't have much 21 to do with our decisions about anything. 22 Q. Okay. What did you rely on for 3968 1 those -- purposes of those decisions? 2 A. We needed to target sort of a spread 3 that we wanted to earn, first of all. And then 4 beyond that, you can tell how much hedge you need. 5 Secondly, a consideration was 6 liquidity. You couldn't be in very illiquid hedge 7 instruments in case you needed to do something 8 other than what you had on. 9 Another consideration was margin flow. 10 If you could be in something that would give you a 11 margin flow that would counteract the margin calls 12 on the repo for the asset, that would be 13 desirable. There were a lot of considerations. 14 Q. Okay. Well, let's go back to the 15 subject matter you mentioned. Obviously, when 16 you're talking about a risk-controlled arbitrage, 17 you have a spread between the assets and your 18 funding cost. Right? 19 A. Yes. 20 Q. And you -- to the extent that you -- 21 you can hedge away that entire spread. Right? 22 A. Except for the credit. 3969 1 Q. And the notion is that in order to 2 determine how much you need -- how much hedges to 3 put on, you have to decide what your goal is as 4 far as the spread? 5 A. Yes. 6 Q. Now, is that a complicated or fairly 7 widely accepted notion? 8 A. Yes. It's not complicated and fairly 9 widely accepted. 10 Q. Okay. I mean, you really -- how do you 11 get away from that? 12 A. You don't. 13 Q. Now, let me ask you to look -- and 14 again, I apologize if this is missing. Mr. Guido 15 may want to look here -- at Page US3002406 which 16 is Page 4 of Mr. Giarla's letter where he writes 17 "Clearly the addition of the hedging program in 18 May 1984 reduced the interest rate risk of the 19 association considerably. The net sensitivity was 20 reduced in absolute terms to minus 4.9 million 21 from minus 6.6 million immediately after the 22 hedging program was initiated. Thus, from a macro 3970 1 perspective, the hedging program is, indeed, risk 2 reducing. Subsequent elimination of the remainder 3 of the association's interest rate sensitivity was 4 accomplished by swapping to higher coupon 5 mortgages which have shorter durations and less 6 interest rate sensitivity, internally hedging, and 7 incremental purchases of mortgages with duration 8 matched funds and the execution of an interest 9 rate swap in May of 1985." 10 Now, all of this had occurred before 11 you came to USAT. Right? 12 A. Yes. 13 Q. And Mr. Giarla is just giving a 14 historical perspective from his analysis of what 15 had happened at the institution? 16 A. Yes. 17 Q. Now I'm going to ask you -- and let's 18 see if we can find this in the book. At US -- in 19 your -- at US2119, which is the -- Mr. Breeden and 20 Mr. Giarla's article of May 31, 1986. 21 A. Yes. 22 Q. And it's about three pages into the 3971 1 article. This is -- May of 1986 is the date of 2 the article. Right? 3 A. Yes. 4 Q. Okay. Could you read for the Court 5 what it says at the bottom of Page 2 there? Can 6 you -- right here. 7 A. "As interest rates decrease, prepayment 8 rates on mortgages increase. Additionally, 9 prepayment rates are positively related to the 10 strength of the economy, particularly to housing 11 starts. Schedule 2 shows how prepayments rates 12 have actually changed and how our assumptions 13 about long-run future for payment rates have 14 changed in recent months. As you can see, 15 anticipated prepayment rates on Fannie Mae 13s 16 changed from 15 percent in September 1985 to 17 51 percent in April 1986 as interest rates fell 18 sharply. At the same time, anticipated prepayment 19 rates on lower coupon 8s moved from 7 percent to 20 9 and a half percent." 21 Q. Now, is that referencing the 22 development that you mentioned earlier about the 3972 1 perception of prepayment rates and how it changed 2 in the first quarter of 1986? 3 A. Yes. 4 Q. And if you look over at the schedule, 5 the next page, which is 2120, you can follow 6 there. There are two schedules. One is a coupon 7 treasury yield curve, '84 to '86. And Schedule 2 8 is the Smith Breeden assumed annualized long-term 9 prepayment rates on -- at 2121. 10 Can you point out for the Court how 11 those assumptions about prepayment rates changed 12 in that period in December of '85 through the 13 first part of '86? 14 A. December '85, first part of '86? Okay. 15 So, say on a 12 percent Fannie, they went from 16 20 percent CPR to 37 percent CPR. Actually, 17 39 percent was the peak. On a 13 percent Fannie 18 Mae, they went from a 40 percent to a 52 percent. 19 Q. And as indicated in his letter, the 20 Fannie Mae 13s changed from 15 percent in 21 September of '85 to 51 percent -- 51 percent or 22 not quite four times in April of '86? 3973 1 A. Yes. 2 MR. RINALDI: I'm sorry. Did you say 3 15 to 50 was four times? 4 MR. NICKENS: I said 15 to 51 was not 5 quite four times. 6 MR. RINALDI: Four times would be 60. 7 MR. NICKENS: Yes, sir. 8 MR. RINALDI: Okay. New math. 9 Q. (BY MR. NICKENS) Now, we can find 10 this. There is a chart on Page 27 called "Hedging 11 With Options" and it's Page 27 of the article. 12 And it's marked at 2144. And I'd just like if you 13 could, Ms. Orr, read along here. In the third 14 paragraph. "As interest rates change, the 15 sensitivity of assets, liabilities, and hedging 16 instruments may change by different amounts, 17 leaving the firm in a situation of having to 18 periodically rebalance the hedge. Consider figure 19 8s third panel which shows that the hedge is 20 initially duration matched; but as interest rate 21 levels change, the hedge loses in both 22 directions." 3974 1 Do you see that? 2 A. Yes. 3 Q. Now, that was typical of a 4 risk-controlled arbitrage, was it not? 5 A. Yes. 6 Q. I mean, if you've got it balanced, if 7 you had movement in either direction, you were 8 going to be worse off than you were in the 9 balanced position? 10 A. Yes. 11 Q. Was that something that was avoidable 12 through some special management techniques? 13 A. Yes. You can buy options. You're 14 short options on either side, basically. You're 15 hurt if rates go down because the mortgages 16 prepay. You're left with a liability at a high 17 rate on the books. If rates go up, the asset 18 extends and you're unhedged on the extension. The 19 duration extends on the asset. 20 So, yes, you can buy a lot of options 21 and spend a lot of money to protect yourself 22 either side. But that's why you have an excess 3975 1 spread on a mortgage security over a treasury of 2 whatever it was at that time. 3 Q. So, it wouldn't be at all startling to 4 find out that you were in a situation where, if 5 interest rates moved in either direction, your 6 arbitrage would be worse off? 7 A. Right. 8 Q. In fact, that would be the normal 9 situation? 10 A. Yes. That's true of any mortgage 11 portfolio that's fixed rate hedged with 12 treasuries. 13 Q. And if you choose to hedge away some of 14 that risk, as a practical matter, do you have to 15 choose one side or the other? That is, you'd have 16 to choose -- make a choice about interest rates 17 coming down or going up? 18 A. Well, you could pay to protect both 19 sides but you'd eliminate your spread so... 20 Q. And that's what I meant by as a 21 practical matter, if you were going to go that 22 way, you'd have to choose one way or the other or 3976 1 you would have no spread; is that right? 2 A. Right. 3 Q. Then at the end of that paragraph, 4 Mr. Breeden and Mr. Giarla write, "A hedge that 5 initially matches the interest rate sensitivity of 6 the assets with the sensitivity of the liabilities 7 plus hedges, as was done with the futures hedge 8 described above, will not necessarily be balanced 9 after a change in interest rates has occurred." 10 The next paragraph, "One can choose to 11 counteract this problem by rebalancing the futures 12 hedge periodically. Rebalancing the hedge 13 position entails costs, including transaction 14 costs, which are akin to the cost of buying 15 options and which increase with the volatility of 16 interest rates and the frequency of rebalancing." 17 Do you see that? 18 A. Yes. That was what I was talking about 19 earlier where they are looking at their futures 20 position every day and they are creating an option 21 basically. They are adding optionality to their 22 hedge position by simulating an option using the 3977 1 futures market. It's very expensive because, as I 2 said, you're selling into a down market. You're 3 selling once rates have already moved down and 4 you're buying once rates have already -- no. 5 Values. Once values have already moved up, you're 6 buying. And once values have already moved down, 7 you're selling. It's like being in the stock 8 market and selling after the market's gone down or 9 buying after the market's gone up. And that's to 10 create -- to create the option essentially that 11 you're short with mortgage security. That's why 12 you do that. 13 Q. Now, this is talking about hedging with 14 futures? 15 A. Yes. 16 Q. And the futures market was at that time 17 a fairly well-developed market? 18 A. Extremely well-developed. 19 Q. Now, how did that compare with the swap 20 market at that point in time? 21 A. Marginally developed, the swap market 22 was. 3978 1 Q. Was it more or less expensive to go 2 into the swap market as compared to the futures 3 market if you had chosen to hedge with swaps? 4 A. Well, in the swaps, you have a credit 5 spread that you don't have in the futures because 6 you remargin your account every night on the 7 exchange. The Chicago Board of Trade requires you 8 to rebalance your position every day with them. 9 They don't have as much credit risk as you do in a 10 swap contract. So, a swap is more expensive 11 because somebody on the other side is absorbing 12 the risk that you're a thrift in Texas and 13 committing to a five-year commitment to pay them 14 11 percent. So... 15 Q. And was there, in fact, a new 16 instrument developed known as a swaption to try to 17 address those kinds of problems? 18 A. I'm sure, yes. I mean, I've heard of 19 the instrument. I don't think we ever used it. 20 Q. You were not using swaps for United 21 MBS? 22 A. I don't recall. 3979 1 Q. Okay. The institution owned a lot of 2 swaps when you arrived there? 3 A. Yes. 4 Q. Now, with regard to the instructions 5 that you received, you know, how to do your job, 6 were you ever told that you had to deal with 7 specific dealers? 8 A. No, not at all. 9 Q. What choice did you have with regard to 10 the dealers that you did business with? 11 A. We did a lot of business with Goldman 12 Sachs, Salomon Brothers. Because I had worked at 13 Salomon, I knew people there on the desk. We did 14 probably most of our business, I would guess, with 15 Drexel Burnham Lambert simply because they were 16 the largest presence in the mortgage market at 17 that point in time. 18 Q. Were you ever told that you had to deal 19 with Drexel? 20 A. Never. 21 Q. Were you ever told that you had to go 22 to Drexel if their price wasn't competitive? 3980 1 A. No. 2 Q. What reasons did you exercise with 3 regard to which investment bankers you did 4 business with? 5 A. In the case of Drexel, their salesman 6 was honest. So, that was mainly it. 7 Q. Okay. But were you looking -- I mean, 8 what about price considerations? How did that 9 affect -- 10 A. We got competitive bids on everything, 11 bids or offers. So, generally, it was just best 12 price. 13 Q. Were you ever told that you had to do a 14 trade by someone at the institution? 15 A. Once, and it was the one mentioned 16 yesterday. I believe it was called unauthorized 17 trade. Mike Crow, it was a quarter end. He 18 needed some maturity matching credit to make the 19 capital standards was my understanding of it. 20 Q. And he instructed you to buy ARMs? 21 A. Yes. 22 Q. And to be clear for the record, that's 3981 1 adjustable rate mortgages? 2 A. Right. 3 Q. And adjustable rate mortgages were at 4 that time very expensive, were they not? 5 A. Yes. 6 Q. Now, why were they expensive at that 7 particular -- 8 A. Because the government told you that 9 you could do this maturity matching credit so they 10 drove up the price on these adjustable rate 11 mortgages to a premium of -- they were at 5 point 12 premium to par. 13 Q. Well, let's just make that -- there 14 were a lot of similar institutions doing the same 15 thing? 16 A. Yes. 17 Q. And there were a limited number of 18 adjustable rate mortgages available? 19 A. Yes. 20 Q. And it drove the price up -- this 21 demand drove the price up to where you didn't want 22 to buy them? 3982 1 A. Yes. 2 Q. But for some other reason in the 3 institution, Mr. Crow told you you had to buy 4 them? 5 A. Yes. 6 Q. And you were resistant? 7 A. Yes, but I did the trade. 8 Q. Okay. Now, with that exception, was 9 there ever any circumstance that you can recall in 10 which you were instructed to do a trade? 11 A. No. 12 Q. Now, what about your -- well, let me -- 13 specifically, did Mr. Hurwitz ever instruct you to 14 do a specific trade or to deal with a specific 15 dealer? 16 A. Never. 17 Q. What was his role as you perceived it? 18 A. He was very interested in the equity 19 arbitrage, somewhat interested in the junk bonds, 20 not at all interested in the mortgage securities. 21 He would wander around the trading room 22 periodically and hang around Clint -- and I don't 3983 1 remember his last name -- Clint's desk to see what 2 was going on with the equity arbitrage market and 3 talk to Ron Huebsch and check in with us. But 4 other than that, we didn't see much of him. He 5 was in the weekly meetings, the investment 6 committee meetings. My guess is -- not having 7 statistical confirmation, but 75 percent of the 8 time in the beginning when I was there and more 9 towards, like, 50 percent of the time towards the 10 end. 11 Q. Now, you testified some yesterday about 12 risk-controlled arbitrage and about spreads. And 13 a risk-controlled arbitrage is designed, is it 14 not, to develop a spread? 15 A. Yes. 16 Q. And the idea is to maintain it over 17 time? 18 A. Yes. 19 Q. And in that sense, it is more a cash 20 flow model than a market value model? 21 A. Yes. 22 Q. And can you explain that to the Court? 3984 1 A. Okay. Banks and thrifts have a unique 2 ability that nobody else has in the market -- 3 maybe insurance companies can do it -- but that 4 they used to be able to carry portfolios against 5 deposits and take in spread income and not have to 6 mark-to-market because they did have long-term 7 holding ability for portfolios, unlike other 8 institutions, such as mutual funds which are 9 mark-to-market every day or brokerage firms, which 10 are mark-to-market every day. 11 For this reason, mark-to-markets were 12 not a big concern for banks or thrifts. In fact, 13 a lot of places wouldn't even mark their 14 portfolios to market except for quarterly. I came 15 from a background where I was marking every week 16 at a minute. And so, I insisted that we mark the 17 portfolio weekly because it gives you a clue as to 18 what your margin demands are going to be on the 19 repos against the assets. 20 So, I took a very conservative approach 21 in that way that wasn't required by anybody. 22 Q. Now, if we can elaborate on this a 3985 1 little bit. You know when you set up the 2 arbitrage that the market values of your assets as 3 well as the market value of your hedges are going 4 to go up and down? 5 A. Yes. 6 Q. That's expected? 7 A. Yes. 8 Q. But the notion is that you manage the 9 spread to maintain that spread. Right? 10 A. Well, not even to maintain a set spread 11 but to maintain a spread that's in a reasonable 12 range of where you start out, up or down a 13 reasonable range, because even the spread -- the 14 spread will vary by nature. 15 Q. And the spread will get greater or less 16 depending on market conditions? 17 A. Yes. 18 Q. And -- but the idea is that you come to 19 the end of the arbitrage and if you have matched 20 your assets and liabilities, you know, and had a 21 little luck, then you will be able to close it out 22 without a loss? 3986 1 A. Yes. I've never seen that happen, but 2 that is the theory. 3 Q. That is the notion? 4 A. Yes. 5 Q. And that was the notion that was 6 prevalent at the time? 7 A. Yes. 8 Q. And -- but what you were watching for 9 were those cash flows every month -- 10 A. Yes. 11 Q. -- in terms of priorities? 12 A. Yes. 13 Q. And the way you look at these interest 14 rate -- the effects of interest rates on the 15 market values was through the durations and 16 through correlations? 17 A. Correlations were really just something 18 for the accountants to look at. 19 Q. Okay. And so, what was the tool that 20 you used to try to maintain these cash flows and 21 to the market values? 22 A. Well, you knew what additional hedges 3987 1 would cost if you were thinking about rebalancing. 2 And so, you would say "Do we really need to 3 contract our spread by 30 basis points to get rid 4 of this risk up 200 basis points or do we not need 5 to?" That was the analysis that would go on. 6 Q. Okay. Now, United Savings had owned 7 MBS outside of the risk-controlled arbitrage, did 8 they not? 9 A. Outside of Joe's portfolio or -- 10 Q. Yes, ma'am, at United MBS. 11 A. I don't know. I don't recall. 12 Q. Well, let me ask it this way. Was the 13 DARTs and AMPs program a risk-controlled 14 arbitrage? 15 A. No. 16 Q. What was it and how does that differ 17 from the risk-controlled arbitrage? If you could 18 explain that to the Court. 19 A. It was simply using assets as 20 collateral against a debt issuance. We -- 21 Q. And you could substitute that 22 collateral pursuant to the terms of those debt 3988 1 instruments? 2 A. Yes. 3 Q. And were there times where it was 4 advantageous to do so? 5 A. Yes. 6 Q. And what did you do? 7 A. We substituted collateral. 8 Q. And did that have anything to do with 9 the risk-controlled arbitrage? 10 A. No. 11 Q. Now, was there also a liquidity or 12 treasury portfolio at United? 13 A. Yes. 14 Q. Now, how was that different, if it was, 15 from a risk-controlled arbitrage? 16 A. Given the instruments you're allowed to 17 own by regulation in that portfolio, you were 18 almost always at a negative spread in it. So, it 19 was just -- we tried to keep the minimum in that 20 that you could to get by because it was hurting 21 the institution to hold that. And it was in 22 assets that were totally -- I don't even know 3989 1 what -- I can't remember at this point what assets 2 we had in there. Generally, people held 3 treasuries or something short because it was a 4 negative spread and you had to have a five-year 5 final maturity or less. So, you tried to minimize 6 that portfolio as best you could. 7 Q. Okay. Let me ask you some questions 8 about what I'll call tools or controls. You had 9 available to you consultants? 10 A. Yes. 11 Q. And your street contacts? 12 A. Yes. 13 Q. You had a computer system? 14 A. Yes. 15 Q. And how was that set up? 16 A. At the beginning, I don't think we had 17 Bloomberg. I think we just had either street 18 models for calculating yields, which was really 19 what you're talking about, just calculating yields 20 on different securities; and then we had an 21 internal system for just looking at risk 22 sensitivity that was developed by one of our 3990 1 consultants. And then we finally at some point 2 got Bloomberg. I'm not sure when. 3 Q. Now, did you ever feel that you were at 4 a competitive disadvantage in dealing with the 5 street in doing your job? 6 A. No, not at all. 7 Q. Let me -- 8 A. Mainly because they were not -- the 9 street's designed totally differently than a bank 10 or a thrift. They are not designed to buy and 11 hold assets. So, they use the banks and the 12 thrifts' asset bases basically to create CMOs off 13 of. So, they require the banks and thrifts to 14 make the securities that they get underwriting 15 fees off of. So, they use them as holding tanks 16 for the collateral, basically, and both sides 17 benefit in that. 18 Q. This is probably overly simplistic, but 19 they are a middle man in creating the market. 20 Right? 21 A. Yes. 22 Q. Let me ask you with regard to the 3991 1 question of the source of prepayment assumptions 2 which you were asked about yesterday -- I want to 3 ask you to look at a document that is A10638. And 4 A10638 is a memo from Bruce Williams to the 5 investment committee dated May 27th, 1986. 6 Subject: MBS prepayment speed assumptions. 7 MR. NICKENS: Your Honor, we offer 8 A10638. 9 MR. GUIDO: No objection, Your Honor. 10 THE COURT: Received. 11 Q. (BY MR. NICKENS) Now, Ms. Orr, this 12 is, of course, prior to the time that you were at 13 USAT. Right? 14 A. Yes. 15 Q. But you can look at the document -- and 16 we'll just read the first paragraph if it's 17 acceptable. It says "After review and discussion 18 of various projected MBS prepayment speed 19 assumptions, the asset liability committee has 20 recommended for approval the use of Morgan 21 Stanley's CPR figures summarized in Exhibit 1. 22 These prepayment speeds will be used to record 3992 1 income and will be adjusted on a quarterly or 2 semi-annual basis to compensate for major changes 3 in interest rates, prepayment speeds, et cetera." 4 Have I read that correctly? 5 A. Yes. 6 Q. And then what we see here is simply, as 7 you turn the pages, the CPR assumptions, 8 prepayment assumptions from various sources on the 9 first page. It looks -- indicates Morgan, Drexel, 10 and Smith. 11 Have I read that correctly? 12 A. Morgan, Drexel, and Smith? Which page? 13 Q. It's the very first page on my copy. 14 Yes. There we are. 15 A. Yes. 16 Q. Someone has just done a chart comparing 17 what these street quotes are. And then you'll see 18 there's a memo that follows that, an indication of 19 CMO collateral, and then some sort of bulletin or 20 pamphlet from Morgan Stanley fixed income and 21 setting out how they have done their research to 22 come up with their CPRs. 3993 1 Was that a common or uncommon way for 2 an institution such as USAT to determine what CPR 3 assumptions that it would use in that time frame? 4 A. I think it's probably better than most. 5 Q. Okay. Let me -- again, in terms of 6 these issues of tools, I'm going to ask you to 7 look at B1501. B1501 appears to be a memo to the 8 investment committee from Bruce Williams dated 9 February 24th, 1987. 10 MR. NICKENS: Your Honor, we offer 11 B1501. 12 MR. GUIDO: No objection, Your Honor. 13 THE COURT: Received. 14 Q. (BY MR. NICKENS) Now, B1501 indicates 15 that and you Mr. Schwenkel and Bruce Williams were 16 to meet with the Sendero Corporation. 17 Do you see that? 18 A. Yes. 19 Q. And they were -- you were thinking 20 about using their model to use for certain 21 purposes at the institution; is that correct? 22 A. Yes. 3994 1 Q. And it indicates other savings and loan 2 institutions that used the Sendero model? 3 A. Yes. 4 Q. And it indicates that among the things 5 that it could produce for you was duration 6 analysis and current market value, cash flows, 7 income statements, balance sheet results, 8 "what if" capabilities for various growth 9 strategies and asset liability structures, and 10 results under four interest rate scenarios; is 11 that correct? 12 A. Yes. 13 Q. And you did meet with the Sendero 14 people? 15 A. I don't remember. 16 Q. Do you remember whether or not this 17 tool was purchased? 18 A. Yes, it was. 19 Q. Let me ask you to look at what's been 20 marked as B1657, which is a memo dated June 11th, 21 1987, from Mr. Schwenkel to Mike Crow, 22 Re: Economic consulting services. 3995 1 MR. NICKENS: Your Honor, we offer 2 B1657. 3 MR. GUIDO: No objection, Your Honor. 4 THE COURT: Received. 5 Q. (BY MR. NICKENS) Now, Mr. Schwenkel 6 is at the bottom of the first paragraph before the 7 indented portion. It says -- it describes some 8 information. It says "This information is being 9 received by Sandy Laurenson on an ongoing basis 10 and she believes it is as accurate as other 11 services which require retainer fees." Then there 12 are six investment bankers listed there? 13 A. Yes. 14 Q. Are those six investment bankers with 15 whom you had regular contacts? 16 A. Yes. 17 Q. And the institution was looking at 18 whether we need yet more information. Right? 19 A. They wanted somebody to give an 20 interest rate forecast for the weekly investment 21 committee meeting and they were considering paying 22 somebody for it. And I suggested "Why do that 3996 1 since all these forecasts, you know, are right 2 about 50 percent of the time anyway? So, just get 3 the free information. It's as good as the stuff 4 that you would pay for." So... 5 Q. But the investment committee was 6 considering whether you needed to go get some yet 7 additional information? 8 A. In the format where it would be 9 presented at the time of our investment committee 10 via telephone or whatever, yes. 11 Q. And Mr. Schwenkel, in indicating to 12 Mr. Crow, says -- and this is the resumption of 13 the paragraph after the indention. "In addition 14 to brokerage houses, several firms provide 15 services on a retainer basis. We have contacted 16 Townsend/Greenspan, Data Resources, Inc. and Chase 17 Econometrics. (Chase Econometrics has recently 18 merged with the Wharton Group and is now Wharton 19 Econometrics.) These firms were reluctant to 20 quote price overs the telephone due to the varying 21 options to which an institution can subscribe. In 22 general, all the firms supply clients with monthly 3997 1 forecasts and unlimited access to their 2 economists, et cetera." 3 Now, were these services subscribed to? 4 A. I have no knowledge. 5 Q. In addition to the -- this sort of 6 information available to you, did you prepare on a 7 regular basis a performance report? 8 A. Of the portfolio? 9 Q. Yes. 10 A. Yes. 11 Q. And how frequently was that done? 12 A. Weekly. 13 Q. And let me show you a document that's 14 been marked as A12038 by way of example only. 15 MR. NICKENS: I can't find my copy, 16 Your Honor. I'll go past that, Your Honor, and 17 come back to it. 18 Q. (BY MR. NICKENS) In addition to -- 19 you have weekly meetings of the investment 20 committee. Right? 21 A. Yes. 22 Q. A performance -- where you prepared 3998 1 regular reports? 2 A. Yes. 3 Q. Then you had the performance reports 4 done on what kind of frequency? 5 A. I don't remember. I don't know what 6 performance reports are referring to. 7 Q. I'll come back to that. And in 8 addition to that, in addition to these 9 consultants, was there an audit process at United? 10 A. Yes. 11 Q. And you were -- you and your department 12 were audited both internally and by the external 13 auditors, Peat Marwick? 14 A. Yes. 15 Q. With regard to -- what were they 16 looking for? 17 A. I don't know. 18 Q. Let me show you a document that we've 19 marked as B1845 which purports to be the internal 20 audit report for United Financial Group dated 21 November 13th, 1987, Peat Marwick & Company. 22 MR. NICKENS: Your Honor, we offer 3999 1 B1845. 2 MR. GUIDO: No objection, Your Honor. 3 THE COURT: Received. 4 Q. (BY MR. NICKENS) And, Ms. Orr, if you 5 can just look through here, you can see that you 6 were audited for your compliance with internal 7 committee policies. And I'll refer you over to 8 180498. 9 A. I don't know what -- 10 MR. GUIDO: What are you referring to? 11 Q. (BY MR. NICKENS) If we look over at 12 Page 180497? 13 MR. GUIDO: There is no such number. 14 Q. (BY MR. NICKENS) Let me do it this 15 way. If you look over at the page entitled 16 "Summary of Investment Committee Policies and 17 Procedures" with the number 156683, you'll see 18 that the auditors had summarized the policies and 19 procedures -- 20 MR. GUIDO: Objection. That's a 21 mischaracterization of what the documents says. 22 The document says it was prepared by the internal 4000 1 audit department at USAT. It doesn't say the 2 outside auditors. 3 MR. NICKENS: Well, Your Honor, I said 4 the auditors but I'll accept that clarification. 5 THE COURT: All right. 6 Q. (BY MR. NICKENS) It indicates that -- 7 and then the next page, you see that they have 8 listed various UFG and USAT investment committee 9 policies. Do you see that? 10 A. Yes. 11 Q. Which they are indicating that they are 12 auditing compliance with that, correct? 13 A. Yes. 14 Q. And you'll see on the next page, which 15 is 156685, they have got overriding policies and 16 the very first thing there is compliance with 17 regulations, correct? 18 A. Yes. 19 Q. So, you were -- 20 A. We were very careful about that. 21 Q. So, you were audited with your 22 compliance with regulations where it says "Every 4001 1 policy shall first and foremost be consistent with 2 external regulatory requirements. No investment 3 transaction for the company shall knowingly be 4 allowed to cause the company to violate any 5 regulation of the FSLIC, the Texas Savings and 6 Loan Department, the Federal Home Loan Bank Board, 7 or any other regulatory body to which the company 8 is responsible"? 9 A. Yes. 10 Q. And you were audited for compliance 11 with that -- those issues. Right? 12 A. Yes. And in addition, Art Berner was 13 very careful in my area, that I know of, to run 14 everything past the regulators. Any futures 15 transaction that we did was approved by them. Any 16 futures options transaction that we did was 17 approved by them. 18 Q. And it also indicates "assumption of 19 responsibility and authority, delegation of 20 responsibility and authority," the circumstances 21 in which thus should occur. And then if we turn 22 over a few pages to Page 156690, you have a list 4002 1 of authorized brokers? 2 A. Yes. 3 Q. Now, how many -- give me an estimate. 4 A. This isn't all of my authorized brokers 5 for the mortgages. This includes equity 6 arbitrage, junk bonds, other people also. So, I 7 guess my guess is that I had Bear Sterns 8 authorized. I had Dean Witter, DLJ, Drexel 9 Burnham, Federal Home Loan Bank. 10 MR. GUIDO: Your Honor, I object to 11 this line of questioning. If you read the cover 12 page of the audit report on Page 1, Mr. Nickens is 13 assuming a fact that isn't presented by this 14 document. The document sets out what the scope of 15 the audit is and Mr. Nickens is asking questions 16 that are unrelated to the scope of the audit and 17 trying to get this witness to confirm that those 18 matters were audited. I think that this line of 19 questioning is inappropriate in light of the 20 description of what the audit is, Your Honor. 21 MR. NICKENS: Your Honor, that is 22 clearly a subject for cross-examination if it is 4003 1 factual at all, but I was asking the witness at 2 this point in time to identify from those list of 3 brokers those that she personally did business 4 with which, of course, is an issue in this case 5 because the OTS has made this claim about Drexel 6 Burnham. 7 THE COURT: And that's based on her 8 knowledge rather than the auditors? 9 MR. NICKENS: That's what we were 10 hearing, Your Honor. 11 THE COURT: All right. Proceed. 12 Denied. 13 A. Goldman Sachs, Greenwich Capital, 14 Kidder Peabody, Merrill-Lynch, Morgan Stanley, 15 Prudential Bache, Salomon Brothers, Smith Barney. 16 I'm not sure about that one, but I think they 17 were. 18 Q. Was there any major dealer in 19 mortgage-backed securities that were not on your 20 list of people? 21 A. No. 22 Q. Now, coming back to -- and this is just 4004 1 by way of example -- A12038. 2 MR. NICKENS: Your Honor -- 3 Q. (BY MR. NICKENS) Well, have you had a 4 chance to look briefly at the format reflected by 5 A12038? 6 A. Yes. I'm familiar with it. 7 Q. And it is the page from the monthly 8 performance reports relating to mortgage-backed 9 securities? 10 A. Yes. 11 Q. What was your role in preparing these 12 monthly reports? 13 A. None. Russell McCann prepared them. 14 Q. And what was your -- did you supply 15 information to Mr. McCann to prepare them? 16 A. I don't remember. 17 Q. Now, did they become a part of your 18 reports to the investment committee, if you 19 recall? 20 A. No. I don't think so. I mean, I don't 21 recall doing that. 22 Q. Let me ask you to look over to the 4005 1 third page of Exhibit A12038. 2 MR. NICKENS: Your Honor, we offer 3 A12038. 4 MR. GUIDO: No objection, Your Honor. 5 THE COURT: Received. 6 MR. GUIDO: Did you say the third page? 7 MR. NICKENS: Third page, which is 8 US859. 9 Q. (BY MR. NICKENS) Do you see a 10 handwritten note there from Mr. Crow to you? 11 A. Yes. 12 Q. Indicating "shouldn't you present this 13 to the investment committee on Wednesday"? 14 A. Yes. I did have information after I 15 left from an internal source at United that 16 indicated that, if anything, these yield spreads 17 were conservative, that there had been sort of a 18 miscalculation on the yields to the point where 19 they were light in these reports and they 20 corrected it subsequent to my departure. 21 Q. And to your information, did USAT keep 22 track of its gap position? 4006 1 A. Yes. 2 Q. And what did the gap position purport 3 to measure? 4 A. The gap is the difference between the 5 asset maturity and the liability maturity which 6 it's something that the regulators require to 7 measure. It's not -- it's not really useful to 8 portfolio management, per se, because it's very 9 limited in the information that it gives. 10 Q. But it purports to represent interest 11 rate exposure of the institution? 12 A. Yes. 13 Q. And you had your own methodologies for 14 measuring interest rate exposure, did you not? 15 A. Yes. Duration, other things. 16 Q. You had durations as well as your 17 scenario analysis which you did on a weekly basis? 18 A. Yes. 19 Q. Now, that scenario analysis might be 20 called today a stress test? 21 A. Yes. 22 Q. And tell the Court how that tool has 4007 1 evolved: That is, the use of scenario analysis or 2 the stress test. 3 A. It's now required by the banking 4 regulators to run scenarios up and down 200 basis 5 points. I was just doing it because it's what I 6 thought was needed to see what was going to happen 7 to the portfolio. You make assumptions in the 8 test about the speeds in varying rate scenarios. 9 So, it is very subjective but it gives you 10 probably the most useful information that you can 11 get on a portfolio as a whole. 12 Q. And it's run on the holdings that you 13 have in the portfolio on a particular date? 14 A. Yes. 15 Q. So, for example, if you had swapped a 16 position, you'd be able to compare the effect of 17 that transaction, along with all the other things 18 that had happened in that week, from looking from 19 one week to the next? 20 A. Yes. 21 Q. Okay. Now, I'm going to go through 22 with you, if we can, a rather imposing stack of 4008 1 investment committee minutes, most of which were 2 introduced yesterday. And in order to facilitate 3 this, I have -- to the extent we can -- put those 4 in front of you, Ms. Orr. And I will start with 5 Exhibit A1412? 6 MR. GUIDO: Excuse me, Your Honor. 7 Could we have a list of the group of them so we 8 can organize them so that we don't have to disrupt 9 the flow of the proceedings to find the documents? 10 MR. NICKENS: Your Honor, I don't -- I 11 can get a list, but these are done -- I'm going to 12 go through them chronologically. And until we get 13 toward the latter time frame -- it's pretty much 14 all of them. Mr. Guido introduced most of them 15 yesterday and I will indicate to the Court and 16 supply copies when I get to one that was not 17 discussed yesterday. But they are otherwise 18 chronological. And by and large, they were -- the 19 exhibit numbers themselves are chronological, 20 along with the date. 21 MR. GUIDO: Starting with 1412? 22 MR. NICKENS: 1412. 4009 1 Q. (BY MR. NICKENS) Ms. Orr, do you have 2 Exhibit 1412 in front of you? 3 A. Yes. 4 Q. Which purports to be the investment 5 committee minutes of October 8th, 1986? 6 A. Yes. 7 Q. And these are the weekly investment 8 committee minutes? 9 A. Yes. 10 Q. Now, let me ask you: Were these 11 minutes highly secret documents? 12 A. Not at all. 13 Q. Were they made available to any of the 14 management that wanted them? 15 A. I believe so. 16 Q. Were they made available on a routine 17 basis to the examiners and regulators? 18 A. I believe so. They would have been. 19 Q. Well, were you ever told to not put 20 something into your report because the regulators 21 would see those reports on a routine basis? 22 A. No. 4010 1 Q. Were you ever instructed that you ought 2 to try to hide something you were doing by not 3 putting it into your report? 4 A. No. 5 Q. Did you ever do so? 6 A. No. 7 Q. Now, with regard to Exhibit 1412, I'd 8 like, if you could, to turn over to Page -- it's 9 4917 if I'm reading that correctly. 10 A. It's a good number. 11 Q. Do you have that? 12 A. Yes. I've got it. 13 Q. You were questioned yesterday about 14 that policy with regard to trading policy? 15 A. Yes. 16 Q. And this is the one that you had 17 proposed? 18 A. Yes. 19 Q. And we see that because if we go back 20 to the second page of Exhibit 1412, at the very 21 top, it says "Ms. Laurenson then discussed the 22 association's mortgage-backed securities. She 4011 1 presented a proposal regarding mortgage-backed 2 security trading policy. Such proposal was fully 3 discussed and unanimously approved by the 4 investment committee. It was ordered that such 5 proposal would be presented to the board of 6 directors for their approval. Ms. Laurenson then 7 reviewed the persons with which she would be 8 trading and the method that she would be utilizing 9 in conducting such trades." 10 Now, this was one of your very first 11 meetings of the investment committee, correct? 12 A. Yes. 13 Q. Then it says "She also reviewed her 14 views on the market outlook and suggested some 15 recommendations to the investment committee. She 16 described in detail the mechanics of a Smith 17 Breeden-type proposal, including the creation of a 18 synthetic treasury security and utilization of 19 various hedging devices. The investment committee 20 fully discussed the proposals and agreed to review 21 them at the next committee meeting." 22 Do you see that? 4012 1 A. Yes. 2 Q. Now, at this point in time, the Smith 3 Breeden proposal was still being actively 4 considered. Right? 5 A. Yes. 6 Q. I mean, in fact, we saw the proposal 7 earlier and it's dated, like, October 13th, a few 8 days after this meeting? 9 A. Right. 10 Q. And then if we go over where we were 11 before, it shows your trading policy. Then 12 brokers authorized to conduct business is the next 13 page, is it not? 14 A. Yes. 15 Q. And was that your list or somebody 16 else's list? 17 A. It was my list. This was probably very 18 early on because it's very limited and it's not 19 who we ended up doing a lot of business with. 20 Q. And with regard to Drexel Burnham 21 listed there, there's a Roger Whitlin and then 22 marked in Mike Sorensen? 4013 1 A. Yes. 2 Q. Now, was that your choice or somebody 3 else's choice? 4 A. My choice. I knew Roger Whitlin from 5 Goldman Sachs. Yeah. The reason that's marked 6 that way is because Roger Whitlin was at Goldman 7 Sachs at that time and it was a correction to show 8 that Roger was at Goldman Sachs and then Mike 9 was -- Mike Sorensen was at Drexel Burnham. 10 Q. Okay. And then it goes on. It shows 11 recommendations to the investment committee. It 12 says "Complete contract with Smith Breeden in 13 order to allow United access to the exact 14 transaction descriptions that they are 15 recommending. This will allow presentation of RCA 16 performance over a range of rate and spread 17 assumptions in next week's meeting. Prepare 18 processing and accounting reports to track the 19 trades." You go into this brief discussion of 20 market outlook. 21 Then you, on the next page, you 22 describe the MBS portfolio as it then existed? 4014 1 A. Yes. 2 Q. Is that correct? 3 A. Yes. 4 Q. And you had mostly 8s and 9s, Fannie 5 Mae and Freddie Mac, with one small piece of a 6 12 and a half? 7 A. Yes. 8 Q. You then go on the next page to 9 describe in detail the Smith Breeden-type 10 proposals? 11 A. Yes. 12 Q. Including the risks associated with it? 13 A. Yes. 14 Q. Then there's a diagram and then you 15 give a report about the summary of results under 16 varying scenarios? 17 A. Yes. 18 Q. And then you give -- what's the next 19 page? Cash flows if rates are unchanged? What is 20 that? 21 A. I don't know at this point in time. I 22 can't remember what -- if this was describing the 4015 1 Smith Breeden transaction or what it was. 2 Q. Now, let me ask you to turn to 1413. 3 Here we are eight days later and it indicates on 4 the front page that "Ms. Sandy Laurenson then 5 discussed the association's mortgage-backed 6 securities portfolio. A report showing her views 7 on market and economy was ordered attached to the 8 minutes of the meeting." 9 And then if we turn over to the first 10 page of your report, which is the third page of 11 the document, you've got -- 12 MR. GUIDO: What's the Bates stamp, 13 please? 14 MR. NICKENS: It is US3004935. 15 Q. (BY MR. NICKENS) You have a market 16 commentary and then you get to recommendations. 17 And would you read what you were recommending with 18 regard to swap ideas at that point? 19 A. "Continue to look for opportunities to 20 complete rolling 200 million Freddie Mac 9s to 21 Freddie Mac 9 and a half's. We've already done 22 114 million at 2 and 10/32nds (the market is now 4016 1 at 2 and 16/32nds), having picked up two or more 2 basis points in yield and $91,000 in earnings. 3 This roll is being done to diversify the portfolio 4 more and give it more cushion in a rising rate 5 scenario. At the same time, it does not affect 6 the duration of the mortgage portfolio versus the 7 swaps." 8 Q. Okay. Then you go to discuss another 9 possibility? 10 A. Yes. 11 Q. Now, what did you mean that this roll 12 is being done to diversify the portfolio more and 13 give it more cushion in a rising rate scenario? 14 A. We were rolling to a higher coupon. 15 What Joe had done was they had put on the initial 16 position of the Ginnie Mae 12s and -- versus the 17 swaps. And then he'd rolled down in coupon to the 18 point where he was at a Freddie Mac 8, I believe. 19 A Freddie Mac or -- yeah. Freddie Mac 8 or 9. A 20 lot of 8s and 9s. I felt like that was a little 21 bit too much of a current coupon security in terms 22 of rate risk going forward. I wanted more cushion 4017 1 if rates rose. So, I bought Freddie Mac 2 9 and a half's instead. 3 Q. And you made an analysis there of the 4 effect of the durations on the swap. Right? 5 A. Right. 6 Q. And that is an analysis of the effect 7 of market -- interest rate movements on market 8 values? 9 A. Right. 10 Q. It's a measure of the price elasticity 11 of the mortgage-backed securities, is it not? 12 A. Yes. 13 Q. And it is talking about the effect of 14 interest rate movements? 15 A. Yes. 16 Q. Which was an analysis you were doing on 17 the swap proposal? 18 A. Yes. 19 Q. Now, was this good or bad for the 20 portfolio? 21 A. I don't remember the effect of it. But 22 I -- I don't think it would have hurt at all. You 4018 1 know, in a hundred basis point move, I don't think 2 it would have made much different duration-wise 3 and it would have given you some price protection. 4 Q. And greater diversity as you mentioned? 5 A. Yeah. 6 Q. Now, why would it not have much impact 7 duration-wise? 8 A. Because -- well, I don't know. I 9 assume that the 9 and a half's were about 50 basis 10 points out of the money or in the money. Excuse 11 me. In the money in terms of being a premium. 12 Q. Okay. 13 A. Security. So, it just -- it wouldn't 14 have shortened the duration that much on the 15 assets versus the long swaps that we had on. And 16 yet, it would give you more protection in an up 17 rate scenario. 18 Q. And you go on to report about the 19 status of the Smith Breeden and you say "A Smith 20 Breedenite is coming to United today and another 21 on Monday to sell Peat Marwick on their style of 22 transaction accounting. If this is impossible, I 4019 1 recommend that United uses asset accounting if 2 necessary and proceed with a 50-million-dollar dry 3 run transaction." 4 Then the next page of your report is 5 what? 6 A. Monthly economic indicators, historical 7 price volatility for treasury bonds, all kinds of 8 graphs. 9 Q. All right. Comparing it with the 10 Ginnie Mae and 10-year treasuries? 11 A. Yes. 12 Q. And that was something that you 13 watched? 14 A. Yes. 15 Q. And would that be the sort of 16 information for which you might be able to discern 17 a swap opportunity? 18 A. Yes. 19 Q. Then what is the next page? 20 A. This was the first stab probably at a 21 report which would show the mark-to-market, how it 22 changed on the week. 4020 1 Q. You listed every security, its coupon? 2 A. Right. 3 Q. The price? 4 A. Right. 5 Q. The amount? 6 A. Right. We did this every week. I 7 noticed in looking at the exhibits yesterday that 8 the detail wasn't in the weekly investment 9 committee reports, but we had copies of the 10 details to back it up every week. 11 Q. Then the next page is -- I believe you 12 were asked about this yesterday -- is where you 13 summarize the trade proposal that you were 14 presenting to the committee? 15 A. Yes. 16 Q. And you put down the relevant -- what 17 you thought was the relevant information that they 18 needed to consider in looking at it? 19 A. Yes. 20 Q. And then the next page is the beginning 21 of the equity arbitrage report? 22 A. Yes. 4021 1 Q. Let me ask you to look at A1414, which 2 is the investment committee report of 3 October 22nd. 4 Before we move on there, Ms. Laurenson, 5 in the written part of the report, you are 6 explaining the reasons for your recommendation? 7 A. Yes. 8 Q. Yesterday, Mr. Guido just showed you 9 the graphic information that you presented to the 10 committee. Right? 11 A. Yes. 12 Q. And if you read the whole thing, it's 13 clear that you're looking at interest rate -- the 14 effects of interest rate because you've got your 15 duration analysis? 16 A. Yes. It was discussed every week. 17 Q. Okay. Let's go to 1414, which is the 18 minutes of October 22nd, 1986. 19 A. Yes. 20 Q. And I'd like you to turn to the second 21 page, which is US3004950. And it reports there at 22 the beginning of the second paragraph, "Ms. Sandy 4022 1 Laurenson then presented the current status of the 2 association's mortgage-backed securities 3 portfolio. She reviewed the current market 4 outlook and presented a report which was ordered 5 attached to the minutes of the meeting. She noted 6 that the association had perhaps too many of 7 Freddie Mac 9 mortgage-backed securities and that 8 she would be attempting to take profits in the 9 security and diversify the portfolio. She then 10 presented a proposed transaction which was part of 11 her report. After full discussion of the 12 substance of the transaction as well as the 13 accounting which would be reported as a result of 14 the transaction upon a motion duly made, seconded 15 and unanimously adopted, it was resolved" and so 16 on. 17 Now, what did you mean that the 18 association had perhaps too many Freddie Mac 9s? 19 A. Well, actually, looking at the last 20 week's minutes that we just went over, I noticed 21 that the WAM on the mortgages we were holding, the 22 Freddie Mac 9s was 285 or 58, whatever. It was 4023 1 much shorter than a 360. 2 Q. And the WAM is weighted average 3 maturity? 4 A. Weighted average maturity. We had long 5 swaps that we had to cover. And so, it probably 6 would have been a superior position to be in a 7 longer WAM security than that. And that's why we 8 weren't giving up to go to the 9 and a half. Even 9 though it's a premium coupon, the duration on it 10 would have been a little bit longer than the 11 normal premium because it was new origination 12 versus the 9s which were seasoned product. So... 13 Q. And then if we turn over to Page 4961, 14 you give -- this is the beginning of your report, 15 is it not? 16 A. Yes. 17 Q. And you give the market outlook, 18 expectations. Then on the next page, you give a 19 daily mark-to-market on the DARTs and the treasury 20 portfolios? 21 A. I must have been marking every day at 22 that point. 4024 1 Q. Was that required, to your knowledge? 2 A. No. 3 Q. Why were you doing it? 4 A. Because I cared about every aspect of 5 the portfolio. 6 Q. Was this a management tool? 7 A. Again, we were not -- we were not 8 hedging a mark. We were hedging a spread. So -- 9 but, yes, it's a management tool in that you need 10 to know what your margin calls were going to be on 11 the repo. 12 Q. Then there's a chart. It says "Drexel 13 Burnham Lambert." Do you know what's being 14 charted there? 15 A. It looks like a 7 and a quarter 16 treasury of May 16, which would have been the 17 30-year bond at that point in time. 18 Q. Then you give a proposed transaction. 19 You were asked about this yesterday, but in the 20 bottom, what is that -- 21 MR. GUIDO: What's the Bates stamp, 22 please? 4025 1 MR. NICKENS: US3004964 on my copy. 2 Q. (BY MR. NICKENS) Now, you're 3 giving -- is that what we called a scenario 4 analysis down there at the bottom? 5 A. Yes. 6 Q. Of the proposed transaction? 7 A. Yes. 8 Q. Now, how does that relate to interest 9 rate fluctuations which you were asked about 10 yesterday, about whether you ever considered those 11 things in looking at your swap transaction? 12 A. That's what that is. That means -- 13 Q. Explain to the Court how that -- 14 A. If the entire yield curve shifts by 200 15 basis points -- looking at the left-most column -- 16 if the entire yield curve moves down by 200 basis 17 points from the 30-year down to the three-month, 18 then the reaction of the suggested trade would be 19 as detailed. 20 MR. NICKENS: Your Honor, it's 10:30. 21 I intend to march through these reports, which is 22 going to take us a little time. 4026 1 THE COURT: All right. We'll take a 2 short recess. 3 MR. NICKENS: Thank you. 4 5 (A short break was taken 6 at 10:29 a.m.) 7 8 THE COURT: Be seated, please. 9 Mr. Nickens, you may continue. 10 MR. NICKENS: Thank you, Your Honor. 11 (10:54 a.m.) 12 Q. (BY MR. NICKENS) Ms. Orr, when we 13 took our break, we were looking at -- beginning to 14 look at A1416, which is the -- which are the 15 minutes of November 5, 1986. And skipping over 16 the written description in this instance, let me 17 ask you to look over at Page US3005042. 18 A. Okay. 19 Q. Is that -- should be a letter or memo 20 from Mike Crow to the investment committee? 21 A. Yes. 22 Q. Of October 30th, 1986, indicating 4027 1 that -- Mr. Crow indicates that "The Smith Breeden 2 relationship is not working satisfactorily from 3 both United's perspective and Smith Breeden's 4 viewpoint." And going -- moving down that first 5 paragraph there, about five or six lines up from 6 bottom, he says "Smith Breeden is offended by 7 Sandy Laurenson's questioning as well as the 8 groups that we have sent to North Carolina to 9 review their process: Bruce Williams, Doug 10 Hansen, and Jim Wolfe. Doug told me that he did 11 not feel the relationship with Smith Breeden was 12 going to work, especially because of Sandy 13 Laurenson's detailed questioning of their 14 analysis." 15 And then he goes on to list four 16 reasons -- lack of attention, poor response time, 17 failure to suggest specific transactions, failure 18 to answer questions, and then, according to Sandy 19 Laurenson, several examples of weak analytical 20 work on the part of Smith Breeden. 21 In any event, he goes on to say "We 22 were going to terminate the relationship and that 4028 1 we would like to consider hiring Mr. Muller." 2 Do you see that? 3 A. Yes. 4 Q. Now, is that consistent with your 5 recollection of these events -- 6 A. Yes. 7 Q. -- as to the reasons why the Smith 8 Breeden relationship was terminated? 9 A. Yes. 10 Q. Now, let me ask you to turn over past 11 Mr. Muller's resume and the report from the 12 headhunter to the summary of swaps to take profits 13 that you were asked about yesterday at US5047. 14 A. Yes. 15 Q. Now, you indicated that there was some 16 calculation being done about economic value but 17 you could no longer remember what it was; is that 18 right? 19 A. Yeah. I can't recall the exact detail 20 of it. 21 Q. Let me see if we can help on that. I 22 want to refer you to some documents. First, I'm 4029 1 going to hand you a document that has been marked 2 as B1102 which is a document from Doug Hansen to 3 Jenard Gross dated July 14th, 1986, Re: Strategy 4 for next 18 months. 5 MR. NICKENS: Your Honor, we offer 6 B1102. 7 MR. GUIDO: No objection, Your Honor. 8 THE COURT: Received. 9 Q. (BY MR. NICKENS) Now, again, 10 Ms. Laurenson, this is before your time, correct? 11 A. Yes. 12 Q. But let's look at what Mr. Hansen 13 writes to Mr. Gross. In the one-line paragraph, 14 the second paragraph, he says "Our major problems 15 are, in order of importance, capital." And then 16 he goes on to discuss under "capital," he said 17 "Capital is going to be king over the next few 18 years. We might consider having a long-run target 19 of building capital even above the raised 20 regulatory minimum to lower risk and increase 21 ability to take advantage of opportunities. In 22 the short run, our dwindling capital is our 4030 1 largest problem. Implied worth of capital to 2 United is very high due to necessity to survive. 3 We should be willing to pay a lot for capital. 4 High worth of capital means we should hesitate to 5 realize losses for the next 18 months even though 6 long-term economics may recommend doing so. Thus, 7 we should not call bonds or whatever at a loss. 8 We should value very highly any opportunity to 9 realize gains." 10 Then if you go over four pages -- 11 A. To 428? 12 Q. Let me see here. Well, let me ask you 13 to look at another document, B1212. B1212, Your 14 Honor, is a memo from Mr. Hansen to Bruce 15 Williams, Joe Phillips, and Mike Crow headed 16 "mortgage-backed security trading committee." 17 MR. NICKENS: And we would offer B1212. 18 MR. GUIDO: No objection, Your Honor. 19 THE COURT: Received. 20 MR. NICKENS: It is dated 21 September 8th, 1986. 22 Q. (BY MR. NICKENS) It indicates at the 4031 1 top "Meetings of the mortgage-backed securities 2 trading committee were held on Thursday, 3 September 4th and 5th -- excuse me -- 4 September 4th and Friday, September 5th. All 5 members were present at both meetings." 6 And then skipping one paragraph, it 7 says "The committee approved the execution of the 8 second leg of a two-part trade that was in 9 process. Joe Phillips had sold 80 million Freddie 10 Mac 9s and purchased Fannie Mae 9s at the same 11 price. Fannie Mae 9s typically trade 8/32nds 12 dearer than Freddie Mac 9s. The initial trade 13 allowed United to purchase the Fannie Maes 14 cheaply. One month later, Joe Phillips proposed 15 reversing the trade as Fannie Mae 9s were now 16 selling 10/32nds dearer than Freddie Mac 9s. The 17 completion of the trade will yield United a gain 18 of $250,000 and leave us with the Freddie Mac 9s 19 we originally owned." 20 Now, is that the sort of value trading 21 that you were describing for the Court yesterday? 22 A. Yes. 4032 1 Q. Is that the sort of thing that traders 2 do, mortgage-backed securities do on a daily 3 basis? 4 A. Yes. Portfolio managers do on a daily 5 basis. 6 Q. And what are the advantages of the -- 7 well, when you trade a Freddie Mac 9 for a Fannie 8 Mae 9, have you changed the duration outlook of 9 your portfolio in any material respect? 10 A. No. You've just changed the payment 11 delay. That's all. 12 THE COURT: Excuse me? 13 THE WITNESS: The payment delay has 14 change. That's it. 15 Q. (BY MR. NICKENS) Well, now, why is it 16 that the market would price these things 17 differently if they are, in fact, so similar? 18 A. Because there is probably a short 19 position to acquire collateral for a CMO that a 20 broker has established a CMO structure and needs 21 to acquire the collateral to back it up. And so, 22 they are limited to one sort of coupon in agency 4033 1 for the collateral for that CMO and so they have a 2 high demand for that collateral. 3 Q. And willing to pay a slightly higher 4 price for it? 5 A. Yes. 6 Q. Similar things happen with dollar roll 7 financing? 8 A. Exactly. They happen with corn and 9 soybeans and any commodity. 10 Q. And to take advantage of them, you've 11 got to watch the market and -- 12 A. Yes. 13 Q. -- and get in there? 14 A. Yes. 15 Q. Okay. Now, it goes on to say 16 "Mike Crow had a prior conversation with Smith 17 Breeden on this trade. They did not oppose it. 18 The committee noted that although the market yield 19 on the two securities were similar, the second leg 20 of the trade had the effect of lowering book yield 21 by 12 basis points. In the past, trades have 22 generally been made by looking at market values or 4034 1 economics rather than accounting yield. This was 2 appropriate before the recent accounting change." 3 Now, do you recall this reference to 4 your earlier testimony that Peat Marwick had 5 required USAT to begin recognizing gains or losses 6 on the sales of MBS in June of 1986? 7 A. Yes. 8 Q. Now, he goes on to say "With the new 9 accounting treatment, gains and losses on trades 10 are recognized immediately. There is a trade-off 11 with every transaction between one-time earnings, 12 gains, or losses and changes in the recurring net 13 interest margin. The committee recognized the 14 need to devise a decision rule for these 15 situations. The decision rule will hinge on the 16 value United places on capital. The committee 17 discussed a variety of possible cost of capital 18 numbers ranging from 9 to 20 percent. Input from 19 the investment committee on this matter would be 20 helpful." 21 Now, when you go to sell any 22 income-producing -- or when you go to consider a 4035 1 sale of any income-producing asset, one is 2 required, are they not, to measure the value of 3 receiving those funds now as opposed to receiving 4 them over time? 5 A. Yes. 6 Q. And is there anything the least bit 7 unusual about those kinds of considerations for a 8 thrift? 9 A. No. That's just prudent management. 10 Q. Now, let me ask you to look at 11 Exhibit A1409. A1409 is the minutes of the 12 investment committee of United Financial Group 13 dated September 18th, 1986. 14 Do you see that? 15 A. Yes. 16 MR. NICKENS: And, Your Honor, we offer 17 A1409. 18 THE COURT: Received. 19 MR. GUIDO: No objection, Your Honor. 20 Q. (BY MR. NICKENS) And you see there at 21 the top that it was a meeting of the investment 22 committee on September 18th, 1986, and present 4036 1 were Mr. Hurwitz, Mr. Gross, Mr. Williams, 2 Mr. Phillips, Mr. Jacobson, and Mr. Hansen and 3 Mr. Hansen acted as the secretary. 4 Do you see that? 5 A. Yes. 6 Q. Then turn to the second page with me 7 and look at the next-to-last paragraph. "The 8 committee reviewed the minutes of the 9 mortgage-backed securities trading committee for 10 the week. All transactions were approved. The 11 committee then discussed the implicit cost of 12 capital calculation made when a trade is made 13 which improves the association from an economic 14 perspective and allows a book gain but lowers 15 ongoing book spread income. The committee then 16 debated the optimal degree to which United should 17 specify characteristics of particular mortgage 18 pools when trading these securities." 19 Now, in your judgment, Ms. Laurenson -- 20 Ms. Orr, is this the sort of thing that one should 21 be looking at in trying to decide whether or not 22 to sell an asset? 4037 1 A. Yes. 2 Q. And is there anything in your judgment 3 that is untoward or unusual about trying to have a 4 decision point with regard to when to be able to 5 sell an asset in comparing it to the cost of 6 capital? 7 A. Is there anything unusual about that? 8 Q. Yes. I mean, is this -- 9 A. No. 10 Q. Let me ask you to look at B1231. B1231 11 is a memo from Mr. Hansen to Mike Crow, Joe 12 Phillips, Bruce Williams, the investment 13 committee, Re: Mortgage-backed securities trading 14 committee, September 22nd, 1986. 15 MR. NICKENS: We offer B1231, Your 16 Honor. 17 MR. GUIDO: No objection, Your Honor. 18 THE COURT: Received. 19 Q. (BY MR. NICKENS) You see here, 20 Ms. Orr, it says that "The committee met several 21 times during the week of September 15th to approve 22 and execute a trade from Freddie Mac 4038 1 9 and a half's to Freddie Mac 8 and a half's. 2 Crow and Williams were absent. Smith Breeden was 3 consulted on the trade. The book -- the gain 4 booked is $700,000. The loss in spread income is 5 $150,000 in the first year. The implied 6 capitalization rate is 21 percent." 7 Do you see that? 8 A. Yes. 9 Q. And does this indicate that the 10 committee is then looking at a cost of capital 11 analysis -- 12 A. Yes. 13 Q. -- in deciding whether to make these 14 trades? 15 A. Yes. Now, Mr. Guido asked you about a 16 memo which is A10702 and let's see if we can -- 17 which is a memo from Gerald Williams to 18 Mr. Hurwitz, Mr. Gross, Mr. Munitz dated 19 November 24th, 1986. It's entitled "USAT running 20 rate product line P&L." 21 MR. NICKENS: Has this been introduced? 22 MR. GUIDO: Is this the document that 4039 1 was also introduced in Mr. Williams' testimony? 2 MR. VILLA: I believe it was, yes. 3 Q. (BY MR. NICKENS) Before we -- 4 MR. NICKENS: Pardon me for one second. 5 6 (Discussion off the record.) 7 8 Q. (BY MR. NICKENS) Ms. Orr, if I could 9 stand with you here, we're looking at T4310 which 10 is the memo from Bruce Williams of November 24th, 11 1986. And I want to focus -- this is the memo 12 that Mr. Guido questioned you about, I believe, 13 concerning an analysis of the position of the MBS 14 gains vis-a-vis the current mark-to-market rate of 15 the swaps. 16 A. Yes. 17 Q. And that's an analysis which 18 Mr. Williams goes through and ultimately concludes 19 that it is -- it has been basically a break-even 20 situation, quote, "when the equity capital is 21 fully leveraged as shown below." 22 Do you see that? 4040 1 A. Yes. 2 Q. And the assumption that he makes there 3 in November of '86 was assuming a 15 percent cost 4 of capital. 5 Do you see that on the second page? 6 A. Yes. 7 Q. And it says "the economic impact" in 8 quotes. Now, let me ask you to look back at 9 Exhibit A1416 and the page that we were looking at 10 about economic value. 11 A. Yes. 12 Q. Now, if you take -- let's take the 13 first line. If you take the Freddie Mac 14 9 and a half's where you sold 55.7 million and you 15 had a loss of .13 in yield -- correct? 16 A. Yes. 17 Q. On a one-year basis -- and I've tried 18 to do the math, but Mr. Rinaldi can check us -- 19 that would indicate a loss in income of $72,410 -- 20 A. Yes. 21 Q. -- if my math is right? 22 A. Yes. 4041 1 Q. And that's what you're giving up each 2 year by the loss in yield? 3 A. Yes. 4 Q. And what you have gained is an 5 accounting gain of 1,805,376. Right? 6 A. Yes. 7 Q. And if you multiply that by 15 percent, 8 you get 2 million 708 -- excuse me -- 270,806. 9 Right? 10 A. Yes. 11 Q. Okay. 12 MR. NICKENS: Got the numbers going? 13 Q. (BY MR. NICKENS) And then if you 14 subtract 270,000 -- 72,410 from 270,806, what do 15 you get? 16 A. $198,396. 17 Q. And where is that -- is that number 18 reflected on Exhibit A1416? 19 A. Yes. It's the top number in the 20 economic value column. 21 Q. And what would that indicate to you was 22 the calculation going on with regard to 4042 1 determining the economic value? 2 A. That you're comparing the gain which 3 would be added to capital. You're allowing that 4 as sort of cost of capital for a year calculation 5 and that you don't have to go out and raise 6 $1.8 million of capital. You've got it in 7 earnings for the portfolio. 8 Q. All right. In other words, instead of 9 having to go out into the market and raise capital 10 which you have to pay for. Right? 11 A. Yes. 12 Q. And they are assuming that if we have 13 to pay as much as 15 percent for it, we're still 14 better off taking this gain today? 15 A. Yes. 16 Q. Now, let me ask you to come back and 17 look at the investment committee reports and we 18 are on November 12th at A1417. 19 A. Yes. 20 Q. This is one that Mr. Guido asked you 21 about in your direct testimony. And if we turn 22 over to Page US301347 -- 4043 1 A. Yes. 2 Q. You have your report, beginning of your 3 report? 4 MR. GUIDO: This is which exhibit 5 again? 6 MR. NICKENS: This is A1417. The 7 investment committee minutes of November 12th, 8 1986. 9 Q. (BY MR. NICKENS) And you describe 10 there the goals for each segment of the portfolio? 11 A. Yes. 12 Q. And you indicate that for the 13 investment portfolio, you would like to maintain 14 current yield levels on assets and use 15 opportunities to take profits and swap to 16 higher-yielding securities. Use opportunities to 17 shorten swap maturities, take fee income, and 18 reduce swap yields by writing puts on a five- to 19 ten-year treasury. That was your goal? 20 A. Yes. 21 Q. Anything wrong with that goal as you 22 evaluate it here 10 or 11 years later? 4044 1 A. No. 2 Q. With regard to your MBS subsidiary, you 3 were indicating that the goal was to buy high 4 coupon Freddie Macs, 10s and 12s, and hedge the 5 assets and financing for one to two years, earn an 6 annualized return on investment. Right? 7 A. Yes. 8 Q. ROI of 12 and a half percent? Anything 9 looking at it here today that was wrong with that 10 goal? 11 A. No. 12 Q. Then you've got "old DARTs." It says 13 "Replace old valuable collateral, large pools, 14 even coupons with odd coupon TBA" -- that's to be 15 announced. Right? 16 A. Yes. 17 Q. -- "product --" that means new product. 18 Right? 19 A. Right. 20 Q. "To enhance yields. Work up procedures 21 to ensure smooth transaction of replacements." 22 Now, you saw some trades that we looked 4045 1 at yesterday and some of those trades were these 2 DARTs trades that are described right here, 3 correct? 4 A. I can't remember if I saw any quarter 5 coupon trades in there or not. So, I don't know. 6 But it would be a worthy goal. 7 Q. And by "quarter coupon," you're talking 8 about the coupons that there's not a large market 9 for? 10 A. Right. It's limited supply. 11 Q. And then you indicate that the goal for 12 the new AMP was to buy out of the money puts on 13 Freddie Mac 9s at low volatilities to protect the 14 portfolio liquidation value. Buy long-dated 15 Eurodollar futures put options to protect 16 financing rate of collateral and roll of AMP 17 rates. Gradually replace good pools of collateral 18 with old coupon junk pools." 19 See that? 20 A. Yes. 21 Q. Now, how do you evaluate that goal here 22 today 11 years later? 4046 1 A. I think it was fine in the situation we 2 were in. 3 Q. What you're basically doing was 4 replacing the collateral to the extent that you 5 could under the limitations of the agreements that 6 you had with the people that had the preferreds? 7 A. Yes. 8 Q. But those were not arbitrage -- not 9 risk-controlled arbitrages like the one you were 10 doing at United MBS? 11 A. No. We had large generic pools of 12 Freddie Mac 9s, I would assume, something like 13 that, against the AMPs, and those are very dollar 14 rollable. The street really loves them for 15 collateral for CMOs, whereas we didn't care that 16 the stuff was CMO or not. It was no advantage to 17 us except for carrying costs at the Federal Home 18 Loan Bank. But -- so, we could replace with 19 smaller pools with less -- smaller pools 20 basically. 21 Q. Okay. Let me ask you, if we could, to 22 move on to the next minutes, which is A1418, the 4047 1 minutes of November 19th, 1986. 2 A. Yes. 3 Q. And at the bottom of the first page, it 4 indicates that "Ms. Sandy Laurenson then discussed 5 the mortgage-backed securities portfolio. She 6 presented a report which was ordered attached to 7 the minutes of the meeting." 8 That was the sort of standard 9 procedure. Right? 10 A. Yes. 11 Q. And then "She reviewed the report in 12 detail going over each of the items set forth 13 therein." That also was standard procedure, 14 correct? 15 A. Yes. 16 Q. And this is a bit of an aside, but if 17 you look over at 10337, you see a newspaper 18 account there? 19 A. Yes. 20 Q. Now, that -- you weren't dealing with 21 the junk bonds, but this was reported that the 22 Federal Home Loan Bank had determined in some 4048 1 study by Mr. Sahadi that junk bonds were no 2 problems to thrifts, November of 1986? 3 A. Yes. And then they subsequently 4 destroyed the junk bond market. 5 Q. Then let me ask you to look over to 6 your report which begins at Page US3010339. 7 A. Yes. 8 Q. And again, the typical format, you've 9 got the market overview stating what had happened 10 and the expectations for the coming week. Right? 11 A. Yes. 12 Q. And then the next page shows your 13 portfolio activity? 14 A. Yes. 15 Q. Indicating some incremental economic 16 yield over in the last column for these trades? 17 A. Yes. 18 Q. And then finally, the next page is 19 what? It's hard to read. 20 A. That's just the weekly mark-to-market. 21 Q. This is where you told the committee 22 what had happened to the value of the securities 4049 1 in the portfolio on a weekly basis? 2 A. Right. 3 Q. Let me ask you to look over at A1419. 4 A. Yes. 5 Q. Which is the minutes of November 25, 6 1986. 7 A. Yes. 8 Q. And if we look at the second page, you 9 presented your report as usual and it was attached 10 and then it says "The report was discussed at" -- 11 this is in the third paragraph, the second page. 12 "The report was discussed at great length 13 including the current trading in the portfolio in 14 order to adjust the portfolio for market gains and 15 losses. Ms. Laurenson also distributed a report 16 on the current yield and a report which showed 17 what the yields would be if rates were up 50 basis 18 points. A lengthy discussion was had on the 19 effect of interest rate changes on the portfolio 20 and it was determined that in view of the desire 21 to adjust the portfolio, it would be appropriate 22 to take profits from the AMPs mortgage-backed 4050 1 securities collateralizing the DARTs and AMPs 2 issues while keeping yield at an appropriately 3 high spread." 4 Do you see that? 5 A. Yes. 6 Q. So, the committee did consider the 7 effect of interest rates on the portfolios? 8 A. Always. 9 Q. And in this particular instance, they 10 indicated that it should be appropriate to take 11 profits from the AMPs mortgage-backed securities 12 which was the subsidiary that we discussed. 13 Right? 14 A. Yes. 15 Q. Which was not a risk-controlled 16 arbitrage? 17 A. Yes. 18 Q. Then quickly if we go over to 10312 -- 19 oh. It's Page 10312, yes. 20 A. Okay. 21 Q. It shows your typical organization, 22 your market review for the past week, the 4051 1 expectations for the next week shows your 2 activities, indicates the profit and loss 3 highlights. Then it gives your weekly 4 mark-to-market. Right? 5 A. Yes. 6 Q. Then we see a couple of page over, it 7 indicates that this is the -- 8 MR. GUIDO: Which Bates stamp are you 9 talking about? 10 MR. NICKENS: 5106, where it shows up 11 50 basis point scenario. 12 MR. GUIDO: Which exhibit are you in? 13 MR. NICKENS: I'm in 1419. 14 MR. GUIDO: What page? 15 MR. NICKENS: US3005106. 16 THE WITNESS: It's in the front. 17 MR. GUIDO: What's the heading on the 18 page? 19 MR. NICKENS: Well, my page -- they are 20 backwards is the problem, but it says "up 50 basis 21 points." 22 THE COURT: Seems to be a disruption in 4052 1 the serial numbers there from 329. The next one 2 is 3210. 3 MR. NICKENS: Mine goes from 315 to 4 5106, Your Honor. 5 Q. (BY MR. NICKENS) But this is the -- 6 this is the up 50 basis points scenario that was 7 mentioned in the beginning. Right? 8 A. Yes. 9 Q. Then if we go over to -- on mine, it's 10 10323 -- we find Mr. Williams' memo that we just 11 discussed? That is, Mr. Bruce Williams? 12 A. Yes. 13 Q. Attached to the minutes. See that? 14 A. Yes. 15 Q. Now, was the thinking about when to 16 take gains highly secret at United Savings? 17 A. No. 18 Q. And, of course, it was well known that 19 these minutes were one of the first things that 20 the examiners looked at? 21 A. Yes. 22 Q. So, why attach this description of 4053 1 Mr. Williams' analysis? 2 A. Why not? We were open about what our 3 motives were with the portfolios. We checked 4 everything with Peat Marwick to make sure it stood 5 up to the tests of the time. So, why not? 6 Q. Okay. Well, let's look over, if we 7 could, to the next investment committee minutes of 8 B1421. 9 A. Yes. 10 MR. GUIDO: 1421? 11 MR. NICKENS: Yes. The second page, 12 which is 5122 if I'm reading it correctly. 13 Q. (BY MR. NICKENS) And you see your 14 report there at the top? 15 A. Yes. 16 Q. You reported that you were looking to 17 take some profits from the AMPs and DARTs mortgage 18 portfolio of replacing the collateral. Same thing 19 we talked about before. Right? 20 A. Yes. 21 Q. And then selling some puts to create 22 artificial dollar rolls. Why don't you explain to 4054 1 the Court how that worked? 2 A. Well, when you sell -- if we were going 3 to grow the portfolio anyway, which we decided to 4 do as seen in the memos from Jerry Williams and 5 the constant reminders of Jenard, we needed to 6 grow the portfolio by a certain amount by a 7 certain time apparently. And one of the best ways 8 to do that is to write puts. And if you get 9 exercised, then you get the assets plus you get 10 the fee income. 11 Q. Okay. That is what you discussed 12 yesterday. Right? 13 A. Yes. 14 Q. And if we go over to Page 5129, which 15 is the beginning of your report, you show your 16 market review for the past week and your 17 expectations for the coming week, correct? 18 A. Yes. 19 Q. Then on the next page, you list your 20 activities as you typically did? 21 A. Yes. 22 MR. GUIDO: What's that page again? 4055 1 MR. NICKENS: It is Page 5130. You 2 asked about this yesterday. 3 MR. GUIDO: May I make a suggestion, 4 Your Honor? I think that it would be appropriate 5 if counsel in referring to the pages would refer 6 to the Bates stamp number so that the testimony of 7 the witness can be properly compared between the 8 two. Otherwise, I think that all of this is going 9 to be very meaningless if we don't do that. 10 MR. NICKENS: Well, I object to any 11 comment about it being meaningless; but I will try 12 to accommodate the record and to make that 13 designation because it is technical and a lot of 14 numbers. 15 THE COURT: All right. 16 Q. (BY MR. NICKENS) Now, you were 17 questioned about this document yesterday -- that 18 is, 5130. And in the one transaction you've got, 19 you're selling Freddie Mac 9 and a half's and 20 buying Fannie Mae 9s. That is, in the first of 21 the inventory accounts? 22 A. Yes. 4056 1 Q. Now, what would be your expectation 2 with regard to the impact of such a transaction on 3 your duration matching? 4 A. Buying 9s and selling -- it depends on 5 the WAM on the bond really. I can't say at this 6 point. 7 Q. Was that the sort of thing that you 8 looked at? 9 A. Yes. 10 Q. And that is, again, by looking at 11 duration matching, you are looking at the price 12 elasticity or the impact of interest rates? 13 A. Yes. 14 Q. Then if we turn over -- well, first of 15 all, there's -- in here in the middle of this, 16 there's some stuff about equity arbitrage. Right? 17 A. Yes. 18 Q. And then if we get over to Page 5136, 19 you then describe for the committee about the 20 option writing buying program? 21 A. Yes. 22 Q. And you give them, at Page 5137, a 4057 1 scenario analysis which is called a chart of 2 return patterns? 3 A. Yes. 4 Q. And then on the next page, you give 5 them a chart of the price changes in relationship 6 to what? 7 A. Rate changes. 8 Q. Okay. Then you tell them at Page 5139 9 what the problems are with the return pattern? 10 A. Yes. 11 Q. And then on the next page, you offer a 12 solution? 13 A. Yes. 14 Q. And this would all be things that would 15 be discussed in the committee? 16 A. Yes. 17 Q. Then you go on to option strategies, 18 shortening the liability duration, using puts to 19 create an artificial dollar roll. And then you 20 move into the subject of residuals which is 21 referenced the first of the report, correct? 22 A. Yes. 4058 1 Q. Let me ask you to turn to Exhibit 1423 2 which is the -- which are the minutes of 3 December 22nd, 1986, of the investment committee. 4 And you see there in the middle of the page, 5 you're talking about acquiring ARMs? 6 A. Yes. 7 Q. Coffee ARMs. Right? 8 A. Yes. 9 Q. And about $300 million worth? 10 A. Yes. 11 Q. Now, if you buy ARMs, would you 12 typically hedge those instruments? 13 A. Not if you had deposits that were 14 financing them in that case. 15 Q. Now, why is that? 16 A. Because the deposits are a liability 17 that moves in the same -- at the same rate that 18 the asset would move in terms of yield. 19 Q. ARMs using short-term rates are in some 20 respects self-hedging, aren't they? 21 A. Yes. 22 Q. I mean, they change with short-term 4059 1 rates on an annual basis? 2 A. Yes. 3 Q. Now, if we look over at your report 4 which begins at US35181 -- 5 A. Yes. 6 Q. And you give your typical market 7 review -- last week, this week -- and then the 8 next page gives your typical activities and 9 indicates the transactions that have occurred in 10 the prior week. Right? 11 A. Yes. 12 Q. And you look there at your DARTs and 13 AMPs. Remember we were talking about that? 14 A. Yes. 15 Q. Are you there effectuating the goal 16 that you talked about? 17 A. Yes. 18 Q. And in particular, you sold some Fannie 19 Mae 9s and bought some Ginnie Mae 9s in the DARTs 20 and AMPs program? 21 A. Yes. 22 Q. And then look over at the next page, 4060 1 which is 5183. And you've got your profit and 2 loss comments. Right? 3 A. Yes. 4 Q. And your third item is "Freddie Mac 5 9 and a half's increased in value relative to 9 6 and 8 and a half's. The portfolio is barbelled 7 around the 9 percent coupon to maintain duration 8 while increasing yield. Pass-through certificates 9 8 and a half's -- that's PC 8 and a half's have 10 not been issued in volume yet and are expected to 11 become especially scarce in January." 12 Do you see that? 13 A. Yes. 14 Q. Now, describe for the Court what a 15 barbell strategy is. 16 A. Rather than buying an expensive coupon, 17 if, let's say, 10s are expensive, you'd buy 18 9 and a half's and 10 and a half's instead. And 19 that way, you're creating something that's 20 duration neutral to the 10 that you would really 21 want to buy, but it's out of line in price for 22 some reason. 4061 1 Q. Now, you're referring to duration 2 analysis there. That is, as we have discussed 3 several times, price elasticity, the relationship 4 of the -- the reaction, rather, of the securities 5 to changes in interest rates? 6 A. Yes. 7 Q. Then let me ask you to turn over to 8 Page 5185, which I think is two pages over. And 9 you are describing there your 11th District coffee 10 ARMs that you purchased. Right? 11 A. Yes. 12 Q. And you've got your note "Why did we 13 buy this?" And you go through the explanation? 14 A. Yes. 15 Q. Now, were these the ARMs that you did 16 not want to buy? 17 A. Yes. 18 Q. Let me ask you to look at A1424, which 19 are the minutes of January 5, 1987. 20 A. Yes. 21 Q. Okay. The first page indicates 22 "Ms. Sandy Laurenson then reported on the 4062 1 mortgage-backed securities portfolio. A report 2 which she had prepared was ordered attached to the 3 minutes of the meeting. Her report was then 4 discussed in detail, including her proposed plans 5 which, after full discussion, were unanimously 6 approved." 7 Do you see that? 8 A. Yes. 9 Q. Once again, that was sort of the 10 standard procedure. You came in with your report. 11 You went over it point by point. Everybody said 12 whatever they had to say about it, correct? 13 A. Yes. 14 Q. Now, we go over to your report which is 15 at Page 5194. And Mr. Guido asked you about this 16 yesterday where you indicate what your plans -- at 17 the bottom -- what your plans for the portfolio 18 were with regard to each of the different items, 19 different portfolios? 20 A. Yes. 21 Q. And then the next page is, again, your 22 sort of standard reporting on the various market 4063 1 movements and prices? 2 A. Yes. 3 Q. Okay. Let me ask you to look over at 4 A1426, which are the minutes of January 21, 1987. 5 A. 1426? 6 Q. 26, yes. I skipped one of them. 7 A. Yes. 8 Q. It indicates that you reported as usual 9 and your report was attached and then it says "A 10 full discussion of the portfolio's interest rate 11 sensitivity took place showing the effect on the 12 mortgage-backed securities portfolio of increases 13 and decreases in interest rates." 14 So, you did discuss the effect of 15 interest rates? 16 A. Yes. 17 Q. "Ms. Laurenson also discussed the 18 results of her put program. It was determined 19 that the program would be reduced in size to a 20 maximum of $100 million." And if you look over at 21 your report which is at Page 5222 -- 22 A. Yes. 4064 1 Q. -- you report as usual, the market 2 review of the prior week, the upcoming week, the 3 activities that you describe as "Realized profits 4 in the speculative put-writing program exceed 5 1.87 million over one and a quarter months. We 6 have not had puts exercised against us and the 7 strategy of acquiring excess inventory in cheap 8 forward delivery months has worked well." 9 Then on the next page, you describe the 10 transactions in which you are going from -- you 11 are exchanging some Freddie Mac 9 and a half's for 12 Fannie Mae 9 and a half's, a pure value trade, 13 correct? 14 A. Yes. 15 Q. And exchanging some Freddie Mac 9s and 16 Fannie Mae 9s. Right? 17 A. Yes. 18 Q. Now, would you expect that such trades 19 would have any significant or material duration 20 impact? 21 A. No. It would depend on the WAM; but, 22 no. 4065 1 Q. Then the next page, which is at 5224, 2 you have a discussion about sensitivity analysis? 3 A. Yes. 4 MR. GUIDO: That's 5225, isn't it? 5 MR. NICKENS: 5224 is mine. 6 Q. (BY MR. NICKENS) And you were -- this 7 was discussed with you yesterday, and I'll not go 8 through it again. But the paragraph -- the second 9 paragraph under the sensitivity analysis was "This 10 is an improvement of roughly $19 million in 11 liquidation value over the value run on 12 December 31. The liquidation value approved by 13 7 million if rates declined 100 basis points and 14 17 million if rates rise 100 basis points." And 15 then you discuss your plans and goals about 16 enhancing fee income and purchasing 15-year 17 products. You see that? 18 A. Yes. 19 Q. The next page is at 5225 where you show 20 the up and down 100 basis points scenario 21 analysis, correct? 22 A. Yes. 4066 1 Q. The next page is your regular report on 2 the market value of each? 3 A. Yes. 4 Q. Let me ask you then to look at A1427, 5 which are the minutes of January 28th, 1987. 6 A. Yes. 7 Q. Again, the usual indication that you 8 reviewed your report and went over it and it was 9 attached. And then if we go over to the report 10 which begins at Page 5259 -- 11 A. Yes. 12 Q. -- we see, again, the typical 13 arrangement. And then at the top of Page 5260, 14 your sensitivity analysis? 15 A. Yes. 16 Q. And let me specifically refer you to 17 Bullet Point No. 2. You say there "The overall 18 portfolio has become even more bullish due to the 19 addition of 100 million Freddie Mac 8s that were 20 put to us this week. If these are called away, 21 the bullishness will be mitigated. The investment 22 portfolio and DART subs contribute to this 4067 1 performance. The DART sub is totally unhedged and 2 the swaps in the investment portfolio are 3 overcollateralized." 4 Now, what would be the effect of that 5 observation with regard to the sensitivity 6 analysis? 7 A. When rates go up, you get hurt. 8 Q. And this is what you were discussing 9 with the committee? 10 A. Yes. 11 Q. Then you've got your values and then 12 you've got your -- at Page 5262, you've got your 13 portfolio activity that you reported on every 14 week? 15 A. Yes. 16 Q. And there in the DARTs, you were, 17 again, exchanging Fannie Mae 9 and a half's for 18 Freddie Mac 9 and a half's? 19 A. Yes. 20 Q. That was what was discussed with you 21 yesterday? 22 A. I don't remember. 4068 1 Q. Well, you were asked, Ms. Orr, about 2 the consideration of interest rates with regard to 3 such a trade, the effect on interest rates. 4 Would you expect -- 5 MR. GUIDO: Objection. That's not what 6 the question was yesterday. The question was 7 whether or not she had considered the effect of 8 the trade on interest rate sensitivity, not on 9 interest rates. 10 MR. NICKENS: Okay, Your Honor. If I 11 misspoke, I apologize. 12 Q. (BY MR. NICKENS) But in any event, 13 you were questioned with the -- about whether or 14 not you had considered the impact of this trade on 15 the interest rate sensitivity of the institution? 16 MR. GUIDO: Objection, Your Honor. 17 That wasn't the question. The question was 18 whether or not this report reflected an analysis 19 of a consideration of the trade on interest rate 20 sensitivity of the association. The questions 21 were very carefully phrased in that way, Your 22 Honor. 4069 1 MR. NICKENS: I don't want to go back 2 and find the question, Your Honor. 3 Q. (BY MR. NICKENS) Do you recall that 4 you were questioned on this general subject 5 yesterday? 6 A. Yes. 7 Q. Okay. And you see the sensitivity 8 analysis that's reflected in this very same 9 exhibit which goes over the reasoning for these 10 trades which is -- I just questioned you about at 11 Page 5260? 12 A. Yes. 13 Q. And you're trading Fannie Mae 14 9 and a half's for Freddie Mac 9 and a half's. 15 Would you expect such a trade to have any 16 significant impact on durations? 17 A. No. 18 Q. And therefore, no significant impact on 19 interest rate sensitivity? 20 A. No. 21 Q. Okay. Now, why is that? 22 A. Because they are both the same coupon. 4070 1 They are both the same relative maturity. 2 Q. The same mortgages underlay those 3 securities. Right? 4 A. Yes, exactly. There is a payment delay 5 difference of a minor amount. 6 Q. Okay. Now, let's look at Exhibit 1428. 7 A. Yes. 8 Q. Those are the minutes of February 4th, 9 1987. And, again, the usual indication that you 10 made your report and then your report starts at 11 Page 5270? 12 A. Yes. 13 Q. And you've got your market review and 14 then on the second page, you've got some graphs 15 there. 16 Now, why would you be looking at those 17 spreads and projected historical prepayment 18 assumptions? 19 A. You'd be looking at the projected and 20 historical prepayment assumptions to determine 21 what your asset sensitivity is to rate moves. 22 Q. Okay. And you -- you have your -- if 4071 1 you turn to the next page at 5272, you have your 2 usual discussion about your profit and loss 3 summary, your activities, your asset sensitivity 4 which, again, is sensitivity to interest rates. 5 Right? 6 A. Yes. 7 Q. And your plans for the next week. Then 8 on the next page, you've got your portfolio 9 activity. Then on the next page, you've got a 10 daily mark-to-market? 11 A. Yes. 12 Q. Then you have your report on values at 13 page -- beginning at Page 5275? 14 A. Yes. 15 Q. And then you've got -- if you go over 16 to 5278, you report on your scenario analysis or 17 what we call today a stress test, the effect on 18 yields of movements of 100 basis points up and 19 down? 20 A. Yes. 21 Q. Again, that is a market value 22 consideration, is it not? 4072 1 A. Yes. 2 Q. Now, let me ask you to look over at 3 February 11th, 1987, which is Exhibit A1429. 4 A. Yes. 5 Q. Okay. And it reports there on the 6 second paragraph that "Ms. Sandy Laurenson 7 presented a report on mortgage-backed securities 8 and the report was ordered attached to the minutes 9 of the meeting. She discussed in detail the Kaput 10 Program and the effect of the mortgage-backed 11 security portfolio. It was determined that she 12 would review this information with Messrs. Gross 13 and Crow to determine if the association would 14 enter into the put program," and then you also 15 discuss excess servicing program. 16 What was the Kaput Program, if you 17 recall? 18 A. It's a call on a put. 19 Q. Okay. 20 A. It's the right to buy a put at a later 21 date. 22 Q. And what is its utility in a 4073 1 mortgage-backed securities portfolio? 2 A. If you don't want to diminish the 3 spread in your portfolio to the degree that you 4 would by immediately buying a full put, then you 5 can buy -- you can partially diminish it by buying 6 a call. 7 Q. It's a cheaper way of getting your 8 hedge? 9 A. Yeah. It's a cheaper way of getting 10 your hedge later on in terms of spread. 11 Q. Then let's look at your report which 12 begins at 5308. You've got your usual market 13 review and you've got your -- next page, 5309, 14 your interest rate sensitivity analysis. You've 15 got your plans for the week. You then have your 16 portfolio activity at 5310. And you indicate 17 there among other things that -- these are the 18 value trades that you discussed with Mr. Guido 19 yesterday? 20 MR. GUIDO: What page is that? 21 MR. NICKENS: 5310. 22 A. Yes. 4074 1 Q. (BY MR. NICKENS) Okay. Then you have 2 your daily mark-to-market, your valuations. Then 3 at Page 5314, you've got your scenario or stress 4 test? 5 A. Yes. 6 Q. And then the following page, you've got 7 your kaput scenarios for varying interest rate 8 paths. Right? 9 A. Yes. 10 Q. This is something you prepared -- 11 A. Yes. 12 Q. -- indicating the advantage and 13 disadvantages of this particular strategy? 14 A. Yes. 15 Q. Then you've got a discussion about 16 excess servicing on the page at 5316? 17 A. Yes. 18 MR. NICKENS: Okay, Your Honor. This 19 is at Exhibit 1431 which was offered and then 20 withdrawn yesterday. I would like to reoffer 21 Exhibit A1431. We have provided Mr. Guido with a 22 copy of the exhibit that has the US numbers in the 4075 1 same font and same sequence in order to indicate 2 that nothing untoward has happened with this 3 document. 4 MR. GUIDO: This is what page? 5 MR. NICKENS: February 18th, 1987, the 6 minutes of the investment committee of 7 United Financial Group. 8 MR. GUIDO: What page does your 9 document show the beginning of the Laurenson 10 report? 11 MR. NICKENS: I still have the old 12 document so -- I'm going to be questioning the 13 witness about United Financial Group statement of 14 strategies and objectives which is at US35341. 15 And then it appears that the mortgage-backed 16 securities report begins at 5375. 17 MR. GUIDO: Is that through 5384? 18 MR. NICKENS: Yes. 19 MR. GUIDO: I have no objection to the 20 use of US35338 through US35342 or US35375 through 21 US35384, Your Honor. The rest of it I would have 22 to have someone testify as to the authenticity of 4076 1 the remainder of the document. 2 MR. NICKENS: Your Honor, here we are 3 so many years later. I mean, this is -- these 4 Bates numbers indicate that it was produced from a 5 warehouse which was numbered gosh knows how many 6 years ago and Mr. Guido is fully aware of that. I 7 do not know what the problem with the document is 8 in light of the fact that we have this original or 9 a copy of the original. 10 THE COURT: Does your document have the 11 smaller US3 numbering? 12 MR. NICKENS: Yes, Your Honor. We just 13 went back and got the other copy. And it appears 14 evident that someone at some point tried to 15 reconstruct the document, but it's exactly the 16 same pieces of paper, just with a different number 17 on it. 18 THE COURT: All right. Received. 19 Q. (BY MR. NICKENS) Now, Ms. Laurenson, 20 if you would look over at the third page of the 21 document that's entitled "UFG Mortgage-backed 22 Securities Statement of Strategies and 4077 1 Objectives." 2 A. Yes. 3 Q. And it indicates that -- at the top -- 4 "UFG, Inc. and its subsidiary shall invest in 5 mortgage-backed securities and their derivatives 6 as attractive opportunities are available." 7 And then it indicates that they are to 8 be segregated into various portfolio, one of them 9 being investment portfolios where it says "The 10 objective of these designated portfolios will be 11 to invest in a diversified group of MBS which will 12 generate a net interest margin over a range of 13 interest rate environment scenarios. The 14 securities will be funded primarily with 15 short-duration liabilities which may or may not be 16 hedged with various financial instruments such as 17 interest rate caps, collars, swaps, futures, 18 options, et cetera. It is management's intent to 19 maximize the net interest spread while maintaining 20 prudent interest rate risk exposure." 21 Now, does that accurately capture the 22 policies with regard to the investment portfolio? 4078 1 A. Yes. 2 Q. And then it says, "It is management's 3 intent to hold each security on a long-term basis. 4 However, sales may be executed from time to time 5 to, No. 1, maintain or enhance current yield 6 spreads on assets as market opportunities exist, 7 adjust the portfolio for changes in yields caused 8 by prepayment speed variations, manage the 9 portfolio's exposure to interest rate risk, 10 prepayment speed risk, and coupon agency 11 concentrations risk, meet liquidity requirements, 12 and meet other appropriate requirements that may 13 be approved by the investment committee consistent 14 with generating an ongoing net interest spread." 15 Now, were the trades that you've looked 16 at here consistent with those goals? 17 A. Yes. 18 Q. And then with the trading portfolio, it 19 says "The objective of this -- of the portfolio 20 will be to invest in a limited volume of MBS or 21 other financial instruments such as puts and calls 22 which are expected to provide capital appreciation 4079 1 or fee income. The assets acquired will be funded 2 with short-term liabilities and may or may not 3 generate a positive net margin." 4 It goes on to explain that you've got 5 some specific capital appreciation and that that 6 portfolio was going to be mark-to-market. Right? 7 A. Yes. 8 Q. Okay. Then if we look over at where 9 your report began -- because our copy's a bit 10 different than -- my copy bears the number 11 5340.026. 12 A. Okay. 13 MR. GUIDO: Where? 14 MR. NICKENS: Right here. 15 MR. GUIDO: That's at 53575. 16 MR. NICKENS: That's the one I just 17 mentioned, right? 18 MR. GUIDO: That's a substitute A. I 19 don't know which one you're working from. I'm 20 working from the substitute 1431. 21 Q. (BY MR. NICKENS) Well, let me -- so 22 we hopefully can avoid these difficulties, I will 4080 1 refer to the page number which is 5375 which is 2 different from yours, Ms. Orr. 3 A. Fine. 4 Q. There, you report on your -- the 5 treasury market. And then you report on the 6 mortgage market. Then your activities. And you 7 indicate that you swapped 113 million Freddie Mac 8 9 and a half's -- it's the second paragraph under 9 activities -- for Fannie Mae 9 and a half's to 10 pick up a 20 basis point in yield. 11 That, again, is a pure value trade. 12 Right? 13 A. Yes. 14 Q. Freddie Mac -- Fannie Maes for Freddie 15 Macs? 16 A. Yes. 17 Q. And you paid .78125 to do so. "Fannie 18 May 9 and a half's will become increasingly 19 valuable as the street strips an additional 20 $2 billion this week from a total free supply of 21 only $1 billion." 22 Now, what did you mean by "stripping an 4081 1 additional $2 billion"? 2 A. That there were going to be $2 billion 3 worth of CMO strips created. 4 Q. And that increased the demand for a 5 specific type of security. Right? 6 A. Yes. 7 Q. Some Wall Street firm has promised the 8 market that it's going to supply specific security 9 and it, therefore, then has to go out and buy it 10 and has to pay a little bit of a premium to get 11 it. Right? 12 A. Yes. 13 Q. And if you own it, then you can sell it 14 at a little bit above the market for the other? 15 A. Yes. 16 Q. Is there anything wrong or speculative 17 about such activities? 18 A. Any activity is speculative -- 19 Q. Well -- 20 A. -- in this, but it seems going into 21 that activity that that makes sense. 22 Q. Is this the very thing that traders do? 4082 1 A. Yes. Not just traders, quote, unquote, 2 but portfolio managers do this. 3 Q. And you're just trading Freddie Mac 4 9 and a half's for Fannie Mae 9 and a half's or 5 vice versa? 6 A. Yes. 7 Q. Then you go on as usual to report your 8 P&L comments, your yield analysis at Page 5377 or 9 5,340.028, depending on which copy you've got. 10 A. Yes. 11 Q. You give your daily mark-to-market. 12 You give your values. You give your up and down 13 scenario. And then you give an example which we 14 talked about before of a copy of your performance 15 report for January of '87. 16 Do you see that? 17 A. Yes. 18 Q. Okay. Then you give a summary of your 19 stripped MBS and various comments about -- that we 20 just discussed. And that's your report. Right? 21 A. Yes. 22 MR. NICKENS: Your Honor, it's noon. 4083 1 THE COURT: All right. We'll adjourn 2 until 1:30. 3 4 (Luncheon recess taken at 12:00 p.m.) 5 6 THE COURT: Be seated, please. We'll 7 be back on the record. 8 Mr. Nickens, you may continue with your 9 cross-examination. 10 MR. NICKENS: Thank you, Your Honor. 11 (1:31 p.m.) 12 Q. (BY MR. NICKENS) Ms. Orr, when we 13 took our lunch break, we had been discussing for 14 some period of time the investment committee 15 minutes. And I would like to refer you to the 16 minutes of March 2nd, 1987, which have been marked 17 as A1432. 18 MR. NICKENS: Your Honor, this is 19 another document that was offered yesterday but 20 withdrawn, and I would reoffer it. I think the 21 only question about this document, Your Honor, is 22 whether some investment committee policies 4084 1 beginning with Nos. W100897 were attached to the 2 minutes. The minutes internally refer to a 3 discussion about structural changes to the 4 investment committee which are reflected in that 5 document. But I am willing to separate them and 6 treat them as two documents if that is necessary. 7 MR. GUIDO: Your Honor, I have no 8 objection to A1432 as amended to be US35386 9 through US3500514. I object to W100895 without 10 identification of the source of the documents. I 11 suspect that what that is, from looking at the 12 document and looking at the number on it, is that 13 it is the -- it's probably from one of those board 14 packets which are a different set of exhibits. 15 But I haven't been able to ascertain which set of 16 the board packets it comes from. But I have no 17 objection to the inclusion of A1432 up through the 18 Page 35414, Your Honor. 19 THE COURT: Well, maybe this witness 20 can provide some foundation for that document and 21 tie it to the first portion of the exhibit. 22 MR. NICKENS: Let me ask a few 4085 1 questions in that regard, Your Honor. 2 Q. (BY MR. NICKENS) Ms. Orr, could you 3 look at the second page of Exhibit A1432? 4 A. Yes. 5 Q. And do you see there in addition to the 6 report about your -- the recordation, rather, of 7 your report, immediately thereafter, "Mr. Gather 8 Jacobson then reviewed certain structural changes 9 to the investment committee"? 10 A. Yes. 11 Q. Ask then if you turn over to the 12 portion of the document that begins at W100895, do 13 you see that's a memo from Mr. Jacobson dated 14 February 20th, 1987, dealing with investment 15 committee policies? 16 A. Yes. 17 Q. And was there a discussion of 18 investment committee policies at this meeting? 19 A. I can't specifically attest to that. 20 However, I do remember he was given charge of 21 reviewing policies because they couldn't think of 22 what else to do with them basically at that point 4086 1 in time. 2 MR. NICKENS: Okay. Mr. Jacobson is 3 not a respondent and I don't think he's accused of 4 doing anything, Your Honor. But we would -- Your 5 Honor, if necessary, we can just attach a 6 different number to the second exhibit for the 7 exhibit that begins at 100895 if that will allay 8 Mr. Guido's concerns. 9 THE COURT: Well, are you going to 10 object to the receipt? 11 MR. GUIDO: Your Honor, I object to the 12 documents that are Bates W100895 through W100905. 13 MR. NICKENS: Your Honor -- 14 MR. GUIDO: I mean, if these are part 15 of investment committee minutes, I don't mind if I 16 have the exhibit number and it can be shown that 17 it's part of the board packet. But I have no idea 18 where this came from. All of the documents that I 19 know that have a W prefix on it, Your Honor, are 20 documents that pertain to board packets. They 21 have nothing to do with the investment committee 22 minutes. So, I have no idea whether or not this 4087 1 is the document in the board packet. We have 2 reviewed the documents in the board packets to 3 ascertain whether or not those conform to the sets 4 that we have, Your Honor. But at this point in 5 time, I cannot stipulate to the authenticity of 6 this document. 7 MR. NICKENS: Your Honor, two things. 8 One is there is certainly an internal reference to 9 this very issue. Secondly, we had a procedure set 10 up to deal with authenticity issues before the 11 hearing was to begin. And pursuant to an 12 agreement that we had, we were to give objections 13 to the other side relating to authenticity issues. 14 We did that. 15 The OTS, just before we started the 16 hearing, informed us that they would be unable to 17 give us their objections on any grounds. So, as a 18 result, we were unable to prepare the necessary 19 foundation for the documents to which they had 20 some objection because they didn't inform us of 21 their objection despite our agreement that that 22 would be done. 4088 1 Now, these are internally related. It 2 is on its face a USAT document. We've identified 3 Mr. Jacobson. We've identified through the 4 witness that he was given responsibility of this 5 nature. And I just want to ask -- 6 THE WITNESS: And I can tell you that 7 this is his writing style. 8 MR. GUIDO: Your Honor, may I address 9 the larger question because I do want to have it 10 resolved. That with regard to the agreement 11 between counsel on how to minimize authenticity 12 questions, it was agreed that the respondents 13 would prepare an index with the Bates stamped 14 numbers and the identifying information and they 15 would provide that to the OTS so the OTS could go 16 and verify the accuracy of the documents that it 17 had pursuant to that list. 18 We were informed when we received the 19 list that it was inaccurate. We told them, "Fine. 20 Send us the accurate list and we will be able to 21 do what we agreed to do." I have repeatedly asked 22 respondents to produce the correct key to the 4089 1 Bates stamp numbers. To this date, they have not 2 done so, Your Honor. 3 I have, despite that, throughout this 4 proceeding, attempted to ascertain, although it's 5 been difficult to do so because I have not had 6 prior notice of documents that have been presented 7 as direct testimony in the course of 8 cross-examination whether or not the documents are 9 authentic. I have tried to anticipate what those 10 documents are without notice of those and to 11 minimize the objections on authenticity grounds. 12 The last few days, documents have 13 appeared that I have not seen anything that 14 indicates to me that I can authenticate those 15 documents. Therefore, for that reason, in the few 16 instances that I have raised the objection, I have 17 done so because I do not have any document that I 18 can utilize to identify the documents as documents 19 that we have in our possession, Your Honor. 20 MR. NICKENS: Your Honor -- and I don't 21 want to continue this forever. But I will point 22 out that this was a document that he identified 4090 1 and that he introduced and then withdrew. So, the 2 idea that he didn't know it was going to be 3 introduced is just not true. He introduced it. 4 Secondly, with regard to procedures, we 5 provided them with hard copies of the exhibits. 6 And what the problem was that we also provided 7 them with an index. And the index in certain 8 respects wasn't entirely accurate as to the hard 9 copies. But the hard copies were there and if 10 anybody wanted to review these documents, they 11 were available to have been reviewed. Now, you 12 know, I am willing because of this objection to 13 simply detach the document and regard it as a 14 separate document. But the witness is here. 15 She's preparing to move out of town shortly, and 16 we ought to ask her what she knows about these 17 investment committee policies. 18 THE COURT: All right. I'll receive 19 A1432 that Mr. Guido has indicated. And if you 20 mark the other part, I'll receive that on separate 21 grounds so that they are not confused. 22 MR. NICKENS: Your Honor, I'll just 4091 1 mark it as A1432(A). 2 THE COURT: All right. Received. 3 MR. NICKENS: Thank you. 4 Q. (BY MR. NICKENS) Okay. Ms. Orr, with 5 regard to the policies which we have now 6 identified as A1432(A) -- 7 A. Yes. 8 Q. Do you see here that it was indicated 9 that there was to be some new policies for the 10 investment committee constituting "a hybrid of 11 policies that had evolved through the investment 12 committee resolutions and modifications we have 13 made that we believe reflect more clearly the 14 policies currently intended by the committee"? 15 A. Yes. I see that. 16 Q. And this was directed to you and other 17 members of the investment committee for their 18 comments? 19 A. Yes. 20 Q. And just to point out to you, if you go 21 over to Page 100898 -- 22 A. Yes. 4092 1 Q. Do you see there under "overriding 2 policies," those are the same policies that I 3 pointed out to you in connection with the audit 4 material, are they not? 5 A. Yes. 6 Q. And specifically, if I would ask you to 7 go over to Page 100900 -- 8 A. Yes. 9 Q. -- Item No. 3 indicates that 10 "Mortgage-backed securities portfolio MBS 11 investment action shall be approved on a portfolio 12 level basis as opposed to a security-by-security 13 or group basis." 14 Now, at least after the date of this 15 memo, was that done -- was the securities 16 transactions approved on a portfolio basis with 17 the mortgage-backed securities? 18 A. I don't remember any change in how it 19 was handled the entire time I was there; so, I 20 don't remember a breaking point. I mean, to my 21 mind, we always did it on a group basis. We'd 22 talk about Freddie Mac 9s, not Pool No. 3129364. 4093 1 So, it was, to my mind, done all the time in a 2 generic coupon agency basis. 3 Q. Okay. Now let me ask you to look at 4 1433, which was the investment committee minutes 5 of March 11th, 1987. 6 MR. NICKENS: And, Your Honor, these 7 were not -- 1433 was not offered and we hereby 8 offer it. 9 THE COURT: This still has the puzzling 10 numbering system? 11 MR. NICKENS: Your Honor, we have -- we 12 have gone back and pulled, as we had with 1431, 13 the original US numbers, which is available here 14 in that form. What it reflects is that the 15 documents are identical. It's just that someone 16 has attached a different numbering system. And I 17 don't know how that happened, but we do have the 18 document available for Mr. Guido to look at and 19 determine that what we've said is correct. 20 MR. GUIDO: I have no objection to the 21 substitute document being introduced as 1433, Your 22 Honor. 4094 1 THE COURT: Received. 2 Q. (BY MR. NICKENS) Let's try to work 3 with the substitute document. Okay. That's this 4 one. Let me ask you to just go directly over, 5 Ms. Orr, to your report which begins, I believe, 6 at Page US3005442. 7 A. Okay. 8 Q. And then if you will turn to the next 9 page, which is 5443, do you see the activity 10 highlights? 11 A. Yes. 12 Q. And No. 1 states that "The MBS sub 13 balance stands at 1.2 billion. Last month's 14 prepay figures prompted some pruning of the 15 1 billion high coupons. The second wave of 16 purchases for the sub based upon a new capital 17 infusion will consist of Fannie Mae, Freddie Mac, 18 swap 9 percents in a combination with a Fannie 19 May 9 percent IO strip to create a synthetic 20 Fannie Mae 12 coupon that prepays like a Freddie 21 Mac/Fannie Mae 9. To hedge the financing of the 22 asset, a series of cap agreements to five years is 4095 1 used. The result is an asset that yields between 2 8.99 percent and 9.26 percent which is financed by 3 repo, capped at a 7 percent rate for four years." 4 Do you see that? 5 A. Yes. 6 Q. Now, there was some question raised 7 about the use of IOs in the portfolio. Does your 8 activity highlights indicate one such use of IOs? 9 A. Yes. 10 Q. And can you explain to the judge how 11 that worked, how you were able to use the IOs to 12 create this synthetic or hybrid mortgage-backed 13 security? 14 A. Okay. Sure. 15 Q. I know it's a long time ago. 16 A. Well, I mean, even to explain it just 17 is hard. An interest rate-only strip is a series 18 of cash flows that's taken off of an underlying 19 asset. In this case, Fannie Mae 9 percents. And 20 they will strip off a portion of that 9 percent 21 interest flow. And so, it's just interest that 22 they are stripping off. There's no principal 4096 1 return. It's simply the interest on the security. 2 They strip that off and you can buy it separately 3 from any of the principal flows. You take that 4 interest-only strip and it adds to your coupon, 5 basically, on the security we are buying -- we are 6 buying the complete 9 and adding on an interest 7 rate strip to get something that in coupon would 8 look like a Fannie Mae, what was it, 12 it said on 9 here? 10 Q. Yes. A Fannie Mae 12. 11 A. Fannie Mae 12. However, the prepayment 12 risk on it is much lower because the collateral 13 underneath both of the pieces is a 9 percent 14 coupon bond. 15 Q. And that's because the IO has a higher 16 coupon? 17 A. Yeah. The synthetic has a higher 18 coupon, but it's got less prepayment risk. 19 Q. Okay. And that was -- reflects one use 20 of your purchase of IOs? 21 A. Yes. 22 Q. Then you indicate in the second bullet 4097 1 point, "We sold 100 million of Fannie Mae 2 9 percent collateral into a Goldman Fannie Mae 3 strip deal. This allowed us to buy the IOPs of 4 the strip to use in our RCA." 5 And then finally, you say "We are 6 creating cheap synthetic assets for portfolio to 7 replace coupons that are relatively rich. We 8 swapped 10 percent coupons for a mix of 10 and a 9 half percent and 8 percent coupons to create an 10 asset with superior return characteristic to the 11 10 percent coupons in our portfolio." 12 Now, could you explain to the judge how 13 that was -- how you accomplished that? 14 A. Well, you'd duration match -- it's a 15 barbell basically. We saw that 10 percent coupons 16 were extremely rich in relation to their normal 17 relationships, rich in relation to other coupons 18 because the street was probably demanding them for 19 some reason or another. And so, rather than hold 20 the expensive asset on the books, we could replace 21 it with something that would have a higher return 22 by buying a 10 and a half and an 8 and duration 4098 1 mixing it. So, you'd have probably a lot of 10 2 and a half and a little bit of 8 to get your 10 3 coupon replicated. 4 Q. And if you go over a couple of pages to 5 5445, there is your activity report which is 6 explained in this activity description that you 7 just -- that we just read; is that correct? 8 A. Yes. 9 Q. Let me ask you to look at 1434, which 10 is the investment committee minutes of March 18th, 11 1987. 12 A. Yes. 13 Q. And if you'll look over -- just 14 directly over to 5498 -- 15 A. Okay. 16 Q. -- there again, you have your 17 portfolio activity sheet which Mister -- some of 18 which Mr. Guido questioned you about. And then on 19 the page before it, 5497, under the activity 20 highlights, you reflect and explain what you're 21 doing; is that correct? 22 A. Yes. 4099 1 Q. Including this creation of a synthetic 2 Freddie Mac 9 and a half out of Fannie Mae 10s and 3 Fannie Mae 7 and a half's. Right? 4 A. Yes. 5 Q. Now, in the first item under the 6 activity highlights -- that's Page 5497 -- you say 7 "We finished purchases of a total of 500 Ginnie 8 Mae 9 12 percents for the MBS subsidiary." Now, 9 was that United MBS? 10 A. Yes. I assume so. 11 Q. And you say "These are hedged by a 12 series of OTC" -- that's over-the-counter? 13 A. Yes. 14 Q. -- "cap agreements to a five-year 15 liquidation horizon"? 16 A. Yes. 17 Q. Indicating that at least some point in 18 time, you had cap agreements assigned to United 19 MBS? 20 A. Yes. 21 Q. Okay. Now, let me ask you to look over 22 at Exhibit 1435, A1435, which are the minutes of 4100 1 March 25, 1987. 2 A. Yes. 3 Q. Okay. As to the first page, in the 4 fifth paragraph, it was noted that you went 5 through your report in detail and was questioned 6 extensively by Mr. Williams concerning the 7 economic effect of various transactions, again 8 reflecting discussions about interest rate 9 movements and their effects on the portfolio; is 10 that right? 11 A. Yes. 12 Q. Then on the second page at the 13 next-to-the-last paragraph, it indicates that 14 "Mr. Bruce Williams then discussed the possible 15 exchange of ARMs mortgages in the mortgage-backed 16 security subsidiary for fixed interest rate 17 mortgages held by the association. An exchange of 18 approximately 300 million was unanimously approved 19 by the committee. It was also unanimously 20 approved that the association acquire a maximum of 21 100 million of caps prior to March 31, 1987. The 22 quantity would be determined by a subcommittee 4101 1 consisting of Mr. Williams, Mr. Crow, and 2 Ms. Laurenson." 3 Do you see that? 4 A. Yes. 5 Q. Now, this exchange was that there was 6 to be -- the subsidiary was to transfer ARMs to 7 the association in return for some fixed rate 8 securities? 9 A. Yes. 10 Q. But there was no -- well, was there any 11 transfer of caps, or were those caps held already 12 by the association? 13 A. It looks as though the association was 14 going to acquire them. 15 Q. Now, let me ask you to go over to your 16 report which begins at 5508. 17 A. Yes. 18 Q. Again, it has the usual form, the 19 market review, your discussion of the mortgage 20 market, your plans, along with your profit and 21 loss highlights, your reporting on the market for 22 the specific items in the portfolios, and then 4102 1 your liquidation. And once again, you've got an 2 activity report at 5515 which, if you go back and 3 look at your discussion, explains what the reasons 4 for those trades were? 5 A. Yes. 6 Q. Let me ask you to look at Exhibit 1437, 7 which -- you may skip one there. These are the 8 investment committee minutes of April 8th, 1987? 9 A. Yes. 10 Q. Let's go to the second page, if you 11 will. Why don't you read it this time? 12 A. At the top? 13 Q. Yes, ma'am. 14 A. "Ms. Laurenson presented an interest 15 rate forecast from numerous economists that was 16 ordered attached to the minutes. After a lengthy 17 discussion, it was agreed that the consensus was 18 interest rates over the next year would be moving 19 in an upward direction. As a result, it was 20 agreed that the association should begin 21 lengthening the liability structure and using 22 various hedges to continue to reduce the gap." 4103 1 Is that it? 2 Q. Then the next paragraph, please. 3 A. "Ms. Laurenson then presented a report 4 on the mortgage-backed securities portfolio and 5 activity. The written report was ordered attached 6 to the minutes of the meeting. In order to hedge 7 the portfolio in a rising rate environment, 8 various strategies were discussed including the 9 purchase of high coupon principal-only securities, 10 interest-only securities, interest rate caps, and 11 put protection. After a lengthy discussion, the 12 committee approved the purchase of up to 13 50 million high coupon principal-only 14 mortgage-backed securities to hedge the Arbitrage 15 1 portfolio to purchase interest-only 16 mortgage-backed securities as a replacement for 17 the mortgage-backed securities in the investment 18 portfolio and to purchase up to 100 million of 19 interest rate caps to hedge the preferred stock 20 subsidiaries." 21 Q. So, the purchase of IOs and POs is here 22 documented as having a hedging purpose? 4104 1 A. Yes. 2 Q. And it was in reaction to the 3 conclusion that you were encountering a rising 4 interest rate environment? 5 A. That's what it indicates here. 6 Q. Now, how would lengthening the 7 liability structure help you respond to such an 8 environment? 9 A. Lengthened liabilities would mean that 10 you're fixing your liability cost at lower levels 11 if rates rise. You're doing it in advance of the 12 rate rise. So, if rates rose, you would already 13 have your funding cost fixed. 14 Q. And was this an accepted method for 15 dealing with this particular situation; that is, 16 the purchase of POs and caps? 17 A. The purchase of caps. 18 Q. And the purchase of POs? 19 A. I don't know that it's recorded here, 20 what was said in the meeting, because I don't 21 understand how the purchase of high coupon 22 principal-only securities is a hedge in a rising 4105 1 rate environment. So -- 2 Q. So, you're indicating that you don't -- 3 you're not sure that -- 4 A. I'm not sure the minutes reflect what 5 was said really at this point. 6 Q. And that's because you don't see the 7 purchase of POs as being a hedging instrument in a 8 rising interest rate environment? 9 A. No. 10 Q. Now, let me ask you to look at 11 Exhibit 1441, which are the minutes of May 5, 12 1987. And I'd ask you to look over at 13 Page US35704. 14 A. Yes. I'm there. 15 Q. And in describing the mortgage market, 16 you refer in Bullet Point No. 1 to "The 17 Merrill-Lynch PO debacle might have far-reaching 18 consequences on not only IOs and POs but also new 19 mortgage derivatives in the future." 20 And then in Bullet Point No. 2, "IOs 21 and POs are marketed as hedge instruments which 22 have the advantage of a current yield even if the 4106 1 hedge is not in the money. However, the hedge is 2 against prepayment risk, not interest rate risk, 3 and there is no consensus on the relationship 4 between market rates and prepayment levels." 5 Do you see that? 6 A. Yes. 7 Q. Now, what was the Merrill-Lynch PO 8 debacle that you referenced here in May of 1987? 9 A. One of their traders -- I think it was 10 Howie Rubin -- shelved some trades. He stuck them 11 in a drawer. He had acquired a large position in 12 POs, and he hit hid it. 13 Q. And that related to a large loss for 14 Merrill-Lynch? 15 A. Yes. 16 Q. Because they didn't know they owned 17 them? 18 A. Right. 19 Q. Then if you could go to the third 20 bullet point which is at Page 5705 -- 21 A. Okay. 22 Q. -- you say "Market observers were 4107 1 shocked at how quickly treasury market volatility 2 filtered down to the mortgage origination level. 3 Price differences among brokers were as wide as 2 4 to 3 points for the same PO at the same time. It 5 was indicated to us that Salomon, which also 6 apparently has a large PO holding, was able to 7 effectively hedge their position with IO off of 8 the same issue." 9 Now, is a 2- to 3-point difference 10 between the bid and ask among investment bankers 11 usual or unusual? 12 A. Highly unusual. 13 Q. And explain to the Court what that 14 means. 15 A. When they bid to buy something from you 16 versus when they offer to sell something to you, 17 how they earn money is a spread in between. 18 Usually on a standard pass or security, it can be 19 two 32nds of a point. In this situation -- IOs 20 and POs will be a little bit wider than that. 21 They may be as wide as possibly 16 32nds or half 22 of a point. But in this situation, the bid ask 4108 1 spreads were 2 to 3 points. So, people did not 2 know where to bid or where to offer basically. 3 The market was highly illiquid. 4 Q. Okay. And if you look over at the next 5 page, 5706 or Page 5 of your report, you are 6 reporting on some dollar roll activity. 7 A. It's blank. Oh, okay. 8 Q. Yeah. There's just a couple extra 9 pages in there. Explain to the Court what a 10 dollar roll is. 11 A. It's the agreement to sell and then 12 subsequently buy back, let's say, a Fannie Mae 9 13 or a Fannie Mae -- any coupon. It exists for all 14 coupons. And it -- what happens is the 15 accountants, instead of making you book it as a 16 sale and then a repurchase, they allow you to book 17 that as a financing because basically you're 18 taking in money and you are then giving money back 19 and paying a rate on that money essentially is the 20 way it works. 21 So, it is -- it looks not unlike a repo 22 agreement where you agree to repurchase the loans 4109 1 at a later date. But the difference is in a repo 2 agreement, you get the same collateral back, the 3 same exact collateral back. In a dollar roll, you 4 give them Pool No. 3514 and 3502 and you get back 5 Pool No. 51806. It's a different pool, but it has 6 the same coupon, relatively the same maturity, and 7 it's the same agency. So, there's a collateral 8 transfer in between, but it's not booked as a sale 9 and a purchase. It's booked as a financing. 10 Q. When the parties agree on the original 11 purchase price, they also agree on the repurchase 12 price? 13 A. Yes. 14 Q. And that difference in price is an 15 implicit interest rate for the loan? 16 A. Right. 17 Q. And what are the advantages of dollar 18 roll transactions, at least at certain times in 19 the marketplace? 20 A. If a dealer has a short position in a 21 certain issue because they are assembling 22 collateral for a CMO, then the dollar roll will 4110 1 become out of whack with relation to the repo 2 market. In other words, if they have a heavy need 3 for Freddie Mac 9s, then if it took me 6 percent 4 in the repo market to borrow the money to pay for 5 the Freddie 9s, then I might look at the dollar 6 roll market and the rate would be 4 percent. 7 Q. Well, in fact, look at, if you would, 8 Page 5706. And what is the financing rate that 9 you're recording for the various securities there 10 as opposed to the repo rate? 11 A. From 2 and a half to 4 and a quarter 12 versus a 6.90 repo rate. 13 Q. So, substantial savings on the 14 financing cost? 15 A. On your financing, yes. 16 Q. Now, why don't people do that all the 17 time? 18 A. They do. 19 Q. Well -- but are there situations where 20 the dollar roll opportunities just aren't in the 21 marketplace? 22 A. Yes. Yes. 4111 1 Q. Now, let me ask you to go to 2 Exhibit 1449, which are the investment committee 3 minutes of June 25, 1987. 4 MR. NICKENS: And, Your Honor, we offer 5 Exhibit A1449. 6 MR. GUIDO: No objection, Your Honor. 7 THE COURT: Received. 8 Q. (BY MR. NICKENS) Two minor points 9 here, Ms. Orr. In the fifth paragraph, it's 10 reported that "The committee heard from Mr. Malcom 11 Roesch, president of Quantitative Analysis 12 Services." 13 Was it unusual -- or how would you 14 characterize how frequently the investment 15 committee heard from street experts in 16 mortgage-backed securities? 17 A. It was virtually weekly. I tried to 18 line up somebody to speak at every meeting. 19 Q. Okay. Then let me ask you to look over 20 to Page 6015, which is a part of your report. 21 A. Yes. 22 Q. And the third bullet point on Page 6015 4112 1 says "At the end of 1986, FCA's 17.4 2 billion-dollar MBS portfolio was $305 million 3 under water. In April, it was estimated to have 4 lost another $447 million in value." 5 Now, who was FCA? 6 A. It was a large thrift in California. 7 Q. And had the volatility in the 8 mortgage-backed securities market in 1986 and 1987 9 caught up with some people? 10 A. Very many people. 11 Q. So, it wasn't unusual for people in 12 that market to be showing large losses during this 13 time frame? 14 A. No. 15 Q. Okay. Let me ask you to look at 16 Exhibit 1460, A1460, which are the minutes of the 17 investment committee dated September 2nd. Here we 18 are. I've been giving you these, but they are up 19 here. 20 MR. NICKENS: Your Honor, we offer 21 Exhibit A1460. 22 MR. GUIDO: No objection, Your Honor. 4113 1 THE COURT: Received. 2 Q. (BY MR. NICKENS) Let me ask you to 3 look over to Page US3 -- looks like 6342. 4 A. Okay. 5 Q. Part of your report. And do you see 6 the part dealing with the mortgage market? 7 A. Yes. 8 Q. And the fourth bullet point, would you 9 read that for the Court? 10 A. "Morgan, among others, continues to 11 tout the advantages of the use of option adjusted 12 spread analysis in investment decision-making." 13 Q. Okay. And this is in September of 14 1987? 15 A. Yes. 16 Q. Does that help you place in time when 17 the OAS models began to become talked about on the 18 street for trading purposes? 19 A. Yeah. This would have been very early 20 on. 21 Q. And you then go on on the next page, 22 which is 6343, to analyze the Morgan model as well 4114 1 as other models; is that correct? 2 A. Yes. Yeah. 3 Q. And I gather you still weren't sold on 4 it? 5 A. No. I'm still not. 6 Q. Then finally, with regard to the 7 minutes, let me ask you to look at Exhibit 1473 8 which are the minutes of November 4th, 1987. 9 MR. NICKENS: And, Your Honor, we offer 10 Exhibit A1473. 11 A. Yes. 12 THE COURT: Received. 13 Q. (BY MR. NICKENS) And specifically, 14 let me ask you to turn over to Page 3 of your 15 report which is recorded at US3006671. 16 A. Yes. 17 Q. Do you have that in front of you? 18 A. Yes. 19 Q. And the last bullet point on mortgage 20 market, would you read that for the record? 21 A. "Goldman is down playing the value of 22 option adjusted spread analysis on deep discount 4115 1 post-1980 issue MBS. Because the prepayment 2 option is so far out of the money, the option 3 adjusted analysis doesn't add materially to a 4 static yield analysis. I.e., one with CPR 5 assumption." 6 Q. Again, reflecting the early use of 7 option adjusted spread analysis? 8 A. Yes. 9 Q. Ms. Orr, you were in charge of the USAT 10 mortgage-backed securities portfolio for a period 11 from approximately October of 1986 through the end 12 of 1987? 13 A. Yes. 14 Q. And you terminated your employment in 15 1988 and thereafter sued UFG to get your 16 termination pay; is that correct? 17 A. Yes. 18 Q. And that was eventually worked out 19 after you had filed the lawsuit? 20 A. Yes. 21 Q. You said yesterday that the management 22 of USAT were, in your words, risk averse. What 4116 1 did you mean by that? 2 A. They weren't wild-eyed speculators. 3 You know, we tried to do everything within a range 4 of hedged behavior. You can't eliminate the total 5 spread that you want to earn on the portfolio; but 6 at the same time, you want to make sure that 7 you're not materially affected by rising rate 8 environment. 9 Q. Did you ever see any evidence during 10 the time that you were there of some tie-in other 11 than the normal commercial relationship with 12 Drexel Burnham Lambert? 13 A. Not at all. 14 Q. Did you have meetings with Terry Smith 15 with regard to your activities in the 16 risk-controlled arbitrage? 17 A. I specifically remember one meeting 18 with him; but beyond that, my recollection is 19 vague. 20 Q. Do you recall anything that was said 21 during that meeting? 22 A. No. 4117 1 Q. Do you recall what was the subject for 2 discussion? 3 A. I remember we talked about the fact 4 that he went to U Chicago. That was it. 5 Q. Okay. Now, during the time that you 6 were managing the mortgage-backed securities 7 portfolio, did you do anything to harm or hurt the 8 institution? 9 A. No. 10 Q. Did you do anything that you thought 11 was imprudent? 12 A. No, except for the purchase -- it 13 wasn't imprudent by the regs. The regs justified 14 it totally -- the purchase of the ARMs. 15 Q. You were against that because you 16 thought they were too expensive? 17 A. Yes. 18 Q. Were you able to maintain a positive 19 spread during all the time that you were there on 20 the United MBS portfolio? 21 A. I'm not sure. 22 Q. You'd let the records reflect whatever 4118 1 that was? 2 A. Yes. 3 Q. And did you -- did you apply your 4 talents to the best of your ability to make the 5 mortgage-backed instruments work for USAT? 6 A. Yes. 7 MR. NICKENS: Your Honor, we pass the 8 witness. 9 THE COURT: Do you have some redirect? 10 MR. GUIDO: Yes, Your Honor. 11 THE COURT: All right. Proceed. 12 13 REDIRECT-EXAMINATION 14 15 16 Q. (BY MR. GUIDO) Ms. Orr, you were 17 asked some questions about your contract by 18 Mr. Nickens. 19 Do you recall -- 20 A. Yes. 21 Q. -- those questions? And you were asked 22 whether your contract changes that you requested 4119 1 were more advantageous than the initial offer. 2 Do you recall that testimony? 3 A. Yes. 4 Q. And you indicated that with regard to 5 Paragraphs 5 and 6, that your contract was 6 performance based. 7 Do you recall that testimony? 8 A. If I verified what was written on the 9 paper, that's possible. 10 Q. And do you recall testifying that you 11 wanted to have a contract that was comparable to 12 the contract that you had had at Salomon Brothers 13 which was also performance based? 14 Do you recall that testimony? 15 A. No. I said that I didn't accept the 16 first offer because it was not as good as the one 17 that I had at Salomon Brothers. 18 Q. Was your contract at Salomon Brothers 19 performance based? 20 A. Somewhat, yes. 21 Q. And what was the performance it was 22 based upon? 4120 1 A. Subjective. 2 Q. Which is a pure subjective judgment 3 about how well you had done? 4 A. Yes. 5 Q. Was that measured by any measurement of 6 the performance of the portfolio you were 7 responsible for? 8 A. No. 9 Q. Now, you indicated that when you were 10 at Freddie Mac, that there was a turnover in that 11 portfolio. 12 Do you recall that? 13 A. Yes. 14 Q. And were you talking about rolling 15 forward hedges because they were -- the liquidity 16 was only seven months out in those -- 17 A. Yes. 18 Q. You were not talking about selling 19 mortgage-backed securities and trading them for 20 other mortgage-backed securities, were you? 21 A. Yes. In a way, yes. That was part of 22 the hedging. 4121 1 Q. Was it -- when you talked about the 2 turnover as being two and a half times, were you 3 referring to the exchange of mortgage-backed 4 securities of one sort for mortgage-backed 5 securities of another sort in order to generate a 6 gain? 7 A. Not in order to generate a gain. A 8 hedge. 9 Q. Now, what is the difference between 10 selling a mortgage-backed security and purchasing 11 another one to generate a gain as opposed to 12 selling a mortgage-backed security and purchasing 13 another one for purposes of hedging? 14 A. It would be theoretical in difference 15 because in terms of actual transaction, it's the 16 same transaction. 17 Q. Pardon? 18 A. It would be theoretical in difference 19 because in terms of the actual transaction, it's 20 the same thing. 21 Q. So, it's your testimony that if you 22 sell one mortgage-backed security and you purchase 4122 1 it for another, it doesn't matter whether your 2 purpose is to reduce interest rate risk or to 3 increase the profits to the institution? 4 A. It may matter to the audience that 5 you're speaking to. 6 Q. And why is that? 7 A. Because they may want to hear one thing 8 versus another. 9 Q. But is it your testimony that in terms 10 of reality, there is no difference? 11 A. No. You've got a buy and a sell. 12 Q. And so, therefore, it doesn't matter? 13 It's just a buy and a sell? It doesn't matter 14 what the purposes are. Is that what you're 15 testifying? 16 A. I'm saying that in reality, it does 17 not. It may matter to your audience because 18 you're trying to please them. 19 Q. Well, do mortgage-backed security pools 20 have different durations? 21 A. Yes. 22 Q. Okay. So -- and mortgage-backed 4123 1 securities can generate profits or generate 2 losses. Right? 3 A. Yes. 4 Q. And you could have a sale that would 5 generate a profit or a loss. Right? 6 A. Yes. 7 Q. And you could have a sale that would 8 either lengthen or shorten the duration. Right? 9 A. Yes. 10 Q. And are you saying that if you do 11 one -- and that is to generate a gain -- it is 12 automatically going to have the same effect on 13 duration as any other sale? 14 A. I don't understand your question. 15 Q. You testified that you didn't think 16 there was any difference between a sale and a 17 purchase of a mortgage-backed security depending 18 on the purposes. And I'm trying to ascertain what 19 the basis for that conclusion is, Ms. Orr. My 20 question is -- 21 A. I said that there was no difference 22 because the transaction is the same. You sell 4124 1 something, you buy something. 2 Q. And one has one effect and one has 3 another. Right? 4 A. No. I'm saying that the effect is 5 exactly the same between selling something and 6 buying something and calling it a hedge and 7 selling something and buying something and calling 8 it something else. 9 Q. Well, if you sell -- 10 A. Calling it blue. 11 Q. Let me ask you a question. If you sell 12 something for a gain, one transaction you sell 13 Fannie Maes and you buy Freddie Macs, let's say, 14 9s. Okay? 15 A. Yes. 16 Q. And you do that on day one. 17 A. Yes. 18 Q. And it generates a gain. Could that 19 have an impact on the duration of the underlying 20 mortgage-backed security? 21 A. It's possible, but not highly likely. 22 Q. What if you traded a 10 for a 9? Could 4125 1 that have an effect? 2 A. Yes. 3 Q. Okay. And if -- 4 A. But that wasn't what you asked. You 5 asked if I call one a hedge and I have the same 6 transaction and I call it a trade for profit, and 7 that's not what you asked. 8 Q. What I asked you was -- and maybe -- 9 THE COURT: Let's have another 10 question. 11 MR. GUIDO: I have another question, 12 Your Honor. 13 Q. (BY MR. GUIDO) My question is: If 14 you enter into a transaction for purposes of 15 hedging, are you looking to see -- are you looking 16 for a different impact than if you are looking to 17 enter into a transaction to generate a gain? 18 A. Not necessarily. 19 Q. No? 20 A. Because you can take the gain from the 21 trade and reinvest it in an additional security, 22 possibly lever up, and possibly widen or stabilize 4126 1 your spread in that way. So, that gain ask a 2 useful part of an ongoing hedge program. 3 Q. Now -- so that it doesn't necessarily 4 follow, based on your view, that if a person is 5 trading a portfolio actively to generate a gain, 6 that they are not necessarily doing those trades 7 to reduce interest rate risk? 8 A. They are not -- you're going to have to 9 restate your question because it's an anomaly. 10 Q. If a person is trading a portfolio 11 actively to generate gains -- 12 A. Yes. 13 Q. -- is it your testimony that that 14 doesn't necessarily mean that that person is 15 trading that portfolio for purposes other than to 16 minimize interest rate risk? 17 A. Now, that makes sense. Yes, that is 18 true. 19 Q. Now, when you were managing USAT's 20 risk-controlled arbitrage portfolio and you were 21 engaged in those value trades that we walked 22 through yesterday, were you doing that for the 4127 1 purpose of minimizing interest rate risk or were 2 you doing that in order to generate a gain? 3 A. I was doing it -- 4 MR. NICKENS: Your Honor, I object to 5 the form of the question because it's posed as if 6 those are impossible contradictions. 7 THE COURT: The witness may answer. 8 A. I agree with the objection to the 9 question. Those are not disparate goals. 10 Q. (BY MR. GUIDO) Do you recall this 11 morning you looked at the trades in November and 12 December that you put on that portfolio and you 13 looked at the trades that Joe Phillips had put on 14 that portfolio and it's exchanging, I think it 15 was, Fannie Mae or Freddie Mac 9s for 9 and a 16 half's and the purpose was, one, to create 17 diversification, I think one of your reports said, 18 and the other was to lengthen the duration of the 19 mortgage backs. 20 Do you recall that testimony? 21 A. To go from 9s to 9 and a half's, unless 22 there was a WAM differential, that would not 4128 1 lengthen the duration. 2 Q. I may have misspoke about what the 3 particular trade was, but you did indicate that 4 there was a sale of one set of mortgage-backed 5 securities that was done in exchange for another 6 and that the purpose was essentially to lengthen 7 the duration, I think was what you testified to? 8 A. You know, I'd have to check that 9 testimony because if you were replacing seasoned 10 9s with new origination 9 and a half's, that would 11 be true. If it was anything else, that would not 12 be true. 13 Q. But do you recall the transactions that 14 you testified about without having to go back into 15 the exhibits? 16 A. No, I don't. 17 Q. You don't? Will you take a look at 18 Exhibit 1412? 19 MR. NICKENS: 1412 or 1212? 20 MR. GUIDO: I think it's 1412. I may 21 be wrong. 22 MR. NICKENS: Your Honor -- 4129 1 MR. GUIDO: 1413. Excuse me. 2 Q. (BY MR. GUIDO) It's on 4935 of that 3 document, Ms. Orr. 4 A. 4935? 5 Q. Uh-huh. It's 4935. 6 A. Okay. It says it does not affect the 7 duration of the mortgage portfolio; so, it did not 8 lengthen -- 9 Q. It says -- look at the sentence before 10 that. It says "This role is being done to 11 diversify the portfolio more and give it more 12 cushion in a rising rate environment." 13 Do you see that? 14 A. Yes. And then it says "At the same 15 time, it does not affect the duration of the 16 mortgage-backed portfolio versus the swaps." 17 Q. Okay. Now, how did it give more 18 cushion in a rising rate scenario? 19 A. Because the price would not react -- 20 Q. As much? 21 A. -- as significantly in a rising rate 22 environment. 4130 1 Q. So, therefore, it would reduce the 2 sensitivity to rising interest rates. Is that a 3 fair assessment? 4 A. Yes. 5 Q. Okay. So, were you rebalancing that 6 portfolio to make it less sensitive to interest 7 rate changes? 8 A. Yes. 9 Q. Okay. We looked at a number of other 10 transactions and I can go pull out another example 11 if you want. But you testified yesterday and 12 today that there were a number of transactions 13 that you engaged in in order to generate either an 14 increased yield or to recognize a gain on the sale 15 of the security. 16 Do you recall that? 17 A. Yes. 18 Q. Okay. 19 A. Yes. I will agree with that. 20 Q. Those are two different purposes, are 21 they not? 22 A. No. I disagree with that. 4131 1 Q. And why is that that you disagree? 2 A. Because when you take in income, then 3 you can turn around and you can reinvest the 4 income. And if you take in earnings and it 5 becomes capital and you can lever the capital and 6 buy more spread, therefore enhancing your spread. 7 Q. So, is it your testimony that when you 8 managed that portfolio, by trading the portfolio 9 to generate gains, that you were reducing the 10 interest rate sensitivity of that portfolio? 11 A. If the gains were reinvested at the 12 total leverage that you removed the asset at, yes. 13 Q. Did you reinvest -- 14 A. But you never were. 15 Q. -- the funds that were entrusted to you 16 to invest for USAT in the mortgage-backed 17 securities portfolio at United MBS? 18 A. I don't believe so. I don't believe 19 so. They were used institution-wide in the junk 20 bond portfolio, in equity arb across the 21 institution. 22 Q. Now, you testified about a 6 percent 4132 1 CPR, I think is what you called it, were customary 2 for at-the-money coupons. 3 Do you recall that testimony? 4 A. Yes. 5 Q. What did you mean by "CPR"? 6 A. I don't even know what it stands for 7 anymore. Constant prepayment rate. It's the 8 annualized rate at which a mortgage pays down in 9 excess of its normal amortization. 10 Q. Now, will you take a look at 11 Exhibit A10638? 12 A. 10638? 13 Q. Uh-huh. That's the investment 14 committee memo from Bruce Williams of May 27th, 15 1986, on MBS prepayment speed assumptions. 16 A. Yes. 17 Q. Do you see that? 18 A. Yes. 19 Q. Now, is this table a table similar to 20 tables that you've seen on prepayment assumptions? 21 A. Yes. 22 Q. Okay. Now, explain to the Court what 4133 1 the interest -- current interest rate assumption 2 is that's implicit in this chart. 3 A. I don't know. 4 Q. You don't know? Well, you indicated 5 that the at-the-money prepayment rate was about 6; 6 is that correct? 7 A. Yes. No. I indicated that when I was 8 at Freddie Mac that the technology was such that 9 prepayment rates were not seen to vary much around 10 6. This was not when I was at Freddie Mac. 11 Q. That's not my question. 12 A. Okay. 13 MR. NICKENS: Your Honor, that was the 14 testimony. I mean, we were -- I was asking her 15 about 1984 and '85 and he's talking about May of 16 1986. And I went to great lengths to show that 17 those assumptions changed dramatically in that 18 very time frame. 19 THE COURT: All right. What's your 20 question? 21 MR. GUIDO: My question, Your Honor, 22 is: Have you seen charts like this in the past? 4134 1 A. Yes. 2 Q. (BY MR. GUIDO) And they have built 3 into them an assumption of what the current 4 interest rate is, do they not? 5 A. I don't know. This chart -- 6 Q. You said you've seen similar charts. 7 A. Yes. I've seen charts. I don't know 8 where this one -- it's -- yeah. I assume it's 9 from current rate levels. This could be 10 projecting if rates go up a hundred. There is no 11 title on it. I can't tell. 12 Q. Well, look at the cover memo. You 13 testified relying upon this document, and I'm 14 trying to find out what your testimony was. 15 A. I never relied on this document. I 16 never -- this is Bruce Williams' document showing 17 that, yeah, the company looked at prepayment 18 rates. I wasn't even involved in this memo at all 19 or -- 20 Q. Let me ask you some questions about the 21 memo. Look the first paragraph of the memo. 22 A. Okay. 4135 1 Q. "After review and discussion of various 2 projected MBS prepayment speed assumptions, the 3 asset liability committee has recommended for 4 approval the use of Morgan Stanley's CPR figures 5 summarized in Exhibit 1. These prepayment speeds 6 will be used to record income and will be adjusted 7 on a quarterly or semi-annual basis to compensate 8 for major changes in interest rates, prepayment 9 speeds, et cetera." 10 My question was: Is this chart similar 11 to charts that you have seen that set out 12 prepayment speed assumptions? 13 A. Yes. 14 Q. Now, do prepayment speeds increase as 15 interest rates fall from a particular level? 16 A. Not necessarily. 17 Q. And why not? 18 A. Because it depends on what you're 19 talking about. If you're talking about an 20 adjustable rate mortgage, it may not. If you're 21 talking about a fixed rate that falls 50 basis 22 points, it may not because there are costs of 4136 1 prepaying for the mortgage or they have to pay a 2 fee to prepay. 3 Q. Okay. Now, if interest rates are at 4 10 percent and you have a 12 percent 5 mortgage-backed security pool, does that sell at a 6 premium? 7 A. Interest rate is 10, you've got a 12 8 percent pool. If mortgage spreads are more than, 9 say, 250 basis points, it would be at a discount. 10 If they are less than 250 basis points, it would 11 be at a premium. 12 Q. And why is that? 13 A. Because you're receiving a coupon in 14 excess of what the required yield in the market 15 is. 16 Q. Okay. Now, if you have a 17 mortgage-backed security that is selling at the 18 money, is it selling at a premium? 19 A. A mortgage-backed security that's 20 selling -- 21 Q. That is selling at the market. 22 A. At the market? 4137 1 Q. Whatever the current interest rates 2 are. Let's say the interest rates are 12 and the 3 pool is 12. Does it sell at a premium? 4 A. Not necessarily. 5 Q. As it moves above that 12 percent, does 6 it sell at a premium? 7 A. As the price -- as the rate -- what 8 moves above 12 percent? 9 Q. Does the value of the pool -- 10 A. The value of the pool. 11 Q. -- increase? 12 A. And the pool has a 12 percent coupon 13 and rates are 12 percent. 14 Q. And as it moves to 12 and a half, let's 15 say you've got a 12 and a half mortgage-backed 16 security pool, does that sell at a premium over 17 pools that are at 12 percent? 18 A. Yes. 19 Q. Now, does it -- if it's at 13 percent, 20 the pool -- sell at a premium? 21 A. Yes. 22 Q. Does it if it's at 13 and a half? 4138 1 A. Yes. 2 Q. Now, does that increase occur at the 3 same rate as you go up? 4 A. No. It's not linear. 5 Q. Why isn't it linear? 6 A. Because you have differences in the 7 prepayment rates at each point. They will 8 extremely accelerate as you get further, further 9 in the money on the option that you're short. 10 You're short an option. An option has a price 11 yield curve that -- it's a curve that -- so, when 12 you're short the option, it responds in a curve 13 linear manner instead of a linear manner. 14 Q. Now, is one of the purposes of an OAS 15 model to take out the value that's in that premium 16 because of the prepayment option that the holder 17 of the mortgage-backed security pool has? 18 A. Yes. But even nowadays, the 19 assumptions in an OAS model are so extreme that I 20 don't know anybody that relies on them solely. 21 Q. Now, in 1985, you said that you were 22 managing a portfolio and selling or trading 4139 1 mortgage-backed securities because -- for hedging 2 reasons, I think is what you said. 3 A. Yes. 4 Q. Did that include the shifting of one 5 coupon mortgage-backed security to another? 6 A. Yes. 7 Q. And what was your customary practice in 8 terms of selling and repurchasing mortgage-backed 9 securities if you were in a declining interest 10 rate market? How soon would you evaluate what the 11 impact was of the declining rates on the value of 12 your mortgage-backed securities? 13 A. Daily. 14 Q. Okay. When did you start purchasing 15 different mortgage-backed securities as the rates 16 went down? 17 A. It depended on the availability of the 18 coupon. 19 Q. How soon did you consider trading into 20 another coupon? 21 A. The question doesn't have any meaning 22 to me. A day, a week, two days, weeks. Any 4140 1 period of time given any set of circumstances. 2 Q. What if there was a 50 basis point 3 decline in the market price? 4 A. If it happened in the space of a day 5 and you missed it, then you'd probably not do 6 anything maybe. That would be one option. 7 Q. Okay. What happened if it happened 8 within the space of a week? Would you do 9 something? 10 A. Possibly. Possibly not. 11 Q. Okay. But would you consider doing 12 something at that point in time? 13 A. Maybe. Maybe not. 14 Q. What do you mean "maybe, maybe not"? 15 A. You would look at the problem and look 16 at the various solutions that you have and the 17 impact of all the solutions and you determined the 18 best thing according to what the needs of the 19 situation were. 20 Q. Did you ever wait until interest rates 21 declined 200 basis points to readjust the 22 portfolio for declining interest rates? 4141 1 A. It depends on what the other side of 2 the trade is. 3 Q. I mean, did you ever wait? I'm asking 4 you -- 5 A. Sure. 6 Q. -- a factual question. 7 A. Sure. 8 Q. Tell us the situation in which you 9 waited. 10 A. I can't think of one specifically; but 11 I would have, I'm sure, in various situations 12 depending on what the liability was on the other 13 side of the spread. 14 Q. What do you mean "what the liability 15 was on the other side"? If you have a variable 16 rate liability on the other side, is that what you 17 mean? 18 A. For example, at Freddie Mac, the first 19 CMO that was issued was a billion-dollar CMO. It 20 was sold at a time when rates were rising. They 21 must have risen about 200 basis points in the 22 space of three months, something like that. We 4142 1 didn't do anything about the hedge because the 2 hedge was lengthening in duration in the rate rise 3 and we took the gains, the excess gains off the 4 hedge and ended up making more money on the hedge 5 than we did on the sale of the assets. It depends 6 on the situation. 7 Q. I didn't ask you about a rise in 8 interest rate market. 9 A. It would be similar to a falling rate 10 environment. 11 Q. Why is that? 12 A. Just make it the asset instead of the 13 liability. 14 Q. So, the situation that you're 15 describing, you had some -- something on the other 16 side that offset whatever the loss was in your 17 transaction as interest rates were rising? 18 A. Yes. 19 Q. Did you ever hedge mortgage-backed 20 securities at Fannie Mae with swaps? 21 A. Not at Fannie Mae, no. At Freddie Mac, 22 yes. 4143 1 Q. Okay. And at Freddie Mac, did you ever 2 encounter a declining interest rate market when 3 you were hedged with swaps? 4 A. I'm sure I did. 5 Q. Did you ever hold the mortgage-backed 6 securities through a 200 basis point decline when 7 they were hedged by swaps at Freddie Mac? 8 A. It's possible. 9 Q. But you don't know? 10 A. I don't remember. 11 Q. Now, in 1985, was a rapid increase in 12 prepayment rates unexpected with a 200 basis point 13 decline in interest rates? 14 A. Yes. 15 Q. And why is that? 16 A. Because nobody had ever seen it before. 17 People started offering zero-point refinanced 18 mortgages. That was a big development. So, you 19 had people refinancing at 50 basis point intervals 20 whereas before, they would have waited for a full 21 2-point move in the rate of their mortgage to 22 refinance. 4144 1 Q. So, there was something that changed in 2 the market that made the 200 basis point move not 3 have the impact that it has today? 4 A. There was something that changed that 5 made it have more of an impact as it does today. 6 Q. But in 1985, was it expected when you 7 had a decline in interest rates of 200 basis 8 points that there would be an increase in 9 prepayment rates? 10 A. Not an increase as severe as what 11 happened. 12 Q. Okay. But it was understood there 13 would be an increase? 14 A. Sure. 15 Q. I mean, people weren't walking around 16 assuming that prepayment rates would stay constant 17 no matter what interest rates did, were they? 18 A. Pretty close to that when I was at 19 Freddie Mac. 20 Q. And what year was that? 21 A. That was in '82 to '85. 22 Q. And where were you after that? Fannie 4145 1 Mae, did you say? 2 A. No. Salomon Brothers. 3 Q. In '85, what were the expectations if 4 there was a 200 basis point decline in interest 5 rates? 6 A. Depends on when in '85 you were talking 7 about. Probably in the beginning of '85, you had 8 almost constant expectations. At the end of '85, 9 you had quite volatile expectations. 10 Q. What do you mean by "the end of '85"? 11 November, December? 12 A. Yeah, whatever. 13 Q. Now, you testified that the minutes, I 14 think, from the January 21st, 1986, investment 15 committee meeting was -- 16 A. January '86 or '87? 17 Q. '87. Excuse me. January 21st, 1987. 18 A. Yes. 19 Q. That that portfolio was favorably 20 positioned for an interest rate decline. 21 Do you recall that? 22 A. I remember you reading that phrase 4146 1 repeatedly yesterday. I don't see it here in the 2 21st minutes yet. 3 Q. Now, you also testified that -- and I 4 think we looked at one of those minutes just a few 5 minutes ago where you repositioned the portfolio 6 to cushion the effect of a rising interest rate 7 market. 8 Do you recall that? 9 A. Yes. 10 Q. Now, why in November of '86 were you 11 positioning or rebalancing the portfolio to 12 cushion it against rising interest rates? Do you 13 recall? 14 A. I must have thought possibly that rates 15 would rise. 16 Q. Okay. And in January when you said 17 that the portfolio was favorably positioned for 18 further rate declines, did you do so -- did you 19 make that statement in anticipation that interest 20 rates were going to decline? 21 A. No. 22 Q. No? 4147 1 A. Not necessarily, no. That's just a 2 statement of how the portfolio risk profile was. 3 It has nothing to do with a judgment. And that 4 "favorably" word was not a judgment call in any 5 sense. It was simply saying that if rates fell by 6 50 basis points or mark-to-market, then it's 7 better. 8 Q. Are you saying you were helpless and 9 you couldn't do anything about that? 10 A. No. I'm never saying that. No. I'm 11 saying that that was the position of the portfolio 12 regardless of -- at that moment when I was sitting 13 there not trading. I was sitting there. 14 Q. You were sitting there? 15 A. Yeah. 16 Q. And you managed that portfolio for 17 three months by then. Right? 18 A. I'm not sure that I -- at that point I 19 had been able to manage it for three months, if I 20 had the necessary authorizations or the trading 21 ability at that point. 22 Q. But you ascertained that it was 4148 1 favorably positioned for further rate declines? 2 A. I must have, yes. 3 Q. Okay. And that it wasn't until April 4 that you started doing anything to readjust that 5 portfolio for rate declines, was it? 6 A. I don't know. 7 Q. Well, if the documents we've gone 8 through indicate that you didn't do anything until 9 April -- 10 A. I'm not sure that they indicate that 11 because I have to go through every trade that was 12 made, every transaction every week and see what 13 the effect was, which I haven't had time to do. 14 Q. Well, if the documents indicate that 15 the portfolio was favorably positioned for further 16 rate declines similar to the sensitivity analysis 17 that follows on Page 5225, is it fair to assume 18 that your management of that portfolio was based 19 on the assumption that there would be further rate 20 declines? 21 A. No. 22 Q. No? 4149 1 A. Because I don't think that's what the 2 activity would show if I went through week to week 3 and did the trades that I was positioning myself 4 intentionally for a rate decline, no. 5 Q. But you don't dispute -- we've gone 6 through the documents twice now. You don't 7 dispute the accuracy of the statements that are in 8 the documents, do you? 9 A. I dispute your interpretation of them, 10 but I don't dispute the accuracy of the documents. 11 Q. Now, you testified that you made the 12 value trades to increase yields or capture 13 unrealized gains as income. 14 Do you recall that testimony? 15 A. Yes. 16 Q. And you testified in response to 17 questions from Mr. Nickens that it was done so in 18 order to increase capital because capital was 19 king, I think was the term that was used. Right? 20 A. Yes. 21 MR. NICKENS: Your Honor, that is not 22 an accurate summation of the testimony. I asked 4150 1 some questions about a memo that related to 2 capital that was drafted before Ms. Orr was at the 3 institution. And so, once again, Mr. Guido is 4 mixing the time frame that is relevant. 5 THE COURT: But her testimony was that 6 these trades were made to increase capital. That 7 was part of the question. 8 MR. NICKENS: Your Honor, the testimony 9 has been that trades were made with regard to 10 various purposes which are documented in the 11 records. Yesterday, Mr. Guido elicited from the 12 witness with regard to two or three specific ones 13 that they were either to increase yield or to take 14 a gain. The witness has explained about what she 15 believes that relationship is. But we've gone 16 over virtually every one of these which is 17 documented in the investment committee minutes and 18 which I believe she has indicated that she stands 19 by as to what their purposes were. 20 MR. GUIDO: Your Honor, the witness has 21 just answered the question. She seemed to confirm 22 what the summation of her testimony was, and I 4151 1 think I've accurately summarized her testimony. 2 MR. NICKENS: It just shows -- it just 3 shows the vice of allowing a question which I 4 didn't object to that summarizes the testimony, 5 but it summarizes it inaccurately. 6 THE COURT: All right. The next 7 question. 8 Q. (BY MR. GUIDO) Now, you indicated in 9 your testimony, Ms. Orr, that you thought that was 10 an appropriate thing to do. 11 Do you recall that testimony? 12 MR. NICKENS: Your Honor, I don't know 13 what "that" refers to. 14 Q. (BY MR. GUIDO) It was appropriate to 15 make trades for purposes of increasing yields? 16 A. Yes. 17 Q. Okay. And it was appropriate to make 18 trades to increase profits? 19 A. To increase capital which could be used 20 to lever further in increased spreads, yes. 21 Q. And then you made reference to traders. 22 Do you recall that reference? 4152 1 A. No. 2 Q. You made reference to portfolio 3 managers with regard to yields. Do you recall 4 that testimony? 5 A. No. 6 Q. Okay. Is it your -- to your knowledge, 7 do mortgage-backed security portfolio managers 8 trade or swap mortgage-backed securities in order 9 to increase yield? 10 A. Yes. 11 Q. Now, what portfolio managers are you 12 talking about when you say that? 13 A. Any of them. 14 Q. Any of them? All of them? 15 A. All of the above. 16 Q. How do you know that? 17 A. Because I've been involved with almost 18 every line of mortgage business around, and I've 19 seen it happen. 20 Q. Now, that happened at Salomon Brothers, 21 did it not? 22 A. Yes. 4153 1 Q. Did it happen at Fannie Mae? 2 A. Yes. 3 Q. Did it happen at Freddie Mac? 4 A. Yes. It happens at mutual funds. It 5 happens at banks. It happens at thrifts. It 6 happens everywhere. Insurance companies. 7 Q. Now -- 8 A. Mortgage banking firms. 9 Q. At Salomon Brothers, was the 10 mortgage-backed security portfolio mark-to-market? 11 A. Yes. 12 Q. At Freddie Mac, when there was trading, 13 was it mark-to-market? 14 A. When there was a trading account, yes. 15 But, no, the normal activity of the portfolio 16 management was not mark-to-market when I was 17 there. I don't know now. And also, a lot of 18 banks are still not mark-to-market on their 19 portfolio management trading, such as NationsBank. 20 There are a lot of institutions, insurance 21 companies, that are not mark-to-market on their 22 mortgage assets and yet, they swap coupons. 4154 1 Q. Now, how actively were you looking for 2 value trades when you were at USAT managing its 3 portfolio? 4 A. Extremely actively. 5 Q. Were you looking for them on a daily 6 basis? 7 A. Yes. 8 Q. Now, did Peat Marwick ever raise a 9 question about the trading in USAT's junk bond and 10 mortgage-backed security portfolios? 11 A. I have no idea what they did about the 12 junk bonds. They may have raised a question. I 13 don't recall. If they did raise a question, it 14 was sufficiently answered that they approved 15 everything we did. 16 Q. Did you have any dealings with them 17 with regard to their inquiry or -- 18 A. I provided backup on such things. 19 Q. Pardon? 20 A. I provided backup on such things when 21 Mike Crow requested it. 22 Q. Okay. So, you do know that they raised 4155 1 a question about the trading in the 2 mortgage-backed security portfolio in 1986? 3 MR. NICKENS: Your Honor, the witness 4 has said she does not recall that. 5 A. I don't recall specific instances, 6 but -- 7 MR. GUIDO: She indicated also, 8 Mr. Nickens, Your Honor, that she provided backup 9 to Mr. Crow in response to inquiries and that it 10 seems to -- 11 THE COURT: Well, that reference was 12 pretty vague. I think we can proceed. 13 A. Whenever Mike Crow had an inquiry, if 14 he had one, then I would provide the backup in any 15 accounting issue. 16 Q. (BY MR. GUIDO) But you don't recall 17 today any question being raised -- 18 A. No specific ones. 19 Q. -- about trading in that portfolio? 20 A. No. 21 Q. Do you recall whether the policy 22 statement that -- with regard to mortgage-backed 4156 1 security trading in the portfolios you could 2 manage was changed subsequent to your proposal in 3 October of 1986 to the investment committee? 4 A. I have no idea. 5 Q. Did any -- has anyone ever shown you a 6 document that is different than the document that 7 you testified about with regard to -- I think it 8 was October 8th where the policies are mentioned. 9 Take a look at Exhibit A1412, please. 10 A. Yes. 11 Q. And look at 4917, please. 12 A. Yes. 13 Q. The first sentence says "It shall be 14 the policy of United Savings Association of Texas 15 to undertake trading activities related to the 16 mortgage-backed securities investment portfolio 17 trading operation from time to time in order to 18 enhance the profitability of the association." 19 Do you see that sentence? 20 A. Yeah. 21 Q. Okay. And you proposed that sentence, 22 did you not? 4157 1 A. I wrote it, I'm sure. 2 Q. Okay. Have you ever seen the same 3 document, the identical document, but after it 4 says in order -- it picks up, drops the rest of 5 the sentence, and it says "to reduce the net 6 interest rate exposure of the association"? 7 A. No. 8 Q. You've never seen such document? 9 A. Not unless you showed it to me today in 10 the ream of documents that we have sitting here. 11 Q. I haven't shown you a document today 12 that has that. 13 A. I don't remember seeing that document 14 unless it was waved in my face. 15 Q. Now, who did you meet with representing 16 the respondents before your testimony? 17 A. Representing respondents -- 18 Q. Pardon? 19 MR. NICKENS: I'll say for the record 20 it was me and Ms. Clark and Mr. Keeton. 21 Q. (BY MR. GUIDO) Has anyone ever shown 22 you a document that has that sentence completed 4158 1 the way I just read it into the record? 2 A. How could I possibly know that? Look 3 at these documents. How could I possibly know 4 that? 5 Q. Excluding all the documents that you've 6 seen in this courtroom, have you ever seen a 7 document that completes that sentence -- 8 A. Do you know how many documents they 9 gave me? Here. They gave me this many documents. 10 It may have been in one of them. 11 Q. Okay. Did they discuss the documents 12 with you? 13 A. Some of them, yes. 14 Q. Okay. Did they discuss a document that 15 completed that sentence with the phrase "to reduce 16 the net interest rate exposure of the 17 association"? 18 A. I don't recall. 19 Q. Now, you've testified about the 20 sensitivity analysis that you did periodically 21 with regard to the portfolio. 22 Do you recall that testimony? 4159 1 A. It's all been that. 2 Q. Pardon? 3 A. It's all been relating to that as far 4 as I'm concerned. 5 Q. Well, let's just use, for example, 6 A1426, the January 21st document. 7 A. Yes. 8 Q. That document you've described as a 9 sensitivity analysis, have you not? It's on 5225. 10 A. Fine, yes. 11 Q. Okay. Now, why did you do the 12 sensitivity analyses that Exhibit 1426, Page 5225, 13 is an example of? 14 A. Because it's the prudent thing to do. 15 Q. And why is it the prudent thing to do? 16 A. So that you can anticipate when rates 17 later move in a direction what's going to happen 18 to the value of your portfolio. 19 Q. Does it also tell you what's happened 20 to your portfolio at that date in the column that 21 says "yields unchanged"? 22 A. It shows you the mark-to-market. It 4160 1 doesn't explain it in any way. 2 Q. But it shows you what's happened based 3 on the accumulated decisions up to that date? 4 A. It shows you the mark-to-market. It 5 doesn't show you anything about spread. It 6 doesn't show you anything about profits that have 7 gone to capital. 8 Q. Now, does it tell you something 9 different than the spread yield figure tells you? 10 A. Yes. 11 Q. And what is it that it tells you? 12 A. It shows you the present value of the 13 cash flows related to that portfolio at that point 14 in time. 15 Q. Okay. And what does the yield spread 16 tell you? 17 A. It shows you the accounting earning 18 spread. 19 Q. For how far out into the future? 20 A. However far out you run it. 21 Q. Now, I'd like you to take a look at 22 Exhibit B1845, which is that -- why don't we just 4161 1 look at my copy because you're just going to look 2 at one page. 3 MR. NICKENS: May I ask what the 4 document is? 5 MR. GUIDO: It's the internal audit 6 report that you used. 7 A. Okay. What is it? 8 Q. (BY MR. GUIDO) Look the first 9 introduction. It says -- it's on Bates stamp 10 OW156674. It says "A limited review of the 11 investment portfolio and individual issue limits 12 was performed for the month of July 1987. In 13 addition, high-yield bond purchases for July and 14 August were compared to the investment committee 15 authorizations. The transactions that occurred 16 during the period were matched to the appropriate 17 authorizations outlined in the investment 18 committee minutes and limits provided to the 19 treasury controller by the chief financial officer 20 as set forth in the portfolio position limits 21 form. The investment committee minutes for July 22 and August were reviewed and occurring during this 4162 1 period are also noted." 2 And then it has the results. One, the 3 first category says "portfolio position limits" 4 and then it talks about individual issues. 5 Did that report purport to be an 6 analysis of whether the portfolio, the 7 mortgage-backed security portfolio, was within the 8 position limits? 9 A. Yes. 10 Q. Did it do anything more? 11 A. I don't know because I haven't read all 12 of the pages. 13 Q. Well, you only have to read the results 14 section. 15 A. Okay. Results. 16 MR. NICKENS: Well, now, Your Honor, I 17 would -- if the intent is to limit the question to 18 the results section -- 19 MR. GUIDO: That's what I'm limiting 20 the question to, Mr. Nickens. 21 MR. NICKENS: Which section is that, 22 may I ask? My copy -- 4163 1 THE COURT: We'll take a short recess. 2 3 (A short break was taken 4 at 3:01 p.m..) 5 6 THE COURT: Be seated, please. We'll 7 be back on the record. Mr. Guido, you may 8 continue. 9 MR. GUIDO: Thank you, Your Honor. 10 (3:26 p.m.) 11 Q. (BY MR. GUIDO) I'd like to show you a 12 document that I've had -- we've had marked as 13 A1487, Ms. Orr. 14 MR. GUIDO: I'd like to move the 15 admission of A1497, Your Honor. 16 MR. NICKENS: I believe it's 1487. 17 MR. GUIDO: 1487. Excuse me, Your 18 Honor. 19 MR. NICKENS: No objection. 20 THE COURT: Received. 21 MR. GUIDO: The minutes of the 22 investment committee of UFG and -- or United 4164 1 Savings Association of Texas. 2 Q. (BY MR. GUIDO) And I'd like to direct 3 your attention to the first page of the report, 4 Ms. Orr, where it says in the fifth -- fourth 5 paragraph down, "Ms. Sandy Laurenson then reported 6 on the mortgage-backed security portfolio. Her 7 report was ordered attached to the minutes of the 8 meeting. She noted that she could sell caps at a 9 profit. She also noted that she was selling some 10 of the Fannie Mae 9 and a half and rolling up in 11 coupon. This will be an 8.8-million-dollar 12 transaction." 13 Then it says "Ms. Laurenson discussed 14 the final 1987 report. Performance numbers of 15 United MBS Corporation." 16 I'd like to direct your attention to 17 Page US3012503. 18 A. Yes. 19 Q. Now, that says "United MBS Corporation 20 performance report, December year-to-date." And 21 it's December 1987. 22 A. Yes. 4165 1 Q. Do you recall making that presentation 2 to the -- 3 A. No. 4 Q. -- investment committee? Okay. It 5 shows -- you see where the total amount under 6 total assets, it shows $1.48 million? Do you see 7 that? 8 A. It would be billion. 9 Q. Billion. Excuse me. 10 A. Yes. 11 Q. Do you see that figure? 12 A. Yes. 13 Q. Was that the approximate size of the 14 United MBS portfolio at that time? 15 A. I would assume it was the exact size. 16 Q. Okay. Now, you testified that at some 17 point in time, Jenard Gross had instructed you to 18 create a portfolio for United Savings Association 19 of $3 billion? 20 A. Yes. 21 Q. Is it your understanding that he was 22 talking about the United Savings Association 4166 1 portfolio combined with the UMBS portfolio? 2 A. I wasn't sure; but once we got to this 3 size, we seemed to go along fine without any 4 further reference to that so... 5 Q. So, it's your assumption that when he 6 was referencing $3 billion, he was referring to 7 the combined MBS portfolio? 8 A. I'm not sure. I don't know. 9 Q. Did he tell you how he had arrived at 10 that 3-billion-dollar figure? 11 A. No. 12 Q. No? Did he tell you whether or not 13 someone had instructed him to convey that 14 information to you? 15 A. No. No. That wouldn't have been an 16 instruction. That was just -- Jenard came up with 17 that somehow. 18 Q. Now, look at the portfolio. One of 19 them is ARMs. Do you see that column? 20 A. Yes. 21 Q. Okay. You have broken it out into four 22 different categories, ARMs being one of them. And 4167 1 it says $316 million in ARMs. 2 Are those the adjustable rate mortgages 3 that you testified about earlier -- 4 A. Yes. 5 Q. -- with Mr. Nickens? Now, you 6 indicated that adjustable rate mortgages are 7 mortgages that the interest rates change depending 8 upon what the current interest rates are at a 9 particular point in time? 10 A. Yes. 11 Q. Okay. Can you tell us how that works? 12 A. They have an index that the person 13 paying the mortgage is notified when the index 14 changes and their payment changes. 15 Q. And how often does that index kick in? 16 A. The index kicks in monthly on these. 17 The payment adjusts yearly. They are "neg am" 18 loans. 19 Q. Now, is there -- are there any caps on 20 what the interest rates can do in adjustable rate 21 mortgages? 22 A. Not on these. 4168 1 Q. Not on these? 2 A. No. There is a 7 and a half percent 3 payment cap, but there is no interest rate cap. 4 Q. Is there a yearly payment cap? 5 A. Yes. 6 Q. What was the yearly payment cap in 7 those -- 8 A. 7 and a half percent. 9 Q. 7 and a half percent per year? 10 A. Uh-huh. (Witness nods head 11 affirmatively.) 12 Q. So, the payments couldn't exceed more 13 than 7 and a half percent in any given year? 14 A. Yes. Increase, yes. 15 Q. Okay. Now, you said that there was an 16 Arb 2, I think is what this says. Was the Arb 2 17 the second wave of purchases of mortgage-backed 18 securities in the United MBS portfolio? 19 A. That would make sense, but I don't know 20 that to be fact. 21 Q. And then in the first column, it says 22 "fixed hedged instruments." Are those the 4169 1 mortgage-backed securities that were hedged with 2 those Eurodollar futures that were purchased 3 sometime in November or December of 1986? 4 A. I don't know. 5 Q. And then it says there's $516 million 6 of fixed unhedged mortgage-backed securities. 7 Do you see that column? 8 A. Yes. 9 Q. Did you make that classification? 10 A. Let me see. Is this -- no. That's the 11 performance report. I did not do that. 12 Q. Who did that? 13 A. Russell McCann. 14 Q. Were there a category of fixed mortgage 15 rate 30-year mortgages that were denominated 16 unhedged in the United MBS portfolio? 17 A. In his mind, there must have been; but 18 in mine, I never made that designation. 19 Q. Now, let's turn to Page 12501, which is 20 about four pages before that. 21 A. Yes. 22 Q. That has one of your sensitivity 4170 1 analysis summaries. 2 Do you see it there at the bottom of 3 the page? 4 A. Yes. 5 Q. And it shows for Arb 1 a negative 6 figure in the unchanged of around $36 million. 7 Do you see that? 8 A. Yes. 9 Q. And for Arb 2, somewhere around 10 $33 million negative figure. 11 Do you see that? 12 A. Yes. 13 Q. Okay. Are those United MBS? 14 A. I assume so. It's a rational 15 assumption. 16 Q. And it shows a total figure for all 17 portfolios of a minus or negative $245 million. 18 Do you see that figure? 19 A. Yes. 20 Q. When you took over the portfolio, I 21 think the sensitivity analysis showed that there 22 was something approximating $100 million negative 4171 1 market value in the portfolio. 2 Do you recall that figure? 3 A. I don't think so. I think that was 4 just the swaps alone were marking down 122 million 5 net of the assets. I think it was more like 6 50 some-odd million. 7 Q. Let's go back to those minutes again 8 from January 21st, 1987. 9 A. 1987 or nineteen -- 10 Q. '7. That's Exhibit 1426, A1426. You 11 can take a look at my copy, Ms. Orr. 12 A. Thank you. Yes. 13 Q. See the column that says "net 14 liquidation value, yields unchanged"? 15 THE COURT: What page are you on? 16 MR. GUIDO: It's 5225, Your Honor. 17 A. Yes. 18 Q. (BY MR. GUIDO) What's the figure 19 there? 20 A. That's a 100-million-dollar figure. I 21 believe I did an earlier evaluation that showed it 22 to be even lower in loss. 4172 1 Q. But as of January 21st, 1987, it's 2 $100 million counting the MBSs and the swaps. 3 Right? 4 A. Yes. 5 Q. Okay. And in January 20th, 1988, it 6 shows a negative figure of $245 million, does it 7 not? 8 A. Yes. 9 Q. Now, look at the performance report on 10 12503 on Exhibit 1487. 11 A. It also shows that in January '87, the 12 book value of assets was 674 million and in 13 January of '88, it was 3,041,572,000. 14 What was the next question? 15 Q. Now, look at the performance report for 16 January of 1988 at 12503. 17 A. Yes. 18 Q. It shows a net income figure of 19 $22,890,000. Do you see that figure? 20 A. Yes. 21 Q. If you subtract the 100 million from 22 the 245 and you subtract the 22 million, you come 4173 1 up with $123 million negative figure 2 approximately, Ms. Orr. 3 Is that the results of your management 4 of that portfolio -- 5 A. No. 6 Q. -- from October 1986 through December 7 of 1987? 8 A. No. The mark-to-market that you're 9 referring to in both cases are totally different. 10 The mark-to-market on the January 21st, 1987, that 11 you're referring to includes all of the mortgage 12 portfolios at that time. This performance report 13 only includes the MBS sub, which was 1.4 billion 14 of a 3-billion-dollar total. 15 Q. I'm sorry. When you make reference to 16 the latter figure, what is it you're referring to? 17 A. I'm saying you're only looking at 18 1.4 billion of a 3-billion-dollar total portfolio 19 when you're look looking at that 22-million-dollar 20 figure. 21 Q. And so, there was other income that's 22 not included in that calculation? 4174 1 A. Yes. 2 Q. Do you know what that other figure was? 3 A. I have heard it was roughly 4 $60 million, something along those lines. 5 Q. Was that 60-million-dollar figure a 6 figure you got from Mr. Nickens? 7 A. He mentioned that figure once, but I 8 also heard it from other sources in United. 9 Q. In United? When? 10 A. In '89, '88. I still had contacts 11 there. 12 Q. Do you know whether or not that 13 60-million-dollar figure includes the 22? 14 A. I have no idea. 15 Q. If we give you credit for that 16 $60 million, what was the result of the 17 performance of the portfolio during the period of 18 time you managed that portfolio? 19 A. Well, $60 million versus $245 million 20 versus what the market did versus everything else 21 versus the ongoing positive spread that was in it 22 at the end of my management, I'm not sure. You 4175 1 tell me. 2 Q. Did you ever have any discussions with 3 any of the people that you spoke to at Salomon 4 Brothers when you joined USAT after you had left 5 USAT? 6 A. Yes. 7 Q. Okay. Did you describe to them your 8 experience at USAT? 9 A. I don't remember specifically doing 10 that, no. 11 Q. Did you ever describe to them the 12 outcome of the portfolios that you had managed 13 during that period of time? 14 A. I don't remember. 15 Q. Did you ever describe to them what the 16 investment policy was in the mortgage-backed 17 securities portfolios during the time that you 18 managed them at USAT? 19 A. I don't believe so. I can't imagine 20 that they would have cared about something like 21 that. 22 Q. Okay. 4176 1 MR. GUIDO: Thank you, Ms. Orr. No 2 further questions. 3 THE COURT: Mr. Nickens? 4 5 RECROSS-EXAMINATION 6 7 (3:41 p.m.) 8 Q. (BY MR. NICKENS) Ms. Orr, let me show 9 you -- Mr. Guido asked you some questions about 10 the swaps. I'm going to show you A11022 which is 11 a document that Mr. Hargett prepared, Page 6. 12 What is the amount of caps indicated in 13 United MBS in December of 1987? 14 A. Caps: 1,180,000,000. 15 Q. And if you look at 1487 over there at 16 the performance report that he questioned you 17 about on the year-to-date figures, the net 18 interest spread for every one of your portfolios 19 is positive or negative? 20 A. Positive. 21 Q. Ranging from what numbers? 22 A. Ranging from 25 basis points to a 4177 1 hundred -- from 302 basis points. And may I just 2 also comment that Mary Mims has told me that 3 subsequent to my departure, they revised their 4 accounting yield so that the spreads were actually 5 even wider. 6 Q. Was the mortgage-backed portfolio at 7 USAT growing at all times that you were employed 8 there? 9 A. No. So, the gains that we were taking 10 at were not reinvested continuously in a leveraged 11 fashion to achieve the rate of return that one 12 would have done in an ideal situation. 13 Q. Well, the -- you just pointed out that 14 the portfolio when you came was something under a 15 billion and when you left, it was something like 2 16 and a half billion. Is that -- 17 A. Yes. 18 Q. Do I have those numbers wrong? 19 A. That sounds about right. I think it 20 did reach a high of about 3 billion. 21 Q. Ask then came back down? 22 A. Came back down, yes. 4178 1 Q. And with regard to the transactions 2 that we have looked at, most of those transactions 3 are swap transactions, are they not? 4 A. Yes. 5 Q. Meaning that you sold something and 6 then reinvested the proceeds from that sale in 7 other MBS? 8 A. Yes. 9 Q. And the documentation that we have 10 looked at reflects the purpose of those 11 transactions? 12 A. Yes. 13 Q. And do you stand by that documentation 14 made at the time with regard to the purpose of 15 those transactions? 16 A. Yes. 17 Q. Now, Mr. Guido asked you about a 18 document, whether you had ever seen a document 19 relating to a statement of policy regarding 20 mortgage-backed securities. And I'm going to show 21 you a document that we've marked as B1281. 22 MR. NICKENS: Your Honor, we offer 4179 1 B1281. 2 MR. GUIDO: No objection, Your Honor. 3 THE COURT: Received. 4 Q. (BY MR. NICKENS) B1281 indicates from 5 Mr. Berner to you and Mr. Jacobson and 6 Mr. Williams dated October 22, 1986, correct? 7 A. Yes. 8 Q. And he states here that "The board of 9 directors has recently" -- and I'm looking at the 10 fifth paragraph. "The board of directors has 11 recently adopted Sandy's policy and at the board 12 of directors meeting which is scheduled to be held 13 on November 13th, 1986, we will present the memo 14 setting out the procedure governing 15 mortgage-backed security trading to the board for 16 approval." 17 Do you see that? 18 A. Yes. 19 Q. Then on the second page, you see a 20 document that is similar in nature to the one that 21 Mr. Guido showed you with regard to -- that was 22 attached to the minutes. Right? 4180 1 A. Yes. 2 Q. But you see that in the sentence at the 3 top, it says "It shall be the policy of United 4 Savings Association to undertake trading 5 activities related to the mortgage-backed 6 securities investment portfolio trading operation 7 from time to time" -- and then underlined there is 8 "in order to reduce the net interest rate exposure 9 of the association." 10 Do you see that? 11 A. Yes. 12 Q. And that's different than the one that 13 had been -- that Mr. Guido showed you with regard 14 to your proposal? 15 A. Yes. 16 Q. Okay. Now -- and then if you will turn 17 to the next page, you'll see a copy, apparently, 18 of the regs for FSLIC insured institutions. 19 Do you see that? 20 A. Yes. 21 Q. And I think the record will reflect 22 that this is dealing with financial options 4181 1 transactions. 2 A. Yes. 3 Q. And do you see what is underlined in 4 Paragraph 6B relating to short positions? 5 A. Yes. 6 Q. And what is the language used there? 7 A. It says "To reduce its net interest 8 rate risk exposure as provided in this 9 Paragraph B." It's describing the use of the -- 10 the authorized use of options. 11 Q. All right. And so that the language of 12 the proposal at some point or another was 13 apparently changed to conform with the regs 14 dealing with the options that you were intending 15 to buy, or do you know? 16 A. I don't know. I don't know what was 17 done. 18 MR. NICKENS: Your Honor, that's all my 19 questions. 20 21 22 4182 1 2 REDIRECT-EXAMINATION 3 4 (3:46 p.m.) 5 Q. (BY MR. GUIDO) Ms. Orr, have you seen 6 this document before? 7 MR. NICKENS: Well, it's addressed to 8 her. Does he mean in the recent time or that 9 she's got any recollection of it? 10 Q. (BY MR. GUIDO) Do you have any 11 recollection of this document? 12 A. I have no recollection of the document. 13 Q. Because you originally testified you 14 had never seen such a document before. 15 A. I have no recollection of the document. 16 Q. Have you seen this document recently 17 before today? 18 A. Not recently, no. 19 Q. Do you know whether or not this policy 20 was adopted by the board of directors -- 21 A. No, it's not signed. 22 Q. -- of USAT? Okay. Did anyone ever 4183 1 tell that you this policy had been adopted? 2 A. No. 3 Q. Okay. 4 MR. GUIDO: No further questions, Your 5 Honor. 6 MR. NICKENS: That's all we have, Your 7 Honor. 8 THE COURT: Thank you, Ms. Orr. You 9 may step down. 10 MR. RINALDI: Your Honor, the next -- 11 THE COURT: Mr. Rinaldi. 12 MR. RINALDI: Yes. The next witness is 13 James Whatley, a former director of UFG and USAT 14 who also had the distinction of serving on the 15 compensation committee for both entities. He will 16 be testifying about a wholly different area of -- 17 in the case. He'll be talking about the 18 compensation practices that occurred in the period 19 at the end of '87 and throughout '88 with respect 20 to certain executives of USAT and UFG. So, all of 21 these documents which relate to the 22 mortgage-backed trading need to be removed. But I 4184 1 have been advised by Mr. Whatley that he is 2 available through the early afternoon tomorrow and 3 then must go onto Natchez, Mississippi. So, I 4 would like to get him started this afternoon and 5 see if we can't wrap him up by tomorrow. 6 Otherwise, he has indicated to me that he is 7 willing to come back at a later date but that he's 8 not quite sure what his schedule will permit. 9 So, I'd like to as quickly as possible 10 get him on and see how far we can get with him. 11 THE COURT: All right. You need about 12 ten minutes to straighten up your documents and 13 get ready? 14 MR. RINALDI: Yeah, if that. But that 15 would be fine. 16 THE COURT: We'll take a ten- minute 17 break. 18 19 (A short break was taken 20 at 3:49 p.m.) 21 22 THE COURT: Be seated, please. We'll 4185 1 be back on the record. 2 MR. RINALDI: Thank you, Your Honor. 3 THE COURT: Mr. Rinaldi. 4 MR. RINALDI: Yes. The OTS calls as 5 its next witness Mr. James Whatley. 6 THE COURT: Would you take the oath, 7 please? 8 9 JAMES WHATLEY, 10 11 called as a witness and having been first duly 12 sworn, testified as follows: 13 THE COURT: Be seated, please. 14 15 EXAMINATION 16 17 (4:02 p.m.) 18 Q. (BY MR. RINALDI) Will you state your 19 full name for the record, sir? 20 A. James Royce Whatley. 21 Q. And you've been called here to testify 22 in a matter relating to United Savings Association 4186 1 of Texas. 2 How did you first become associated 3 with United Savings Association of Texas? 4 A. We acquired the association. Our 5 company acquired the association. 6 Q. Okay. And when you say your company 7 acquired it, what company are you referring to? 8 A. Kaneb Services, Incorporated. 9 Q. And can you describe for the Court 10 how -- when that occurred? 11 A. Not precisely. In the late Seventies, 12 I believe. 13 Q. Now, after Kaneb -- what was your 14 position with respect to Kaneb? 15 A. At that time, I believe I was president 16 and chief executive officer. 17 Q. And what was the nature of the business 18 of Kaneb? 19 A. Pipelines principally, oil and gas 20 production, oil drilling. 21 Q. And what was your position at Kaneb? 22 A. I was president and chief executive 4187 1 officer at that time. 2 Q. Okay. And what would cause Kaneb to 3 acquire USAT? 4 A. Kaneb had been active in acquisitions 5 for a number of years and we had a financial 6 services group of subsidiaries and we thought this 7 would be additive to that. 8 Q. And I'm sorry. Approximately what 9 point in time did Kaneb acquire USAT? 10 A. The record will reflect that. I think 11 it was the late Seventies. 12 Q. Okay. And prior to that, had you had 13 any experience with respect to the operation of 14 savings and loans? 15 A. No. 16 Q. Okay. And did you -- after Kaneb 17 acquired USAT, become a director of United Savings 18 Association of Texas? 19 A. I did. 20 Q. And are you familiar with the entity 21 known as United Financial Group? 22 A. Yes. 4188 1 Q. And did you also become at some point 2 in time a director of United Financial Group? 3 A. I did. 4 Q. And approximately what point in time 5 did you become a director of those entities? 6 A. At the time of the acquisition, I 7 believe. 8 Q. And after you became a director, did 9 you then continually -- for what period of time 10 did you continue to serve as a director of 11 United -- USAT? 12 A. Until it was taken over. 13 Q. And when you say "until it was taken 14 over," you mean at which point in time the 15 institution was placed into receivership? 16 A. Correct. 17 Q. And do you recall that that was at the 18 end of 1988? 19 A. I'll accept that. 20 Q. So that you would have been a director 21 of that institution, United Savings Association of 22 Texas, for approximately -- from the end of 1970 4189 1 through the end of 1988? Yes. 1988? 2 A. You say the end of 1970. I think that 3 was before the date of acquisition. 4 Q. I'm sorry. Between -- from the end of 5 the 1970s, that is -- 6 A. I'll accept that. The records will 7 reflect that. 8 Q. Okay. And for how long did you remain 9 a director of United Financial Group? 10 A. As far as I know, until this day. 11 Q. So, all the way from the end -- the 12 acquisition date through the present? So that -- 13 A. Correct. 14 Q. -- would be some 27 years at least? 15 A. I'll accept whatever the record 16 reflects. 17 Q. Okay. Well, let me hand you a copy -- 18 in the interest of moving this along, I will 19 forego the specific dates. 20 Now, did you -- can you describe for me 21 what committees you served on while you were a 22 member of USAT? 4190 1 A. I served on the compensation committee, 2 the executive committee, and I think at least for 3 some brief period on the audit committee. 4 Q. Okay. And do you recall approximately 5 the period of time that you served on the 6 compensation committee of USAT? 7 A. I do not. 8 Q. Did you also serve on the compensation 9 committee of United Financial Group? 10 A. I don't know that United Financial had 11 a compensation committee. If it did, I probably 12 did, yeah. 13 Q. Now, you indicated that you served, 14 also, on the executive committee. Was that the 15 executive committee of USAT or the executive 16 committee of UFG? 17 A. USAT. 18 Q. Okay. And what was the function of the 19 executive committee, as you recall? 20 A. To meet from time to time between board 21 meetings to take up matters to be discussed at 22 ensuing board meetings. 4191 1 Q. And I'll hand you a copy of what's been 2 previously marked as A3014. This is the 1987 3 proxy statement for United Financial Group. 4 Do you recall who else was on the 5 executive committee at the point in time when you 6 served on that committee, sir? 7 A. I believe that Barry Munitz was and 8 Jenard Gross. There could have been others. I'm 9 not sure. 10 Q. And directing your attention to Page 8 11 of what's been marked as Exhibit 3014, in the 12 paragraph under "executive committee," it 13 identifies who the other individuals were on the 14 executive committee in 1987. 15 Do you see that? 16 A. Okay. 17 Q. And it indicates that it was you, 18 Mr. Gross, Mr. Munitz, and Mr. Hurwitz. 19 Do you see that? 20 A. Okay. 21 Q. And were you also then on the executive 22 committee of USAT? 4192 1 A. This is United Financial Group? 2 Q. Uh-huh. 3 A. I believe that's correct. 4 Q. And do you recall who the members of 5 the USAT executive committee were? 6 A. I do not. I assume that it's the 7 persons listed here. 8 MR. RINALDI: Your Honor, I would move 9 Exhibit A3014 into evidence at this time. 10 MR. EISENHART: I believe it's already 11 in. 12 MR. VILLA: If it isn't in, we don't 13 object. No objection, Your Honor. 14 Q. (BY MR. RINALDI) Now, it indicates in 15 the middle of that page that the executive -- 16 well, let me ask you this. 17 Can you -- approximately how many times 18 a year did the board of directors of USAT meet, 19 sir, that you recall? 20 A. I believe regular meetings were about 21 once a month. 22 Q. This is at USAT? 4193 1 A. I believe so. 2 Q. Okay. Now, were those the meetings of 3 the full board or were those the meetings of the 4 executive committee? 5 A. I think they were full board. 6 Q. Do you recall being previously deposed 7 in this matter and having been questioned on 8 these -- on this same matter? 9 A. I remember being deposed before, yes. 10 Q. Okay. And it says -- do you recall 11 being asked the following questions? Question, 12 "And what? It indicates here that the executive 13 committee met on 14 occasions. Did the executive 14 committee always meet in person, face-to-face, or 15 were there telephonic meetings? Do you recall?" 16 "I don't recall." 17 "You indicated earlier that you thought 18 you came to Houston four to six times a year with 19 respect to USAT. Do you recall coming to Houston 20 14 times regarding UFG matters?" 21 And you said, "No. It's very clear 22 that I did not attend anything approaching all of 4194 1 those meetings." 2 Do you remember giving those answers? 3 A. I don't remember, but I'll accept it. 4 Q. Well, I'm just trying to get a sense of 5 what the process was by which you attended 6 meetings. Did you live in Houston? 7 A. Not at that time. Depending on the 8 period in question. I left Houston in December of 9 1982; so, any meetings subsequent to that, I was 10 not in Houston. 11 Q. Well, during the period specifically of 12 1987 and 1988, where were you living at that point 13 in time? 14 A. On a lake in Pittsburgh, Texas. 15 Q. Okay. And do you recall during that 16 time frame approximately how many times you would 17 come to Houston to attend meetings of the board of 18 USAT or UFG? 19 A. I do not. 20 Q. Does that refresh your recollection 21 that it was sometime -- somewhere between four and 22 six times? 4195 1 A. I'll accept that. 2 Q. Okay. Now, it indicates here in the 3 proxy statement that you attended -- that the 4 executive committee had met on 14 occasions in 5 1987. 6 Is that consistent with your 7 recollection, or do you recall how many times? 8 A. I don't recall. I normally attended 9 executive committee meeting if it were timed to 10 coincide with a board meeting. 11 Q. So, in other words, if you were coming 12 to a board meeting, you would -- and an executive 13 committee meeting was held at the same time, you 14 would attend the executive committee meeting? 15 A. That's correct. 16 Q. Would you make special trips to Houston 17 to be at the executive committee meetings? 18 A. Possibly. I don't recall any specific 19 ones. 20 Q. Okay. And do you recall that the board 21 meetings were scheduled quarterly? 22 A. We're talking about UFG? 4196 1 Q. UFG and USAT. 2 A. I thought USAT were more frequent than 3 that, but maybe I'm wrong. 4 Q. Okay. I'm just trying to get your best 5 recollection, sir. 6 Did the UFG and USAT board meetings 7 occur together? 8 A. Not as I recall. The same persons were 9 not involved. 10 Q. Well, what I mean by "together," did 11 they occur one after the other? Were they 12 scheduled for the same dates? 13 A. I don't recall. 14 Q. You don't recall? Now, you indicated 15 that you were a member of the compensation 16 committee. 17 Do you recall that? 18 A. Yes. 19 Q. And directing your attention to Page 8 20 again of the proxy statement, it indicates at the 21 bottom of that page that the members of the 22 compensation committee in nineteen -- at the end 4197 1 of the year 1986. 2 Do you see that? 3 A. Yes. 4 Q. And it identifies a Mr. Duckett and 5 Mr. Whatley and a Mr. LeMaistre. Do you see that? 6 A. Uh-huh. (Witness nods head 7 affirmatively.) 8 Q. Now, did the compensation committee 9 constituency change at some time after that, that 10 you recall? 11 A. Yes, it did. 12 Q. And could you describe for me your best 13 recollection of what occurred? 14 A. The members changed. For whatever 15 reason, Mr. Duckett resigned from the board and so 16 did Dr. LeMaistre at points in time, and 17 additional people were appointed. 18 Q. Okay. And let me show you what's been 19 marked as Exhibit 8004. It appears we don't have 20 8004. 21 Now, what were the -- I'm sorry. Here 22 it is. Would you take a look at what's been 4198 1 marked as 80 -- T8004. 2 Now, this purports to be a list of the 3 members of the compensation committee and it 4 indicates the dates people went on the committee 5 and the dates that they apparently resigned. 6 Do you see that? 7 MR. VILLA: Objection. I think it 8 shows the dates they resigned. 9 MR. RINALDI: I'm sorry. 10 A. I see that, yes. 11 Q. (BY MR. RINALDI) Okay. Now, it 12 indicates that Mr. Duckett resigned on 6-'87. Do 13 you see that? 14 A. Yes. 15 Q. And then it indicates that 16 Mr. LeMaistre resigned on 5-7-87. And then it 17 indicates below that that a Mr. Silverman replaced 18 a Mr. Duckett. 19 Do you see that? 20 A. Yes. 21 Q. And then it indicates that on 2-19-88, 22 Mr. Silverman resigned. Do you see that? 4199 1 A. Yes. 2 Q. And finally, it indicates that a 3 Mr. Keltner resigned on 3-2-88. Do you see that? 4 A. Yes. 5 Q. Do you recall that after Mr. Keltner 6 and Mr. Silverman had resigned that you remained 7 the only member of the compensation committee 8 after Mr. Keltner's resignation on 3-2-88? 9 A. I don't recall that. 10 Q. Let me show you a copy of what's been 11 previously marked as A3015. This is the proxy 12 statement for March 30th, 1988. 13 A. Okay. 14 Q. Okay? And if you'd turn to the section 15 on the compensation committee which appears on 16 Page 7 -- you see that? 17 A. Yes. 18 Q. And it states that -- in the last 19 sentence -- "The compensation committee currently 20 consists of Mr. Whatley. The compensation 21 committee met on four occasions during the year 22 and at December 31st, 1987." 4200 1 Do you see that? 2 A. I do. 3 Q. Does that refresh your recollection 4 that by March of 1988, you were the sole member of 5 the compensation committee for United Financial 6 Group? 7 A. I have no recollection of that, but 8 I'll accept it. 9 Q. Okay. Now, you were also on the 10 compensation committee for USAT; is that correct? 11 A. I believe that's correct. 12 Q. And were you also the sole member of 13 the compensation committee with respect to USAT? 14 A. I don't recall. 15 Q. Do you recall during 1988 that there 16 were additional members of the compensation 17 committee with respect to USAT? 18 A. I do not recall. 19 Q. Now, in the first sentence of that 20 paragraph, it says "The compensation committee 21 reviews, reports to, and recommends actions to the 22 board of directors regarding salaries and other 4201 1 compensation of officers of the company and its 2 subsidiaries." 3 Do you see that sentence? 4 A. I do. 5 Q. Okay. What was your understanding of 6 the function -- of the authority of the 7 compensation committee? 8 A. Precisely as recited here. 9 Q. Okay. And when you say "precisely as 10 recited here," did the committee have authority to 11 take action and actually approve compensation 12 actions on behalf of the board? 13 A. Not in my opinion. 14 Q. Okay. Well, if I might, I'd like to 15 just break that down. If the -- an individual was 16 to receive a raise in salary, let's say the 17 president of the company, is that something that 18 the compensation committee would -- could approve 19 by itself, or did that require the approval of the 20 board? 21 A. In my opinion, it required the approval 22 of the board. 4202 1 Q. Okay. And in practice, were those 2 kinds of decisions regarding increase of executive 3 salary submitted to the full board for their 4 approval? 5 A. Yes. 6 Q. So, the compensation committee's 7 authority was limited to simply making 8 recommendations to the board? 9 A. That was my understanding, yes. 10 Q. Now, would your answers also be the 11 same with respect to the granting of bonuses? 12 A. Yes. 13 Q. So that, in other words, if a bonus 14 were to be given to an executive of UFG, the bonus 15 would have to be approved by the full board? 16 A. Correct. 17 Q. And the compensation committee would 18 simply make recommendations? 19 A. Correct. 20 Q. Would your answers to those questions 21 regarding the authority to give bonuses and to -- 22 to increase salaries be the same with respect to 4203 1 USAT, as well? 2 MR. VILLA: Objection. It's leading 3 the witness, Your Honor. 4 THE COURT: Denied. 5 Q. (BY MR. RINALDI) Would your answers 6 be the same, sir? 7 A. Yes. 8 Q. So that, in other words, if USAT wanted 9 to give a salary increase to one of its 10 executives, the compensation committee would 11 simply make a recommendation and that would be 12 subject to the approval of the full board? 13 A. Correct. 14 Q. Okay. Now, let me show you what's been 15 previously marked as T8013. Before I get to that, 16 let me ask you: Were there any matters regarding 17 compensation of executives that could be 18 undertaken by the board -- by the compensation 19 committee without the approval of the full board? 20 A. Are we -- you're talking about 21 executive officers. Right? 22 Q. That's correct, sir. 4204 1 A. No action was taken, to my knowledge, 2 no, without the full board. 3 Q. Okay. Was it possible for actions to 4 be taken with respect to lower-level employees by 5 the compensation committee without the full board 6 approving it? 7 A. Possibly. I'd have to review all the 8 documentation, and it would take me a week to do 9 that. 10 Q. Okay. But as you recall it, with 11 respect to executives of USAT and UFG, no 12 compensation actions could be taken by the 13 compensation committee acting alone? 14 A. No such action was ever taken, in my 15 opinion, to my recollection, by the compensation 16 committee acting alone. 17 Q. Now, in connection with employment 18 contracts, from time to time, UFG and USAT gave 19 employment contracts or entered into employment 20 contracts with executives of those associations, 21 did they not? 22 A. Correct. 4205 1 Q. Okay. And with respect to those 2 employment contracts, did the board have the 3 authority to approve the entry of USAT into an 4 employment contract with an executive of USAT 5 without the full board's approval? 6 A. You said did the board have the 7 authority to -- 8 Q. Did the -- I'm sorry. Did the 9 compensation committee have the authority to 10 approve an employment contract without the board's 11 full approval? 12 A. No. Not in my opinion, no. 13 Q. And with respect to UFG, did the 14 compensation committee have authority with respect 15 to UFG to do that? 16 A. Let me, Mr. Rinaldi, just say that my 17 service on the compensation committee, I would 18 never consider unilaterally increasing anyone's 19 salary without board concurrence whether I had the 20 authority or not. I wouldn't do it. 21 Q. Okay. Now, as a direct or -- strike 22 that. 4206 1 Did there come a period of time when 2 the board of UFG and the board of USAT underwent a 3 change in membership? 4 A. Sure did. 5 Q. Okay. And approximately what period of 6 time would that have been, if you recall? 7 A. It was when the association went into 8 receivership. 9 Q. Now -- 10 A. Maybe before then. I don't know. But 11 certainly at that time, it did. 12 Q. All right. And when it went into 13 receivership, people that were employed by USAT 14 were no longer -- or may have been terminated as 15 employees; is that correct? 16 A. I don't recall. 17 Q. But the board members no longer then 18 served on the board of USAT? 19 A. That's correct. 20 Q. Did the board members continue to serve 21 on the board of UFG after USAT went into 22 receivership? 4207 1 A. Certain of them did. 2 Q. And did you continue to serve on the 3 board? 4 A. I did. 5 Q. Now, directing your attention once 6 again to Exhibit T -- I'm sorry -- A3014. And in 7 particular, on Page 5 of that document, it lists 8 the directors who were on the board as of the date 9 of that document, which is March 31st, 1987. 10 Do you see that? 11 A. No, I don't see that. 12 Q. Oh, no. I'm making reference to this 13 document, sir. And if you turn to Page 5 which 14 would be Exhibit -- there we are. On Page 5 and 15 then over to Page 6. 16 A. Okay. 17 Q. And it shows that in March of 1987, 18 there were, I believe, Mr. Duckett, Mr. Gross, 19 Mr. Silverman, Mr. Hurwitz, Mr. Keltner, 20 Mr. Sterling, Mr. Borman, Mr. Kozmetsky, 21 Mr. Munitz, and Mr. Whatley all were members of 22 the board of United Financial Group. 4208 1 Do you see that? 2 A. Yes. 3 Q. And then if you turn to the document 4 which has been marked as Exhibit 3015 which is the 5 next year's proxy statement and you turn to Page 5 6 of that document, we see now that there is a 7 different assemblage of people on the board of 8 directors? 9 A. Yes. 10 Q. And now on the board of directors, 11 there is Barry Munitz, Mr. Whatley, Mr. Crow, 12 Mr. Schwartz, Mr. Berner, and Mr. Gross. 13 Do you see that? 14 A. I do. 15 Q. So that between March of 1987 and March 16 of 1988, there was a dramatic change in the 17 constituency of the UFG board, was there not? 18 A. Correct. 19 Q. And how many members of the board who 20 were on the board in 1987 were still on the board 21 in 1988 besides yourself? 22 A. Well, the documents reflect that. You 4209 1 want me to go through these individually? 2 Q. Mr. Munitz was on there, was he not, in 3 '87 and '88? 4 A. Correct. 5 Q. And Mr. Gross? 6 A. Correct. 7 Q. And all the -- the rest of the members 8 who were on the board in 1987 had all resigned; is 9 that correct? 10 A. Yeah. They are all listed here. 11 Q. Okay. And when you say "they are 12 listed here," if you look at Page 4 of 13 Exhibit 3015 where it says "nominees," it 14 indicates that "Subsequent to the annual meeting, 15 seven directors -- M. Burton Borman, a Class 3 16 director, Mr. L.L. Duckett, a Class 2 director, 17 Mr. Charles E. Hurwitz, a Class 1 director, 18 Mr. Edgar Keltner, a Class 1 director, and 19 Dr. George Kozmetsky, a Class 3 director, and 20 Mr. Steven A. Silverman, a Class 2 director, and 21 Mr. Barry Sterling, a Class 1 director -- resigned 22 from the board of directors of UFG." 4210 1 Do you see that? 2 A. What page is that on? 3 Q. That's on Page 4 of Exhibit 3 -- A3015, 4 I believe, in that paragraph identifies the 5 members of the board. 6 A. Okay. I see it. 7 Q. And do those appear to be the members 8 who resigned in 1987 and early '88? 9 A. I accept the proxy statement as being 10 accurate. 11 Q. Now, did the board of directors of USAT 12 also suffer a similar turnover? 13 A. I don't recall. 14 Q. Do you know -- let me ask you: With 15 respect to the individuals listed on Exhibit 3014 16 at Page 5 -- now, that's the 1987 proxy statement. 17 That's the ten directors that we talked about. 18 Can you identify which of those 19 directors are inside directors and which of them 20 are outside directors? 21 A. We're talking about the proxy statement 22 of UFG dated March 31, 1987; is that correct? 4211 1 Q. That's correct. 2 A. Okay. Mr. Gross was an inside director 3 and Mr. Hurwitz -- although not employed by UFG to 4 my knowledge -- and Barry Munitz were the inside 5 directors. 6 Q. So, there were two and perhaps three 7 inside directors? 8 A. Correct. 9 Q. If you count Mr. Hurwitz? 10 A. Yeah. 11 Q. And all the rest were outside 12 directors; is that correct? 13 A. Correct. 14 Q. So that the relationship would have 15 been three insiders to seven outsiders in 1987? 16 A. Okay. 17 Q. Now, after the constituents of the UFG 18 board changed during 1987 and early '88, which of 19 the remaining members of the board did you 20 consider to be inside directors and outside 21 directors? That is, in 1988. And if you look at 22 the proxy statement which is T3015 at Page 5, it 4212 1 indicates the directors. 2 A. Okay. Dr. Munitz, Michael Crow, Arthur 3 Berner, and Jenard Gross. 4 Q. And they were all inside directors? 5 A. Correct. 6 Q. Now, how about Mr. Schwartz? Was he 7 affiliated with MCO and Federated? 8 A. It was my understanding. 9 Q. Did you consider him to be an inside 10 director or an outside director? 11 A. Outside. 12 Q. Okay. So, there were two outside 13 directors and four inside directors in March of 14 1988. Is that a fair statement? 15 A. Okay. I'll accept that. 16 Q. Now, why did so many directors of UFG 17 resign between the period -- at the period at the 18 end of 1987 and early '88? 19 A. I can't speak for them. You'd have to 20 talk to them. 21 Q. Do you recall when you were previously 22 deposed having been asked the following question 4213 1 and giving the following answer? 2 MR. VILLA: Can you give us a page? 3 MR. RINALDI: 259, 2. 4 Q. (BY MR. RINALDI) Did you have 5 occasion to talk to any of these -- Page 259, Line 6 2. 7 "Did you have occasion to talk to any 8 of these directors at or about the time they 9 resigned regarding their resignations?" 10 "No." 11 "Did any of them indicate to you at any 12 time why it was they resigned from the board of 13 directors of UFG?" 14 "I think they -- I don't know." 15 "Did you have a discussion with any of 16 them?" 17 And then there is an objection by 18 Mr. Malone. "He hadn't finished his answer." 19 Mr. Rinaldi: "Okay. I'm sorry. Do 20 you want to finish your answer?" 21 The witness: "I think the motivation 22 was that the institution was going under and they 4214 1 didn't want to go down with the ship." 2 Do you see that? 3 A. I don't see it, but I'll accept that 4 as -- 5 Q. Okay. Was that your understanding of 6 why the directors resigned at that point in time? 7 A. No, no. What I said in the deposition 8 is that was purely speculation on my part. I have 9 no idea why they resigned. 10 Q. Okay. When you said that they didn't 11 want to go down with the ship, what were you 12 referring to there? 13 A. The fact that the institution was 14 losing money day by day and was getting into a 15 very bad financial condition. 16 Q. Okay. Now, I'm going to get to that 17 financial condition in just a moment. Before we 18 get to that, I'd like to show you a document 19 No. 8012 and ask you -- this is T8012. 20 Now, sir, do you recall that you -- 21 United Savings Association of Texas had a business 22 ethics and conflict of interest policies? 4215 1 A. I do not specifically recall it, but 2 I'm sure they did. 3 Q. Well, let me ask you -- take a look at 4 T8012. Do you recognize that document? 5 A. No. 6 Q. Do you recall -- who was Arthur Berner? 7 A. He was general counsel for USAT and 8 UFG. 9 Q. And directing your attention to the 10 second page of that document, it states that "On 11 January 8th, 1987, the board of directors of 12 United Financial Group, Inc. and United Savings 13 Association of Texas adopted a business ethics and 14 conflicts of interest policy. The policy is 15 attached to this memorandum and it requires that 16 each employee read and understand the policies 17 and, on an annual basis, prepare a financial 18 disclosure statement." 19 Do you see that? 20 A. I do. 21 Q. Was it your understanding that UFG and 22 USAT had both adopted an ethics and conflicts 4216 1 policy at about the beginning of 1987? 2 A. I don't recall the time period, but 3 I'll accept the fact that they did, yeah. 4 Q. Let me show you what's been previously 5 marked as T8011. This is a copy of the board of 6 directors minutes for January 8th, 1987. 7 MR. RINALDI: And, Your Honor, at this 8 time, while he's taking a look at that document, 9 I'd like to move into evidence 280 -- I'm sorry. 10 T8004, T8012 and T8011. Are there any objections 11 to any of those documents? 12 MR. VILLA: I believe on T8012 -- is 13 that the one you just moved in? The business 14 ethics policy. 15 MR. RINALDI: 8012? No. That is 16 the -- yes. 17 MR. VILLA: I believe the pagination is 18 out of order in that document. But if you put the 19 first two pages at the end of the document in 20 connection with the Bates stamping, we have no 21 objection. 22 MR. RINALDI: Fine. 4217 1 MR. EISENHART: Your Honor, T8001 is 2 already in evidence. It's admitted at A3014. 3 MR. RINALDI: Thank you, Counsel. 4 Q. (BY MR. RINALDI) Now, it indicates 5 that -- 6 THE COURT: Wait a minute. We have no 7 objection to T8004. 8 MR. VILLA: No objection, Your Honor. 9 THE COURT: All right. Received. 10 MR. RINALDI: Now, sir -- 11 THE COURT: Wait. 12 MR. RINALDI: Oh, I'm sorry. 13 THE COURT: How about 8012? 14 MR. VILLA: No objection. 15 THE COURT: All right. Received. And 16 8011 is already in? 17 MR. EISENHART: No. 8001 was already 18 in. 8011 is not in. 19 Q. (BY MR. RINALDI) Have you had a 20 chance to look at T8011, sir? 21 MR. VILLA: No objection -- 22 MR. RINALDI: Fine. 4218 1 MR. VILLA: -- to 8011. 2 MR. RINALDI: I would move 8011 into 3 evidence. 4 THE COURT: Which one is already in? 5 MR. RINALDI: 8001, which was the proxy 6 statement for nineteen -- 7 MR. EISENHART: It was the 3-31-87 8 proxy statement, Your Honor. 9 MR. RINALDI: Yeah. Actually, it also 10 bears the number of 3014. That may be what's 11 confusing, Your Honor. It is a different version 12 of -- or it is from the A series of documents so 13 that it has both the number A3014 and T8001. They 14 are one and the same document. They are the 1987 15 proxy statement. 16 THE COURT: All right. While we're on 17 this, I believe we indicated that A3014 was 18 already in; is that right. 19 MR. RINALDI: Yes. That is the same -- 20 THE COURT: How about A3015? 21 MR. RINALDI: It is also -- I believe 22 it's in. It has the alternative number of T8036. 4219 1 MR. VILLA: Your Honor, no objection to 2 3015. I'd object to T8036 because the only they 3 only copied every other page. So, the 1987 and 4 1988 proxy statements, no objections to them. 5 THE COURT: And they are already in? 6 MR. EISENHART: They are already in, 7 Your Honor. 8 Q. (BY MR. RINALDI) Sir, you've had an 9 opportunity to look at the document that's marked 10 as T8011. This purports to be the minutes of the 11 board of directors of UFG or a joint meeting of 12 UFG and USAT. 13 Do you see that? 14 A. Okay. 15 Q. And as you look at the document, it 16 indicates that "all members of the board were 17 present with the exception of Barry Sterling." 18 So, would that indicate that you 19 attended this meeting, sir? 20 A. It would. 21 Q. Okay. And directing your attention to 22 the last full page on -- that's 404, the first 4220 1 full paragraph, it states "Mr. Berner also then 2 reviewed the business ethics and conflicts of 3 interest policy. After full discussion, such 4 policy was unanimously adopted by the board of 5 directors." 6 Do you see that? 7 A. Yes. 8 Q. Does it appear then, sir, that in about 9 January 8th, 1987, both the board of UFG and USAT 10 adopted the policy of conflicts of interest that 11 appears as Exhibit T8012? 12 A. Yes. 13 Q. Thank you, sir. Now, do you recall 14 that there came a point in time when, as a 15 director, you were advised that USAT was failing 16 its net-worth requirement? 17 A. I don't have any specific recollection, 18 but that was my overall feeling. 19 Q. Okay. And as you sit here today, do 20 you have any recollection of approximately what 21 point in time you learned that USAT was having a 22 problem with respect to its maintenance of its 4221 1 net -- minimum net capital requirement? 2 A. I have no specific recollection, no. 3 Q. Okay. Let me hand you a copy of what's 4 been previously marked as T8014. This is a letter 5 to the board of directors of United Savings 6 Association of Texas dated April 16th, 1987. And 7 the letter is signed by a Daniel A. Thomas. And 8 if you'll take just a moment to look at it, it 9 indicates in the first paragraph in this first 10 full sentence, "Our review of examination 11 comments, monthly financial reports, and recent 12 correspondence between the association and the 13 bank raises several matters of supervisory concern 14 including capital adequacy." 15 Do you see that? 16 A. Which paragraph was that? 17 Q. That is the second sentence in the 18 first full paragraph. 19 A. I'm sorry. I don't see it. 20 Q. It is the sentence that starts "our 21 review of the examination comments." Do you see 22 that? 4222 1 A. Okay. All right. 2 Q. And then as you read further down the 3 paragraph, the last full paragraph on the page 4 indicates "As calculated by Examiner Carlton, 5 United failed to meet its net-worth requirement as 6 of June 30th, 1986, by $10.5 million or 7 4.6 percent of net worth." 8 Do you see that? 9 A. I see it. 10 Q. Now, the date of this letter is 11 April 16th, 1987. Does it appear then that by 12 April of 1987, the board of directors of USAT was 13 aware that there was a problem with respect to 14 USAT's compliance with its minimum capital 15 requirements? 16 A. My recollection is that there was a 17 great deal of difference in the -- what the 18 examiners came up with here and what the 19 association deemed its net worth to be, that there 20 was a wide variance in -- of opinion with respect 21 to that. 22 Q. That's correct. And if you look at the 4223 1 last full -- the last paragraph that runs over, it 2 starts out by saying that -- The Federal Home Loan 3 Bank of Dallas writes to the board of directors. 4 "We acknowledge management's comments and 5 subsequent correspondence refuting the 6 calculations of the net-worth requirement." 7 Do you see that? 8 A. What paragraph is that? 9 Q. I'm sorry. It's the last paragraph -- 10 no. It's right at the bottom of this page. 11 A. All right. 12 Q. And so, there was a dispute going on 13 between the bank board and USAT as to whether it 14 had failed its minimum net-worth requirement. And 15 that dispute would have occurred sometime in the 16 early part of 1987; is that correct? 17 A. Correct. 18 Q. Now -- then turning over to the next 19 page, it states on the first full paragraph, "We 20 also note that the amount of net worth reported as 21 of June 30th, 1986, has subsequently been revised 22 to increase reported net worth by 13.2 million. 4224 1 However, we are aware of at least five amendments 2 to the June 30th, 1986, quarterly report. The 3 directorate is advised that frequent and/or 4 routine amendments are, at best, viewed 5 unfavorably and, at worst, give the impression of 6 adjusting the line items to reflect a 7 predetermined position. As members of the board, 8 you have the responsibility to determine the true 9 condition of the association. This office is very 10 concerned that United's true condition has not yet 11 been revealed." 12 Do you see that? 13 A. I see it. 14 Q. Okay. And after receiving that, as a 15 member of the board, did you attempt along with 16 the other board members to ascertain the true 17 financial condition of USAT? 18 A. I relied on external auditors, internal 19 auditors, and other procedures within the company. 20 I did not undertake a personal investigation of 21 the condition of the association. 22 Q. And in that connection, who would have 4225 1 been the individuals at USAT that you would have 2 looked to to rely upon for a determination as to 3 the true condition of that institution? 4 A. The whole financial team, the external, 5 internal. 6 Q. Well, let me ask you this: Who was 7 Mike Crow? Do you remember? 8 A. Mike Crow, as I recall, was chief 9 financial officer. 10 Q. Okay. And is he one of the individuals 11 that you would have looked to to obtain financial 12 information regarding the true financial condition 13 of USAT? 14 A. I would. 15 Q. Okay. Now, who was Jenard Gross? 16 A. At points in time -- I'm not sure what 17 time -- but he was chairman of the board. 18 Q. Okay. And is he also a person you 19 would have looked to to determine the true 20 financial condition? 21 A. Yeah. You would look to management for 22 their opinion. 4226 1 Q. And how about Arthur Berner? Who was 2 he? 3 A. General counsel, as I testified 4 earlier. 5 Q. Okay. And would you have looked to 6 Mr. Berner, as well, to advise if you there was a 7 problem with respect to failure to comply with the 8 regulatory capital requirements? 9 A. Entire team. 10 Q. And that would have included 11 Mr. Berner? 12 A. Of course. 13 Q. Now, did there come a time when 14 Mr. Berner advised the board that USAT was failing 15 its net-worth or about to fail its net-worth 16 capital requirement? 17 A. I don't recall. 18 Q. Okay. Now, I'm handing you a copy of 19 what's been previously marked as T8022? 20 MR. RINALDI: Your Honor, I would move 21 the last exhibit into evidence if it has not 22 previously been put into evidence. That's 8014. 4227 1 MR. VILLA: No objection. 2 THE COURT: Received. 3 Q. (BY MR. RINALDI) Now, this is a 4 memorandum labeled "privileged and confidential" 5 from Mr. Berner to Mr. Charles Hurwitz, Mr. Barry 6 Munitz, Mr. Jenard Gross, Michael Crow, Jim Wolfe, 7 and Bruce Williams. 8 Who was Bruce Williams? 9 A. I don't know. He was an officer of the 10 association, but I don't recall what his duties 11 and responsibilities were. 12 Q. Okay. And how about Mr. Hurwitz? Do 13 you recall whether -- what his involvement with 14 USAT was? 15 A. He was a director. 16 Q. And was he a director of USAT or UFG? 17 A. I'm not sure. 18 Q. Okay. Now, this is in reference to 19 interim non-compliance with regulatory capital 20 requirement. And it's dated October 29th, 1987. 21 MR. RINALDI: Your Honor, I would move 22 T8022 into evidence. 4228 1 MR. VILLA: No objection. 2 THE COURT: Received. 3 Q. (BY MR. RINALDI) And the first 4 sentence there says "Based on the current 5 estimates, it appears as if United will fail to 6 meet its minimum regulatory net worth at 7 October 31st, 1987." 8 Do you see that? 9 A. I do. 10 Q. Okay. Do you recall whether that 11 information was conveyed to the board of directors 12 of USAT by the management of USAT? 13 A. I don't recall. 14 Q. Would you have expected that in the 15 normal course of the operations of the 16 institution, that information like that which 17 impacted on the financial condition of the 18 institution would have been conveyed to the 19 directorate? 20 A. Yes. 21 Q. And it goes on further down and it 22 talks about Section 563.13D, and this is the last 4229 1 full paragraph. Do you see that? 2 A. Yes. 3 Q. "Sets forth the powers of the Federal 4 Home Loan Bank Board in the event an insured 5 institution fails to meet its regulatory capital 6 requirements. These include requiring the 7 institution" -- and then it lists a whole number 8 of things which the institution would be required 9 to do. 10 Do you see that? 11 A. Yes. 12 Q. And directing your attention to Item 8, 13 it says "limit operational expenditures to 14 specified limits." 15 Do you see that? 16 A. I do. 17 Q. Was it your understanding that if an 18 institution failed its minimum regulatory capital 19 requirements, that its operational expenditures 20 could be limited by the Federal Home Loan Bank 21 Board? 22 A. If so ordered by the regulators. 4230 1 Q. Okay. Now, I'd like to -- after you 2 received the -- I'm sorry -- what was the practice 3 at USAT for reporting the financial condition of 4 the institution to the directorate? 5 A. It was reported at each meeting. 6 Q. Okay. And when you say reported at 7 each meeting, did the chief financial officer, 8 Mr. Crow, make a report on the financial condition 9 of USAT at each meeting of the board? 10 A. He did. 11 Q. And did that include a calculation as 12 to whether USAT was then meeting its minimum 13 capital requirements? 14 A. I don't recall. 15 Q. Do you recall -- I'm handing you a copy 16 of what's been previously marked as T8028. This 17 is a meeting of the board of directors of USAT. 18 It's dated November 10th, 1987. And directing 19 your attention to about the middle of the page, it 20 says "Michael Crow then reviewed the financial 21 statements of the association." 22 Do you see that? 4231 1 A. Yes. 2 Q. "He reviewed the scheduled items and 3 loan deficiency, as well as the lending activity 4 of the association. He also reviewed the 5 high-yield bond and mortgage-backed security 6 portfolio performances." 7 Do you see that? 8 A. Yes. 9 Q. And -- 10 MR. VILLA: Your Honor, if he would 11 move into evidence documents before he read them 12 to the witness, it might be better. 13 MR. RINALDI: Fine. I didn't want to 14 get objections. 15 Q. (BY MR. RINALDI) Does this appear to 16 be the minutes of United Savings Association of 17 Texas? 18 A. It would appear to be. 19 MR. RINALDI: I would move into 20 evidence Document No. 8028. 21 MR. VILLA: Your Honor, the document we 22 have has three pages, and the third page shows an 4232 1 agenda for a meeting that occurred two or three 2 months later. Does that show it on your 8028? 3 MR. RINALDI: It does. 4 MR. VILLA: If you would remove the 5 agenda for the unrelated meeting, I have no 6 objection to the first two pages. 7 MR. RINALDI: Yeah. I don't know where 8 that came from. 9 THE COURT: All right. T8028, pages 10 marked 0239 and 0230 are received. 11 Q. (BY MR. RINALDI) Now, at the board 12 meeting on November 10th, would Mr. Crow have 13 conveyed to you the information that's contained 14 in the October 29th, 1987, memo of Mr. Berner? 15 A. I don't recall. 16 Q. Is that the type of information that 17 Mr. Crow typically would confer to the board at 18 board meetings regarding the financial condition 19 of the institution? 20 A. As recited in the minutes, Paragraph 4, 21 I think that accurately describes the kind of 22 information Mr. Crow would normally report on. 4233 1 Might not be all-inclusive. 2 Q. Okay. So, you don't know that he 3 reported on the projected net-worth failure of 4 USAT at that board meeting? 5 A. I have no specific recollection, no, 6 sir. 7 Q. Okay. Would you -- now, would Mr. Crow 8 usually provide you with financial statements at 9 that those meetings, as well? 10 A. Yes. 11 Q. I'm handing you a copy of what's marked 12 as T8024. Now, I probably glossed over this, sir, 13 but you are a certified public accountant, are you 14 not? 15 A. That is correct. 16 Q. Okay. And so, can you -- 17 MR. RINALDI: I'd move into evidence 18 T8024. It's a consolidated statement of 19 operations of United Financial Group. 20 MR. VILLA: No objection. 21 THE COURT: Received. 22 Q. (BY MR. RINALDI) Now, is this the 4234 1 kind of financial statement that would have been 2 submitted to the board at the board meetings? 3 A. Yes. 4 Q. Now, I notice that it's a consolidated 5 statement of operations for United Financial 6 Group. 7 What does that mean with respect to 8 USAT, sir? 9 A. It's the financial results of 10 United Financial Group and all of its 11 subsidiaries. 12 Q. And would the consolidated statement of 13 operations for United Financial Group have been 14 submitted to the board of USAT, or would they have 15 submitted a different financial statement? 16 A. I have no idea. 17 Q. Okay. Now, directing your attention to 18 the second page of this document, it has a 19 net-worth calculation. 20 Do you see that? 21 A. Yes. 22 Q. Okay. Now, was it typical for Mr. Crow 4235 1 to provide the board members with net-worth 2 calculations at the board meetings? 3 A. I don't recall. 4 Q. Okay. Do you recall that in addition 5 to the financial information that the board 6 received at the board meetings, that you were also 7 provided with monthly statements of the financial 8 condition of USAT by Mr. Crow? 9 A. I don't recall. 10 Q. Do you have any reason to believe that 11 that wasn't the case, sir? 12 A. No. I have no reason to believe it was 13 not the case. 14 Q. Now, directing your attention to the 15 document that's identified as October 31st, 1987, 16 net-worth requirement, it indicates that UFG -- I 17 mean, USAT had an excess net-worth of $12,997,000. 18 Do you see that? 19 A. Yes. 20 Q. Okay. And then we talked earlier that 21 there was some dispute with respect to USAT and 22 the regulators as to whether USAT was, in fact, in 4236 1 compliance with its net-worth requirement. 2 Do you recall that? 3 A. Yes. 4 Q. And if you look at the footnotes below 5 there, the second footnote says "Pending final 6 resolution with the regulators, there are 7 94.7 million of disputed assets which have not 8 been included in the scheduled items by the 9 association. Should the regulators' position 10 prevail, the association's capital requirement 11 would increase by an additional 18.9 million. The 12 94.7 million is composed of the following." And 13 then it lists what the scheduled items are that 14 the regulators were indicating they thought should 15 be included as scheduled items. 16 Do you see that? 17 A. Yes. 18 Q. Okay. Now, does that reflect the 19 ongoing discussions that you referred to earlier 20 that management was having with the Federal Home 21 Loan Bank Board regarding USAT's compliance with 22 its net-worth requirement? 4237 1 A. I'm aware that there were apparently 2 some discussions taking place, yes. 3 Q. Okay. And does this appear to reflect 4 the discussions that were being -- that were 5 taking place between management and the 6 regulators? 7 A. I don't know. 8 Q. Now, in Paragraph 3, it indicates 9 "Included in the net worth is 13.2 million of 10 general reserves as originally determined by the 11 regulators which they now believe might be 12 specific reserves. Actual net worth would 13 decrease by this amount retroactive to June 30th, 14 1986 if the regulators' revised position does not 15 change." 16 Do you see that? 17 A. I do. 18 Q. Now, if the regulators' position as 19 expressed in Paragraphs 2 and 3 on that page did 20 not change, how would that have affected the net 21 worth of $12,997,000 that appears above? 22 A. I don't know. 4238 1 Q. Well, let me ask you this. It 2 indicates that "Should the regulators' position 3 prevail, the association's capital requirement 4 would increase by an additional 18.9 million." 5 Do you see that? I'm reading from 6 Paragraph 2. It indicates an increase of 7 18.9 million. 8 A. Okay. 9 Q. And if we go up and we -- if the 10 capital requirement of the institute were to 11 increase, then that would mean that you would have 12 to have greater net worth; is that correct? 13 A. Presumably, yes. 14 Q. And if it were to increase by 15 $18 million, it would exceed the excess net worth 16 that's available as of October 31st, 1987. 17 Do you see that? 18 A. Yeah. I'm not sure about all these 19 dates, but I'll accept that. 20 Q. And similarly, if they -- if 21 Paragraph 3 -- had prevailed on their position, 22 the net worth would have -- would have decreased 4239 1 by $13.2 million. 2 Do you see that? 3 A. Yes. 4 Q. So that if either of the positions of 5 the regulators had prevailed, USAT would have been 6 failing its minimum net-worth requirements. 7 Do you see that? 8 A. The regulators did not take any action. 9 So, apparently, there was a legitimate difference 10 of opinion. 11 Q. Okay. Now, did there come a point in 12 time when notwithstanding the difference of 13 opinion, that the board of directors agreed with 14 the regulators that, in fact, USAT had failed its 15 net-worth requirement? 16 A. I don't recall. 17 THE COURT: Mr. Rinaldi, we'll adjourn 18 until 9:00 o'clock tomorrow morning. 19 20 (Whereupon at 5:01 p.m. 21 the proceedings were recessed.) 22 4240 1 STATE OF TEXAS COUNTY OF HARRIS 2 REPORTER'S CERTIFICATION 3 TO THE TRIAL PROCEEDINGS 4 I, Marcy Clark, the undersigned Certified 5 Shorthand Reporter in and for the State of Texas, 6 certify that the facts stated in the foregoing 7 pages are true and correct to the best of my ability. 8 I further certify that I am neither 9 attorney nor counsel for, related to nor employed 10 by, any of the parties to the action in which this 11 testimony was taken and, further, I am not a 12 relative or employee of any counsel employed by 13 the parties hereto, or financially interested in 14 the action. 15 SUBSCRIBED AND SWORN TO under my hand 16 and seal of office on this the 21st day of 17 October, 1997. 18 ____________________________ MARCY CLARK, CSR 19 Certified Shorthand Reporter In and for the State of Texas 20 Certification No. 4935 Expiration Date: 12-31-97 21 22 4241 1 STATE OF TEXAS COUNTY OF HARRIS 2 REPORTER'S CERTIFICATION 3 TO THE TRIAL PROCEEDINGS 4 I, Shauna Foreman, the undersigned 5 Certified Shorthand Reporter in and for the 6 State of Texas, certify that the facts stated 7 in the foregoing pages are true and correct 8 to the best of my ability. 9 I further certify that I am neither 10 attorney nor counsel for, related to nor employed 11 by, any of the parties to the action in which this 12 testimony was taken and, further, I am not a 13 relative or employee of any counsel employed by 14 the parties hereto, or financially interested in 15 the action. 16 SUBSCRIBED AND SWORN TO under my hand 17 and seal of office on this the 21st day of 18 October, 1997. 19 _____________________________ SHAUNA FOREMAN, CSR 20 Certified Shorthand Reporter In and for the State of Texas 21 Certification No. 3786 Expiration Date: 12-31-98 22