10309 1 UNITED STATES OF AMERICA Before the 2 OFFICE OF THRIFT SUPERVISION DEPARTMENT OF THE TREASURY 3 In the Matter of: ) 4 ) UNITED SAVINGS 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 12-12-97 22 10310 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 PAUL LEIMAN, Esquire (Not present) SCOTT SCHWARTZ, Esquire (Not present) 5 BRUCE RINALDI, Esquire RICHARD STEARNS, Esquire (Not present) 6 and BRYAN VEIS, Esquire (Not Present) of: Office of Thrift Supervision 7 Department of the Treasury 1700 G Street, N.W. 8 Washington, D.C. 20552 (202) 906-7395 9 ON BEHALF OF RESPONDENT MAXXAM, INC.: 10 FRANK J. EISENHART, Esquire 11 of: Dechert, Price & Rhoads 1500 K Street, N.W. 12 Washington, D.C. 20005-1208 (202) 626-3306 16 13 DALE A. HEAD (in-house) 14 Managing Counsel MAXXAM, Inc. 15 5847 San Felipe, Suite 2600 Houston, Texas 77057 16 (713) 267-3668 17 ON BEHALF OF RESPONDENT FEDERATED DEVELOPMENT CO. AND CHARLES HURWITZ: 18 RICHARD P. KEETON, Esquire 19 KATHLEEN KOPP, Esquire DAVID GRIFFITH, Esquire 20 of: Mayor, Day, Caldwell & Keeton 1900 NationsBank Center, 700 Louisiana 21 Houston, Texas 77002 (713) 225-7013 22 10311 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 (Not present) 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 10312 1 2 EXAMINATION INDEX 3 4 Page 5 JAMES MILLINOR 6 Cross-Examination by Mr. Nickens........10313 7 Redirect-Examination by Mr. Guido.......10378 8 JOE PARSONS 9 Examination by Mr. Guido................10399 10 Cross-Examination by Ms. Clark..........10455 11 Redirect-Examination by Mr. Guido.......10539 12 13 14 15 16 17 18 19 20 21 22 10313 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 the direct 5 examination of Mr. Millinor is complete. 6 Mr. Nickens, you're going to cross? 7 MR. NICKENS: Yes, Your Honor. 8 Mr. Millinor has been able to rearrange his 9 schedule based upon my representation that I would 10 try my best to take less than an hour for my part 11 of the examination, which I very much intend to 12 try to do. But he has returned. 13 14 CROSS-EXAMINATION 15 16 17 Q. (BY MR. NICKENS) Good morning, 18 Mr. Millinor. Thank you for coming back this 19 morning. 20 Yesterday, you indicated in your 21 testimony in an answer to questions from Mr. Guido 22 that you had worked for other S&Ls while at -- had 10314 1 other S&L clients while at Peat Marwick in their 2 Houston office. 3 How many such clients did you have 4 approximately? 5 A. If I remember correctly, the office had 6 20 or 22 or so, and I think I probably had 12 or 7 14. 8 Q. And you were -- what was your position 9 with regard to each of those clients? 10 A. I was the engagement partner on the 12 11 or 14 I just referred to. 12 Q. And could you describe for the judge 13 Peat Marwick's audit practice with regard to the 14 thrift industry nationally as you knew it in those 15 days? 16 A. Well, at that time, I think we were the 17 largest firm in that business maybe by far. I had 18 regional responsibilities in the southwest and I 19 think we had the largest practice here, although 20 when some of the craziness started, our rules were 21 pretty strict. And we didn't get some of the work 22 that came up. We were lucky that we didn't. 10315 1 Q. And what do you mean by "craziness"? 2 A. Well, there was some bad actors in this 3 business during the Eighties in Texas, and it was 4 all well documented in the papers and other 5 places. Whether it was luck or just our guys were 6 smart enough to see what was coming, we had some 7 fairly strict rules about the kind of clients we 8 would take. And we didn't get some work that we 9 probably could have gotten as a result. And as it 10 turns out, we were glad we didn't get it. 11 Q. And you indicated some -- something in 12 excess of 20 clients in this Houston office? 13 A. Yes. I think that's correct. 14 Q. What happened to those 20 thrift 15 institutions? 16 A. If my memory serves, I think all but 17 two were taken over by the government. 18 Q. And as to those two, which were the two 19 that survived? 20 A. One of them was in Orange, Texas, and 21 one of them was in Rosenberg, Texas. They were 22 both fairly small, and they were both very 10316 1 conservative and probably survived because they 2 didn't accept the wisdom of the day that they 3 needed to diversify their balance sheet. They 4 stuck to their home loans and rode it out and they 5 are still there. 6 Q. And the other 20 or so didn't make it? 7 A. That's correct. 8 Q. Now, with regard to the -- your 9 relationship with USAT, you became their outside 10 accountants or Peat Marwick became their outside 11 accountants before MCO or Federated made their 12 investment in UFG? 13 A. I believe that's correct. I don't 14 believe that MCO or Charles Hurwitz had an 15 interest at all at the time we got this client. 16 Q. And so, at the beginning of the 17 engagement, you were working with Sonny Bentley 18 and Jim Coles and Rex Baker or -- 19 A. I don't think Mr. Baker was involved at 20 that point. If he was, it was very passively. 21 But definitely Sonny Bentley and Jim Coles. 22 Q. And then who later became your 10317 1 principal contact with the client? 2 A. Later, you mean when Charles Hurwitz 3 exerted control over the institution? 4 Q. Well, I'm talking about the time, for 5 example, when Mr. Crow and Mr. Gerald Williams 6 came to the institution. 7 A. Right. At some point along the way, 8 Mike Crow was probably the main contact. Jim 9 Wolfe, to a lesser extent. 10 Q. And you mentioned Mr. Hurwitz. Did you 11 have any dealings with Mr. Hurwitz? 12 A. Very little directly. 13 Q. Did you have any dealings with 14 Mr. Munitz? 15 A. Very little directly. 16 Q. How about Mr. Huebsch? 17 A. I might have met Ron a couple of times, 18 but personally I didn't interact with him very 19 much. 20 Q. Or Mr. Berner? 21 A. Art, more. 22 Q. So, in terms of exercising your 10318 1 responsibilities, the principal people would have 2 been Mr. Crow, Mr. Gerald Williams, and Mr. Wolfe? 3 A. And the legal counsel because it was a 4 public company and we were involved in filings 5 from time to time. 6 Q. So, either -- depending upon the time 7 frame -- Mr. Pledger or Mr. Berner? 8 A. That's correct. 9 Q. Now, why don't you describe for the 10 Court the Peat Marwick team that worked on the 11 USAT account as it was constituted while you were 12 there. 13 A. For most of the time, it was the same 14 group. I think Jerry Claiborne was the SEC and 15 pre-issuance review partner from the start. If -- 16 I had two managers that I can remember -- Jim 17 Wolfe who went to work for United and then Joe 18 Parsons. The group underneath that would change 19 over fairly regularly as accounting teams do. 20 You'd have different seniors every couple of 21 years. 22 Q. And when you left, who became the 10319 1 engagement partner? 2 A. I think Lee Mitchell was assigned for a 3 very brief period of time right after I left, but 4 that changed quickly. And Jerry Claiborne picked 5 up the account. 6 Q. And do you recall the name Barry Tiedt, 7 T-I-E-D-T? 8 A. Yes, I do. 9 Q. What was his role in the team? 10 A. Barry, I think, by the time I left, 11 might have been the senior in the field. But he 12 certainly was a member of the audit team. 13 Q. Now, although this may be obvious, 14 would you describe for the Court in your own words 15 the services that Peat Marwick provided to USAT? 16 A. If I remember correctly, other than the 17 audit itself, I believe we did all of their tax 18 work. I don't believe they used any other firms 19 for that, doing their tax returns and tax planning 20 and that sort of thing. Our consulting group in 21 the early days of Jim Coles did some work, some 22 strategic planning sort of work for them. I don't 10320 1 recall anything else specific that we did. 2 Q. As part of this audit work, you would 3 review and provide the necessary documentation, 4 depending upon the conclusions, for all of their 5 SEC filings? 6 A. Well, we signed off on the financial 7 statements that were included in the SEC filings, 8 yes. 9 Q. Now, how much time was involved in this 10 engagement on an annual basis? 11 A. This could be off, but it seems like 12 the basic audit was 5,000 hours or so. 13 Q. And how much of that -- was that all 14 professional time or included some clerical time? 15 A. No. That's professionals. 16 Q. And approximately -- I know these 17 things -- what was the annual charge for your 18 services to United Savings? 19 A. I think it was $250,000, give or take, 20 for the audit. 21 Q. What was your impression of USAT's 22 management? 10321 1 A. Highly-skilled people. Very talented 2 at what they did. 3 Q. Okay. Were they, in your view, hard 4 working? 5 A. Yes. 6 Q. Competent people? 7 A. Yes. 8 Q. Now, if I could turn very briefly to 9 the audit process itself, could you give the judge 10 an overview of what was involved in these 5,000 11 professional hours on an annual basis in order to 12 exercise your responsibilities to the institution? 13 A. Could you be a little more specific as 14 to what you're looking for? 15 Q. Well, I'm trying to get an idea of the 16 process. You know, we've seen, for example, some 17 documentation here where there's a planning memo 18 and it indicates various activities. We've seen 19 some other documentation of carrying out those 20 plans, conversations with the client, then the 21 management letter. I'm just trying to get an 22 overview for the Court of how all those pieces fit 10322 1 together. 2 A. This might be a little rough, but I 3 think it would be something like this: By late 4 summer -- mid-summer, late summer, we would sit 5 down with the client and plan the following year's 6 audit. The way we did that at Peat Marwick at the 7 time was -- I think the system was called SEADOC 8 or some gizmo name like that that basically meant 9 we audited the documentation process for the 10 engagement on the front end by going from the 11 balance sheet and the P&L outward so that we 12 designed our audit procedures to fit what was out 13 there as opposed to using a standard 50-page audit 14 program that we had done in the past. 15 Once that was designed, the planning 16 along with the client, when they wanted to release 17 earnings and that sort of thing was done so that 18 we were in the field quite a bit during the fall, 19 came in again right after year end, and did a 20 review for the last couple of months that we 21 hadn't audited already. I think United issued 22 their earnings fairly quickly after year end. We 10323 1 would then work through the 10K and have it filed 2 within 90 days of the end of the year and go from 3 there. 4 Q. And did you audit on a quarterly basis? 5 A. We reviewed the quarterly numbers, yes, 6 we did. 7 Q. In terms of your work, did it involve a 8 review of the books and records of USAT? 9 A. Yes. 10 Q. And did those books and records include 11 the board of directors minutes, the minutes of 12 major committees, the performance reports, the 13 general ledger, documents such as that? 14 A. I don't know what "performance reports" 15 means, but a standard audit procedure would be to 16 review minutes of the boards and committees. 17 Q. And did you review the TFRs or thrift 18 financial reports? 19 A. That name is vague; but if you're 20 meaning anything that came out of the Federal Home 21 Loan Bank that had to do with United, yes, we 22 would look at all of that. 10324 1 Q. Or whatever they sent to the Federal 2 Home Loan Bank? 3 A. Yes. We should look at all of that. 4 Q. Now, did, at your suggestion, USAT 5 institute or found an internal audit team? 6 A. They had an internal audit team. I 7 don't know that we can take credit for it. 8 Q. Okay. I'm going to show you a document 9 about that in a few minutes. 10 A. Okay. 11 Q. What was the -- what was your -- what 12 was the role of the internal audit team? 13 A. Those people were supposed to do a lot 14 of what we did, but on a regular basis to make 15 sure that the various departments within United 16 were complying with their own rules and 17 regulations and policies and procedures. 18 Q. And was there an audit committee of the 19 board of directors? 20 A. Yes. 21 Q. And did you attend the meetings of the 22 audit committee? 10325 1 A. Yes. 2 Q. Did you receive the reports of the 3 internal audit team that reported to the audit 4 committee of the board? 5 A. We reviewed their internal audit 6 reports, yes. 7 Q. Were you ever aware of USAT withholding 8 information from you? 9 A. No. 10 Q. Now, the -- you were asked by Mr. Guido 11 about various management letters. 12 Would you tell the Court what the role 13 of the management letter is? 14 A. I'm not sure how cleanly this is coming 15 out of the literature; but it's just to let the 16 client know of our findings, where we thought 17 there were weaknesses in their policies and 18 procedures that needed attention. 19 Q. Okay. Let me ask you to look back -- 20 and I've put in front of you Exhibit 1569, which 21 appears on its face to be the minutes of the 22 meeting of the audit committee of the board of 10326 1 directors of July 22, 1981, and you're shown in 2 attendance at these meetings, at this particular 3 meeting. 4 Do you see that? 5 A. Yes. 6 MR. NICKENS: Your Honor, we would 7 offer A1569. 8 MR. GUIDO: No objection, Your Honor. 9 THE COURT: Did you say "59"? 10 MR. NICKENS: 1569, Your Honor. 11 THE COURT: Received. 12 Q. (BY MR. NICKENS) And Mr. Millinor, I 13 would ask if you would read for the record and for 14 everyone's benefit the fifth paragraph of these 15 minutes which starts out "Mr. Holt." 16 A. You would like me to read that aloud? 17 Q. Aloud, yes, sir. 18 A. "Mr. Holt asked for review of the first 19 half of 1981 from the Peat Marwick 20 representatives. Mr. Millinor said that 21 operations had stabilized at approximately 1.3 22 million pre-tax loss per month operationally. The 10327 1 association has a lot of work to do to regain its 2 profitability, but they were pleased with the 3 changes being made by Mr. Coles. He said the 4 association could look forward to continued gains 5 on sales with its property portfolio. Mr. Holt 6 asked whether there would be a written report from 7 Peat Marwick on the first six months. Since the 8 SEC no longer requires a separate 10Q for USAT, no 9 written audit report was planned." 10 Q. And do you see in the next paragraph 11 that because of the Kaneb spinoff, you were 12 reporting that you would not have the benefit of 13 the internal audit team from Kaneb? 14 A. Yes. 15 Q. And then if you would go over to the 16 second page and read for the record the first 17 paragraph concerning the situation at United at 18 that point in time. 19 A. "The association's net worth is 20 deteriorating but is still relatively strong 21 compared to other S&Ls in Texas. Houston First is 22 reporting a net worth of half the dollar amount 10328 1 reported by USAT." 2 Q. And are those reports of the financial 3 condition of USAT at that point in time consistent 4 with your recollection of those matters? 5 A. It rings some bells from long ago, but 6 the fact that they were losing money at the time 7 certainly wouldn't have been unusual. Most people 8 were with the high interest rates that were 9 prevailing then. 10 Q. And if I could, I'd like to ask you to 11 look at one similar document, which is A1571, 12 which is the minutes of the audit committee of 13 March 25th, 1982. 14 MR. NICKENS: Your Honor, we would 15 offer A1571. 16 MR. GUIDO: No objection, Your Honor. 17 THE COURT: Received. 18 Q. (BY MR. NICKENS) And do you see at 19 the very bottom, you noted that "The auditors 20 viewed the lack of an internal audit staff as a 21 material weakness which had resulted in such 22 problems as ineffective review over the use of 10329 1 supervisory teller keys"? 2 A. Yes. 3 Q. And up above, you had indicated -- and 4 I'm in the fourth paragraph that starts out 5 "Mr. Millinor distributed copies of Peat Marwick's 6 1981 audit letter to the association's board of 7 directors, their planning memo for the audit, and 8 their recommendation to the board of directors 9 regarding internal accounting control. 10 Mr. Millinor explained that the 1981 audit was a 11 difficult one due to a number of disruptions, 12 including the Kaneb spinoff, the move to 13 Westbridge, the Ludwig negotiations, and ADP 14 problems." 15 What do you recall, Mr. Millinor, about 16 those matters? 17 A. I recall that when we took this 18 engagement, Kaneb owned this institution; and I 19 don't remember the spinoff. I'm not sure how they 20 got free of Kaneb. Obviously, this is how. 21 They moved the company out to an office 22 building far out on Westheimer somewhere, I think, 10330 1 away from Kaneb or wherever they were before. 2 Ludwig, I think, has to do with Houston First. I 3 believe that's the concern that owned Houston 4 First Savings. "ADP problems," I don't know what 5 that was. 6 Q. And this was before Mr. Wolfe went to 7 work there, Mr. Crow worked there, and Gerald 8 Williams was there? 9 A. Yes. 10 Q. Now, let me ask you to look at a 11 document that Mr. Guido asked you about yesterday, 12 which is A7004. It should be right here. 13 That's one of the management letters of 14 February 1985? 15 A. Yes. 16 Q. Now, you were there at that point in 17 time and I believe you indicated that you signed 18 this document on behalf of Peat Marwick? 19 A. That's correct. 20 Q. I'd like to focus your attention on the 21 first sentence of the second paragraph. "As a 22 result of our examination, we did not identify any 10331 1 conditions that we believe to be a material 2 weakness in internal accounting control." 3 Was that an important representation? 4 A. Yes. I remember at the time it was, 5 that if you found something that was considered a 6 material weakness, it probably meant you had to 7 perhaps qualify your opinion in some way. 8 Q. Although somewhat formulaic, we might 9 see that sentence in -- year to year in a variety 10 of institutions in which you're auditing; is that 11 correct? 12 A. That's correct. 13 Q. But it's still significant? 14 A. Yes. 15 Q. Now, let me ask you to turn to the 16 exhibit you were asked about yesterday, A7008. 17 And it is in our record as B1481 at Tab 902. 18 MR. GUIDO: 1482? 19 MR. NICKENS: 1481, Tab 902. 20 Q. (BY MR. NICKENS) Mr. Guido asked you 21 a number of questions about Page 3 of this 22 document. I would like for you to turn to Page 4. 10332 1 It's actually numbered Page 2 down at the bottom. 2 Do you recall he asked you about the 3 process of the management letter that you would 4 make your comment and could get a response? 5 A. Yes. 6 Q. And it's so reflected in this document. 7 Right? 8 A. Yes. It looks like it is. 9 Q. Now, there's a paragraph entitled 10 "Complex Accounting Transactions." And again, 11 although this -- this is February 6th, 1987, which 12 is approximately six months after you had left 13 Peat Marwick? 14 A. That's correct. 15 Q. Could you -- I'd like for you to read 16 the first paragraph under "complex accounting 17 transactions." And my question is going to be: 18 What is your recollection with regard to the 19 matters addressed there? 20 A. "The association has entered into 21 certain complex transactions which require a high 22 degree of judgment and subjectivity in determining 10333 1 the appropriate accounting treatment. In some 2 cases, guidance regarding the accounting treatment 3 has not been clearly defined by accounting 4 authorities: I.e., financial accounting standards 5 board, AICPA, FASB, Emerging Issues Task Force, et 6 cetera at the time the transaction was 7 consummated. We recommend the association adopt 8 an aggressive program of documenting positions and 9 rationale with respect to accounting treatment of 10 complex or unusual transactions." 11 Q. And was that something that was 12 developing before you left Peat Marwick, 13 developing at USAT before you left Peat Marwick? 14 A. You mean the complex transactions where 15 the accounting rules were not in place? 16 Q. Yes, sir. 17 A. Yes. 18 Q. And if you look down at the response, 19 the response was, "When the association enters 20 into new complex transactions requiring a high 21 degree of judgment and subjectivity in determining 22 the appropriate accounting treatment, it will 10334 1 continue to consult with Peat Marwick Mitchell 2 & Co. prior to proceeding with the transactions." 3 Now, was that procedure consistent with 4 your experience with United Savings? 5 A. Yes. 6 Q. And if you look over at the next page, 7 which is numbered Page 3 and probably about the 8 fifth page of the document, do you see that there 9 is an entire paragraph dealing with trading versus 10 investment treatment for corporate debt and 11 mortgage-backed securities? 12 A. Yes. 13 Q. Now, what would be the significance of 14 the fact that this was an identified item to be 15 addressed in the management letter? 16 A. Well, without reading the paragraph, 17 obviously it was an area of concern. I don't know 18 that we're addressing the weakness here as much as 19 making a point that they need to pay particular 20 close attention to document what they are doing. 21 Q. Okay. Now, in addition to reviewing 22 the documents and preparing these various 10335 1 documentation, of course, you had personal 2 interaction with management; is that correct? 3 A. Yes. 4 Q. And we've seen where you attended the 5 audit committee and some of the board meetings. 6 Did you have conversations with 7 management? 8 A. Yes. 9 Q. And to what extent would those 10 conversations become documented in the work 11 papers? 12 A. I would assume that any time we had any 13 discussions that led to conclusions or presented 14 problems that we needed researched or something 15 like that, we would probably begin to document 16 them. 17 Q. I'm just trying to get a feel for this, 18 Mr. Millinor. Every time you talked to anybody at 19 USAT, would you make a note of it to go in the 20 work papers or was it something more formal than 21 that? 22 A. I certainly didn't make a memo out of 10336 1 every conversation I had with anybody, if that's 2 the question. 3 Q. Now, what does it mean for a particular 4 area to be identified as a critical audit area? 5 A. If I remember correctly, it had two or 6 three layers to it. One, obviously by definition, 7 it sounds like something that you need to pay 8 particularly close attention to. It was one of 9 the areas, I think, that the engagement partner 10 programs had to sign all the papers within 11 critical areas, although that might not be 12 correct. It just required the audit team, in 13 doing their planning, to heighten the concern over 14 those areas that we felt like cost the greatest 15 amount of exposure for whatever reason. Either 16 they were just big or they were complicated. 17 Q. So, they got heightened scrutiny? 18 A. Yes. 19 Q. Now, I'd like to turn to a subject you 20 were asked about yesterday with regard to USAT 21 Mortgage Finance, the entity that was created 22 toward the end of 1985. And Mr. Guido had shown 10337 1 you your memorandum concerning that entity and 2 Mr. Phillips' memorandum. 3 A. Yes. 4 Q. And my question is: Apart from your 5 review of those memos yesterday, which -- tell the 6 Court in your own words what you remember about 7 the creation and dissolution of United Mortgage 8 Finance. 9 A. Specifically, very little, other than, 10 obviously, it happened. I don't remember any 11 specific conversations. I don't even remember 12 talking to Joe Phillips about it. I don't 13 remember whether he handed me that memo. I don't 14 remember any of the details like that. 15 Q. Now, to your knowledge, does your 16 memorandum accurately describe the situation as 17 you understood it? 18 A. As best I can tell, it does. 19 Q. And looking at that memorandum -- it's 20 at Exhibit B819, which is Tab 586. Let me say, 21 that typed part is something that we prepared in 22 order to assist our consideration of the document. 10338 1 Mr. Millinor, my question is: You 2 prepared this memorandum because you had had 3 some -- you were encountering an accounting issue, 4 a difficult accounting issue, and you had some 5 conversations with the people in New York about 6 how it should be addressed; is that correct? 7 A. Yes. 8 Q. And tell the Court what the accounting 9 issue was that appeared to you to be difficult. 10 A. Well, stated in a very basic way, 11 because I don't remember the details of these 12 portfolios and how they hedged them, what we had 13 seen in my experience in accounting that had to do 14 with hedging was done by the mortgage banking 15 clients we had where they took a very specific 16 group of loans and they either pre-sold them or 17 they had an obligation from somebody to take them 18 somewhere out in the future at a certain price. 19 And there was no question that everything was 20 contained in a box and you didn't break the box or 21 you marked everything to market. Once something 22 was hedged, usually it locked in a gain or loss 10339 1 and you rode that out until the end. 2 Things became a lot more complicated at 3 United and other places as people tried to find a 4 way to manage the interest rate risk and the 5 duration risk in their balance sheets. But the 6 issue was still the same. If you have something 7 that is typically mark-to-market and you hedge it, 8 you might can stop that process of marking it to 9 market because your loss or gain has been locked 10 in. And when do you break a hedge and when do 11 things fall outside of the hedge and when do you 12 have to mark contracts to market as a result and 13 record a sale of something, in effect? 14 And that was really the issue here. 15 There were very large dollars involved in their 16 balance sheet, obviously. 17 Q. All right. And the specific issue was 18 the use of a mirror and the question of whether 19 that mirror constituted a termination of the 20 hedge. Is that -- 21 A. From reading this memo, that sounds 22 like that was the issue, although I don't recall 10340 1 that specifically. 2 Q. Okay. But as to -- you certainly knew 3 then that they were using what they called -- and 4 you used the term -- macro hedges, using the swaps 5 as macro hedges against their interest rate risk? 6 A. Correct. 7 Q. And those swaps were not being marked 8 to market? 9 A. No. 10 Q. And was there any -- was that 11 considered to be, at the time, a difficult 12 accounting issue? 13 A. I remember it being a difficult issue, 14 yes, because it was poorly defined in the rules. 15 Q. But you and the people above you -- if 16 that's a fair description -- in New York reviewed 17 this specific situation at United and concluded 18 that the swaps should continue to be not marked to 19 market? 20 A. That's what this says we did, yes. It 21 sounds like it. 22 Q. Okay. Now -- and the treatment of the 10341 1 sale of the MBS -- that is, the gain realized when 2 the MBS was sold -- that was not a complicated 3 accounting issue, was it? 4 A. It seemed to me that it was. 5 Q. Okay. 6 A. New York tells me it wasn't. I mean, 7 the rules should have been clear that those should 8 have been recorded. 9 Q. Now, what I'm trying to ask you about 10 is distinguishing from the roll-down, which occurs 11 shortly thereafter, and the treatment here where 12 they simply sold the securities and did not 13 replace them. 14 A. That should have been clear cut. 15 Q. Okay. So, that's -- what was the 16 difference between the roll-down where the 17 securities were replaced and the situation here 18 where they simply were sold outright? 19 A. You're asking me about circumstances 20 that I have very poor recall of. I don't even 21 know what the roll-down meant. 22 Q. Okay. Well, let's come to that. But 10342 1 first, let me ask you some questions about the 2 documentation of this issue which Mr. Guido 3 focused on yesterday. And for that purpose, I 4 would ask that you look at Exhibit B800 and, also, 5 B690, which is at Tab 585. 6 What is B800? 7 A. It's obviously a memo from Joe Parsons 8 to Chuck Doolittle. And at the time, I don't 9 remember whether Chuck worked for United or worked 10 for us. 11 Q. Okay. 12 MR. NICKENS: Your Honor, we would 13 offer Exhibit B800. 14 MR. GUIDO: No objection, Your Honor. 15 THE COURT: Received. 16 Q. (BY MR. NICKENS) What's the very 17 first bullet point addressed in this memorandum? 18 A. It says "gain on sale of 19 mortgage-backed securities." 20 Q. And it reads, "We need supporting 21 documentation for the purchase and subsequent sale 22 of mortgage-backed securities at the USAT Mortgage 10343 1 Securities, Inc. subsidiary level. In particular, 2 we need documentation of the forward commitment 3 with Salomon Brothers which resulted in a 4 6-million-dollar gain. We understand that Joe 5 Phillips has contacted Salomon Brothers in order 6 to obtain this information." 7 And then it goes on to mention other 8 issues, all dealing with the gain on sale of 9 mortgage-backed securities. 10 Do you see that? 11 A. Yes. 12 Q. Now, does that indicate to you that you 13 were in the process of acquiring the needed 14 documentation and getting USAT to do so? 15 A. Yes. 16 Q. And the particular subject matter of 17 this document are the pending audit concerns 18 relating to the general ledger accounts, January 19 of '86. 20 Now, what is the significance of that 21 January date, not the 23rd, but just what goes on 22 in the audit process in that January period? 10344 1 A. I assume at this time, we're trying to 2 audit those significant transactions that happened 3 during the period that we audited through in the 4 fall. So, my guess is these transactions happened 5 in the last three months of the year or so. 6 Q. Now, let me ask you to look at B690, 7 which is a memorandum from Mr. Pledger concerning 8 recent Federal Home Loan Bank Board finance 9 subsidiary regulations. You've indicated to us 10 that you don't recall exactly what was reviewed, 11 but would this be the sort of document that one 12 might look at in order to support the conclusions 13 that you had reached in your discussions with New 14 York? 15 MR. GUIDO: Objection, Your Honor. 16 It's pure -- asking for pure speculation on the 17 part of the client. 18 MR. NICKENS: Your Honor, he made a big 19 point about lack of documentation, asked the 20 witness about "you relied only on Mr. Phillips' 21 memo," and I'm just pointing out that there was 22 ample documentation that was available to the 10345 1 accountants, some of which is in the accountant's 2 files, that was not touched upon by Mr. Guido. 3 MR. GUIDO: Your Honor, if he's asking 4 whether or not the witness relied on the document 5 or whether or not the document's in the work 6 papers, I think it's an appropriate question. But 7 he's just asking "Is this some sort of document 8 you might have relied upon or would have relied 9 upon?" He's asking for pure speculation, Your 10 Honor, and I object to the question. 11 THE COURT: All right. Restate your 12 question. 13 Q. (BY MR. NICKENS) You don't recall 14 seeing any of this documentation prior to what was 15 shown to you yesterday; is that correct? 16 A. This memo from Jim Pledger 17 specifically? 18 Q. Well, yes, sir, or even your memo and 19 the memo from Mr. Phillips. 20 A. Some of these I had seen over the last 21 several years as this stuff bubbled along and 22 people had conversations. I gave a deposition at 10346 1 one point. I don't recall ever seeing this memo 2 from Jim Pledger, though. 3 Q. And the question is: Is this the sort 4 of documentation that one would look at in the 5 course of an audit? 6 MR. GUIDO: Same objection, Your Honor. 7 THE COURT: Denied. 8 Q. (BY MR. NICKENS) You can answer the 9 question. 10 A. It certainly could be. 11 Q. Now, let us turn to the roll-down, the 12 restatement issues. And again, I'd like to ask 13 you, so that we can have some sense of this, what 14 you recall concerning those issues, what you 15 remember about those issues as opposed to what 16 you've been asked to comment about as you have 17 seen these documents. 18 Do you understand the distinction? 19 A. You're going to have to explain to me 20 what you mean by "the roll-down." 21 Q. Okay. What we're talking about was the 22 sale by United Savings in the first six months or 10347 1 so of 1986 of higher coupon MBS to -- and 2 replacement of that -- those securities with lower 3 coupon MBS in an effort to stem prepayments and 4 where they adopted the practice of accounting for 5 those transactions of rolling the gains in the 6 sale into the basis of the replacement securities. 7 A. And those were the deferred gains 8 that -- 9 Q. That led to -- 10 A. -- that we agreed -- I agreed with them 11 that they would do that led to the restatement? 12 Q. Yes. And that's what I'm going to 13 question you about, is about your role in this. 14 But then led to the restatement of earnings in the 15 first quarter -- for the first quarter of 1986. 16 A. From reading the memo yesterday, it 17 seems to me what happened was I agreed with United 18 and they agreed with me that although we had 19 guidance from New York that those transactions 20 could be booked as sales and those gains recorded, 21 that they wouldn't do that, that they would defer 22 them and amortize them off somehow through the 10348 1 yield mechanism. And obviously, they did that for 2 the first quarter of '86. And at some point 3 during the second quarter -- I don't know why or 4 how -- it came up as an issue and I was told that 5 they couldn't do that, that they had to restate 6 those earnings and book those gains. 7 Q. Now, is there any question in your own 8 mind that you were involved in the process of the 9 initial decision of rolling the gains into the 10 basis of the replacement securities? 11 A. None. 12 Q. And did their accounting treatment for 13 that process make sense to you? 14 A. It made sense to me then and now. 15 Q. And is that -- is rolling the gain into 16 the basis of the replacement securities consistent 17 with selling securities to recognize accounting 18 gains? 19 A. I didn't think so, obviously, or I 20 wouldn't have suggested what I did. 21 Q. In fact, you don't recognize accounting 22 gains if you followed that procedure. Right? 10349 1 A. You'd defer it. 2 Q. Until you sell or otherwise dispose of 3 the replacement securities? 4 A. Well, I don't know the last part. 5 Somehow, I felt like that those transactions and 6 those securities fit within their hedging 7 mechanism of trying to lock up yields on their 8 balance sheet and that recording the transactions 9 as sales really wasn't appropriate. 10 Q. Now, from an accounting perspective, 11 how was the roll-down different from the 12 mortgage-backed securities that had been sold when 13 United Mortgage Finance had been dissolved? 14 A. I don't remember exactly why they would 15 have been; but obviously, I thought they were and 16 that these particular securities somehow fit 17 within their hedging mechanism whereas the others 18 did not. 19 Q. Now, was this issue looked at -- I'm 20 talking about the one that led to the 21 restatement -- looked at closely? 22 A. Yes. 10350 1 Q. It's not something that you -- you go 2 to a company who's publicly traded -- you go to 3 them and do it lightly and tell them, "I'm sorry, 4 but we're going to have to restate earnings"? 5 A. No. 6 Q. Now, explain to the Court why that's a 7 big deal. 8 A. It's embarrassing for everybody 9 concerned. It was very painful for me. Nobody 10 likes to restate earnings. It implies ineptitude. 11 Q. You often get lawsuits out of 12 restatement of earnings? 13 A. You can. 14 Q. Let me -- with regard to that issue, 15 let me show you a document that we've marked as 16 Exhibit B1080; and it should be in front of you. 17 Mr. Millinor, can you identify exhibit 18 B1080 as work papers entitled "Deferred gain on 19 Sale of M/B securities test work prepared by 20 BT" -- it looks like in July of '86? 21 A. Yes. 22 MR. NICKENS: Your Honor, we would 10351 1 offer B1080. 2 MR. GUIDO: No objection, Your Honor. 3 THE COURT: Received. 4 Q. (BY MR. NICKENS) Would "BT" be Barry 5 Tiedt? 6 A. I believe so. 7 Q. And just look at a couple of aspects of 8 this document with me, Mr. Millinor. He writes 9 that the purpose -- "The purpose of this memo is 10 to describe the test work performed re: USAT's 11 recognition of the previously deferred gains on 12 sales of mortgage-backed securities (MBS)." 13 And then it says "Situation. During 14 1986, United has been turning over their portfolio 15 monthly of MBS in attempt to match the MBS 16 estimated maturities with the maturities of the 17 interest rate swaps associated with the reverse 18 repos that the MBS are collateralizing." 19 And then he goes on to discuss the ways 20 in which you were going to correct that situation 21 in light of the fact they had been told that they 22 had to recognize the income from those securities. 10352 1 Would this indicate to you a careful 2 assessment of those issues? 3 A. I think we looked at it very carefully. 4 MR. NICKENS: Your Honor, let -- 5 Q. (BY MR. NICKENS) Mr. Millinor, let me 6 ask you to look at B1123 and ask you to identify 7 that for the record. 8 A. It says it's a memo from Jerry 9 Claiborne to the files of United Financial Group. 10 Subject: Second quarter 10Q dated July 23rd, 11 1986. 12 MR. NICKENS: Your Honor, we offer 13 Exhibit B1123. 14 MR. GUIDO: No objection, Your Honor. 15 THE COURT: Received. 16 Q. (BY MR. NICKENS) And this is the 17 documentation of your conversations informing 18 United Savings of the decision that they would 19 have to restate their earnings? 20 A. It deals with that issue, yes. 21 Q. And in particular, you were dealing 22 with what kind of disclosure that you were going 10353 1 to have to make concerning that restatement? 2 A. That's what it appears to be, yes. 3 Q. Now, Mr. Millinor, I'd like to ask you 4 a few questions concerning this investment versus 5 trading issue. 6 You'll recall yesterday that Mr. Guido 7 had asked you about a memo that had been authored 8 after you left Peat Marwick by Mr. Parsons. Let's 9 see if we can find it. It's attached to the Bruce 10 Williams -- Mike Crow/Bruce Williams memo. 11 MR. GUIDO: Is that A10716? 12 MR. NICKENS: Yes, that's it. A10716. 13 Q. (BY MR. NICKENS) If you could turn to 14 the second page. This is a document that you were 15 asked about yesterday. And you'll recall the 16 questions dealing with the role of intent and the 17 decision about -- management's intent with regard 18 to a decision about investment versus trading 19 designation of the portfolio? 20 A. Yes. 21 Q. Now, at what point in time are we 22 talking about the intent? Is it the intent at the 10354 1 time the securities are purchased, or some other 2 time? 3 A. Typically, it's at the time they are 4 purchased, I think. 5 Q. And the subsequent actions go to the 6 question of whether or not it brings that original 7 intent into question? 8 A. I believe that's correct. 9 Q. And that's the reason that you look at 10 those subsequent actions and require them to be 11 documented, because if a person comes to you and 12 can give no reasons for his subsequent actions, 13 that brings into question the original intent? 14 A. I would agree with that. 15 Q. Okay. Now, how firm were the 16 accounting rules with regard to these issues at 17 the time you were trying to apply them in 1985 and 18 '86? 19 A. I don't remember them being firm at 20 all. 21 Q. What is your recollection of the 22 situation with regard to this particular issue -- 10355 1 that is, investment versus trading? 2 A. The situation at United or just in 3 general? 4 Q. In general, sir. 5 A. It was a problem that didn't exist too 6 much in prior years coming up to the Eighties 7 because people typically did buy government 8 securities and leave them in their portfolio. It 9 was a requirement from a regulatory standpoint 10 that they have certain amounts invested that way. 11 But as people began to look for 12 different ways to create earnings, as the interest 13 rate spike caused a lot of deterioration in net 14 worth and some sophistication came to this 15 business of "How do you make money doing this kind 16 of thing," it came more and more of a problem. 17 Q. In terms of deciding how it should be 18 treated from an accounting point? 19 A. Yes. 20 Q. Now, what was the general practice at 21 the time concerning whether or not you could have 22 some level of trading, even in an investment 10356 1 portfolio? 2 A. I don't know if we had anything written 3 down. It seems to me that I recall some kind of 4 rule of thumb that maybe if a fourth of a 5 portfolio turned over in a year, then maybe that 6 was okay. And if it was more than that, you had 7 to look into it a little more. 8 Q. Okay. Was it unusual to see some 9 trading in investment portfolios? 10 A. No. 11 Q. Was it thought to be absolutely 12 inconsistent with the original intent to hold? 13 A. Not necessarily. 14 Q. So, you know, a person buys something 15 intending to hold it. Circumstances change, and 16 they decide to sell it. You don't immediately 17 conclude that their original intent was a 18 falsehood? 19 A. Not necessarily. 20 Q. Now, Peat Marwick carefully monitored 21 USAT's activity in investment securities, did they 22 not? 10357 1 A. We did. 2 Q. On a quarterly basis? 3 A. Yes. 4 Q. And let me ask you to look at 5 Exhibit B4135, which hopefully is here, and ask 6 you if you can identify that document. 7 A. Looks like the 1985 planning memo for 8 the United audit. 9 Q. Okay. And you were there at the time? 10 A. If I'm reading the date correctly, 11 12-31-85, the answer is yes. 12 Q. And let me ask you to look over -- and 13 we'll refer to the Bates numbers at the bottom 14 since they are the most easily identified -- to 15 the number KPMG 056219. 16 MR. NICKENS: And while you're doing 17 that, Your Honor, I would offer B3145. 18 MR. GUIDO: Your Honor, the document is 19 basically illegible and I object to its admission 20 for that reason. If Mr. Nickens has a better 21 copy, I'll have no objection to the admission of 22 the document. But I can't read any of the 10358 1 handwriting on the document that I have in front 2 of me. 3 THE COURT: Do you have a better 4 document? 5 MR. NICKENS: Your Honor, we would 6 provide the absolute best copy because it's in 7 everybody's best interest, but I don't believe 8 that Mr. Guido's ability to read the document is a 9 basis for objection. The witness has identified 10 the document as being from the work papers and 11 reflecting the year end planning memo for 12 Peat Marwick at United Financial Group. 13 THE COURT: Well, I'd like to have the 14 most legible document that's available. And if 15 this is it, then we'll accept this. 16 MR. NICKENS: Your Honor, this is the 17 best I have at the moment. If we can get it 18 enlarged or -- 19 THE COURT: I'll receive it. And if we 20 later have a more legible copy, I'd like to have 21 it. 22 Q. (BY MR. NICKENS) Mr. Millinor, did 10359 1 you find Page 56219? 2 A. Yes. 3 Q. And I'll just ask you if it's possible 4 for you to read that first line about -- under 5 "significant change." 6 MR. GUIDO: 56219? 7 MR. NICKENS: Yes. 8 A. Well, I don't know what the first word 9 is. I think it says "Securities designated a 10 critical audit area." 11 Is that what you're talking about? 12 Q. (BY MR. NICKENS) Yes, sir. It 13 appears to say "Investment securities designated a 14 critical audit area"? 15 A. If you tell me that's what that first 16 word is, then it makes sense that that's what that 17 is. 18 Q. Okay. Well, as far as what you can 19 read, it's "securities designated as a critical 20 audit area"? 21 A. Yes. 22 Q. And you've earlier told us what the 10360 1 importance was of such a designation? 2 A. Yes. 3 Q. Now, let me ask you to turn the page to 4 220. 5 MR. GUIDO: Your Honor, I would like to 6 have the witness read the entire section. I don't 7 think that it's appropriate to partially read 8 something that is totally obscured. This is 9 prejudicing our ability to cross -- to redirect or 10 cross-examine this witness about this basic direct 11 testimony. And I object, Your Honor. This 12 document, basically, was not on the original 13 exhibit list. It was part of the supplements of 14 the documents that were produced. It was 15 provided -- it is being used basically for direct 16 evidence today, and I believe that I should be 17 entitled to have a document that I can read so 18 that I can cross-examine the witness about what's 19 in there. There are words in here talking about 20 trading securities in this paragraph, and I think 21 it's highly relevant to this witness' testimony. 22 THE COURT: Which paragraph are you 10361 1 talking about? 2 MR. GUIDO: The paragraph that's on 3 56219, Your Honor. I think the witness should be 4 obligated to read the entire paragraph in there, 5 as Mr. Nickens has insisted on with every other 6 witness and which we've done so. 7 This document is not legible, Your 8 Honor, and I find this whole line of questioning 9 rather objectionable to using this document at 10 this time. 11 MR. NICKENS: I think what Mr. Guido 12 finds objectionable is the fact that he can read 13 the document. But in light of his objection, I am 14 going to go to that portion that I believe to be 15 in Mr. Millinor's own handwriting so that we can 16 get what he can read of that. And then if we have 17 to bring Mr. Tiedt here to read the document or to 18 get some expert that can read the document -- but 19 I will point out that this document has been 20 available to the OTS perhaps for a decade. And 21 for him to now complain that they don't know what 22 it says, I find passing strange. 10362 1 MR. GUIDO: Your Honor, there have been 2 10,000 or 100,000 documents that have been 3 available to the OTS for a decade. We're talking 4 about a document that someone is attempting to use 5 in this proceeding today. And I believe that 6 applying the principles of fairness that 7 Mr. Nickens has insisted on, which is that it's 8 highly inappropriate to read just one sentence of 9 that illegible paragraph and to deprive us of an 10 opportunity to cross-examine this witness about 11 what the meaning of what he read into the record 12 was because I think the rest of it explains what 13 that is. And it seems to me that there is a 14 document that exists -- I've seen documents that 15 Mr. Nickens has produced blown up in this 16 courtroom for his own use, and I believe that the 17 Court is entitled to have a document that's 18 legible so that it can make a ruling and that I'm 19 entitled to a document that's legible so that I 20 can cross-examine this witness. 21 MR. NICKENS: How much of the 22 document -- 10363 1 MR. GUIDO: -- on this document. 2 MR. NICKENS: Pardon me, Your Honor. 3 How much of the document would Mr. Guido prefer 4 that we read? I only offered the sentence to 5 indicate the critical area, that it had been 6 designated a critical audit area. But we will 7 read as much as we are able to, although I suggest 8 that part of this is an effort to make me not make 9 my obligation to Mr. Millinor. 10 MR. GUIDO: Your Honor, I object to the 11 sort of insinuations that are being made here. 12 This document is very clearly not legible. 13 THE COURT: We do have a problem of 14 legibility, and I'm not quite sure how to handle 15 it. If we don't have anything else, then the 16 alternative is to exclude the document as such. 17 And I'm a little reluctant to do that, too. So, I 18 don't know who's going to be assigned the task of 19 trying to read this paragraph that you're talking 20 about, but we've read the first sentence. 21 MR. NICKENS: Ms. Clark can read it. I 22 have a memo that says -- I think we know what it 10364 1 says. 2 MS. CLARK: I can try to read it. I 3 can't read every word, and I don't have my right 4 glasses with me, unfortunately. But I think it 5 says that "Our interim test work revealed a lack 6 of authorization" -- 7 MR. GUIDO: Can you read more slowly, 8 please? 9 MS. CLARK: "Our interim test work 10 revealed a lack of authorization and review of 11 securities transactions as the company was much 12 more active in trading securities than 13 anticipated." 14 MR. EISENHART: "They have also 15 increased" -- 16 MS. CLARK: "They have also increased 17 their investment in equity securities and created 18 a trading account which requires a mark-to-market 19 adjustment." I believe that's it. 20 MR. NICKENS: It can be read. 21 MR. GUIDO: What does the last line 22 say? 10365 1 MS. CLARK: "For financial 2 statement" -- 3 MR. NICKENS: -- "presentation." 4 MS. CLARK: -- "presentation." 5 MR. GUIDO: And what does the 6 right-hand side of that section say? I mean, I 7 think -- 8 MR. NICKENS: We will never finish with 9 this process. 10 MR. GUIDO: This demonstrates why I 11 think it's highly important that the entire 12 section be read, because it's talking about what 13 this client is doing and what led this to be a 14 critical audit area. And I think that what has 15 just been read into the record is highly relevant 16 to the points that the OTS has been making in its 17 case, Your Honor. 18 MR. NICKENS: Your Honor, if we can 19 read it, they can read it. And he can raise it on 20 cross-examination if that's appropriate. 21 MR. GUIDO: Your Honor, I can't read 22 the document. As I said, you know, I have seen 10366 1 blown-ups of these similar documents that the 2 respondents have, and I don't know whether 3 Ms. Clark has had access to a blowup so that she 4 can read it. I still can't read that document. 5 MR. NICKENS: I have indicated that we 6 will try to provide blowups or whatever for the 7 Court and for the use of Mr. Guido. I can't do 8 that right this minute. The witness is here, and 9 we need to address his testimony. 10 THE COURT: All right. I have received 11 the document. I'd like to receive it. 12 Mr. Guido's had part of it read. I don't know. 13 Maybe you can read the other side later. 14 Q. (BY MR. NICKENS) Mr. Millinor, could 15 I ask you to turn over to 56238? Is that -- can 16 you identify that particular memorandum? 17 A. It says "USAT 1986 projections." The 18 memo itself is in my handwriting. 19 Q. Well, I would ask you, in light of the 20 fact that it's in your handwriting, to read the 21 first paragraph. 22 A. If I can. 10367 1 Q. Yes, sir. 2 A. "As can be seen, USAT does not expect a 3 great year in 1986. 1986 looks better than 1985 4 partially because of an expected improvement in 5 the loan and real estate loss provision. 1986 is 6 also expected to contain, as did 1985, several 7 large gains from sales of, one, securities, two, 8 loans, three, branch deposits and, four, loan 9 servicing. Real estate is expected to show a 10 dramatic turnaround, primarily due to sells of the 11 east point development in Fort Worth. Non-earning 12 assets continue to drag down interest margins." 13 Q. Thank you. Does that document indicate 14 to you that you were aware that USAT was in the 15 process of selling securities from time to time? 16 A. Yes. 17 Q. And let me ask you to look over at an 18 exhibit that is at A12064. It's at the very end 19 of the stack that I gave you. It purports to be a 20 letter to you dated July 28th, 1986, from Vivian 21 Carlton. 22 MR. NICKENS: Your Honor, we would 10368 1 offer A12064. 2 MR. GUIDO: No objection, Your Honor. 3 THE COURT: Received. 4 Q. (BY MR. NICKENS) Mr. Millinor, it's a 5 little easier to read, although it's small print. 6 Could you read this to the Court, this letter to 7 you from Vivian Carlton, examiner in charge? 8 A. "In compliance with Section 9 563.17-1(a)(2), examinations and audits, for 10 FSLIC-insured institutions, your firm performed an 11 audit of the consolidated financial statements of 12 United Savings Association of Texas and its 13 subsidiaries for the year ended December 31, 1985. 14 The Federal Home Loan Bank examiners request all 15 work papers to support the aforementioned audit. 16 If you have any questions, please feel free to 17 contact me. I thank you in advance for your 18 immediate attention." 19 Q. Would Exhibit 41 -- B4135 that you were 20 just looking at be a part of the work papers that 21 the examiners requested to have delivered to them 22 in July of 1986? 10369 1 A. I assume so, yes. 2 Q. Now, I'm just going to ask you to 3 identify a few other documents for us, 4 Mr. Millinor. Let me ask you to look at B769. 5 Could you tell us and the Court what 6 the B769 is? 7 THE COURT: Mr. Nickens, is that in 8 or -- 9 MR. NICKENS: No, Your Honor. I'm 10 going to offer it. I'm sorry. I apologize. 11 THE COURT: Thank you. 12 A. I'm not 100 percent certain what it is. 13 It looks like portions of a general ledger of 14 certain accounts. 15 Q. (BY MR. NICKENS) Okay. Do you see it 16 says "to Barry" and "from" -- and I can't read 17 that. 18 A. I think there was a fellow named 19 Courtney who worked in the accounting department 20 at United. 21 Q. And it shows a quarterly analysis, 22 January through March of 1986, in thousands on the 10370 1 gain and loss of securities? 2 A. Yes. 3 Q. And this is from the work papers of 4 Peat Marwick? 5 A. You're telling me that it is? I don't 6 know how to tell. 7 Q. Well, if you would turn over to 59791, 8 do you see those notes? I'm not going to ask you 9 to read them. But "gain/loss January February 10 March." And at the bottom, it's signed, after a 11 note, "BT," in Mr. Barry Tiedt's signature? 12 A. That's what it appears to be, yes. 13 MR. NICKENS: Your Honor, we offer 14 B769. 15 MR. GUIDO: Objection for the same 16 reason, that the document is not legible, Your 17 Honor. Because of that, there is no way of 18 ascertaining whether or not the document -- 19 THE COURT: Received. 20 MR. GUIDO: -- is what Mr. Nickens 21 alleges it is. 22 Q. (BY MR. NICKENS) Would you look over 10371 1 at B913? Can you identify that as a quarterly 2 review audit project, "Significant transactions, 3 3-31-86, United Financial Group"? Again 4 indicating from the work papers of Peat Marwick? 5 A. That's what it appears to be, yes. 6 MR. NICKENS: Your Honor, we would 7 offer KPMG -- excuse me -- B913. 8 MR. GUIDO: No objection, Your Honor. 9 THE COURT: Received. 10 Q. (BY MR. NICKENS) Do you see at the 11 top, it says "Per discussion with the client, the 12 following significant transactions occurred in 13 this quarter"? 14 A. Yes. 15 Q. This is the sort of document that we 16 discussed before, a way of documenting 17 conversations or discussions with the client in 18 the work paper? 19 A. Yes. 20 Q. Let me ask you to look at B1048. 21 MR. GUIDO: I'm sorry. I missed that 22 number. 10372 1 MR. NICKENS: B1048. 2 Q. (BY MR. NICKENS) And if you look 3 over -- you see the KPMG mark, and if you look 4 over about five or six pages -- one more page, 5 Mr. Millinor, please. Do you see there it says 6 "May performance summary" on some Peat Marwick 7 work papers? 8 MR. GUIDO: 1080? 9 A. Yes. 10 Q. (BY MR. NICKENS) Can you identify 11 B1048 as a copy of the USAT May 1986 performance 12 report from the files of Peat Marwick? 13 A. Yes. I assume these came out of our 14 files. 15 MR. NICKENS: Your Honor, we offer 16 B1048. 17 MR. GUIDO: No objection, Your Honor. 18 THE COURT: Received. 19 Q. (BY MR. NICKENS) If you look at the 20 second page -- well, actually, turn over to the 21 last page, if you would, Mr. Millinor. Excuse me. 22 The third page. And at the bottom, do you see in 10373 1 the last paragraph, it says "No significant gains 2 or losses on the sale of securities occurred this 3 month to offset the provision. Year-to-date, the 4 net gain on the sale of investment securities 5 amounted to 9.3 million net of a 4-million-dollar 6 provision for losses and was far in excess of the 7 2 and a half million net gain budgeted." 8 MR. GUIDO: What page are you reading 9 from? 10 MR. NICKENS: It's page KPMG 056932, 11 the last paragraph on the page. 12 MR. GUIDO: 922. 13 MR. NICKENS: 932. 14 Q. (BY MR. NICKENS) Do you see that a 15 certain amount of gain on the sale of securities 16 was actually budgeted at USAT? 17 A. That's what it says, yes. 18 Q. And on the second page where it says 19 "net interest income," do you see that there 20 appears to have been some highlighting and a 21 marking with a Note 2? 22 A. I see the circled 2 over on the 10374 1 right-hand margin. Is that what you're referring 2 to? 3 Q. Yes, sir. 4 A. Yes. 5 Q. And that corresponds with Mister -- 6 with the notes on the last page. It starts out 7 "per discussion with Jim Wolfe"? 8 A. Yes. 9 Q. Now, with regard to the investment 10 versus trading issue, Mr. Millinor, basically what 11 happened was that USAT asked for your advice on 12 those issues, did they not? 13 A. Yes. We were in constant conversation 14 about it. 15 Q. And you gave them your best 16 professional advice concerning how those things 17 should be accounted for? 18 A. That's how I remember it, yes. 19 Q. And that was according to your -- the 20 standards and practice at the time? 21 A. To the best of my knowledge, it was, 22 yes. 10375 1 Q. Your experience and the resources of 2 Peat Marwick? 3 A. Yes. 4 Q. And they heeded your advice? 5 A. As far as I could tell, they did. 6 Q. Even when they disagreed or it was 7 painful? 8 A. Occasionally, I think. 9 Q. One final area, if I might, 10 Mr. Millinor, with regard to a document that we 11 have marked as B970. 12 Can you identify that as meeting notes 13 of the meeting with yourself and Mr. Jim 14 Halverson, Ginger Mitchell -- on May 5th, 1986 -- 15 and certain people from United Financial? 16 A. That's what it appears to be, yes. 17 MR. NICKENS: Your Honor, we offer 18 B970. 19 MR. GUIDO: No objection, Your Honor. 20 THE COURT: Received. 21 Q. (BY MR. NICKENS) Is this in your hand 22 or in somebody else's handwriting? 10376 1 A. Mine. 2 Q. Could you read the next-to-last 3 paragraph on the page for us? 4 A. Beginning with "Jim and Ginger"? 5 Q. Yes, sir. 6 A. "Both described United as white hot 7 guys but weren't very encouraging regarding 8 United's applications." 9 Q. Might I suggest, Mr. Millinor, that's 10 "white hat"? 11 A. There you go. That sounds different, 12 doesn't it? White hat. I'm sorry. 13 Q. I don't want to -- I mean, what does it 14 say, Mr. Millinor? 15 A. "White hat guys." 16 Q. Okay. What did that mean to you? 17 A. Obviously, it meant during the time 18 that the Federal Home Loan Bank didn't see United 19 as bad guys. 20 Q. And would you read the last paragraph 21 for the Court? 22 A. "We indicated that we were very 10377 1 comfortable with United as a client. No specific 2 questions were asked of us." 3 Q. What did that mean when you informed 4 the Federal Home Loan Bank Board in May of '86 5 that you were very comfortable with the client? 6 A. That we were not concerned with their 7 credibility or with the ability to audit their 8 financial statements. 9 MR. NICKENS: Your Honor, I have no 10 further questions for this witness. 11 THE COURT: Do any of the other 12 respondents have questions for the witness? 13 MS. CLARK: No, Your Honor. 14 MR. EISENHART: I have no questions, 15 Your Honor. 16 MR. GRIFFITH: None, Your Honor. 17 MR. PERRY: None, Your Honor. 18 THE COURT: You're going to have some 19 redirect? 20 MR. GUIDO: Yes, Your Honor. 21 THE COURT: We'll take a short recess. 22 10378 1 (A short break was taken 2 at 10:17 a.m.) 3 4 THE COURT: Be seated, please. We'll 5 be back on the record. 6 Mr. Guido, you may redirect. 7 MR. GUIDO: Thank you, Your Honor. 8 9 REDIRECT-EXAMINATION 10 11 (10:41 a.m.) 12 Q. (BY MR. GUIDO) Mr. Millinor, you 13 testified in response to one of the questions or 14 you had a question. You said was the time period 15 that you were being asked about when Charles 16 Hurwitz exerted control over the institution. 17 Do you recall that question? 18 A. Yes. 19 Q. When did Charles Hurwitz exert control 20 over the institution? 21 A. I don't remember. I mean, what I'm 22 referring to, obviously, is when he acquired his 10379 1 interest in United. I don't remember when that 2 was exactly. 3 Q. Okay. Now, take a look at 4 Exhibit A7008, which is also B1481, Tab 902. 5 A. Have I got that here somewhere? 6 Q. Which is the -- Mr. Nickens asked you 7 questions about it earlier. It's the management 8 letter of February 6th, 1987. 9 A. Yes. 10 Q. And the -- it talks about the complex 11 accounting transactions on Page 2, OW011338. 12 Do you see the paragraph that he 13 directed your attention to? It says "We recommend 14 the association adopt an aggressive program of 15 documenting positions and rationale with respect 16 to the accounting treatment of complex and unusual 17 transactions." 18 Do you see that? 19 A. Yes. 20 Q. And that they said -- and see the 21 response in it says, "When the association enters 22 into new complex transactions requiring a high 10380 1 degree of judgment and subjectivity in determining 2 the appropriate accounting treatment, it will 3 continue to consult with Peat Marwick Mitchell 4 & Co. prior to proceeding with the transaction." 5 Do you see that? 6 A. Yes. 7 Q. Okay. Did you consider the USAT 8 Mortgage Finance transactions that were the 9 subject of your memorandum which was marked as 10 Exhibit B819 to be such a complex transaction? 11 A. Yes. 12 Q. Were you consulted prior to the 13 transaction or subsequent to the transaction? 14 A. Prior to which part of the transaction? 15 Q. Prior to the creation of USAT Mortgage 16 Finance and to the sale of the securities that are 17 referred to in your memorandum in Exhibit B819. 18 A. I really don't recall. 19 Q. The memorandum is dated when? 20 A. January 31, 1986. 21 Q. And it makes -- and the memorandum 22 that's attached to it, January 10th, 1986, the Joe 10381 1 Phillips memorandum, makes reference to 2 transactions that occurred in November and 3 December of 1985, doesn't it? 4 A. Yes. 5 Q. Was it your practice to document 6 transactions contemporaneously when they occurred? 7 A. Sometimes there was a bit of a lag, if 8 it took a while to get the facts together. 9 Q. Now, this says "As discussed in a memo 10 from Joe Phillips," your Exhibit B819. It does 11 not make reference to the client consulting you 12 beforehand, does it? 13 A. This memo does not. 14 Q. And you don't recall one way or the 15 other whether or not you were consulted before or 16 afterwards, do you? 17 A. Not about this particular event, no, I 18 don't. 19 Q. So that the only record we have of when 20 you were consulted with regard to this particular 21 event is the memorandum that we have from the work 22 papers? 10382 1 A. That's the only one I have in my hand. 2 I don't know if that's all that exists or not. 3 Q. But that would be all that we would 4 have to ascertain when you were consulted? 5 A. That's all I've been shown. 6 Q. Okay. Now, look at the very last 7 sentence of this paragraph on this page of B819. 8 It says, "Given the facts and circumstances, it 9 does not appear to me that we have any firm rules 10 that would require any loss recognition to offset 11 United's 1985 gain." 12 Do you see that? 13 A. Yes. 14 Q. Then it says "United understands the 15 economic reasoning for doing so, however." And 16 then this paragraph. "It has agreed to start 17 offsetting all such gains in 1986 so that their 18 spreads will not be distorted." 19 Do you see that? 20 A. Yes. 21 Q. Now, that's referring to something 22 that's going to happen in the future. And so, 10383 1 this reflects you being consulted prior to sets of 2 transactions occurring, does it not? 3 A. Restate that question, please. 4 Q. The last phrase in that sentence, does 5 that reflect that you have been consulted prior to 6 transactions that are contemplated in 1986? 7 A. Yes. 8 Q. And it says, "USAT has agreed to." It 9 doesn't say "USAT has proposed," does it? 10 A. No, it doesn't. 11 Q. And would it be fair for us to conclude 12 from this sentence that you had directed them that 13 going forward, it was your view that any gains 14 recognized on the sales of mortgage-backed 15 securities in 1986 would have to be offset by 16 losses on the swaps that were part of that 17 portfolio? 18 MR. NICKENS: Objection, Your Honor. 19 The sentence says "all such gains." It doesn't 20 say "any gains." It says "all such gains." There 21 is no evidence of any similar or such gains that 22 thereafter occurred. 10384 1 Q. (BY MR. GUIDO) You may answer the 2 question. 3 A. My recollection of this in speaking 4 about the gains here, they are the gains that 5 eventually had to be reversed and restated as 6 gains. Whatever those were and whatever 7 portfolios those were in, my recollection of it is 8 that after the events of 1985, I discussed this 9 with United and we agreed mutually that the best 10 thing to do would be to defer those in 1986. 11 Q. This doesn't say anything about 12 deferring, does it, Mr. Millinor? Read the 13 sentence again. 14 A. Well, I think it does. I think 15 "offsetting all such gains in '86" implies that. 16 To me, that's what that meant. 17 Q. So, that's what it means to you? 18 A. That's how I would read that, yes. 19 Q. It doesn't say "all such gains should 20 be deferred"? 21 A. It does not say that. 22 Q. It does not, does it? It says they 10385 1 shall be offset by the losses that are referred to 2 in the previous phrase in that sentence, do they 3 not? 4 A. Well, it says "offsetting all such 5 gains in 1986." To me, that's what that means: 6 That these gains will be deferred. 7 Q. Now, they were restated in June of 8 1986. Right? 9 A. Thereabouts, yes. 10 Q. Thereabouts. And you were surprised 11 that the issue came up, were you not? 12 A. Yes. 13 Q. Now, I'd like to direct your attention 14 to Exhibit B1080, which is one of these long 15 exhibits. One is 1380 and the other is 1080, 16 which is a work paper on the restatement. 17 Look at the Bates stamp KPMG 22180. Do 18 you see Item No. 5 on there? 19 A. Yes. 20 Q. Can you read that into the record? 21 A. I'll try. "United intends to restate 22 first quarter earnings as the notice of these 10386 1 gains is cumulative. Gains on all sales during 2 the quarter were" -- I don't know what that word 3 says -- "into next assets basis. The adjustment 4 for the second quarter is the June 30, 1986 5 adjustment less the adjustment computed at 6 March 31, 1986." 7 Q. And then what else does it say? 8 A. "The above approach appears reasonable 9 and, except for any discount accretion of MBS 10 bought and sold in the same quarter, the effect of 11 which is considered immaterial as it constitutes a 12 reclass between gain on sale and MBS interest 13 income, will provide the proper amounts of these 14 deferred gains which should be recognized." 15 Q. Now, do you see the phrase that says 16 "the above approach appears reasonable"? 17 A. Uh-huh, yes. 18 Q. Doesn't that indicate that USAT had 19 decided to restate and Peat Marwick acquiesced in 20 the restatement? 21 A. I don't know what that seems to imply 22 to you, but that isn't what happened. 10387 1 Q. Okay. Now, I'd like to address this 2 trading versus investment issue and direct you to 3 the memorandum, which is A10716. 4 We've asked you a number of questions, 5 Mr. Nickens and I. We've focused on the 6 investment side of the trading versus investment. 7 What is your understanding of what 8 trading means so that a portfolio has to be 9 mark-to-market? 10 A. I don't know if there is a precise 11 definition; but at the time from an accounting 12 standpoint, something considered a trading 13 portfolio with securities of any kind that were 14 going to be regularly traded for gains or loss and 15 were not to be held to maturity. 16 Q. So that they were securities that were 17 intended to be traded regularly for purposes of 18 generating gains? 19 A. Yes. 20 Q. And if the client had had sales out of 21 a portfolio, its intent to regularly or not 22 regularly trade that portfolio for purposes of 10388 1 generating gains would be an important factor? 2 A. Yes. 3 Q. And you also indicated that there could 4 be other reasons that there would be trades out of 5 a portfolio, and those would be consistent with 6 classifying a portfolio as an investment portfolio 7 as opposed to a trading portfolio? 8 A. That there were some reasons that a 9 client might have to trade securities out of an 10 investment portfolio without marking the whole 11 portfolio to market, yes. 12 Q. All right. Now, I'd like to turn your 13 attention now back to 1080, Exhibit B1080, and 14 direct your attention to KPMG 22179. 15 Do you see the second paragraph of 16 that? 17 A. Yes. 18 Q. Could you read the first sentence into 19 the record, please? 20 A. "During 1986, United has been turning 21 over their portfolio monthly of MBS in an attempt 22 to match the MBS estimated maturities with the 10389 1 maturities of the interest rate swaps associated 2 with the reverse repos that the MBSs are 3 collateralizing." 4 Q. Okay. Now, what is your understanding 5 of what the reason for that turnover was? 6 A. If I remember correctly, as interest 7 rates moved, the expected duration of the 8 securities moved and the yields on the maturities 9 could change and they were no longer matched up 10 properly. If they weren't going to mature at the 11 same time, then that was an implication that maybe 12 they weren't matched up as well as they would 13 like. 14 Q. Okay. Is that your understanding of 15 why the sales were made out of the mortgage-backed 16 security portfolio at USAT? 17 A. It's one of the reasons that I remember 18 being discussed at the time, yes. 19 Q. Do you recall any other reasons? 20 A. No. 21 Q. Is that a reason that you would view 22 consistent with classifying a portfolio as an 10390 1 investment as opposed to a trading portfolio? 2 A. Conceivably, it could be, yes. 3 Q. And there could be gains generated as 4 part of that -- let's call it rebalancing, which 5 is the term that we've used in the past in this 6 proceeding, or roll-down, which has also been 7 used. And that could be generate gains. Right? 8 A. It can. 9 Q. Now -- so that the purpose for 10 generating the gains, whether it's to rebalance on 11 the one hand or to take profits on the other, to 12 bolster net worth, is a determining factor in 13 whether or not you classify sales or 14 mortgage-backed securities portfolio trading 15 versus investment? 16 A. Could be. 17 Q. And with regard to the roll-down of the 18 rebalancing beginning in 1986, did anyone ever 19 tell you that those sales were being made out of 20 USAT's portfolio in order to generate gains to 21 bolster net worth? 22 A. Not that I recall. 10391 1 Q. Now, I'd like to direct your attention 2 to -- back again to A10716 and direct your 3 attention to Page 2 of that memorandum. Do you 4 see at the top, it's talking about a policy? It 5 says, "United's intent in the minutes of 6 investment committee of November 12th, '86, are as 7 stated: It is the policy of United Savings 8 Association of Texas to invest in corporate debt 9 securities as market opportunities exist. The 10 objective of such investments is to spread income 11 over an extended period of time. In general, the 12 portfolio will match" -- "will match funded with 13 long-term CDs. Sales of such securities will be 14 executed from time to time as changes in the 15 credit quality of a particular security exist, an 16 opportunity to upgrade credit with a similar yield 17 as present, to adjust the portfolio for industry 18 exposure, and other appropriate reasons as may be 19 approved by the investment committee. The 20 corporate bond portfolio is not a trading account, 21 however, and should not be managed as a trading 22 vehicle. Accordingly, it is the policy of the 10392 1 association to record investments at cost and 2 establish reserves against known or probable 3 losses in the portfolio. The portfolio will not 4 be mark-to-market on a periodic basis since it is 5 not a trading account." 6 Do you see that? 7 A. Yes. 8 Q. And then -- this is the paragraph next. 9 It says, "Such stated policy does appear to state 10 United's intent to establish an investment 11 portfolio for this portfolio of investments. 12 However, it does not present the objectives of the 13 portfolio and the specific strategy for obtaining 14 such objective." 15 Do you see that? 16 A. Yes. 17 Q. Okay. Joe Parsons, in this memorandum, 18 is concluding that that -- although it talks about 19 trades out of the portfolio -- is trades that are 20 consistent with maintaining an investment 21 portfolio and it didn't need to be mark-to-market. 22 Right? 10393 1 A. Yes. 2 Q. I'd like to show you Exhibit T4302, 3 which is a memorandum dated November 13th, 1986, 4 from Mike Crow to Bruce Williams. And also I'd 5 like to show you Exhibit A10690, which is dated 6 November 7th, 1986, from Mr. Crow to Mr. Berner. 7 First, I'd like to show you A10690. 8 MR. NICKENS: May I ask what the tab 9 number is? 10 MR. GUIDO: I don't have the tab 11 number. I'm sorry. 12 MR. NICKENS: Well, we need that in 13 order to be able to follow along. 14 15 (Discussion off the record.) 16 17 MR. GUIDO: Okay? Mr. Nickens? 18 MR. NICKENS: I have it. Thank you. 19 Q. (BY MR. GUIDO) Now, look at A10690. 20 It says to Art Berner -- dated November 7th. 21 "Please arrange to have the attached policy 22 adopted by the investment committee. We have been 10394 1 advised by Peat Marwick that we need to put on the 2 record our policies as relates to junk bonds to 3 avoid mark-to-market treatment." 4 Do you see that? 5 A. Yes. 6 Q. And look at the policy. Is that the 7 same policy that's referred to in Exhibit A10716, 8 the memorandum prepared by Joe -- 9 A. I don't know. 10 Q. -- Parsons? 11 A. I haven't compared it. 12 Q. Please compare it. 13 A. I don't know how I'm supposed to do 14 that to be certain that every word in here is the 15 same. 16 THE COURT: Mr. Guido, if you have a 17 difference, why don't you just point that out? 18 MR. GUIDO: There are no differences, 19 Your Honor. Why don't we just -- I'll state for 20 the record that they are the same. 21 Q. (BY MR. GUIDO) And so, here's -- 22 Michael Crow saying to Mr. Berner on November 7th 10395 1 "Please adopt this because Peat Marwick has 2 advised us we need to do so." Right? 3 A. He's specifically referring to junk 4 bonds in his memo, and this says corporate debt 5 securities. So, I'm not sure if those two are the 6 same thing. 7 Q. Well, just assume that corporate debt 8 securities and high-yield bonds are one and the 9 same. Okay? 10 A. Okay. 11 Q. For our purposes. Now -- and so, 12 November 7th, Michael Crow to Art Berner says, 13 "Please have the attached policy adopted by the 14 investment committee because Peat Marwick wants 15 it." 16 Then you have a memorandum on trading 17 versus investments from Peat Marwick dated 18 January 5th, 1987, addressing trading versus 19 investment. And it summarizes the minutes of the 20 investment committee with regard to corporate debt 21 securities or high-yield bonds, adopting that 22 policy and saying it's consistent. 10396 1 Now I'd like to show you T4302, which 2 is a memorandum dated November 13, the day after 3 the investment committee minutes that are referred 4 to in Joe Parsons' memorandum. I'd like you to 5 read that. 6 A. (Witness reviews the document.) Okay. 7 Q. Does that appear to be consistent with 8 the policy that Mike Crow asked to be adopted -- 9 Art Berner to have adopted and Joe Parsons relied 10 upon in his memorandum, A10716? 11 A. It sounds like on the 13th, they were 12 trying to decide whether they wanted it to be an 13 investment portfolio or not. 14 Q. So, what you're saying is their stated 15 policy on November 12th, as Mr. Parsons relied 16 upon, was to have an investment portfolio. Okay? 17 A. Uh-huh. (Witness nods head 18 affirmatively.) 19 Q. Then on November 13th, Michael Crow 20 writes to Bruce Williams and says "We had a 21 discussion at the investment committee on selling 22 junk bonds for profits for purposes of quarterly 10397 1 earnings. Ron Huebsch made an impassioned plea to 2 get the word now if we were going to need a lot of 3 profits because the market is favorable right now 4 to getting out of some bonds, taking a profit, and 5 having a chance to get back into some 6 good-yielding stuff. He is probably absolutely 7 correct. GRW and I stated that we would need 8 major amounts of profits because we cannot depend 9 on such things as a branch sale, loan servicing 10 sale, and consumer loan sale to pull us out of the 11 fire." Okay? 12 A. Uh-huh. (Witness nods head 13 affirmatively.) 14 Q. If they were making these sales as 15 reflected in T4302, was that consistent with the 16 policy that they were representing was their 17 policy to Peat Marwick? 18 A. It would be hard to say; but it would 19 be a problematic situation, I think. 20 Q. It would cause you to question the 21 transactions and do a great deal more scrutiny of 22 those transactions, wouldn't it, to ascertain 10398 1 whether or not they were trading versus 2 investment? 3 A. You'd have to look at it pretty 4 closely, sure. 5 Q. Are you aware that Peat Marwick was the 6 subject of an enforcement action by the OTS for 7 accounting during the time period that you were an 8 engagement partner at USAT? 9 A. No. 10 MR. NICKENS: Your Honor, this is 11 irrelevant and goes far beyond any 12 cross-examination. He's just trying to introduce 13 a new subject. 14 THE COURT: Denied. 15 A. No. 16 Q. (BY MR. GUIDO) You're not? 17 A. No. 18 Q. You're not aware that Peat Marwick paid 19 $186 million to settle an enforcement action -- 20 A. Not that I recall, no. 21 MR. GUIDO: I have no further 22 questions, Your Honor. 10399 1 MR. NICKENS: We have nothing further, 2 Your Honor. 3 THE COURT: All right. Thank you, 4 Mr. Millinor. You may step down. 5 Do you have another witness? 6 MR. GUIDO: Yes, Your Honor. Mr. Joe 7 Parsons. 8 At this time, we would like to call 9 Mr. Parsons, Your Honor. 10 11 JOE PARSONS, 12 13 called as a witness and having been first duly 14 sworn, testified as follows: 15 16 THE COURT: Be seated, please. 17 18 EXAMINATION 19 20 (11:10 a.m.) 21 Q. (BY MR. GUIDO) Would you state your 22 full name for the record, please? 10400 1 A. Joseph B. Parsons. 2 Q. And where are you employed? 3 A. Donna Karan International. 4 Q. And can you tell us a little bit about 5 your background from the time you graduated from 6 college, your academic background and your 7 professional background? 8 A. I graduated from Eisenhower College in 9 1976. I got an MS accounting, master's in 10 science, and accountancy degree from the 11 University of Houston in 1979. 12 I joined Peat Marwick after I got that 13 degree. I worked for Peat Marwick for 10 years. 14 Since working for Peat Marwick, I've worked in 15 industry. 16 Q. Okay. And prior to working on the USAT 17 audits, had you had any previous experience in 18 auditing mortgage-backed security risk-controlled 19 arbitrage programs? 20 A. I did not. 21 Q. And when were you first assigned to 22 audits for USAT? 10401 1 A. I believe it was in 1983. 2 Q. Okay. And what was your position at 3 Peat Marwick at the time? 4 A. It was either senior or supervising 5 senior. I'm not sure. 6 Q. And who did you report to at that time? 7 A. I reported to Jim Wolfe, who was either 8 manager or senior manager. I forget the title. 9 Q. And who selected you for the position 10 of senior for the USAT audit in 1984? 11 A. I don't know exactly how that selection 12 occurred. Obviously, it meets the approval of the 13 partner and manager. 14 Q. Okay. Who was the engagement partner 15 at that time? 16 A. Rick Millinor. 17 Q. Okay. And for how long was Mr. Wolfe 18 the manager or senior manager of the USAT audit? 19 A. I don't know. He was the manager when 20 I got there. 21 Q. Okay. Now, subsequent to the time you 22 got there, how much longer was he the manager or 10402 1 senior manager? 2 A. I believe it was about two years. 3 Q. And where did he go? 4 A. He went to work for United Savings 5 Association. 6 Q. Do you know how that came about? 7 A. No. 8 Q. Now, what were your responsibilities as 9 the senior on the audit of USAT in 1985, for 10 example? 11 A. In '85, I believe I would have been the 12 manager. 13 Q. You would have been the manager in 1985 14 for the audit? 15 A. Yes. 16 Q. Do you recall an issue coming up with 17 regard to the sales of mortgage-backed securities 18 out of a subsidiary referred to as USAT Mortgage 19 Finance? 20 A. I don't have a specific recollection of 21 that, no. 22 Q. I'd like to direct your attention to 10403 1 Exhibit B819, which is a typewritten rendition of 2 a memo prepared on January 31, '86, by Rick 3 Millinor regarding some -- regarding interest rate 4 swaps. There is a handwritten rendition and then 5 there is -- attached to that is a January 10th, 6 1986 memorandum to the file from Joe Phillips 7 describing a transaction. 8 I'd like you to read that memorandum to 9 familiarize yourself with the transaction, the 10 last page, the January 10th memo which basically 11 describes the transaction. I'm going to ask you 12 some questions about that document. 13 A. (Witness reviews the document.) 14 Q. Have you had an opportunity to read the 15 memorandum? 16 A. Yes, I have. 17 Q. Do you recall that transaction? 18 A. No, I don't. 19 Q. You don't recall the creation of a 20 subsidiary to purchase mortgage-backed securities 21 which was collapsed for regulatory reason at the 22 end of 1985? 10404 1 A. I have, you know, vague recollections 2 of many transactions going on. I don't recall 3 this specific transaction. 4 Q. But do you recall -- I mean, I'm not 5 asking anything about the details of the 6 transaction. Do you recall the transaction? 7 A. No, I don't. 8 Q. I'd like to direct your attention to 9 another document which has been marked as A7008. 10 It is a document which has also been marked as 11 B1481 at Tab 902. It is the management letter of 12 February 6th, 1987. I'm going to direct your 13 attention to certain questions or certain sections 14 and ask you some questions about those sections. 15 But before I do that, I'd like to ask 16 you some general questions. One, about the 17 structure of Peat Marwick and the audit process, 18 and also what documents you've had an opportunity 19 to review before your testimony. 20 You were a manager on the 1985 audit, I 21 think you testified. And prior to that, you were 22 a senior on audits of USAT and I presume other 10405 1 financial institutions. Did you participate in 2 the audits of more than ten institutions prior 3 to -- financial institutions prior to auditing the 4 USAT account? 5 A. No. 6 Q. What was your experience in auditing 7 financial institutions when you were assigned as a 8 senior to the USAT audit? 9 A. At the time I was assigned? Is that 10 the question? 11 Q. Yes? 12 A. I did not have previous experience with 13 savings and loans at the time I was assigned. 14 Q. Had you taken any courses on auditing 15 financial institutions prior to being assigned as 16 a senior to the USAT audit? 17 A. No, I had not. 18 Q. And had you audited any institutions in 19 which they had mortgage-backed security 20 risk-controlled arbitrage programs? 21 A. No. 22 Q. I'm sorry for repeating that question, 10406 1 but I wanted to put them all together. 2 Now, as the senior, what was your 3 responsibility as, let's say, distinguished to 4 when you became a manager? What is the 5 distinction, I guess, in Peat Marwick at that time 6 between the role of a senior auditor and a 7 manager? 8 A. Well, the role of a senior auditor 9 would be -- I would -- particularly in a very 10 large engagement like this, I spent most of my 11 time in the field with the staff. I directed the 12 staff, ensured that the audit programs were 13 completed and done according to instructions. I 14 reviewed work papers and ensured that the audit 15 work was completed. 16 Q. Now, how did that differ from being a 17 manager? 18 A. The manager typically spent more time 19 on problem areas, conceptual areas, and less focus 20 on detail and reviewing every work paper and going 21 through and reviewing the work paper in as much 22 detail. 10407 1 Q. Between the manager and the senior, who 2 had the primary responsibility for ascertaining 3 the facts to be included in the work papers? 4 A. I don't think there was a difference in 5 responsibility. Maybe a difference in detail. 6 Q. What do you mean by that? 7 A. The lower-level people did the detail 8 work, and that work was then reviewed by 9 higher-level people. 10 Q. Would it be fair to say that the senior 11 and the people working for the senior were the 12 people who went in and looked at the books and 13 record themselves and extracted what you thought 14 needed to be included in the work papers and that 15 the manager reviewed that to ascertain whether or 16 not it was complete? 17 A. Well, there were many levels of doing 18 an audit, obviously. One of the levels is to come 19 in and ascertain what you think is your exposure 20 areas. And your audit program is then based upon 21 that assessment. And after that, then it would be 22 the lower levels who are going in, following the 10408 1 audit program, extracting the detail information, 2 which then gets submitted to different levels. 3 Q. I'd like to direct your attention now 4 to Exhibit A7008, if I could. I'll direct your 5 attention to Page 3 of the document, which is 6 OW011339. I'll direct your attention to trading 7 versus investment accounting treatment for 8 corporate debt and mortgage-backed securities on 9 that page. 10 It says "During 1986, all investments 11 in corporate debt and mortgage-backed securities 12 were accounted for on an investment basis. We 13 were informed that the association is to establish 14 accounts for the purposes of accounting for both 15 investment and trading activities and that a 16 standard policy is being established relating to 17 corporate debt securities and" -- something -- 18 "accounted for under the investment accounting 19 treatment to document why trades of such 20 securities are made with an indication of why such 21 trades are consistent with the investment 22 treatment. We recommend the implementation of 10409 1 this policy be closely monitored to ensure 2 compliance with management's intent." 3 And then it says "Response. A separate 4 account was established in January 1987 which is 5 used to segregate and record MBS trading 6 activities. Trading transactions, along with 7 investment transactions, are discussed and 8 approved weekly by the investment committee." 9 Do you see that entry with regard to 10 mortgage-backed securities? 11 A. Yes, I do. 12 Q. Now, with regard to the format of this 13 letter, was it the practice of Peat Marwick to 14 send a draft of management letters to the client 15 to get the client's response so that the responses 16 could be included in the management letter that 17 went to the board of directors? 18 A. Different engagements are handled 19 differently, but that is the way that we handled 20 it. 21 Q. Now, why in this case was it handled 22 this way and not in all cases? Do you know? 10410 1 A. It was typically up to the discretion 2 of the partner whether he wanted management's 3 response. In all engagements, the management 4 letter would be -- a draft of the letter would be 5 circulated and comments would be received on the 6 draft. And it's up to the discretion of the 7 partner as to whether he wants the response from 8 the client written into the engagement letter or 9 into, excuse me, the management letter. 10 Q. So that a draft would be sent to 11 officers of the entity and then the officers would 12 make comments on the draft and then the management 13 letter would be finalized and sent to the board of 14 directors. 15 Is that what you understand the process 16 to be? 17 A. That is correct. And if I might add, 18 it's not so much to ascertain comments but to 19 ascertain the truthfulness of our comments. 20 Q. Okay. So, to ascertain whether or not 21 your statements were factually correct. It's 22 another check on your statements? 10411 1 A. That's correct. 2 Q. Now, turning to Page 4, it goes on and 3 says, "A separate trading account has not been 4 established for corporate debt securities since 5 management has not entered into such trading 6 account activities. All transactions have been 7 for investment purposes only after full review by 8 the investment committee. A new manager for the 9 department will begin employment in May of 1987 10 and at that time, if the association decides to 11 commence trading activity, a separate account will 12 be established." 13 And then it concludes "All corporate 14 debt securities and MBS transactions are discussed 15 and reviewed weekly by the investment committee to 16 ensure compliance with management's intent. 17 Additionally, a copy of the investment committee 18 minutes are sent to each member of the board of 19 directors." 20 Do you recall the trading versus 21 investment issue coming up at USAT? 22 A. Yes, I do. 10412 1 Q. And have you had an opportunity to 2 review any documents with regard to the trading 3 versus investment issue at USAT prior to your 4 testimony today? 5 A. I have done a very brief review of some 6 of the documents. 7 Q. Were you sent documents by counsel for 8 Peat Marwick at my request to review? 9 A. Yes, I was. 10 Q. And did that also include your 11 deposition -- 12 A. Yes, it did. 13 Q. -- transcript? Did you have an 14 opportunity to review your deposition transcript? 15 A. Yes, I did. 16 Q. Did you have an opportunity to review 17 the documents on trading versus investment? 18 A. A very brief review, yes. 19 Q. Now, I'd like to direct your attention 20 to one of those documents, which is Exhibit 21 A10716. This is a memorandum. It has a cover 22 memorandum from Michael Crow to Bruce Williams and 10413 1 Jim Wolfe dated January 12th, 1987, and attached 2 to that is a memorandum that was prepared by you 3 and sent to Mike Crow dated January 5th, 1987. 4 Looking at the attachment to that 5 memorandum of January 5th, have you had an 6 opportunity to review this particular document 7 before your testimony today? 8 A. I believe this is one of the documents 9 that I looked at, yes. 10 Q. Now, this says "audit" -- do you see 11 where it says "audit concern"? 12 A. Yes. 13 Q. It says "During 1986, we have noted a 14 considerable amount of activity in the high-yield 15 junk bond and mortgage-backed securities 16 portfolios. Such activity raises a question as to 17 whether such portfolios should be more properly 18 accounted for on an investment or trading basis. 19 In addition to the" -- "to our concern as raised 20 by this activity, we have also noted that the 21 accounting basis for similar portfolios has been 22 under scrutiny by regulatory and GAAP accounting 10414 1 authorities." 2 Do you see that? 3 A. Yes, I do. 4 Q. Was the issue of trading versus 5 investment an issue that became of concern to the 6 regulatory and GAAP accounting authorities because 7 of the nature of the activities that had been 8 going on, trading that had been going on, or 9 because there was something unclear about the 10 literature? 11 A. I believe it was due to both. 12 Q. Okay. Was the literature in the 13 process of being changed in any way at that time? 14 A. I don't recall exactly what was 15 happening. Certainly many of the authorities were 16 interested in this. For instance, Emerging Issues 17 Task Force, EITF, I believe, was interested in 18 this. Whether they were changing the literature, 19 I'm not sure. 20 Q. Here, you -- it says "Accounting 21 guidance." It says "Substantially all GAAP 22 accounting guidance is provided by the AICPA, 10415 1 Audit of Banks Industry and Audit Guide (the 2 Guide)." 3 Do you see that? 4 A. Yes, I do. 5 Q. That -- had that guide been in 6 existence for quite a while or had those 7 provisions that you quote in the memorandum been 8 in existence for quite a while? 9 A. I don't specifically recall. I do 10 think that that audit guide had been out for some 11 time. 12 Q. Okay. Now, the audit guide says in 13 here, it says "Management's intent appears to be 14 the prevailing factor in determination of the 15 appropriate accounting. Intent of investment and 16 trading portfolios are summarized from the Guide 17 as follows. If the intent (and the ability) is to 18 hold securities on a longer term basis, with the 19 objective being an optimum balance between credit 20 quality, liquidity, and income, the portfolio 21 would be considered an investment account. If the 22 intent is to deal in certain securities for 10416 1 profits, the portfolio would be considered a 2 trading account." 3 Do you see that? 4 A. Yes. 5 Q. What is your understanding of this -- 6 of the sentence "If the intent is to deal in 7 certain securities for profit, the portfolio would 8 be considered a trading account"? 9 A. I'm sorry. What are you asking me 10 again? 11 Q. What is your understanding of the 12 sentence "If the intent is to deal in certain 13 securities for profit, the portfolio would be 14 considered a trading account"? 15 A. My understanding of that statement? 16 Q. Uh-huh. 17 A. My understanding would be that if a 18 security was purchased for the purpose of holding 19 it for appreciation as opposed to yield, then it 20 would be considered to be a trading account. 21 Q. Well, when would you ascertain when 22 that intent was applicable for determination of 10417 1 the classification? 2 A. Well, all these rules were evolving 3 during the time that I was working on the United 4 Savings audit. So, I'm not exactly sure. As I 5 recall, the guide indicates that the intent is 6 established at the time that a security is 7 acquired. 8 Q. Let me give you a hypothetical. If 9 something is purchased -- there is no statement 10 about intent. It is just purchased. And then 11 subsequently the client looks at it and says, "Oh, 12 I have an unrecognized gain here. I think I will 13 take this gain because I need it to bolster 14 profits." 15 How would you classify that 16 transaction? 17 A. You know, the rules were changing very 18 much during this process. I don't know how I 19 would have classified that back in those days, in 20 this time frame. 21 Q. So -- look at the quote from the guide 22 further on. It says -- first, it says "The Guide 10418 1 indicates that recording of a security in the 2 trading or investment portfolio should be 3 documented at the time of purchase as per 4 management's intent." 5 Then it goes on, "Recording a security 6 in the investment portfolio does not preclude it 7 from being traded if such trading activity has a 8 specific purpose, such as: Maintenance of the 9 optimum balance, as noted above; due to cash 10 requirements; or, for tax planning purposes." 11 Do you see that? 12 A. Yes, I do. 13 Q. So, you could have an investment 14 portfolio that was traded -- I mean, there was 15 turnover in the portfolio for purposes that would 16 were consistent with maintaining it as an 17 investment portfolio. Is that a fair 18 characterization of that sentence? 19 A. That is a fair characterization of this 20 sentence as it relates to the guidance provided by 21 this audit guide. 22 Q. Then it says, "However, the Guide notes 10419 1 that if there is a substantial turnover in the 2 investment portfolio, management's intention and 3 experience determine whether a trading function is 4 occurring and the appropriate classification and 5 valuation method to be used." 6 Do you see that? 7 A. Yes, I do. 8 Q. So, it talks about looking at what 9 happens after the trade -- after the security is 10 initially purchased to ascertain whether or not 11 it's properly classified as a trading versus 12 investment portfolio, does it not? 13 A. Yes, it does. 14 Q. Now, in your discussions when we go 15 back to -- you see the audit concern at the top? 16 It says "During 1986, we have noted a considerable 17 amount of activity in the high-yield (junk) bond 18 and mortgage-backed securities portfolios." And 19 in the management letter for the fiscal year 1986, 20 that's raised as an issue. 21 In your dealings with the people at 22 USAT, were you able to ascertain what the reasons 10420 1 were for the turnover in the mortgage-backed 2 security portfolio? 3 A. As a general statement, I believe that 4 I was able to ascertain that. 5 Q. And what were you told was the purpose 6 for the turnover in the mortgage-backed security 7 portfolio in 1986? 8 A. Well, there are many reasons for such. 9 Q. Can you tell me what those reasons 10 were? 11 A. I don't recall specific reasons that 12 were given to me by United Savings, but reasons 13 that there can be turnover are some of the items 14 indicated here. 15 Q. Okay. 16 A. Need for liquidity, investment 17 considerations, length of maturity. 18 Q. Were you told that the turnover in the 19 portfolio that was classified for accounting 20 purposes as an investment portfolio was primarily 21 due to the need to rebalance the portfolio because 22 of changes in prepayment speeds in mortgage-backed 10421 1 securities? 2 A. That was one thing that was told to me. 3 Q. Okay. Were you told that one of the 4 reasons for the significant turnover in the 5 portfolio that was classified as an investment 6 portfolio was to take unrealized gains to bolster 7 profits and net worth on a quarterly basis? 8 A. I do not recall that. 9 Q. I'd like to direct your attention to 10 the second page of your memorandum where it talks 11 about United's intent -- at the top of the page 12 where it talks about United's intent and the 13 minutes of the investment committee of 14 November 12th. It says, "It is stated" and then 15 it goes on to state a policy with regard to 16 corporate debt securities. I'd like you to assume 17 that corporate debt securities refer to high-yield 18 or junk bonds. 19 Have you had a chance prior to your 20 testimony today to review that specific paragraph? 21 A. I briefly looked at this document. 22 Q. I'd like you to read that policy then, 10422 1 if you could. 2 A. (Witness reviews the document.) 3 Q. And I'd also like to show you 4 Exhibit A10690, which is a memorandum from Michael 5 Crow to Art Berner dated November 7th, 1986. It 6 states, "Please arrange to have the attached 7 policy adopted by the investment committee. We 8 have been advised by Peat Marwick that we need to 9 put on the record our policy as it relates to junk 10 bonds to avoid mark-to-market treatment." 11 Do you see that memorandum? 12 A. Yes. 13 Q. Look at the second page. Assume that 14 that is exactly the same language that is quoted 15 in your memorandum. 16 Do you recall asking or -- you or 17 someone from Peat Marwick asking USAT to put on 18 the record what their policy was as it relates to 19 junk bonds? 20 A. I don't remember a specific 21 conversation. I do remember that management was 22 asked to document their intent. 10423 1 Q. Okay. Now, reading -- having read the 2 policy that's in your memorandum marked A10716, 3 would sales out of the -- would regular sales out 4 of the high-yield bond or junk bond portfolio in 5 order to generate gains to bolster profits and net 6 worth at quarter end have been consistent with 7 that policy? 8 A. Solely to bolster profits. 9 Q. Expressly made for the purpose of 10 bolstering profits, yes. 11 A. I believe that would not be in 12 accordance with this policy. 13 Q. I'd like to show you Exhibit T4302, 14 which is a memorandum from Mike Crow to Bruce 15 Williams dated November 13th, which is one day 16 after the investment committee adopted those 17 policies that you're referring to, and ask you to 18 read that document. 19 A. (Witness reviews the document.) 20 Q. If the sales were made as discussed in 21 the investment committee for selling junk bonds 22 for profits for purposes of quarterly earnings as 10424 1 reflected in this memorandum, would that have been 2 consistent with the policy that you quote in your 3 memorandum in Exhibit A10716 that was adopted by 4 the investment committee on November 12th? 5 A. That's the same question you asked me 6 just now? 7 Q. Yes. But I'm asking you in 8 relationship to this document. 9 A. In relationship to this document? 10 Q. Yes. 11 MS. CLARK: Mr. Guido, would you repeat 12 the question? I believe you misstated what the 13 memo says. 14 MR. GUIDO: I'm sorry. 15 Q. (BY MR. GUIDO) If sales of junk bonds 16 had been made for profits for purposes of 17 quarterly earnings, as Exhibit T4302 indicates was 18 discussed at the investment committee meeting, if 19 those sales had occurred for those purposes, would 20 those sales have been consistent with the 21 investment -- United's intent as expressed in the 22 minutes of the investment committee that you've 10425 1 quoted in your memorandum? 2 A. Again, if sales were made solely to 3 bolster profits, then they would not be consistent 4 with the policy. 5 Q. Now, I'd like to direct your attention 6 to Exhibit B1452, which is a memorandum dated 7 January 28th, 1987, from Jim Wolfe to Joe Parsons, 8 which is accounting issues relative to United MBS. 9 I'd like to show you Exhibit B1452. 10 That is a document that Jim Wolfe sent to you 11 which says "Based on our meeting of January 23rd, 12 1987, to discuss various issues involving the 13 hedging activities of United MBS Corporation, it 14 is apparent to me that there exist several issues 15 that are still open or are subject to 16 interpretation (such as treatment of the Ginnie 17 puts and correlation)." 18 It says, "After your having read United 19 MBS's statement of purpose accounting guidelines 20 and various discussions held regarding the 21 activities of the subsidiary, I feel comfortable 22 that you understand United's business and economic 10426 1 objectives for such company." And then it 2 attaches the United MBS' statement of purposes and 3 accounting. 4 Do you recall an issue coming up over 5 whether a subsidiary that was being considered by 6 USAT at the end of 1986 -- September, October of 7 1986 -- would warrant investment classification 8 and also hedge accounting for the hedges that were 9 being proposed for that subsidiary? 10 A. I'm sorry. Ask your question again. 11 Q. Do you recall a discussion setting up 12 an entity called United MBS that was to be managed 13 by Sandy Laurenson, their newly-hired portfolio 14 manager? 15 A. Is this memo a discussion of that? 16 Q. Yes. 17 A. Yes, I do. 18 Q. United MBS Corporation was, you can 19 assume, the company that was set up after Sandy 20 Laurenson joined USAT for her to purchase 21 mortgage-backed securities. 22 A. Okay. 10427 1 Q. And do you recall that there were 2 questions initially raised about the structure of 3 the portfolio by Peat Marwick because of 4 accounting concerns that it had with the structure 5 that had been proposed by a consulting firm called 6 Smith Breeden? 7 A. Your question is -- again? It's a long 8 question. I apologize. 9 Q. Do you recall whether Peat Marwick had 10 raised questions about the United MBS portfolio's 11 accounting, proposed accounting? 12 A. There was not a question about the 13 asset, per se. 14 Q. Okay. 15 A. There was a question about whether a 16 proposed hedged program would qualify as a hedge. 17 Q. And why was it significant whether it 18 would qualify as a hedge? What is the 19 significance of classifying something as a hedge 20 for accounting purposes? 21 A. When I say it qualifies as a hedge, 22 what I mean is qualify for a hedge in accordance 10428 1 with GAAP, generally-accepted accounting policies 2 or principles. 3 Q. Okay. 4 A. And if it qualifies for accounting in 5 accordance with GAAP, that means that certain 6 gains or losses can be deferred and amortized in 7 accordance with GAAP. 8 Q. Okay. And those were issues that came 9 up because of the nature of the hedges that were 10 being proposed in the transaction? 11 A. It's been a very long time; but as I 12 recall, the issue with the proposed Smith Breeden 13 hedging program was the length of the time because 14 it was, as I recall, a very long hedge program and 15 GAAP addressed shorter hedge periods. 16 Q. Okay. And what was it about the United 17 MBS Corporation structure that avoided the 18 objections that Peat Marwick had to the longer 19 time period that initially had been proposed? 20 A. As I recall, a similar type program was 21 set up, only it was to be -- to go over a shorter 22 period of time. 10429 1 Q. And was it your understanding that that 2 portfolio, that United MBS portfolio, was to be a 3 hedged portfolio and that's why the issue had come 4 up? 5 A. To tell you the truth, I don't remember 6 whether it was the asset that was to be hedged or 7 the liability that was to be hedged. 8 Q. Take a look at the exhibit, what is it, 9 B1452 where it talks about that structure. I just 10 want to ask you some general questions about that. 11 Was it your understanding that United 12 MBS was basically to be a portfolio that was to be 13 substantially hedged so as to raise the hedge 14 accounting issues? 15 A. Again, I don't remember exactly how 16 the -- how it was to work and this memo is a 17 little hard to read and I haven't spent the time 18 to read it. It was a program where assets were to 19 be matched to liabilities. 20 Q. Using hedging instruments? 21 A. No. 22 Q. I'm sorry. 10430 1 A. And those assets -- either the assets 2 or the liabilities -- I don't recall which -- were 3 to be hedged. 4 Q. Why were they to be hedged? 5 A. The purpose of hedging is that -- is 6 that you have an asset and liability which do not 7 have a correlation. So, you hedge -- if you 8 intend to create a correlation, you hedge one -- 9 the asset or the liability in some method to 10 artificially create a correlation. 11 Q. Okay. Now, I'd like to direct your 12 attention to Exhibit B1459, which is a memorandum 13 from you to Jim Wolfe dated January 29th, 1987. 14 And it attaches a memo from you to the work papers 15 dated the same date. 16 Have you had an opportunity to review 17 document this prior to your testimony today? 18 A. I believe this is one of the documents 19 that was sent to me that I looked at. 20 Q. Now, I'd like to direct your attention 21 to the first page of the document, which in first 22 paragraph says "Accounting issues relative to 10431 1 United MBS Corporation. In response to your 2 memorandum of January 28th, 1986, I have attached 3 my memorandum to our work papers addressing issues 4 relating to the hedging program." 5 My first question is: Is it your 6 recollection that that reference to the 7 January 28th, 1986 memorandum from Jim Wolfe is a 8 reference to Exhibit B1452, which I have just 9 previously shown you? 10 A. Yes. I believe it is. 11 Q. Now, I know this has been a long time. 12 A. Yes, it has been. 13 Q. And I'll try to be as general as I can 14 be. Take a look at this discussion of regression 15 analysis. 16 Do you see that? 17 A. Are you referring to the first bullet 18 point in this paragraph? 19 Q. Yes. The first bullet point in that 20 paragraph. 21 A. Okay. 22 Q. What does "regression analysis" refer 10432 1 to? 2 A. It's been a long time since I've done 3 this type of thing. 4 Q. Let me ask you some even more general 5 questions. 6 A. Well, I think I can answer it at least 7 vaguely. Regression analysis a type of analysis 8 which indicates, over time, that there is some 9 correlation between the instrument to be hedged 10 and the hedge instrument. 11 Q. And in this instance, this is talking 12 about Ginnie Mae options matching with the assets, 13 the hedged assets. 14 Do you see that? 15 A. Yes, I do. 16 Q. In that portfolio, was it your 17 understanding the assets were the mortgage-backed 18 securities? 19 A. Yes. 20 Q. Okay. And the liabilities were reverse 21 repos? 22 A. I'm a little vague on -- hazy on what 10433 1 the liabilities were, but that would make sense. 2 Q. And then I'd like to direct your -- let 3 me ask you one more question about the regression 4 analysis. 5 The regression analysis didn't attempt 6 to measure correlation between the reverse repos 7 and the mortgage-backed securities, did it? 8 A. As I recall, there's actually two parts 9 to this hedge program; and I don't -- again, I 10 don't really recall the specifics because it's 11 been a long time since I've done this and I've 12 only had a brief chance to review the memo. 13 I believe that the hedge -- that the 14 asset was hedged so that the time that the 15 transaction was unwound -- because, as you recall, 16 I just indicated that part of the change in this 17 program was that they shortened up the length of 18 time that the program was to address. 19 Q. They made it two years as opposed to 17 20 years? 21 A. So, I believe it was a two-step 22 process. One -- if I recall correctly, one is to 10434 1 hedge the liability side so the liabilities 2 matched the asset side and the other is to hedge 3 the asset value at the time it was to be unwound. 4 Q. Okay. So that there were two aspects 5 of that hedge -- 6 A. I believe -- 7 Q. -- that needed -- the correlation 8 needed to be measured? 9 A. I believe that's correct. 10 Q. Now, I'd like to direct your attention 11 to one comment that's made on here on Page 4 under 12 "PM comments." There were a series of bullet 13 points, but I wanted to address you to the third 14 one. It says, "Can the hedge program be managed?" 15 It says, "A hedge program should be 16 considered to be a structured program, and we 17 believe that the original structure should be 18 maintained to be considered a hedge. Although 19 FASB 80 states that if a futures (or options) 20 contract that has been accounted for as a hedge is 21 closed before the date of the anticipated 22 transaction, the accumulated change in value of 10435 1 the contract shall continue to be carried forward 2 (subject to ongoing assessment of correlation) and 3 included in the measurement of the related 4 transaction, we believe that if it becomes 5 apparent that the hedge is being managed in order 6 to maximize profits, the program should be 7 subsequently be considered to be a speculative 8 position. This situation would arise if the 9 hedges were frequently closed out prior to the 10 assigned date, were not rolled to the assigned 11 date, or if additional hedge positions were 12 purchased even though the projected funding 13 requirements (or asset principal balance) were 14 within the perimeters of the original program." 15 Do you see that? 16 A. Yes, I do. 17 Q. Is that saying that if the hedge -- the 18 swap option, futures contract -- were traded for 19 purposes of generating a gain, that then the hedge 20 accounting would be inappropriate for that 21 transaction? 22 MS. CLARK: Objection. I don't believe 10436 1 there is any reference to swaps in this document. 2 I think this document talks about futures and 3 options. 4 Q. (BY MR. GUIDO) Limit it to futures 5 and options for our purposes. 6 A. I'm sorry. Could you tell me the 7 question again? 8 Q. I'll have to rephrase the question. 9 I'm sorry. 10 Is it a fair characterization of Peat 11 Marwick's position, based on this paragraph, that 12 if the hedge -- in this case, futures or 13 options -- were sold for the purpose of generating 14 gains to bolster profits and net worth, that that 15 would then disqualify the portfolio, the hedged 16 portfolio, from being treated as a hedged 17 portfolio under FASB 80? 18 MS. CLARK: Objection again. I'm 19 sorry. There is no reference to selling anything 20 here. 21 THE COURT: No reference to what? 22 MS. CLARK: To selling anything. He's 10437 1 talking about terminating swaps, not rolling 2 them -- not swaps. Pardon me. The reference in 3 the document that he read about which I thought he 4 was questioning the witness was to terminating 5 futures contracts early or not rolling them over. 6 There is no reference to selling. 7 MR. GUIDO: Ms. Clark, that's exactly 8 why I asked the question. I asked whether or not 9 this applied to the situation, the fact situation 10 I gave the witness. Since you didn't understand 11 the question, I'll rephrase the question again. 12 Q. (BY MR. GUIDO) Is it your 13 understanding that this paragraph provides that 14 it's Peat Marwick's position that if sales are 15 made of hedged instruments -- in this case, 16 futures or options -- for the purposes of 17 generating gains to bolster profits, that it 18 doesn't qualify for hedge accounting under FASB 19 80? 20 A. It's really a very complex question. 21 And if you close out a hedge -- if you close out a 22 hedge, it could impact the hedge. It could impact 10438 1 the hedged position. So, I apologize for not 2 being able to give you a clean answer to that; but 3 it's a very complex question. I think you'd 4 actually have to look at, you know, some specific 5 to understand what the accounting treatment would 6 be. 7 Q. I'm talking about specifically making 8 sales for the purpose -- I say solely for the 9 purpose -- 10 A. Sell of the hedge or the hedged 11 instrument? 12 Q. The hedge. I'm talking about the 13 hedge. Selling the hedge to generate a gain, does 14 that disqualify that hedged instrument, be it a 15 futures contract or an options contract, for 16 hedged accounting? 17 A. I think that would disqualify the 18 hedged instrument for -- 19 Q. Let's move to the second question. If 20 that were done, would that disqualify -- the 21 hedged instrument, you mean -- 22 A. I'm sorry. The hedge itself. That 10439 1 would disqualify the hedge itself, I believe. 2 Q. Now, what would be the consequences of 3 that transaction for whether or not the asset or 4 liability that was hedged would be entitled to 5 investment accounting treatment? 6 A. I don't know. 7 Q. You don't know? 8 A. I mean, the question is too complex. 9 Q. Pardon? 10 A. The question is too complex and, you 11 know, vague. 12 Q. But it's not an easy question? 13 A. It is not an easy question. 14 Q. Now, I'd like you to turn your 15 attention to Exhibit B1455, which is a memorandum 16 from you to the work papers. This is a memorandum 17 to from you to the work papers dated January 29th, 18 1987, and it's a discussion of the memorandum 19 reflecting a meeting on January 23rd, 1987. 20 It says, "Peat Marwick representatives 21 Barry Tiedt and myself met with Jim Wolfe, Bruce 22 Williams, and Russ McCann to discuss the hedge 10440 1 program and related accounted treatment. Sandra 2 Laurenson joined the meeting after it started." 3 Is this a memorandum that you've had an 4 opportunity to review? 5 A. I believe this was in the package that 6 was sent to me, yes. 7 Q. Now, I'd like to direct your attention 8 to the second page of the memorandum. And it is 9 the first question that appears on that page. It 10 says, "What is the expectation that the MBS will 11 be traded? Under what circumstances would the MBS 12 be traded? Note, I thought that it was important 13 to establish that the MBS would not be traded, or 14 at least that there would be minimal trading 15 activity. If the MBS were to be traded, it would 16 appear that the hedge positions should be 17 considered to be speculative." 18 Do you see that? 19 A. Yes, I do. 20 Q. Do you recall having that concern? 21 A. Not specifically. 22 Q. Then it says, "Laurenson stated that 10441 1 the MBS would not be traded under any 2 circumstances." 3 Do you see that? 4 A. Yes, I do. 5 Q. Do you recall that issue being 6 discussed? 7 A. No, I don't -- I don't recall this 8 specific conversation. 9 Q. Do you have any reason to assume that 10 the memo that you wrote to the files is 11 inaccurate? 12 A. I have no reason to think it's 13 inaccurate. 14 Q. No one has raised anything with you 15 that would indicate that that would not be 16 accurate? 17 A. No. Nobody has. 18 MR. GUIDO: Your Honor, I have about 25 19 minutes more. It's now five after. I can go on 20 and continue, or we can break for lunch now and I 21 can do the conclusion in possibly even a shorter 22 period of time. 10442 1 THE COURT: How much cross is there 2 going to be? 3 MS. CLARK: I would think about 90 4 minutes. An hour and a half. 5 THE COURT: All right. We'll adjourn 6 until 1:30. 7 8 (Luncheon recess taken at 12:05 p.m.) 9 10 THE COURT: Be seated, please. We'll 11 be back on the record. 12 Mr. Guido, you may continue. 13 MR. GUIDO: Thank you, Your Honor. 14 (1:33 p.m.) 15 Q. (BY MR. GUIDO) Will you take a look 16 at Exhibit -- I think it's A7008 again, the 17 management letter for 1986. Let me show you a -- 18 THE COURT: Mr. Guido, is that also 19 1481? 20 MR. GUIDO: 1481, yes, Your Honor. 21 B1481. 22 Q. (BY MR. GUIDO) Look at the first 10443 1 sentence under the trading versus investment issue 2 there. It says, "During 1986, all investments and 3 corporate debt and mortgage-backed securities were 4 accounted for on an investment basis." 5 Do you see that? 6 A. Yes, I do. 7 Q. Now, did you have -- when you did the 8 audit for the 1986 accounting year or calendar 9 year or the year ended December 31, 1986, did you 10 have access to the books and records of USAT? 11 A. Yes, we did. 12 Q. Now, was one of the books and records 13 that you had access to the minutes of the 14 investment committee of USAT? 15 A. I believe that is correct, yes. 16 Q. And did you, in review of the 17 investment committee minutes of USAT, also have 18 access to the reports that were ordered attached 19 to those minutes? 20 A. I don't recall. 21 Q. In your review of those investment 22 committee minutes, did the -- did your review of 10444 1 those investment committee minutes raise a 2 question in your mind of whether or not the 3 portfolios of mortgage-backed securities and 4 high-yield bonds be classified as trading versus 5 investment portfolios? 6 A. Yes, they would. I mean, that was a 7 frequent question that occurred; and so, I'm sure 8 we would have asked questions about that. 9 Q. Now, I've asked you a number of 10 questions as we've sort of gone through looking at 11 policies. One of them is a high-yield bond 12 policy. I showed you an exhibit that had been 13 adopted pursuant to your questions that were 14 raised. 15 Was essentially the resolution of the 16 trading versus investment issue that the client 17 would adopt a set of procedures that would provide 18 documentation going forward of what the purposes 19 of the transactions were that it was engaged in? 20 A. I'm not sure that was a resolution of 21 anything. They adopted a policy to do that, I 22 think, based upon our recommendation to do so. 10445 1 Q. Okay. I'd like to show you two 2 documents: Exhibit B1495 and Exhibit B1496, which 3 are two policies that were adopted, it looks like, 4 in the February 18th, 1987 investment committee. 5 I'm sorry. 1469 and 1495, exhibits B. 6 MS. CLARK: Mr. Guido, I think we're 7 confused about what numbers these are. 8 MR. GUIDO: B1469 and B1495. I'm 9 sorry. 10 MS. CLARK: Thank you. 11 MR. GUIDO: I have extra copies of both 12 of them, Your Honor, if that would help. 13 THE COURT: I think we've got it. 14 B1469, has that been -- 15 MR. GUIDO: I think they have both been 16 admitted. No? If not, I would move to admit 17 1469. I thought it had been previously admitted. 18 THE COURT: Well, I do need a copy of 19 that. 20 MS. CLARK: No objection. I believe 21 they have been previously admitted. 22 THE COURT: All right. Received. 10446 1 MR. GUIDO: One of them may have been 2 included in a set of investment committee minutes, 3 Your Honor, and the other one may have been 4 included in some work papers. 5 Q. (BY MR. GUIDO) Have you had a chance 6 to peruse the two documents that I've just shown 7 you? 8 A. To peruse them? 9 Q. Have you had a chance to review them? 10 A. I looked at them. No, I have not had a 11 chance to review them. (Witness reviews the 12 documents.) 13 Q. One of them is for high-yield corporate 14 securities, and the other is for mortgage-backed 15 securities. Exhibit B1469 is for mortgage-backed 16 securities, and Exhibit B1495 is for the 17 high-yield bond portfolio. 18 Do you recall having seen these 19 documents previously? 20 A. No. 21 Q. We'll move on to the next document. 22 I'd like to show you Exhibit B1698, which is a 10447 1 letter dated July 7th, 1987, from you to Michael 2 Crow. B1698. 3 MR. GUIDO: I'd like to move the 4 admission of B1698, Your Honor. 5 THE COURT: We do show that as being -- 6 MR. GUIDO: Oh, you do show -- I 7 thought this one had not been produced. I'm 8 sorry, Your Honor. 9 Q. (BY MR. GUIDO) This says "Dear Mike, 10 you have requested from us guidance regarding 11 certain proposed sales and reacquisitions of 12 securities. In the situation described, United 13 owns a security with the intent of holding it as a 14 long-term investment. However, you have 15 recognized an opportunity where you believe the 16 security is overpriced. Accordingly, to maximize 17 the return, the security should be sold and 18 reacquired after the market has corrected. 19 Because your intent was for a long-term 20 investment, you would prefer to defer the gain," 21 it says. 22 Do you see that? 10448 1 A. Yes, I do. 2 Q. Do you recall having that conversation 3 with regard to sales and reacquisitions of 4 securities with Michael Crow? 5 A. I don't remember a specific 6 conversation like that. 7 Q. Now, let me look at the advice that's 8 given. You quote the AICPA industry audit guide, 9 the audit of banks in discussing what are referred 10 to as wash sales, which, to paraphrase and speed 11 up the process, essentially says you need to look 12 at an appropriate at risk period to decide whether 13 or not you are to defer the gain or to recognize 14 the gain. 15 Do you see that paragraph that's quoted 16 in the indented portion of your letter? 17 A. I see this paragraph, yes. 18 Q. Pardon? 19 A. Yes. I see the paragraph, yes, I do. 20 Q. Then it says, "An appropriate at-risk 21 period would be dependent on the volume of trading 22 activity in the security and the frequency and 10449 1 extent of recent price fluctuations. As general 2 guidance, we believe that a week may be an 3 appropriate at-risk period for a quoted stock or 4 bond that has a high volume of market activity and 5 a history of significant market price fluctuations 6 over a short period of time. An at-risk period of 7 a significantly longer than a week might be 8 required for a thinly-traded security with very 9 low market price volatility." 10 Do you see that? 11 A. Yes, I do. 12 Q. Okay. So, is it fair to conclude from 13 that paragraph if a mortgage-backed security, for 14 example, is bought and sold in less than a week's 15 period of time, the gain is to be rolled into the 16 purchased security and not recognized? 17 A. That seems to be the intent. That 18 seems to be what this is saying, yes. 19 Q. Okay. Now, I've been asking you 20 questions about trading versus investment. Here, 21 the client is telling you that they own the 22 security with the intent of holding it as a 10450 1 long-term investment. However, they may recognize 2 an opportunity where you believe the security is 3 overpriced. And accordingly, to maximize the 4 return, they intend to sell the security and 5 reacquire it after the market is corrected. 6 How is that consistent with maintaining 7 a portfolio that is for accounting purposes 8 classified as an investment, or is that consistent 9 with classifying it as a portfolio -- as an 10 investment portfolio? 11 A. Well, again, I think that's a 12 complicated question. I've been away from this 13 for a long time. The intent of a wash sale rule 14 is to look past the transaction and look at the 15 substance of what has occurred. And the wash sale 16 rule would indicate that -- the substance of the 17 transaction is that the sale did not occur because 18 it was -- the security was reacquired in a short 19 period of time. 20 Q. So, as long as the gain or loss was 21 rolled into the basis for the reacquired security, 22 that would be consistent with holding a portfolio 10451 1 for investment purposes? 2 A. As long as the company that sold the 3 security was not at risk -- 4 Q. During that period of time? 5 A. -- then I believe that this would 6 appear that wash sales would apply. 7 Q. Now, if the client had made the sales 8 and reacquired them in a way that they were not at 9 risk -- let's say bought and sold the securities 10 on the same day -- would that -- and not deferred 11 a gain or loss, rolled it into the basis but, 12 instead, recognized a gain -- would that have been 13 consistent with classifying the portfolio as 14 investment purposes for purposes of 15 mark-to-market? 16 A. They bought and sold? 17 Q. Uh-huh. 18 A. Do you mean sell and buy? 19 Q. Sell and buy. I'm sorry. They sold 20 and they acquired? 21 A. Are you asking me whether they had an 22 investment portfolio? 10452 1 Q. I'm asking you whether or not that 2 would be consistent with an investment portfolio. 3 If they sold and bought, recognizing a gain, not 4 deferring a gain, would that have been consistent 5 with classifying that portfolio as an investment 6 portfolio for purposes of marking to market? 7 A. The same security? 8 Q. Same security. 9 A. The actual same security? 10 Q. Same security. 11 A. I don't know how they could do that. I 12 mean, again, this is a very general question. But 13 I think no matter how you classify that -- 14 whatever classification that security may have, if 15 you sold it and then repurchased it in the same 16 day, I believe that wash sales would apply. 17 Q. Okay. Now, let's -- let me take you 18 one question further. 19 A. Okay. 20 Q. Let's say that you -- on that day, you 21 sold a security, let's say a mortgage-backed 22 security that was issued by Fannie Mae at a 10453 1 9 percent coupon and on that same day, you 2 purchased a 9 percent coupon issued from Freddie 3 Mac. 4 Would that have qualified as a wash 5 sale under these rules? 6 A. I believe it would not. 7 Q. Why not? 8 A. It's a different security. 9 Q. Okay. What if the client had sold a 10 Fannie Mae 9 and purchased a Fannie Mae 8 and a 11 half on the same day? Would that have qualified 12 as a wash sale? 13 A. I believe it would not. 14 Q. Why not? 15 A. Different security. 16 Q. Now, how far out of the -- do the 17 coupons have to move to qualify -- or at least at 18 that time under the Peat Marwick guidance -- did 19 it have to move to qualify as a different 20 security, the coupon? 21 A. My recollection for a wash sale 22 accounting is it has to be the identical security. 10454 1 Q. Okay. So that any time the coupon is 2 different, whether it's 25 basis points, 50 basis 3 points, even though it's the same issuer, Fannie 4 Mae, for example, that then the wash sale rule 5 doesn't apply and the gain or loss must be 6 recognized? 7 A. My recollection is that that is 8 correct. 9 Q. And is your recollection that the 10 Peat Marwick view is when you shift from a Fannie 11 Mae to a Freddie Mac, even though it's the same 12 coupon, that that's a different security for 13 purposes of the wash sale rules? 14 A. Yes. 15 Q. And did you so advise USAT, your client 16 at the time, that that was Peat Marwick's 17 position? 18 A. I don't recall that. 19 Q. Okay. 20 MR. GUIDO: No further questions, Your 21 Honor. 22 THE COURT: Ms. Clark, you're going to 10455 1 cross-examine? 2 MS. CLARK: Yes, Your Honor. 3 THE COURT: Proceed. 4 5 CROSS-EXAMINATION 6 7 (1:50 p.m.) 8 Q. (BY MS. CLARK) Mr. Parsons, I'm 9 Mary Clark. I represent four of the individual 10 respondents in this matter: Art Berner, 11 Mike Crow, Ron Huebsch, and Barry Munitz. I'm 12 going to be asking you questions for a little 13 while this afternoon. 14 Can you tell us a little bit more first 15 about what your current job is? 16 A. I'm executive vice president and chief 17 financial officer of Donna Karan International, 18 Inc. 19 Q. What is Donna Karan International? 20 A. We're an apparel manufacturer and 21 wholesaler. 22 Q. Is that a public entity? 10456 1 A. Yes, it is. 2 Q. And does it have subsidiaries and 3 affiliates around the world? 4 A. We have worldwide operations, that is 5 correct. 6 Q. How large a company is it? 7 A. We have about six -- in excess of 8 $600 million in sales. 9 Q. How long have you been chief financial 10 officer? 11 A. About a year. Slightly more than a 12 year. 13 Q. You have described a bit about the 14 audit process at United. I'd like you to tell the 15 Court, if you would, how the audits changed during 16 the three years that you were involved, if they 17 did, in terms of the size of the team, the 18 complexity of the job, that sort of thing. 19 A. Obviously, the personnel changed 20 because when I got there, I was a senior and then 21 I was promoted to be manager. At that time, Jim 22 Wolfe was senior manager on the job. He was then 10457 1 hired by United Savings, and I became then the 2 lead manager on the job. I did, from time to 3 time, bring in a second manager to help me out. 4 And it did, in general, become more a complex 5 engagement because there were many accounting 6 rules that were evolving over this time and things 7 like trading versus investment became very hot 8 topics in the accounting world and for thrifts 9 and, in particular, United Savings. 10 Q. Did the nature of USAT's business also 11 change during that three-year period that you were 12 there? 13 A. Yes, it did. 14 Q. In what way? 15 A. When I first got there, it was what I 16 would describe as a traditional savings and loan 17 organization whose primary function was to take 18 savings accounts and have mortgages on its asset 19 side. And the entity got much more involved in 20 terms of purchasing mortgage-backed securities and 21 purchasing other types of assets and using those 22 assets as leverage to get what I would call 10458 1 non-traditional liabilities. 2 Q. Do you recall what the financial 3 condition of USAT was when you first arrived -- 4 was that in 1983? Is that your first -- 5 A. I believe that 1983 was the first audit 6 I worked on, yes. 7 Q. Do you recall what the financial 8 condition was at that time? 9 A. Not specifically. 10 Q. Do you recall whether USAT was making a 11 profit, an operational profit when you arrived? 12 A. I believe that it was making a profit, 13 yes. 14 Q. Okay. And can you tell us about the 15 condition of its books and records when you 16 arrived for your first audit? 17 A. Can you ask me a more specific question 18 than that? 19 Q. Yes. Were the internal controls and 20 the state of the books and records in good shape 21 when you first began auditing USAT? 22 A. Yes. They were in good shape. 10459 1 Q. How many people were there on the audit 2 teams at USAT? 3 A. Including -- including partners and tax 4 people, I would guess 10 to 12 people. 5 Q. And do you know approximately how many 6 hours were spent on the audit function during the 7 course of the year? 8 A. I don't recall what our budget was. 9 Q. Did you form an impression on the 10 competence of the financial people within USAT 11 while you were performing the audit function 12 there? 13 A. Yes, I did. 14 Q. And what was that opinion? 15 A. I believed that they were all very 16 competent, professional people. 17 Q. Were they responsive to the audit 18 team's inquiries? 19 A. Yes, they were. 20 Q. And were they responsive to the 21 suggestions that Peat Marwick made in its 22 management letters and in more informal 10460 1 communications? 2 A. Yes, they were. 3 Q. In conducting your audit work at USAT, 4 did you have available resources from outside of 5 the audit team itself, either in the Houston 6 office or nationwide in Peat Marwick? 7 A. Yes, I did. 8 Q. Can you describe what those resources 9 were? 10 A. When I was a senior, I would obviously 11 discuss any issues with managers. When I was a 12 manager, I would obviously discuss any issues with 13 partners. In addition to the people who were on 14 the engagement themselves, there were informal 15 discussions with other partners in the office who 16 also work on thrifts and worked on similar issues. 17 In addition to that, I had access to Department of 18 Professional Practice, which is an office in 19 New York City who deals with technical and 20 difficult accounting issues. 21 Q. Did you make use of those resources 22 regularly in the course of your work on the USAT 10461 1 audits? 2 A. Yes, I did. 3 Q. Were you involved in quarterly reviews 4 at USAT as well as the annual audit at year end? 5 A. Yes, I was. 6 Q. What did that involve? 7 A. That was a much more high-level process 8 primarily involving analytical reviews and did not 9 result in an opinion. As I recall, we did issue a 10 letter to USAT indicating that a timely quarterly 11 review had been done. Additionally, if there were 12 significant transactions, we would sometimes come 13 in and audit that particular transaction not for 14 the purpose of forming an opinion but for the 15 purpose of, in essence, doing audit work in 16 advance of the annual audit. 17 Q. Is that sometimes referred to as 18 interim work? 19 A. That is correct. Interim work is not 20 necessarily relating to performing a quarterly 21 review, but a quarterly review can incorporate 22 interim work. 10462 1 Q. What's the purpose of doing interim 2 work rather than waiting until the end of the year 3 and doing it all then? 4 A. It's primarily to perform the audit 5 procedures primarily so you can complete the audit 6 on a more timely basis. 7 Q. Would you say that throughout the year, 8 a good part of the time, somebody from 9 Peat Marwick would be in USAT either doing a 10 quarterly review or the interim work in 11 anticipation of the final audit work? 12 A. That's correct. We had people in the 13 field fairly frequently. 14 Q. Did you also review or monitor reports 15 at USAT during the year, reports generated by USAT 16 during the year? 17 A. I don't specifically recall doing that. 18 We would look at, obviously, reports in 19 conjunction with performing a quarterly review. 20 Q. Let me show you, if I may, a document 21 marked as Exhibit B1048. 22 MS. CLARK: Which was previously 10463 1 admitted, Your Honor. It's at Tab 914. And I 2 believe we looked at it again this morning with 3 Mr. Millinor. 4 Q. (BY MS. CLARK) Mr. Parsons, B1048 is 5 a copy of a May 1986 performance report for 6 United Financial Group Inc. and it was produced to 7 us out of the Peat Marwick work papers. 8 Can you review the document and see 9 whether you can identify your handwriting anywhere 10 on the document? 11 A. My handwriting is on Page 5. 12 Q. Okay. And if you go to the 13 second-to-the -- 14 A. Also on the back page, which I 15 assume -- the back two pages, that is my 16 handwriting on there. 17 Q. Looking at the work paper reference on 18 the second-to-the-last page, can you identify for 19 me when you would have conducted the review of 20 this particular report, USAT report? Would it 21 have been part of a quarterly review? 22 A. It appears that it would be, yes. 10464 1 Q. It appears to me that, having reviewed 2 the report, you had some questions and contacted 3 Jim Wolfe at USAT for response. 4 Does that appear to be what your notes 5 reflect? 6 A. That is correct. 7 Q. For example, on the page that's second 8 to last or I guess the very last page in the 9 packet, there are two numbered notes: Note 1 and 10 Note 2, correct? 11 A. Yes. 12 Q. And do those notes refer back to the 13 text of the performance report and questions that 14 you had on it? 15 A. Yes, they would. 16 Q. Pardon me? 17 A. Yes. 18 Q. Okay. Can you tell me what Question 2 19 related to? And to assist you, I believe the 20 number 2 is in the margin circled on Page 2 of the 21 performance report. 22 A. That's correct. 10465 1 Q. And what was your question about the 2 information that you saw on Page 2 of this 3 May 1986 performance report? 4 A. I appear to have been questioning the 5 excess hedging. 6 Q. The performance report notes that the 7 spread on the mortgage-backed securities had 8 increased because of a decline in the excess 9 hedging related to unmatched swap volumes. And it 10 appears you asked Jim Wolfe what that was all 11 about, and he told you what that involved. 12 Correct? 13 A. Yes. 14 Q. Was it your normal practice to review 15 these kinds of reports and contact USAT's 16 management whenever you had any question about the 17 information in the reports? 18 A. Yes. 19 Q. When did you begin planning for the 20 annual audit? When during the year? 21 A. Probably late summer. 22 Q. Okay. And did that involve putting 10466 1 together a written work plan and then meeting with 2 USAT's management or audit committee to present 3 what your proposed audit plan was? 4 A. Yes, it did. 5 Q. And did you do that during the time 6 that you were auditing USAT? 7 A. Yes, we did. 8 Q. Did you meet with the audit committee 9 on other occasions during the year? 10 A. Yes, we did. 11 Q. What was the purpose of those meetings? 12 A. We would have one meeting to, I guess, 13 present the annual report, our findings relative 14 to the annual report. And I seem to remember 15 being involved in other meetings, although I can't 16 specifically recall them. 17 Q. Do you recall who the members of the 18 audit committee were? 19 A. Not offhand. 20 Q. Do you happen to recall Mr. Kozmetsky? 21 A. Yes. 22 Q. And what was the nature of his 10467 1 involvement in the audit committee? 2 A. He was one of the members of the 3 committee. 4 Q. And did he participate actively in the 5 discussions? 6 A. He tended to be an active participant, 7 yes. 8 Q. Do you recall the nature of the 9 involvement of the other members of the committee 10 during your meetings? Did they ask a lot of 11 questions, express views? 12 A. I don't recall. 13 Q. During the course of the annual audit, 14 did you have access to all the books and records 15 of the association? 16 A. Yes, we did. 17 Q. And were there some books and records 18 that you reviewed routinely in the course of every 19 audit that you conducted? 20 A. Yes. 21 Q. Would those include the minutes of the 22 board and the various operating committees of the 10468 1 board? 2 A. Yes, they would. 3 Q. In this case, that would be the 4 investment committee? 5 A. Yes. 6 Q. Among others. Did you review the 7 general ledger accounts? 8 A. Yes. 9 Q. And did you review the underlying 10 transaction documents, when necessary, to provide 11 evidential support for your audit findings? 12 A. Yes, we did. 13 Q. Did you ask follow-up questions to 14 management whenever any question at all arose 15 about the evidence that you were reviewing in the 16 course of the audit? 17 A. Yes. 18 Q. Do you recall that you were provided 19 with information and answers by USAT's management 20 when requested? 21 A. Yes. 22 Q. Who were your primary contacts during 10469 1 the audit process? Do you recall? 2 A. When I was a manager and Jim Wolfe was 3 hired by United Savings, it would have been Jim 4 Wolfe and his staff, Bruce Williams, and Michael 5 Crow. 6 Q. Would you routinely have contact during 7 the course of the audit with other staff members 8 at USAT as necessary to answer your questions? 9 A. Yes, we would. 10 Q. You were provided direct access to 11 whoever you wanted to talk with? 12 A. We always tried to keep Jim Wolfe 13 apprised of who we were talking to; but in 14 general, we had access to anybody we needed to 15 talk to. 16 Q. There has been considerable discussion 17 about the so-called "roll-down." Is that a term 18 you're familiar with, the roll-down of the 19 mortgage-backed securities portfolio? 20 A. This is in reference to decreasing the 21 yield on the portfolio so that it would have a 22 more consistent -- a longer maturity? Is that 10470 1 what it refers to? 2 Q. The term has been used to refer to 3 sales of mortgage-backed -- high coupon 4 mortgage-backed securities and replacing them with 5 low coupon mortgage-backed securities in the -- 6 A. I'm familiar with that. 7 Q. -- first half of 1986. And do you 8 recall that USAT had, in fact, approved the 9 deferral of the income from the gains on sale of 10 the mortgage-backed securities during that 11 roll-down process? 12 A. I was not heavily involved in that 13 process. I vaguely recall that they had done 14 that, yes. 15 Q. I'd like to show you a document marked 16 B913. I believe it was admitted this morning. 17 Mr. Parsons, can you identify this 18 document for us? What is it? 19 A. This is a discussion about a 20 quarterly -- or documentation of quarterly review 21 procedures. 22 Q. And is this a document that you 10471 1 reviewed during the course of the audit? 2 A. Yes, it is. 3 Q. And how do you know that? 4 A. I have my initial at the bottom of the 5 page. 6 Q. Is that at the very bottom corner of 7 the document? 8 A. Yes, it is. 9 Q. Now, do you see that under the caption 10 "gain on sales of securities," there is a 11 discussion of the sale of mortgage-backed 12 securities? I believe it says "UFG has swapped 13 out their mortgage-backed securities on reverse 14 repo on all their hedged interest rate swap 15 agreements so that principal pay-down of this 16 mortgage-backed security would better match the 17 hedge" -- something? Maybe you can read this 18 writing better than I can. "All gains have been 19 deferred on these transactions." 20 Do you see that? 21 A. Yes, I do. 22 Q. Okay. Do you recognize this 10472 1 handwriting as Barry Tiedt's handwriting? 2 A. Yes, I do. 3 Q. And then -- and that reflects that 4 their deferral of the gains had been noted in the 5 work papers, correct? 6 A. Yes. 7 Q. Can you read the next item for us? 8 A. "Junk bonds market (interest rate) has 9 fallen" -- with an insert -- "causing an increase 10 in the value of the bonds and UFG has sold certain 11 securities for short-term profits." 12 Q. And that's something that you actually 13 inserted some commentary in? Those are your 14 inserts, are they not? 15 A. That is correct. 16 Q. Now, going up to the heading above 17 that, it says something about "Series D." 18 Do you see that? 19 A. Yes. 20 Q. Okay. I believe in my effort to 21 decipher it, it looks as though there had been a 22 gain on the sale of some mortgage-backs that were 10473 1 collateral for a Series D cash flow bond and that 2 that gain was recognized in the first quarter. 3 Does that appear to be what that says, 4 in substance? 5 A. I'm sorry. I was reading. I was 6 trying to decipher this. 7 Q. Does it appear that some Ginnie Mae 8 mortgage-backed securities had been sold -- they 9 were collateral for a Series D bond -- and the 10 resultant -- as a result, USAT had booked over a 11 million dollars of gain in the first quarter? 12 A. $1.9 million, yes, that is what it 13 appears to say. 14 Q. Looking at this document, do you recall 15 why it is that the gains were booked on the sale 16 of the mortgage-backs on the Series D bond but 17 deferred on the -- what we've called the roll-down 18 transaction? 19 A. As I recall -- I don't remember the 20 Series D. It appears that these were sold and 21 there was no further transaction related to them. 22 Therefore, the gains would have been recognized. 10474 1 On the gain of the mortgage-backed securities, 2 they were deferred because the -- because United 3 Savings was attempting to match the -- match the 4 maturity of the asset side against the maturity of 5 the liability side. And they believed that they 6 were matching, therefore, deferring the gain. 7 Q. And at least as of the first quarter 8 review, Peat Marwick found that to be the 9 appropriate accounting treatment for both of those 10 transactions? 11 A. That is correct. 12 Q. You've been asked many questions about 13 the investment versus trading issue with respect 14 to whether securities have to be marked to market 15 for accounting purposes. 16 Do you recall that this issue was 17 coming up in the audits of thrifts during the 18 mid-1980s, that it was an issue that was coming up 19 frequently in a variety of clients' activities? 20 A. Yes. It was becoming a bigger and 21 bigger issue to the industry in general. 22 Q. Okay. And I believe you testified that 10475 1 the rules were not totally clear, that they 2 were -- would you say that they were in flux or in 3 transition during this period? 4 A. It was very much an evolving set of 5 rules, and there were many issues as we were 6 establishing accounting procedures. 7 Q. What do you recall about the nature of 8 the discussion by the regulators and the 9 accounting authorities of this issue during that 10 time period? Mr. Guido made reference to that, 11 the focus of both regulators and accounting 12 authorities on the investment versus trading 13 issue. 14 What do you recall about that, if 15 anything? 16 A. I don't recall anything specific. 17 There were many -- you know, there are many, many 18 discussions in articles, and I believe the ETIF 19 was looking very actively at the issue. I seem to 20 recall that we had many internal discussions -- 21 that would be within Peat Marwick -- about the 22 treatment of trading versus investment. And it 10476 1 was very much an evolving situation. 2 Q. Now, you mentioned that United's 3 business did change during the three years that 4 you were there. You described it as a movement 5 from a more traditional thrift with single-family 6 loans to a thrift that had more investment 7 activities. 8 Do you recall that as USAT's investment 9 in securities increased that you also saw an 10 increasing portion of USAT's income coming from 11 the gains on sale of securities, that that became 12 a more important part of their income on an annual 13 basis? 14 A. I don't recall that specifically; but 15 yes, obviously, transactions became an important 16 part of certainly our audit procedures and what 17 was happening in their financial records. 18 Q. And you would be able to see that 19 pretty quickly just by looking at the income 20 statements, would you not? 21 A. Yes, we would. 22 Q. During the audit of the 1985, '86 years 10477 1 at USAT, this issue of securities transactions was 2 a very prominent focus of your attention, was it 3 not? It was identified as a significant audit 4 area? 5 A. Yes, it was. 6 Q. And one of the things that you did note 7 in your audit and in your work papers was that 8 there was a very high level of purchases and sales 9 in both the mortgage-backed securities portfolio 10 and the high-yield bond portfolio. 11 Do you recall that? 12 A. I believe that's correct, yes. 13 Q. I would like to give you to review four 14 documents at once, just to move things along a 15 little bit more quickly. They will be B1380 -- 16 MR. GUIDO: Pardon? 17 MS. CLARK: B1380, B1389, B1353, and 18 B1484. The last one was B1484. 19 20 (Discussion off the record.) 21 22 MR. NICKENS: The discussion, Your 10478 1 Honor, is the fact that we have just passed one 2 thousand exhibits. 3 MS. CLARK: Your Honor, I'm not sure 4 this is speeding things up. I thought it might, 5 but... 6 Q. (BY MS. CLARK) Mr. Parsons, I'd like 7 you to look at the first document that I 8 mentioned, B1380. 9 Can you identify that document as one 10 of your work papers in the 1986 audit? 11 A. Yes. 12 Q. And can you identify your handwriting 13 on the third page of the document, which is 353? 14 A. Yes, I can. 15 Q. Okay. 16 MS. CLARK: Your Honor, I move the 17 admission of B1380. 18 MR. GUIDO: No objection, Your Honor. 19 THE COURT: Received. 20 Q. (BY MS. CLARK) What is B1380, 21 Mr. Parsons? 22 A. What is B1380? 10479 1 Q. Yes. What is the purpose of this 2 particular work paper? 3 A. You mean the cover page? 4 Q. Well, I understood -- maybe wrongly -- 5 that this is all one work paper, although there 6 are different schedules and write-ups attached. 7 A. The first page is a cover to a binder; 8 so, it would indicate that this was the B series 9 work papers which address first mortgage loans. 10 And then there is a memo, which appears to be the 11 B40 memo, which is a memo addressing the audit 12 test work of mortgage-backed securities. 13 Q. And then are the rest of the schedules 14 related to the test work of mortgage-backed 15 securities during the 1986 audit? 16 A. Yes, they appear to be. 17 Q. Turn back, if you would, to Page 353, 18 which is the first page of the memo. 19 Do you see that it describes the 20 purpose of the memo being to describe the audit 21 objective approach and test work performed for 22 mortgage-backed securities? 10480 1 MR. GUIDO: What page are you on? 2 MS. CLARK: It's Bates No. 353. It's 3 the first page of the memo. 4 A. Yes, I see that. 5 Q. (BY MS. CLARK) And then the next 6 sentence says, "The association has continued 7 their investment in mortgage-backed securities 8 during the year and their portfolio has been 9 turning over almost monthly during the year." 10 Do you see that? 11 A. Yes, I do. 12 Q. What was the significance of that for 13 the audit work that you were doing? 14 A. The significance would have been that 15 we would have had to test these transactions. 16 Q. Just descriptive of the level of 17 activity in the portfolio. Right? 18 A. Yes. 19 Q. And again, the beginning of the last 20 paragraph on that same page, "Peat Marwick 21 anticipates that the securities held at interim 22 will be sold and replaced with new securities at 10481 1 final and, therefore, will pass any work at 2 interim concerning discounts or premiums, et 3 cetera." 4 Again, that's simply describing the 5 level of activity in the mortgage-backed 6 securities portfolio that you found when you came 7 to begin the 1986 audit. Right? 8 A. Well, in that final paragraph is 9 explaining why we're going to wait until year end 10 to do the test work. And the reason is because 11 there is a considerable amount of activity. 12 Q. So that if you were testing out the 13 securities that were on the books on December 1, 14 you might find that they had all been replaced and 15 you'd have new securities to test at the end of 16 the year, correct? 17 A. That is the assumption of -- 18 Q. That was your expectation? 19 A. Yes. 20 Q. Look at the second document, if you 21 would. It's B1389. This is another document from 22 the Peat Marwick work papers produced to us. It's 10482 1 entitled "United Savings Association of Texas memo 2 re: Reverse repurchase agreements." 3 Can you tell us what the purpose of 4 this work paper is? 5 A. It's to describe the approach to 6 auditing reverse repo. 7 Q. And the reverse repos are the funding 8 mechanism for the mortgage-backed securities; is 9 that correct? 10 A. That is correct. 11 Q. And you see in the second sentence, the 12 memo says "United has been very active in their 13 portfolio management of the mortgage-backed 14 securities reverse repo arbitrage and has been 15 moving the securities almost monthly in order to 16 obtain the most favorable spread between the rate 17 on the securities and the rate on the underlying 18 repo." 19 Do you see that? 20 A. Yes. 21 Q. And that's information that you were -- 22 you or your staff was documenting as part of the 10483 1 work papers for the 1986 audit? 2 A. That is correct. 3 Q. The next document is 1353, B1353. This 4 is, again, a document from the Peat Marwick work 5 papers. 6 Is that your handwriting on the top of 7 the document on the first page? 8 A. Where it says "note" or -- 9 Q. Yes. No. Where it says "United" and 10 then -- 11 A. "Correspondence with client," that is 12 my handwriting, yes. 13 Q. And this is a memo to the client from 14 one of your staff people regarding what the 15 treasury department's responsibilities were going 16 to be for the 12-31-86 audit work? 17 A. Yes. 18 Q. And do you see on the second page under 19 the first heading gains/losses on the sale of 20 securities, the statement that "We anticipate a 21 great deal of activity at year end. As soon as 22 the gain amounts have been determined, we will 10484 1 select a sample of the gains and will need 2 confirmations pulled." 3 Do you see that? 4 A. Yes, I do. 5 Q. And again, that's consistent with the 6 work paper we just looked at which indicated an 7 expectation that there would be considerable 8 activity within the mortgage-backed securities 9 portfolio at year end? 10 A. Yes. 11 Q. And finally, B1484, can you tell me 12 what that document is? It's hard to read, I know. 13 A. Barry Tiedt, who was a senior on the 14 engagement, is writing me an explanation of why we 15 had budget overruns. 16 Q. Okay. And do you see under the heading 17 "mortgage-backed securities" in the third 18 paragraph that one reason he says there has been a 19 budget overrun is that the portfolio has turned 20 over several times in the first quarter, at gains, 21 and this required approximately 30 to 35 hours to 22 test the gains, correct? 10485 1 Is that what he says there? 2 A. Yes, it is. 3 Q. So, in the course of the 1986 audit, 4 you documented in the work papers that there was a 5 very high level of activity in the mortgage-backed 6 securities portfolio during the year and at year 7 end and that it required a significant amount of 8 additional effort on the part of the auditors to 9 test the proper accounting for those transactions, 10 correct? 11 A. Yes. 12 Q. Now, in light of this increased 13 activity, one of the things you did was to 14 carefully review the investment committee minutes 15 to determine the reason for this activity; is that 16 correct? 17 A. That would be correct. 18 Q. In fact, I think Mr. Guido asked you a 19 question earlier on about whether you were aware 20 of sales out of the mortgage-backed securities or 21 junk bond portfolios in order to recognize -- oh, 22 I'm sorry. I guess -- 10486 1 MS. CLARK: I forgot to offer Exhibit 2 B1380, 1389, 1353, and 1484. I offer those in 3 evidence. 4 MR. GUIDO: No objection, Your Honor. 5 If counsel could locate a more legible copy of 6 1484 for the record, I think it would be 7 appropriate for it to be substituted. 8 MS. CLARK: We will substitute a better 9 copy if we can find one, Your Honor. 10 THE COURT: All right. Received. 11 Q. (BY MS. CLARK) In fact, I believe 12 that one of the reasons why you raised an issue 13 concerning investment versus trading was that you 14 had read the investment committee minutes and 15 found in the minutes descriptions of transactions 16 which, in your mind, raised a question as to the 17 proper accounting. 18 Would that be fair? 19 A. That may have one of the reasons that 20 we would have asked that question, yes. 21 Q. And the other would be just the amount 22 of activity that you saw? 10487 1 A. Yes. 2 Q. This was an important and complicated 3 audit issue, was it not? 4 A. Yes, it was. 5 Q. And it's one that you did not delegate 6 to your staff members. You personally did the 7 review and the analysis on that issue, correct? 8 A. When I was a manager, senior manager, I 9 would have handled that myself, that is correct. 10 Q. I'd like to show you, again, three 11 exhibits for the sake of time: B4064, B4065, and 12 B4067. 13 Mr. Parsons, these are documents that 14 were produced to us by -- from the Peat Marwick 15 work papers. Can you identify these documents as 16 the work paper copies of the minutes of 17 United Financial Group during the fourth quarter 18 of 1986? And in particular, B4064 is the minutes 19 for October. 4065 is the minutes for November, 20 and 4067 is the minutes for December 1986. 21 A. Yes. 22 Q. Can you identify your initials on the 10488 1 documents as indicative that you did review these 2 documents? 3 A. Yes. 4 MS. CLARK: I offer these in evidence, 5 Your Honor. 6 MR. GUIDO: No objection, Your Honor. 7 THE COURT: Received. 8 Q. (BY MS. CLARK) Turn to the first page 9 of Exhibit B4064. Is that your initial on the 10 bottom right corner? 11 A. Yes, it is. 12 Q. That's the investment committee minutes 13 of United Financial Group for October 1, 1986? 14 A. Yes. 15 Q. And it looks to me as though someone 16 highlighted this document in the fourth paragraph. 17 Do you recall whether you used a 18 highlighter when you read the minutes? 19 A. I don't recall. 20 Q. It appears that somebody has 21 highlighted the fourth paragraph where it says 22 "Mr. Phillips recommended the sale of a portion of 10489 1 the liquidity and mortgage-backed securities 2 portfolios to recognize profits which were 3 recently created by the market rally." 4 Do you see that faint trace of 5 highlighting there? 6 A. I see some gray on the paper, yes. 7 Q. Okay. And if you would turn to the 8 page that's Bates numbered 35480, which is the 9 second page of the minutes of the investment 10 committee of October 22, 1986. 11 Do you see that there appears to be 12 highlighting in the second paragraph, in 13 particular, the sentence relating to 14 Ms. Laurenson's report? She noted that the 15 association had perhaps too many Freddie Mac 9 16 mortgage-backed securities and that she would be 17 attempting to take profits in the securities and 18 diversify the portfolio. 19 A. Yes, I see that. 20 Q. Let's look at the next document, which 21 is 4065. Look at the first investment committee 22 minutes in that packet, which is Page 35521. 10490 1 Is that, again, your initial on the 2 first page there? 3 A. Yes, it is. 4 Q. Turn to the second page where it says 5 "It was requested by the investment committee that 6 Mr. Crow present a review of the association's 7 internal financial position on or before 8 December 1 so that a decision can be made on a 9 possible sale of high-yield corporate securities." 10 Do you see that? 11 A. Yes. 12 Q. Turn to Page -- toward the back of the 13 packet -- to Page No. 35623. 14 MR. GUIDO: What's that number again, 15 please? 16 MS. CLARK: It's Page 35623. 17 Q. (BY MS. CLARK) Did you make a note in 18 the margin as you reviewed this particular set of 19 minutes, which is the November 25, 1986 investment 20 committee minutes? 21 A. Yes, I did. 22 Q. Turn to the last of the three 10491 1 documents, which is B4067. Can you turn to the 2 first investment committee minute in that package 3 which is at 35658, the December 4, 1986 investment 4 committee? Again, that's your initial on the 5 first page? 6 A. Yes. 7 Q. And on the second page, there is a 8 discussion of Sandy Laurenson's report. And it 9 appears, again, to have some highlighting on the 10 left and right margin of that paragraph. "She 11 noted that she was looking to take some profit 12 from the association's AMPs and DART mortgage 13 portfolio." 14 Do you see that? 15 A. Yes, I do. 16 Q. Turn over a couple more pages to 35665. 17 That's an exhibit to the investment committee 18 minutes that we just were looking at, the 19 December 4 minutes. 20 Does that refresh your recollection as 21 to whether you had access to the exhibits or 22 reports that went along with the investment 10492 1 committee minutes? 2 A. It appears that we had access to the 3 attachments, yes. 4 Q. Okay. And what is this particular page 5 at 35665? Can you tell? 6 A. It seems to be a reconciliation of 7 profits that were taken, but I don't specifically 8 recall this report. 9 Q. The title is "Fourth Quarter Retail 10 Match Profits." And again, there appears to be 11 highlighting on the first line, "profits taken 12 before quarter end program on sale of" -- and then 13 it lists four different securities? 14 A. Yes. 15 Q. And then the next chart has 16 considerably more securities and it says "Profits 17 from quarter end program started on 11-26-86." 18 A. Uh-huh. (Witness nods head 19 affirmatively.) 20 THE COURT: Would you speak up, please? 21 THE WITNESS: Yes. 22 Q. (BY MS. CLARK) And at the bottom, it 10493 1 says "Total profits made during program, 4,600,000 2 plus." 3 A. Yes. 4 Q. And turn over, if you would, to Bates 5 No. 35667. 6 Do you see that chart relating to the 7 transactions in the mortgage-backed securities 8 portfolio? 9 A. (Witness reviews the document.) Yes, I 10 see a chart. 11 Q. And do you recall seeing charts in that 12 same form throughout the investment committee 13 minutes that you reviewed in your work as the 14 auditor for USAT reflecting the purchases and 15 sales of mortgage-backed securities, the amount of 16 principal, market yield, and accounting profits or 17 accounting dollars? 18 A. I don't -- you know, I don't 19 specifically recall these schedules. Obviously, 20 you know, from this, we had them but -- 21 Q. If they are in the documents, you saw 22 them; but you don't remember right now? 10494 1 A. That's right. 2 Q. Now, a number of items that I've 3 brought to your attention, many of them were 4 highlighted, had to do with sales of securities, 5 whether high-yield or mortgage-backed securities. 6 Correct? 7 A. That is correct. 8 Q. And was it items like that that caused 9 you to raise an issue concerning the proper 10 accounting treatment of these portfolios, whether 11 they be trading or investment portfolios? 12 A. Well, there were many reasons why, you 13 know, something would come up in terms of a 14 question like that. But certainly one of them 15 would be a review indicating significant activity. 16 Q. Did you discuss your findings from the 17 review of the minutes in the third quarter with 18 other people at Peat Marwick? 19 A. Yes. 20 Q. And do you recall who else you would 21 have discussed those findings with? 22 A. Either Rick Millinor or Jerry 10495 1 Claiborne, depending upon who was the partner on 2 the job. And Lee Mitchell was actually a partner 3 on the job for a while. 4 Q. Do you recall raising these issues with 5 the client, as well? 6 A. Yes. 7 Q. And what was the client's response when 8 you raised questions concerning what you found in 9 the investment committee minutes? 10 A. They responded with an explanation of 11 the transaction. 12 Q. And do you recall whether -- having 13 reviewed the minutes, having looked at the 14 activity in the portfolio, and discussing the 15 matter with the client, whether you reached a 16 conclusion about the proper accounting for the 17 1986 audit year? 18 A. I do not -- I don't remember any 19 specific conversations. We provided an opinion on 20 the year; so, we obviously concluded that the 21 activity was appropriate. 22 Q. All these many years later, can you 10496 1 reconstruct what your thought process was in 2 reaching that conclusion that the -- to give an 3 opinion on the financial statements and not 4 require these portfolios to be mark-to-market? 5 A. Can I recall my thought process? No. 6 Q. But you're confident that you were 7 satisfied with your conclusion at the time? 8 A. Yes. 9 Q. Based on all the information that we've 10 reviewed and everything else -- every other piece 11 of information that you've collected, you were 12 satisfied with your conclusion at the time? 13 A. Yes, we were. 14 Q. And in reaching that conclusion, were 15 you applying the accounting principles as you 16 understood them at that time? 17 A. Yes, we were. 18 Q. Do you have any reason to believe today 19 that you made a mistake? 20 A. No, I don't. 21 Q. I'd like to show you a document that 22 has been previously marked and admitted with a 10497 1 different number, but I'd like to show you another 2 copy of it. It is marked B3933. This is a memo 3 from Mike Crow to Bruce Williams and Jim Wolfe 4 dated January 12, 1987. It attaches a copy of 5 your memo to Mike Crow dated January 5, 1987. 6 Do you recall this document? 7 A. We looked at it earlier today, yes. 8 Q. This particular copy was produced to us 9 out of the Peat Marwick work papers, and I simply 10 want to ask you whether you recall how it is that 11 the Mike Crow memo to Bruce Williams and Jim Wolfe 12 made its way into Peat Marwick's work papers. 13 A. No, I don't. 14 Q. Would you take a minute to review that 15 short memo? 16 A. (Witness reviews the document.) 17 MS. CLARK: Your Honor, while he's 18 doing that, I move the admission of B3933. 19 MR. GUIDO: No objection, Your Honor. 20 THE COURT: Received. 21 A. Okay. 22 Q. (BY MS. CLARK) Do you recall seeing 10498 1 this document before? 2 A. I don't recall it from then, you know. 3 As I said, I looked at it earlier today. 4 Q. Do you recall discussing with Mike Crow 5 the concerns that are expressed in this memo 6 regarding what would happen if there -- what he 7 calls the hold portfolios had to be 8 mark-to-market? 9 A. I don't remember discussing, you know, 10 the magnitude of the events or the magnitude of 11 the possible swings for holding -- or marking a 12 large portfolio to market, no, I don't recall 13 that. 14 Q. Is this concern expressed in the last 15 couple of sentences of Mr. Crow's memo a concern 16 that you heard expressed from any of the audit 17 clients that you were working with in the 1980s 18 that -- what the result would be if their hold 19 portfolios had to be mark-to-market and their 20 profits would swing by millions of dollars if 21 the -- with the change in interest rates? 22 A. Sure. Anybody would have been 10499 1 concerned about that. 2 Q. Was it your understanding that that was 3 a concern of USAT regarding the mark-to-market 4 issue? 5 A. I don't remember that specifically, but 6 it's very logical that it would be of great 7 concern. 8 Q. That would be of concern to any 9 business. Right? 10 A. Any highly-leveraged business like a 11 bank or a thrift would be concerned about that. 12 Q. Because they are dependent on the 13 interest rate movements; is that right? 14 A. Yes. 15 Q. I think you testified in response to 16 Mr. Guido's question that the intent of management 17 with respect to the holding of the security was to 18 be measured at the time of acquisition of the 19 security for purposes of applying the rules 20 regarding investment versus trading as they 21 existed back in the mid-1980s, correct? 22 A. Yes. The rules were evolving during 10500 1 that time. But clearly, as per the memo that we 2 had reviewed earlier today, the guidance at one 3 point in time was that the intent was to be 4 established at the time the purchase was made. 5 Q. And if you see that there is turnover 6 in the portfolio, you see a certain amount of 7 turnover, then the question becomes does that 8 turnover somehow call into question management's 9 original intent in acquiring the securities. Is 10 that basically how the analysis worked? 11 A. That is correct. 12 Q. And at that point, you would be asking, 13 "Did they really intend to acquire this security 14 as an investment, or did they intend to buy it 15 with the hope that they could sell this" -- "turn 16 around and sell it at a profit because of 17 appreciation," correct? 18 A. Yes. 19 Q. That would be the basic dividing line, 20 conceptually, between a trading and an investment 21 portfolio as you understood it back in the 22 mid-1980s? 10501 1 A. Well, there is one additional criteria, 2 which is the ability to hold it. So, assuming -- 3 which United had -- United Savings had at that 4 time was the ability to hold most of these assets. 5 Q. Turn to the second page of your memo, 6 which is attached to the Mike Crow memo. At the 7 bottom, there is a section called "objectives and 8 strategy." 9 Do you see that? 10 A. Yes. 11 Q. There are a number of bullet points 12 there concerning what would be consistent with the 13 intent to acquire a security as an investment. 14 Do you see that? 15 A. Yes. 16 Q. And one of them is whether the 17 securities are purchased with matched funding, 18 correct? That is, are they matched with certain 19 liabilities or is there funding matched to the 20 maturities of the -- 21 A. That's correct. That's the second 22 bullet point, yes. 10502 1 Q. And what is the significance of that? 2 Why is that pertinent to the trading versus 3 investment issue? 4 A. Well, if the liability and the asset 5 were matched, that reduces the exposure of the 6 person or entity that is buying the asset and 7 leveraging it. And it would create an indication 8 that they intended to hold for a long period of 9 time. 10 Q. If the intent was to buy the security 11 and hope that the interest rates would move real 12 fast so you could sell at a gain, you wouldn't 13 necessarily lock in your funding for a lengthy 14 period of time. Right? 15 A. That would be correct. 16 Q. So, it would be indicative of the 17 management's intent in acquiring the security in 18 the first place? 19 A. That is correct. 20 Q. Do you recall that, in response to Peat 21 Marwick's advice on this issue, United adopted 22 statements of policy with respect both to the 10503 1 high-yield portfolio and the mortgage-backed 2 portfolio? 3 A. Yes. They did establish policies. 4 Q. I'd like to show you a different 5 version of a couple of documents that Mr. Guido 6 showed you. It's B1410. I think it's previously 7 been admitted. It's found at Tab 910. 8 Mr. Guido, I believe, showed you the 9 two separate policies as separate documents during 10 his examination of you. And I believe the two 11 statements of strategies and objectives were, in 12 fact, attached to your work papers and attached to 13 your memo to Mike Crow. 14 Can you identify this document as a 15 copy of your work papers regarding the trading and 16 investment issue with the attached policies? 17 A. Yes. 18 Q. Does this refresh your recollection as 19 to whether you have seen these policies before? 20 A. Yes. 21 Q. One of the recommendations that you 22 made to United regarding the high-yield MBS 10504 1 portfolios was that they better document their 2 intent in acquiring the securities; is that 3 correct? 4 A. That is correct. 5 Q. And that they also lay out their 6 policies with respect to both portfolios in 7 writing, correct? 8 A. Yes. 9 Q. And these two policies were United's 10 response to Peat Marwick's recommendation; is that 11 correct? 12 A. Yes. 13 Q. And did you consider these policies to 14 be an adequate response to your recommendation 15 that they set forth their policies in writing? 16 A. Yes. To the extent it was to document 17 their policies, yes. 18 Q. Turn to Page 24421, if you would, 19 please. That's the mortgage-backed securities 20 statement of strategies and objectives. 21 Do you see the description of the 22 objective of the investment portfolios and 10505 1 mortgage-backed securities under the heading 2 "investment portfolio"? 3 Do you see where it says the 4 objectives -- sorry -- "The objective of these 5 designated portfolios will be to invest in a 6 diversified group of MBS which will generate a net 7 interest margin over a range of interest rate 8 environment scenarios. The securities will be 9 funded primarily with short duration liabilities 10 which may or may not be hedged with various 11 financial instruments (such as interest rate caps, 12 collars, swaps, futures, options, et cetera). It 13 is management's intent to maximize the net 14 interest spread while maintaining prudent interest 15 rate risk exposure." 16 Do you see that? 17 A. Yes, I do. 18 Q. And was that consistent, in your view 19 at the time, with a portfolio that would be 20 accorded investment treatment? 21 A. Yes. 22 Q. Now, you see there are a number of 10506 1 reasons given why there might be sales executed 2 out of the portfolio? 3 A. Yes, I do. 4 Q. The last one of which is "to meet other 5 requirements that may be approved by the 6 investment committee consistent with generating an 7 ongoing net interest spread"? 8 A. Yes. 9 Q. And was that list of reasons consistent 10 in your view with, according to this portfolio, 11 investment accounting treatment? 12 A. At that time, yes. As I say, you know, 13 the rules for this were very much evolving. 14 Q. They are very different today, are they 15 not, the rules? 16 A. Yes, they are. Well, to tell you the 17 truth, I don't know what they are today. They 18 were different at the time I left Peat Marwick. 19 Q. Do you see the last paragraph where it 20 talks about a trading portfolio? 21 A. Yes. 22 Q. It indicates in this statement of 10507 1 strategies and objectives that there will be a 2 trading portfolio. "The objective of the 3 portfolio will be to invest in a limited volume of 4 MBS or other financial instruments, such as puts 5 and calls, which are expected to provide capital 6 appreciation or fee income." And then the 7 paragraph continues. 8 Do you recall that United set up a 9 trading portfolio in mortgage-backed securities in 10 response to the discussion with Peat Marwick at 11 the end of 1986? 12 A. I seem to remember that they did 13 establish a trading portfolio. 14 Q. Do you know what ultimately happened to 15 that trading portfolio? 16 A. No, I don't. 17 Q. Exhibit B4153. B4153 is another work 18 paper from the Peat Marwick work papers that were 19 produced to us, and it is entitled "UFG MBS 20 trading portfolio 6-30-87." 21 Do you see that? 22 A. Yes, I do. 10508 1 Q. And does the bottom right-hand corner 2 indicate that you initialed this document during 3 the course of your review of the work papers? 4 A. Yes, it does. 5 Q. Does this work paper refresh your 6 recollection as to what ultimately happened to the 7 mortgage-backed securities portfolio -- trading 8 portfolio? And I point you specifically to the 9 Footnote 1. 10 A. It appears that they sold the 11 portfolio. 12 Q. They closed it out in -- on or before 13 June 30, 1987. Do you recall -- is that correct? 14 They closed it out? 15 A. Apparently so. I don't specifically 16 remember it, but it was a long time ago. I'm 17 sorry. 18 Q. I know. Do you recall discussing that 19 with anyone at the client at the time you reviewed 20 the work papers or whenever it was that you first 21 learned that they had closed out the trading 22 portfolio? 10509 1 A. I don't recall discussing that. 2 MS. CLARK: Let me offer B4153. 3 MR. GUIDO: No objection, Your Honor. 4 THE COURT: Received. 5 Q. (BY MS. CLARK) Turn back in 6 Exhibit No. 1410 to the statement of strategy and 7 objectives for the high-yield bond portfolio, if 8 you will. The page number is 024417. 9 Do you see that this statement of 10 strategies and objectives also contemplates the 11 establishment of a trading portfolio for the 12 high-yield bonds? 13 A. Yes. 14 Q. Do you recall whether one was 15 established or not? 16 A. I seem to remember that one was 17 established, yes. 18 Q. I think Mr. Guido showed you a -- an 19 excerpt from the management letter that was sent 20 by Peat Marwick in February 1987. Let me ask you 21 to see if you can find Exhibit B1481 in the pile 22 in front of you. 10510 1 A. Yes, I have it. 2 Q. Turn to Page 4 of that document. I 3 believe that Mr. Guido read out loud to you or had 4 you read -- I can't recall -- the first paragraph 5 of that page of the management letter relating to 6 the corporate debt securities trading account. 7 A. Yes, he did read that. 8 Q. I'm going to ask you, if you would, to 9 look at another hard-to-read exhibit. I apologize 10 for that. B2785. Actually, we found a more 11 legible copy, which will be the second page of the 12 exhibit. 13 The first page is from the Peat Marwick 14 work papers, and the more legible copy is from, I 15 think, the Peat Marwick work papers, as well, but 16 it doesn't have the KPMG number stamp. 17 Would you please review that 18 memorandum? It's entitled "Memo re: Trade 19 accounting for junk bonds? 20 A. (Witness reviews the document.) 21 Q. Does this reflect the results of an 22 inquiry that you made concerning why USAT had not 10511 1 established a junk bond trading portfolio as 2 contemplated in the policy that was adopted in 3 response to Peat Marwick's comments on the trading 4 versus investment issue in 1986? 5 A. Yes, it does. 6 Q. And tell the Court what you were 7 informed by Mr. Williams. Just read that middle 8 paragraph. 9 A. "Williams informed me that such an 10 account was not established because they believed 11 that they were not currently trading junk bonds. 12 In fact, the association does not have a bond 13 trader but they were in the process attempting to 14 hire a trader. He stated that subsequent to 15 hiring a bond trader, that" -- I'm not sure what 16 it says -- "that he or they will revisit the 17 concept of a trading account." 18 Q. That's hard to read. And do you 19 believe that that accurately reflects what you 20 were told by the client's representative 21 concerning why the corporate bond portfolio was 22 not established? 10512 1 A. Yes, I do. 2 Q. Do you know whether, notwithstanding 3 the fact that they didn't establish an entire 4 trading portfolio, whether USAT did, in fact, 5 invest in individual corporate or junk bonds for 6 trading and account for them on a mark-to-market 7 basis? 8 A. I don't recall. 9 Q. You don't recall? Okay. 10 MS. CLARK: Let me offer B2785. 11 MR. GUIDO: No objection, Your Honor. 12 THE COURT: Received. 13 MR. GUIDO: That's the two pages, the 14 blowup and the Peat Marwick rendition of the 15 document? 16 MS. CLARK: Uh-huh. 17 Q. (BY MS. CLARK) What would have been 18 the effect on USAT's reported financial 19 performance in 1986 if it had marked its 20 mortgage-backed securities portfolio to market 21 instead of carrying it under investment accounting 22 treatment at historical cost? 10513 1 A. I have no idea. 2 Q. Do you know whether it would have 3 increased United's income or decreased United's 4 income? 5 A. I have no idea. 6 Q. If someone wanted to know what the 7 mark-to-market value of the mortgage-backed 8 securities portfolio was at year end '86, could 9 they obtain that information from the footnotes to 10 the financial statement? 11 A. I believe that they could have had a 12 pretty clear indication of that, yes. 13 Q. Do you know what the results would have 14 been if the high-yield bond portfolio had been 15 marked to market in 1986? 16 A. No. 17 Q. After Peat Marwick raised the 18 investment versus trading issue in the 1986 audit, 19 did the firm continue to monitor that question on 20 a going-forward basis? 21 A. Yes. 22 Q. It would have continued to be an audit 10514 1 concern that would have received the attention of 2 the audit team, correct? 3 A. That is correct. 4 Q. As I understand it, you moved out of 5 the Houston area in 1987 at some point and went to 6 work in Buffalo; is that right? 7 A. That's correct. 8 Q. But before you left, did you continue 9 to work on USAT quarterly reviews during 1987? 10 A. I worked on USAT until I left. I 11 believe it was sometime during the summer. So, I 12 may have done the first quarter review. 13 Q. Let me show you -- again, for the sake 14 of time, I'll ask -- 15 THE COURT: We'll take a short recess. 16 17 (A short break was taken 18 at 3:06 p.m.) 19 20 THE COURT: Be seated, please. We'll 21 be back on the record. 22 Ms. Clark, you may continue. 10515 1 (3:28 p.m.) 2 Q. (BY MS. CLARK) Mr. Parsons, before 3 the break, I was asking you whether you continued 4 working on USAT matters after the completion of 5 the 1986 audit until you left Houston sometime in 6 the middle of 1987. I think you indicated that 7 you did? 8 A. Yes, I did. 9 Q. Let me ask you to look at what's been 10 marked as B4103, another set of documents from the 11 Peat Marwick work papers, and ask you if you can 12 identify that as a set of minutes that you 13 reviewed, based on the initials. 14 A. Yes. 15 Q. And these minutes are for the month of 16 January 1987 and include investment committee 17 minutes; is that correct? 18 A. Yes. 19 Q. What would your purpose have been in 20 reviewing the minutes of the investment committee 21 for January 1987? 22 A. It could have been two things. One 10516 1 would be relating to the 1996 audit, because we 2 continue to investigate events that occur after 3 year end in case something has occurred which 4 would impact the year end. So, I could have been 5 looking at these relative to the year end 1996. 6 Or I could have been looking at these for -- 7 related to the first quarter review. 8 Q. Let me ask you to look at B4093, if you 9 would, please. This is another packet of minutes. 10 The work paper reference is on the back page this 11 time, and it says "Minutes. First quarter 12 review." 13 Do you see that? 14 A. Yes, I do. 15 Q. Can you identify this as a portion of 16 your work papers from your first quarter review of 17 United in 1987? 18 A. Yes. 19 Q. And again, this packet includes 20 investment committee minutes and a number of them 21 have been initialed by you; is that correct? 22 A. They have been reviewed by me, yes. 10517 1 Q. What was your purpose in reviewing the 2 minutes of the investment committee and other 3 committees of USAT during the first quarter review 4 in 1987? 5 A. The purpose of a quarterly review is 6 really to do an analytical review to find out what 7 the company is doing. And so, we would have 8 reviewed the minutes in order to get basically an 9 on top viewpoint of what the company has done. We 10 did, as I mentioned before -- if there were 11 specific or large transactions that we could audit 12 to get out of the way, we would audit those. We 13 would perform audit procedures on those, not for 14 the purposes of forming an opinion for the 15 quarterly review but for the purposes of getting 16 audit work done and complete. 17 Q. In the nature of interim field work? 18 A. Yes, that's correct. 19 Q. Let me ask you, if you would, to turn 20 to Page 44604, which is part of the attachments to 21 the minutes of the March 18, 1987 investment 22 committee meeting. 10518 1 Do you see that that is a report to the 2 investment committee on purchases and sales in the 3 high-yield bond portfolio showing the dates, 4 issuers, coupons, maturity, par value, and 5 gain/loss amounts? 6 A. Yes, uh-huh. 7 Q. And if you would, turn over to Page 8 44639. Have you found that? 9 A. Yes. 10 Q. Do you see that that's a similar report 11 for the mortgage-backed securities portfolio -- 12 A. Yes. 13 Q. -- in March 1987? Do you remember I 14 asked you whether you recalled seeing this basic 15 format of a report in the minutes of the 16 investment committee? Do you see that's another 17 example of that same basic format? 18 A. Yes, it is. 19 Q. Let me ask you to look at B1555, if you 20 would, please. While you're doing that -- 21 MS. CLARK: Your Honor, I would like to 22 offer B4093 and B4103. 10519 1 MR. GUIDO: No objection, Your Honor. 2 THE COURT: Received. 3 Q. (BY MS. CLARK) Mr. Parsons, can you 4 identify B1555 as a work paper that you prepared 5 in connection with the first quarter 1987 6 quarterly review at United? 7 A. Yes. 8 Q. And what is this work paper? 9 A. This work paper is an analytical 10 review. 11 Q. What is the purpose of the analytical 12 review? 13 A. To ascertain and investigate any 14 significant changes that have occurred during the 15 quarter. 16 Q. Turn to the -- well, let's just go 17 through. There is an analytical review of the 18 changes from prior year and prior quarter. Those 19 are the two columns in the schedule; is that 20 correct? 21 A. That is correct. 22 Q. And are these items keyed to the line 10520 1 items on the P&L analytical review schedule that's 2 the second page of the document? 3 A. Yes, it is. 4 Q. And so, there is an analytical review 5 of each of the items of income and expense? 6 A. Each of the income and expense 7 categories, yes, unless -- yes. 8 Q. So, what you're doing in this schedule 9 is you are seeing what has happened to each of 10 these income and expense items since the last year 11 and since the prior quarter, correct? 12 A. That's correct. 13 Q. And that's what you've described in the 14 written part of the document? 15 A. Yes. 16 Q. That applies to loans, investments, 17 deposits, balanced funds. What's number -- what's 18 the next one? Fees and -- 19 A. Borrowed funds, fees and services. 20 Q. Real estate operations? 21 A. Yes. 22 Q. Sales of loans -- sale of loans and 10521 1 sale of securities? 2 A. Yes. 3 Q. Could you read to the Court what you 4 found with respect to sale of loans in your 5 comparative review? 6 A. Under "change from prior year," I said 7 "Gain from sale of loans primarily due to market 8 opportunities available to sell mortgage-backed 9 securities. The market was in the right direction 10 in the fourth quarter of 1996 and first quarter of 11 1997, resulting in the indicated gains. 12 Reasonable and consistent with our knowledge of 13 the market." 14 Q. I believe you meant 1986 and 1987 15 rather than '96 and '97? 16 A. That would be correct. Sorry. 17 Q. All right. And how about sale of 18 securities? What did you find in your comparative 19 review on sale of securities? 20 A. "Situation similar to the sale of 21 loans. See explanation above. Gains are 22 consistent with our knowledge of the market." 10522 1 Q. Let me ask you whether the continuing 2 review and monitoring that you did of USAT's 3 investment activities, both in the high-yield bond 4 and the mortgage-backed portfolios, in the first 5 quarter of 1987 caused you to form any different 6 conclusion than you had reached at the end of 1986 7 concerning the investment versus trading issue. 8 A. No. 9 Q. And do you recall whether you did a 10 similar quarterly review for the second quarter of 11 1986 -- '87? Sorry. 12 A. I do not recall that. 13 Q. Do you recall at any time while you 14 were working on United matters that you reached a 15 different conclusion with respect to the trading 16 versus investment issue? 17 A. I do not recall. 18 Q. You don't recall reaching a different 19 conclusion on United's high-yield bond and 20 mortgage-backed securities portfolios before you 21 left? 22 A. I do not recall reaching a different 10523 1 conclusion. 2 Q. You were asked a number of questions 3 about accounting for hedges. How long has it been 4 since you worked in the public accounting field? 5 A. It's been about six years. 6 Q. Okay. Do you consider yourself to be 7 up to speed on technical issues concerning hedge 8 accounting at this stage in your life? 9 A. There are a certain number of rather 10 simple hedges that I take care of in my role, but 11 nothing nearly as complex as the hedge systems 12 that we're talking about in these work papers. 13 Q. You were asked to make some judgments 14 about hypothetical situations in the questioning 15 by Mr. Guido. I would like to simply ask you 16 whether you recall how the swaps were accounted 17 for at USAT. 18 A. For the swaps, I mean, you're basically 19 changing a fixed interest rate for a variable 20 interest rate. And so, every period, whatever it 21 was -- I can't remember exactly how often they 22 settled up -- but they would settle up through the 10524 1 intermediary what the differential was between the 2 fixed rate and the variable rate. And that would 3 then be accounted for in the books of United 4 Savings. 5 Q. And would that run through the income 6 statement? 7 A. Yes, it would. 8 Q. If they had to pay out money a certain 9 month, there would be an expense. And if they 10 received money on the swap, there would be income? 11 A. That's correct. 12 Q. Let me show you, if -- 13 MS. CLARK: May I offer B1555? 14 MR. GUIDO: No objection. 15 THE COURT: Received. 16 Q. (BY MS. CLARK) Let me show you B735, 17 please. This is a portion of the work papers from 18 the Peat Marwick audit of United for the period 19 ended December 31, 1985. It is a schedule on 20 interest expense; is that correct? 21 A. This is an audit guide. 22 Q. Audit guide? 10525 1 A. Yeah. 2 Q. In the nature of the steps that -- 3 auditing procedure that would be followed with 4 respect to auditing the interest expense item? 5 A. That's correct. 6 Q. Turn to Page 0004, please. Can you 7 tell me if that's your initial on the bottom right 8 corner? 9 A. Yes, it is. 10 Q. Look at Item No. 9. Do you see the 11 description of how the interest rate swaps were 12 being accounted for at USAT? 13 A. Yes, I do. 14 Q. Would you read that to the Court, 15 please? 16 A. "The association has locked in 17 long-term rates by obtaining rate swaps equal to 18 certain reverse repos. Although the association 19 refers to the swaps as hedges, they are not 20 considered to be hedges for accounting purposes. 21 The gain/loss associated with the hedge is netted 22 against the interest expense for financial 10526 1 statement purposes." 2 Q. Is that consistent with your 3 recollection of how the interest rate swaps were 4 accounted for at USAT? 5 A. Yes, it is. 6 Q. Let me show you B4154. 7 MS. CLARK: And while I'm doing that, 8 could I offer the last one? Let me offer B735. 9 THE COURT: Mr. Guido, do you have 10 objection to B735? 11 MR. GUIDO: No objection, Your Honor. 12 THE COURT: Received. 13 Q. (BY MS. CLARK) Can you identify B4154 14 as a memo from you to the general file in 15 connection with the audit of USAT for the year 16 ended December 31, 1986? 17 A. Yes. 18 Q. And the subject matter is "Unusual 19 accounting, auditing, and reporting matters"? 20 A. Yes. 21 Q. Do you see that the first matter 22 reported concerns the United MBS hedged arbitrage 10527 1 program that Mr. Guido was asking you about 2 earlier? 3 A. Yes. 4 Q. Now, in that memo, in the second 5 paragraph, you say, "This is the first structured 6 hedge program entered into by United." 7 Do you see that? 8 A. Yes, I do. 9 Q. What did you mean by that, that it was 10 the first structured hedge program entered into by 11 United? 12 A. I think I meant that it was the first 13 time that they had gone out and actually bought -- 14 acquired assets and leveraged those assets and had 15 a hedge program to minimize the risk of that -- of 16 the transaction. 17 Q. Did it have something to do with 18 whether the hedges were specifically identified 19 with either assets or liabilities? Was that the 20 distinction between a structured hedge program and 21 what we saw in the last memo concerning the swaps? 22 A. I think that's correct. 10528 1 Q. Is this pushing it beyond what you 2 remember at this state about hedge accounting? 3 A. It's a little fuzzy, yeah. 4 Q. Okay. We'll move on. 5 Do you recall that Peat Marwick, in the 6 course of its audit, would review major loans? 7 A. Yes, we did. 8 Q. Was one of the issues that you 9 considered in the review of major loans whether 10 the loans should be properly accounted for as 11 loans or, rather, as investments? 12 A. Yes, I did. 13 Q. Do you recall a loan that United made 14 to a borrower called Norwood/United Park Joint 15 Venture? 16 A. I don't -- I mean, that sounds vaguely 17 familiar. I don't specifically recall the credit. 18 Q. Let me ask you to look at B1374. 19 MR. GUIDO: Your Honor, I object to 20 this line of questioning as going beyond the scope 21 of direct. I didn't ask this witness anything 22 about real estate matters at all. It was earlier 10529 1 witnesses that were asked about real estate 2 matters, and I object to the line of questions as 3 going far beyond the scope of direct at this point 4 in time. 5 MS. CLARK: Your Honor, I'm going to 6 ask one or two questions about two documents. The 7 witness is here. For the convenience of the 8 witness, I would ask to be permitted to do so. It 9 would be very brief. 10 THE COURT: All right. Denied. 11 Q. (BY MS. CLARK) I'm going to ask you 12 about another major loan. We can't locate the 13 document I wanted to show you about the 14 Norwood/United Park loan. So, I'm going to ask 15 you if you can identify B4166, which is from the 16 Peat Marwick work papers from the 1986 audit and 17 it pertains to a deferred fee, Park 410 West. 18 A. (Witness reviews the document.) 19 Q. Let me read to you the note that I 20 wanted to ask you about. It says, "In 1986, 21 Park 410 borrowed money and paid USAT $2.4 million 22 in origination fees. USAT recognized two thirds 10530 1 of this fee (1.6 million) and deferred the 2 remaining portion to be amortized over the life of 3 the loan as an interest yield adjustment. 4 Subsequent to the deferral of this fee, USAT 5 learned that the origination costs exceeded the 6 fees collected. Since costs exceeded fees 7 collected, USAT was planning to remove the balance 8 from the deferred fee account and recognize the 9 income in 1987. However, since all costs incurred 10 on the loan origination were recognized in 1986, 11 all fees (income) relating to this origination 12 should also be recognized to allow proper matching 13 of income and expense. Peat Marwick has proposed 14 this AD to allow proper matching." 15 Did I read that correctly? 16 A. That's correct. 17 Q. Now, do you recall that in the 1986 18 audit, Peat Marwick required that USAT recognize 19 fees in 1986 that USAT had planned to defer into 20 1987 on a major loan called Park 410 West? 21 A. I don't recall that. 22 Q. Is that what this work paper refers to? 10531 1 A. An AD is an audit difference, which 2 means that we would have proposed this as an entry 3 at the end of an audit. You have -- you 4 accumulate your audit differences. If those 5 cumulative audit differences are material, then we 6 would require the client to book all or some of 7 those adjustments. 8 Q. So, it would be your recommendation or 9 your proposal that instead of taking that final 10 one-third of the Park 410 West fee into income in 11 '87, that it be recognized in '86 instead? That 12 was your proposal and then -- 13 A. Well, not necessarily '87, but '87 and 14 thereafter. I don't know how long the credit was 15 for; but our proposed accounting treatment was 16 that it should have been -- basically, what this 17 is saying is our conclusion is that that income 18 should have been recognized in 1986. 19 Q. I think we've now located the exhibit 20 on Norwood. It's B1374. 21 MS. CLARK: And I would like to offer 22 B4154, B4166, and B1374. 10532 1 MR. GUIDO: What was the first number? 2 MS. CLARK: B4154, B4166, B1374. 3 MR. GUIDO: No objection. 4 THE COURT: Received. 5 Q. (BY MS. CLARK) B1374 is a document 6 from the Peat Marwick work papers. It's entitled 7 "ADC loan review worksheet." It pertains to a 8 loan called Norwood/United Park. 9 Can you identify this as Peat Marwick's 10 standard worksheet for review of acquisition, 11 development, and construction or ADC loans during 12 this period? 13 A. I don't recall whether this was Peat 14 Marwick's standard or whether this is a work paper 15 that we developed for reviewing work papers at 16 United. 17 Q. Do you see your handwriting on the 18 second page of this document? 19 A. Yes, I do. 20 Q. Look at the third page of the document, 21 if you would, please. 22 MR. GUIDO: Is that CN185367? 10533 1 MS. CLARK: Yes, it is. 2 Q. (BY MS. CLARK) Can you see in the 3 last three lines in Mr. Tiedt's handwriting, I 4 believe, a statement that "they," meaning the 5 client, "agree that all of the loan balance should 6 be accounted for as an investment"? 7 MR. GUIDO: Where are you on this page? 8 MS. CLARK: Last three lines of 9 CN185367. 10 MR. GUIDO: That doesn't appear to say 11 what you just quoted it to say. Can you have the 12 witness answer the questions? 13 Q. (BY MS. CLARK) Can you read the last 14 three lines of that page? 15 A. "After discussion with United 16 personnel, they agree that all of the loan balance 17 should be accounted for as investment and are 18 making" -- appears to be "this appropriate 19 entries." 20 Q. And turn over two pages to 21 Page CN185274. At the very bottom, can you read 22 that last entry, "no change from conclusion"? 10534 1 A. (Witness reviews the document.) "No 2 change from conclusion at" -- it appears to be 3 "4253. Okay. Loan is to be treated as an 4 investment included in real estate on United's 5 financial statements. The interest income will be 6 deferred" -- and then there is an insert -- "or 7 capitalized as appropriate on this" -- something 8 that I can't read -- "portion of this note." 9 Q. Okay. Does it appear to you from this 10 worksheet that the Norwood/United Park loan was 11 accounted for as an investment rather than a loan 12 on the -- in the financial records of USAT? 13 A. Yes, it does. 14 Q. I'm going to ask you about -- I think 15 you mentioned earlier that apart from the regular 16 quarterly review and annual audits that you also 17 would field questions from USAT from time to time 18 about accounting issues as they came up. 19 Was that the case? 20 A. Yes. 21 Q. I want to ask you about some of those 22 questions, and I'll mark -- or, rather, I will 10535 1 hand you B1245, B2587, and B1803. 2 Is B1245 a memorandum from you to Russ 3 McCann at USAT concerning accounting for dollar 4 roll transactions? 5 A. Yes, it is. 6 Q. And is this typical of the kinds of 7 inquiries that you received from USAT during the 8 time it was an audit client of Peat Marwick? 9 A. Yes. This would be typical of the type 10 of questions. They -- you know, again, many of 11 these things were very complicated and technical 12 in nature and the accounting was evolving. So, 13 the client would look to Peat Marwick to help 14 answer many of these involved questions. 15 Q. Look at B2587. Is this a handwritten 16 memo to the general file that you wrote concerning 17 an inquiry from Jim Wolfe on an accounting issue? 18 A. Yes, it is. 19 Q. And what was the issue that you 20 addressed there? 21 A. Settlement of purchases of 22 mortgage-backed securities. 10536 1 Q. My question was whether the transaction 2 should be accounted for at its trade date or its 3 settlement date? 4 A. Yes, it was. 5 Q. And again, is that typical of the kinds 6 of questions that United would bring to you when 7 you were working on the audits of United? 8 A. Yes, it is. 9 Q. Look at B1803. Is this a memo to 10 you -- from you to Jerry Claiborne concerning 11 another inquiry that United brought to you 12 concerning an accounting matter? 13 A. (Witness reviews the document.) I 14 can't conclude from this as to whether United came 15 to me with this question or whether it was raised 16 just as part of standard procedures. 17 Q. The subject of the memo is an option 18 hedge of assets stated at cost, and the question 19 was whether United would be allowed to defer the 20 gain that was recognized over the remaining -- the 21 gain that was recognized upon the expiration of a 22 T note option rather than recognizing it right 10537 1 away; is that correct? 2 A. That is correct. 3 Q. Now, what was United's position on this 4 issue? What accounting result was United hoping 5 to achieve? 6 A. It appears that what they had hoped to 7 achieve was deferral of the gain and recognition 8 of that income in over the life of the security. 9 Q. This is in August of 1987 and you say 10 here, "United appears to think that it's unfair 11 that the IP is not consistent with FASB and wants 12 to know if there is any way to get around 13 immediate recognition of the gain." Right? 14 A. That is correct. 15 Q. And your answer was? 16 A. The conclusion was that the gain should 17 be recognized immediately. 18 Q. So, they were required to recognize the 19 gains, even though they wanted to defer them? 20 A. That is correct. 21 MS. CLARK: I offer B1245, B2587, and 22 B1803, Your Honor. 10538 1 MR. GUIDO: No objection, Your Honor. 2 THE COURT: Received. 3 Q. (BY MS. CLARK) How would you 4 characterize USAT generally as an audit client, 5 Mr. Parsons? 6 A. It's a rather broad question. Could 7 you be more specific? 8 Q. Did you feel that the people that you 9 were working with were competent in their jobs? 10 A. Yes, I did. 11 Q. Did you feel that they had integrity? 12 A. Yes, I did. 13 Q. Did you feel that they were ever trying 14 to mislead you? 15 A. No. 16 MS. CLARK: No further questions. 17 THE COURT: Was B1374 offered? 18 MS. CLARK: If not, I offer it. 19 MR. GUIDO: No objection, Your Honor. 20 THE COURT: Received. Mr. Guido, do 21 you have some -- 22 MR. GUIDO: I have hopefully only four 10539 1 questions, Your Honor. 2 THE COURT: Do any of the other 3 respondents -- 4 MR. BLANKENSTEIN: No questions, Your 5 Honor. 6 MR. EISENHART: I have no questions, 7 Your Honor. 8 9 REDIRECT-EXAMINATION 10 11 (4:02 p.m.) 12 Q. (BY MR. GUIDO) Would you take a look 13 at Exhibit B4064, which was one of the packets of 14 minutes that Ms. Clark showed you from the work 15 papers? It's right here. It's B4064. 16 Do you see any minutes in there from 17 October 8th, 1986? 18 A. Yes, I do. 19 Q. October 8th, 1986? The board of 20 directors. Do you see any minutes in there of the 21 investment committee of United MBS or USAT from 22 October 8th, 1986? 10540 1 A. No, I don't. 2 Q. I'd like to show you Exhibit B4104, 3 which Ms. Clark omitted to introduce. 4 MR. GUIDO: Do you have extra copies of 5 that with you for the Court? 6 MS. CLARK: I think everyone has a 7 copy. 8 Q. (BY MR. GUIDO) B4104 is a 9 representation letter, is it not, from Mr. Berner 10 to Peat Marwick transmitting minutes of the 11 various committees of USAT to -- and UFG to 12 Peat Marwick? 13 A. Yes. 14 Q. Okay. Was it the practice for you to 15 receive the investment committee minutes directly 16 from the client with a representation letter so 17 that you had the client's representation that 18 those were the complete and full set of the 19 minutes that were provided to you? 20 A. Yes, uh-huh. 21 Q. Now -- and would that letter accompany 22 the transmittals that you received from the 10541 1 client? 2 A. No, they would not. 3 Q. They would not? 4 A. Yeah. Normally, we would look at the 5 minutes prior to receiving the representation 6 letter. 7 Q. And they were minutes that were made 8 available to you by the client; is that correct? 9 A. Yes, uh-huh. 10 Q. I'd like to have you take a look at 11 Exhibit A1412, which has previously been admitted 12 in the record in this case. And I'm particularly 13 going to direct your attention to Page US34917. 14 MR. GUIDO: Your Honor, I move B4104 15 into the record while the witness is looking at 16 this document. 17 MS. CLARK: No objection. 18 THE COURT: Received. 19 A. I'm sorry. I lost the page that you 20 referred me to. 21 Q. (BY MR. GUIDO) I turned down the top 22 of the page for you. Now, this document that I've 10542 1 just shown you, Exhibit B -- A1412 is the 2 October 8th, 1986 minutes of the investment 3 committee of UFG and USAT. And that isn't in the 4 packet of materials that were listed under the 5 fourth quarter minutes of October 1986, B4064. 6 Do you know why? 7 A. No, I don't. 8 Q. Now, if you take a look at the page 9 that I've shown you, which is US34 -- is it -- 10 4917 I think is what it is. It says United's -- 11 A. US3004917. Appears to be. 12 Q. It says "United regarding 13 mortgage-backed security trading policy." 14 Do you see that? 15 A. Yes, I do. 16 Q. It says "It shall be the policy of 17 United Savings Association of Texas to undertake 18 trading activities related to the mortgage-backed 19 securities investment portfolio trading operation 20 from time to time in order to enhance the 21 profitability of the association." 22 Have you ever seen that policy before? 10543 1 A. I don't recall seeing that policy. 2 Q. Would that -- if you had seen that, 3 would that have affected your review of the 4 trading versus investment issue at USAT? 5 A. This would have been one of many things 6 considered in my review. 7 Q. Would it have resulted in closer 8 scrutiny of the trading versus investment issue 9 than had been undertaken at that time? 10 A. It's hard to say. There were many 11 things going on at that time and many 12 considerations. 13 Q. Okay. Now, you indicated that at the 14 time you left Peat Marwick that there was -- that 15 the trading versus investment literature had 16 changed or had altered. 17 When was it that you left Peat Marwick? 18 A. I left in '79. 1979. 19 Q. '79? 20 A. '89. Excuse me. I started in '79. I 21 left in '89. 22 Q. You left in 1989? 10544 1 A. Yes. 2 Q. What was the change that had occurred 3 in the trading versus investment literature during 4 that time period? 5 A. The change that I recall that most 6 profoundly affected us is that the requirement was 7 much stricter in terms of subsequent trading 8 activity, subsequent transactions, so that the 9 accounting literature got progressively more 10 strict in terms of allowing transactions to occur 11 in an investment portfolio. 12 Q. Well, did Peat Marwick, at the time you 13 were auditing USAT, have a guideline of 25 percent 14 of a turnover being permissible before it 15 triggered heightened scrutiny by Peat Marwick of 16 the portfolio? 17 A. I don't remember a guideline like that. 18 Q. Now, I'd like you to take a look at 19 Exhibit B1410, which Ms. Clark so kindly was able 20 to locate and I didn't show you. It is the 21 investment versus trading memorandum that you had 22 prepared in the file, but it had attached to it 10545 1 those two policies I showed you. 2 Do you recall those questions about 3 that? 4 A. Yes. 5 Q. Do either of those policies under 6 investment, in your view -- the one for 7 mortgage-backed securities and the one for 8 high-yield bond or junk bonds -- justify regularly 9 making sales out of the portfolio expressly for 10 the purpose of generating gains to bolster profits 11 and net worth? 12 A. Not expressly to generate gains and net 13 worth. 14 Q. Now, I'd like to show you one other 15 document that she showed you. It's Exhibit B4093, 16 which -- I'll show you my copy because it's 17 quicker. B4093, which are the minutes of -- 18 various packets of minutes which I think you 19 discussed as part of your first quarter review. 20 Do you recall her asking you questions 21 about that and particularly asking you about the 22 MPS portfolio activity sheet that was at 10546 1 KPMG 44639? Do you see that page? 2 A. Yes, I do. 3 Q. Can you tell us what that page refers 4 to? Do you know? 5 A. It is a listing of transactions that 6 have occurred in the mortgage-backed portfolio. 7 Q. And it has various columns, does it 8 not? 9 A. Yes, it does. 10 Q. It has portfolios that are mentioned 11 there. It has one that's mentioned as United MBS. 12 Do you see that? 13 A. Yes, I do. 14 Q. Do you understand that to be the Sandy 15 Laurenson portfolio? 16 A. Yes. 17 Q. Okay. And then it has a thing called 18 "spec." 19 Was that the speculative report that 20 you testified earlier that existed from January to 21 May of 1987? 22 A. I would assume that that is what that 10547 1 is. 2 Q. Okay. And then the third is USAT. Do 3 you see that reference? 4 A. Yes, I do. 5 Q. Is that the old Joe's portfolio? Do 6 you know? 7 A. The old Joe's portfolio -- 8 Q. Yeah. 9 A. I'm not familiar with the old Joe's 10 portfolio. 11 Q. You don't know anything about the old 12 Joe's portfolio? 13 A. No, I don't know anything. 14 Q. Is it your understanding that that's 15 the mortgage-backed securities that were held by 16 USAT directly? 17 A. I don't have an understanding. I would 18 assume that that would be correct. 19 Q. Then it has various columns. It has 20 MBS and it has descriptions and then it has 21 "purchase/sale" and then it has "yield pickup," 22 and then it has this column over here on the right 10548 1 called "accounting gain." 2 Do you see that? 3 A. Yes, I do. 4 Q. Do you know what that refers to? 5 A. I assume that refers to the gain or 6 loss from the purchase or sales transaction. 7 Q. The gain or loss? Is that what it 8 refers to? 9 A. The gap gain or loss? 10 Q. Yeah. Generally-accepted -- 11 A. It would be the gain or loss recognized 12 in accordance with GAAP. 13 Q. Thank you. Then I'd like to have 14 you -- also in your testimony in response to 15 Ms. Clark you looked at Exhibit B1555. And she 16 had you look at Page 0765 which talked about the 17 sale of loans. It says "Gain from sale of loans 18 primarily due to market opportunities available to 19 sell mortgage-backed securities. The market was 20 in the right direction in the fourth quarter of 21 1986 and first quarter of 1987, resulting in the 22 indicated gains." 10549 1 Do you see that? 2 A. Yes, I do. 3 Q. Is that the sets of transactions that 4 you testified earlier that triggered the writing 5 of your memorandum of trading versus investment 6 that resulted in the adoption of the policies that 7 you've just testified about with regard to -- 8 A. I don't think the timing would be 9 correct on that. 10 Q. No? Why not? 11 A. This is March of '87. 12 Q. Uh-huh. Now -- 13 A. I don't recall whether this led to that 14 memo or not, but it seems to me like this may be 15 later than that. I'm not sure. 16 Q. This says that sales were made for the 17 purposes of making gains to realize profits, 18 doesn't it? 19 A. No, it doesn't. 20 Q. Oh, okay. Why not? 21 A. It says it was due to market 22 opportunities. 10550 1 Q. What's a market opportunity other than 2 an opportunity to make a profit? Are there market 3 opportunities called market opportunities to make 4 a loss? 5 A. Market opportunity may incorporate a 6 profit. 7 Q. Well, you don't interpret that to mean 8 those sales were made to generate gains because 9 interest rates had gone down and, therefore, the 10 value of the mortgage-backed securities had gone 11 up, do you? 12 A. I would interpret this that, yes, the 13 value of the mortgage-backs or whatever security 14 had gone up, that's correct. 15 Q. Because of a decline in interest rates? 16 A. Yes. 17 Q. And that was the market opportunity 18 that resulted in the sale. Right? 19 A. That may have been the market 20 opportunity. That was probably the market 21 opportunity. 22 Q. Well, if that was the purpose, isn't 10551 1 that a reason to mark that portfolio to market as 2 a trading portfolio? Isn't that exactly what a 3 trading portfolio is? 4 A. No, not necessarily. 5 Q. No? And why not? 6 A. A market opportunity may be to -- as I 7 say, as I think is indicated here -- recognize an 8 opportunity to take an asset and make it a more 9 valuable asset. 10 Q. And how is that? 11 A. Well, there are many things that may be 12 considered, including duration of the term, 13 prepayment speeds, ability to invest in other 14 assets that may have been comparable returns. I 15 mean, there are many things that go into these 16 considerations. 17 Q. So, let me see if I can get your 18 definition of trading versus investment because 19 I'm a little confused now about what your 20 definition is. 21 If a sale is made out of a portfolio 22 for the express purpose of generating a gain, an 10552 1 accounting gain, a realized gain, that doesn't 2 trigger classification of the portfolio as a 3 trading portfolio? 4 A. If it is the express purpose of solely 5 creating a gain, I would say that it would not. 6 Q. It would not what? 7 A. Well, I would say that it's possible 8 that that would mean that it was trading. 9 Q. Okay. Now, isn't that exactly what 10 those words say there? 11 A. No, it's not. 12 Q. No? 13 A. No. 14 Q. What do those word say, then? 15 A. It says that there was a market 16 opportunity. 17 Q. Okay. And that could mean that there 18 may be a market opportunity to rebalance the 19 portfolio to more closely match the hedges and 20 assets? Is that what you're saying? 21 A. Yes. Well, it may be a market 22 opportunity to recognize a gain and invest in a 10553 1 comparable asset. 2 Q. Okay. 3 A. Lengthen maturities. 4 Q. Are you aware that the OTS has brought 5 or had brought an enforcement action against 6 Peat Marwick in part for its audit practices with 7 regard to auditing the trading versus investment 8 issue in savings and loans? 9 A. I'm aware there was an action. I'm not 10 familiar with the details of it. 11 Q. Okay. And were you aware that 12 Peat Marwick paid $186 million in restitution to 13 settle that action with the Office of Thrift 14 Supervision? 15 A. I was not aware it was that precise 16 amount. 17 Q. Okay. But you were aware it was 18 somewhere in the hundreds of millions of dollars? 19 A. I was aware that there was a settlement 20 and it was a significant amount. 21 Q. Were you aware that part of the 22 settlement involved a consent order directing 10554 1 Peat Marwick to alter its accounting practices 2 when applying the trading versus investment 3 criteria to savings and loans? 4 A. No, I wasn't. 5 MR. GUIDO: No further questions, Your 6 Honor. 7 THE COURT: Any recross? 8 MS. CLARK: No recross, Your Honor. 9 THE COURT: Thank you, Mr. Parsons. 10 You may step down. 11 MR. GUIDO: Thank you very much, 12 Mr. Parsons. 13 THE COURT: We'll adjourn until 14 10:00 o'clock on Monday. 15 MR. GUIDO: Your Honor, we have a 16 letter to deliver to you in response to 17 Mr. Villa's letter regarding the scheduling and 18 copies for all counsel. 19 MR. RINALDI: Your Honor, Mr. Villa and 20 Mr. Leiman have mutually agreed, I am told, that 21 if it's agreeable with the Court, they would like 22 to begin at 10:00 on Monday rather than -- 10555 1 THE COURT: I just said 10:00 o'clock. 2 MR. RINALDI: I'm sorry. You just said 3 what? My hearing isn't too good. I have a sinus 4 problem. 5 THE COURT: Are there other matters the 6 parties want to discuss? 7 MR. EISENHART: Not that I'm aware of, 8 Your Honor. 9 MR. NICKENS: Your Honor, I will want 10 an opportunity to respond to this letter since it 11 directly affects my schedule, and I will do so 12 promptly. 13 14 (Whereupon at 4:20 p.m. 15 the proceedings were recessed.) 16 17 18 19 20 21 22 10556 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 12th day of 17 December, 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 10557 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 12th day of 18 December, 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