SECTION FOUR

 

HIGH-YIELD BONDS –PURCHASES FROM AFFILIATED PARTY DBL AND SPECULATION TO GENERATE GAINS TO FORESTALL REGULATORY INTERVENTION

 

            J1.        The general subject matter of junk bonds is significant in this case for four reasons:  First, by virtue of its complex web of ownership interests in, and business arrangements with, MCO, FDC, and UFG, DBL was an affiliated party of USAT.  USAT realized significant losses on the sale of a number of DBL-underwritten junk bonds.  The OTS seeks restitution for those losses.

J2.        Second, the initiation and growth in the junk bond portfolio strongly corroborate OTS’ allegations that Hurwitz, MCO, and FDC controlled UFG and USAT.  The initial decision for USAT to enter the junk bond market as a purchaser was made by Hurwitz and other officers of FDC and MCO, not USAT or UFG, and the amounts of DBL-underwritten junk bonds, particularly bonds that were not “zero-coupon” bonds, purchased by USAT constituted a disproportionately large segment of USAT’s junk bond portfolio.  Moreover, the growth in the DBL-underwritten junk bonds paralleled growth in the amount of the junk bond issues underwritten by DBL for MCO and its affiliates.  These facts further demonstrate FDC’s and MCO’s actual control of UFG and USAT and the manner in which that control was exercised in order to enhance the mutually beneficial relationship between MCO/FDC and DBL.

J3.        Third, the pattern of activity in the junk bond portfolio, i.e., “gains trading,” is corroborative of a similar pattern of activity in the MBS portfolio.  Fourth and finally, when questioned about USAT’s junk bond activities, the management of UFG misrepresented the nature of those activities to the regulators.  Management’s misrepresentations concerning USAT’s junk bond portfolio and activities are described fully in Section Six below at S68 - S83 and S133 - S143.

I.                  Introduction: A Chronology Of DBL’s Relationships With MCO And FDC And Other Relevant Events                                                                                                

 

            J4.        DBL’s relationships with MCO, FDC, and UFG were discussed in detail above at A39 - A47, A66 - A118.  The following is a chronological recapitulation of that earlier discussion, with some additional information.  DBL assisted MCO and FDC in acquiring 612,185 shares of UFG common stock and 68,550 shares of First American Financial common stock (equal to 47,985 shares of UFG stock) beginning with transactions in May and October 1982 and continuing through the filing of the H-(e)1 Application in June 1983.  DBL made only four sales of UFG stock, totaling 40,900 shares, to third parties during that period.  DBL also acquired approximately 790,000 shares of UFG stock after June 1983 with the intention of selling it to MCO pursuant to the Stock Option Agreement, but because of NASD rules DBL was able to place only 300,000 shares under the put-call option arrangement.  DBL nevertheless retained the remaining 490,000 shares for several years afterward, clearly intending to transfer them to MCO, but ultimately selling them at a substantially lower price than it paid after MCO withdrew its holding company application.

J5.        The timing of the various transactions and events was as follows:

· December 1981 – FedRe began to purchase UFG common stock.  Ex. A-2061, Tab 37, p. 4.

 

· At least as early as December 1981 – Michael and Lowell Milken owned 101,000 shares of MCO common stock.  Ex. T-1217, Tab 219.

 

· March 25, 1982 – The Ludwig offer to purchase UFG was withdrawn.  Ex. A-1681, Tab 137.

 

· May 11, 1982 – FedRe purchased 139,325 additional shares of UFG common stock from the DBL “42 Account.”  FedRe made no additional purchases until the following October.  Ex. T-1206, Tab 216 (OW026136); Ex. A-2063, Tab 37 (MX 007149).

 

· May 18, 1982 – FedRe reported its purchase May 11 purchase in Amendment 2 to Schedule 13D and stated that it then held 711,000 shares (12.03%) of UFG common stock.  Ex. A-2063, Tab 37.

 

· May 19 & 20, 1982 – The Milkens acquired an additional 12,000 shares of MCO common stock, for a total of 113,000 shares.  Ex. T-1217, Tab 219.

 

· July 1982 – DBL purchased MCO’s Zero Coupon Senior Subordinated Notes for $3,496,620.11.  The proceeds were added to MCO’s working capital and were to be used for general corporate purposes.  Ex. Lazard 1, Tab 76.

 

· August 1982 – DBL began to acquire shares of FDC in the “42 Account” administered by the DBL High Yield Bond Department.  Ex. A-14005, Tab 1356, Attachment B, p. 1.

 

· “As of” October 1, 1982 – MCO entered into the loan agreement whereby MCO would lend funds to FDC for the purchase of additional shares of UFG common stock, subject to a call option whereby MCO could acquire the shares in lieu of repayment of advances under the loan agreement.  Ex. T-1014, Tab 9.

 

· October 6, 1982 – DBL purchased UFG common stock (10,000 shares) in the “42 Account” for the first time since May 11, 1982.  Ex. T-1213, Tab 224, p. 1; Ex. T-1206, Tab 216, p.4 (OW026136).

 

· October 11, 1982 – Using funds advanced by MCO, FDC acquired additional shares of UFG common stock (from DBL) for the first time since May 11, 1982.  Ex. T-1206, Tab 216 (OW026136); Ex. A-2063, Tab 37 (MX 007149).

 

· October 1982 through June 1983 – DBL continued to acquire shares of UFG common stock in the “42 Account” for resale to FDC or MCO.

 

· June 29, 1983 – MCO and FDC filed their holding company application, Form H-(e)1.  Together with the Kozmetskys, they owned 1,996,980 shares of UFG stock.  They had purchased 660,170 UFG shares or share-equivalents (converted First American Financial stock) directly from DBL.  See A40 above.

 

· June 29, 1983 – Roni Fischer of MCO forwarded the first “EXCO” memorandum to Munitz at the request of Paul Schwartz, in which it was suggested that a third party should acquire UFG stock for ultimate transfer to MCO.  Ex. T-1041, Tab 58.

 

· July 11,1983 – DBL began to accumulate UFG common stock in the “42 Account.”  Ex. T-1213, Tab 224, p. 3.

 

· March 29, 1984 – Huebsch recommended to Gerald Williams that USAT establish “a centralized trading and investment facility” to handle both short term assets and “longer -term assets like high yield bonds and commons.”  Ex. T-4061, Tab 173, pp. 1, 3.

 

· July 5, 1984 – USAT first approached the Texas Savings and Loan Department to request approval of investments in junk bonds.  Ex. B-355, Tab 160.

 

· July 24, 1984 – USAT received approval of investments in junk bonds from the Texas Savings and Loan Department.  Ex. B-356, Tab 161.

 

· July to September 1984 – USAT began to purchase junk bonds, including junk bonds underwritten by DBL.  See J10 below.

 

· September 1984 – USAT hires Joseph Phillips to manage the junk bond portfolio.  Tr. 5,022: 19-20.

 

· November 1984 – Mr. Schwartz forwarded to Mr. Deremer three proposed “EXCO” transactions involving 585,000 shares of UFG common stock and 47,700 shares of UFG preferred stock.  Ex. T-1055, Tab 60; Ex. T-1056, Tab 61.

 

· December 24, 1984 – FHLBB approved the MCO/FDC H-(e)1 Application subject to several conditions, including a net worth maintenance condition.

 

· January 1985 – MCO and EF Hutton engaged unsuccessfully in negotiations for Hutton’s purchase of 585,000 shares of UFG common stock from DBL, subject to a put/call agreement with MCO.  See A74 - A79 above.

 

· February 11, 1985 – MCO and DBL began the negotiations that led to the Stock Option Agreement.  See A81 above.

 

· February 13, 1985 – DBL filed its first Schedule 13G with respect to UFG common stock, disclosing for the first time to the public that DBL owned 585,000 shares of UFG common stock.  Ex. T-1063, Tab 42; Ex. A-3075, Tab 50.

 

· May 21, 1985 – DBL underwrote a $150 million public debt offering for Maxxam Group, Inc., an MCO subsidiary.  Ex. Lazard 19, Tab 69.

 

· July 31, 1985 – DBL underwrote a $35 million debt offering for MCO.  Ex. Lazard 19, Tab 69.

 

· September 30, 1985 – USAT held $131,750,000 par value of DBL-underwritten junk bonds (45.12% of the USAT portfolio by par value).  Of that amount, $89,750,000 were DBL-underwritten “coupon” junk bonds (42.51% of the USAT “coupon” bond portfolio by par value).  See J20, J22 below.

 

· December 1, 1985 – DBL acquired warrants to purchase 250,000 shares of Maxxam Group, Inc. stock.  Ex. T-4140, Tab 202.

 

· December 2, 1985, DBL underwrote two private placements of debt aggregating $350 million in connection with the acquisition of Pacific Lumber.  Ex. Lazard 19, Tab 69.

 

· During the negotiation of the Stock Option Agreement, DBL continued to acquire shares of UFG common stock until it reached a level of 790,159 shares on December 13, 1985.  Ex. T-1213, Tab 224, p. 12.

 

· December 24, 1985 – MCO and DBL entered into the Stock Option Agreement with respect to 300,000 shares of UFG common stock.  DBL continued to hold the additional (approximately) 490,000 shares despite the NASD’s unwillingness to grant a waiver so that they could be included in the Stock Option Agreement.  See A93 above.

 

· December 31, 1985 – USAT held $178,295,000 par value of DBL-underwritten junk bonds (66.51% of the USAT portfolio by par value).  Of that amount, $124,150,000 were DBL-underwritten “coupon” junk bonds (62.57% of the USAT “coupon” bond portfolio by par value).  See J 20, J 22 below.

 

· March 31, 1986 – USAT held $221,700,000 par value of DBL-underwritten junk bonds (66.58% of the USAT portfolio by par value).  Of that amount, $193,000,000 were DBL-underwritten “coupon” junk bonds (70.76% of the USAT “coupon” bond portfolio by par value).  See J 20, J 22 below.

 

· June 1986 – DBL underwrote one private placement of debt and three public debt offerings in connection with the acquisition of Pacific Lumber aggregating $1,160,472,000.  Ex. Lazard 19, Tab 69.

 

· June 30, 1986 – USAT held $266,180,000 par value of DBL-underwritten junk bonds (58.00% of the USAT portfolio by par value).  Of that amount, $165,750,000 were DBL-underwritten “coupon” junk bonds (58.88% of the USAT “coupon” bond portfolio by par value).  See J 20, J 22 below.

 

· June -September 1986 – DBL acquired 233,600 shares of MCO common stock in the High Yield Bond Department’s “42 Account.”  Ex. A-14005, Tab 1356, Attachment A; Ex. A-14002, Tab 1353, p. 17; Tr. 14,345: 5 - 14,347: 10.

 

· September 30, 1986 – USAT held $228,530,000 par value of DBL-underwritten junk bonds (46.74% of the USAT portfolio by par value).  Of that amount, $133,800,000 were DBL-underwritten “coupon” junk bonds (50.00% of the USAT “coupon” bond portfolio by par value).  See J20, J22 below.

 

· December 31, 1986 – USAT held $286,830,000 par value of DBL-underwritten junk bonds (49.64% of the USAT portfolio by par value).  Of that amount, $215,100,000 were DBL-underwritten “coupon” junk bonds (67.54% of the USAT “coupon” bond portfolio by par value).  See J20, J22 below.

 

· December 31, 1986 – Combined DBL and Milken holdings of MCO stock were 346,600 (6.19% of the outstanding) shares.  Ex. T-1218, Tab 222.  Their combined holdings continued at this level throughout 1987.  See the calculations above at A41, A42.

 

· March 31, 1987 – USAT held $285,180,000 par value of DBL-underwritten junk bonds (50.12% of the USAT portfolio by par value).  Of that amount, $263,450,000 were DBL-underwritten “coupon” junk bonds (61.73% of the USAT “coupon” bond portfolio by par value).  See J20, J22 below.

 

· May 1987 – DBL disposed of its FDC shares in the “going private” transaction.  Ex. A-14005, Tab 1356, Attachment B, p. 4; Tr. 14,358: 10-16.

 

· June 30, 1987 – USAT held $289,680,000 par value of DBL-underwritten junk bonds (50.31% of the USAT portfolio by par value).  Of that amount, $254,450,000 were DBL-underwritten “coupon” junk bonds (57.69% of the USAT “coupon” bond portfolio by par value).  See J20, J22 below.

 

· September 1987 – DBL began to liquidate its position in UFG common stock.  Ex. T-1213, Tab 224, pp. 17-18.

 

· September 30, 1987 – USAT held $320,080,000 par value of DBL-underwritten junk bonds (48.65% of the USAT portfolio by par value).  Of that amount, $274,850,000 were DBL-underwritten “coupon” junk bonds (59.34% of the USAT “coupon” bond portfolio by par value).  See J20, J22 below.

 

· November 20, 1987 – UFG common stock traded for less than $1.00 for the first time; DBL held 674,324 shares of UFG common stock.  Ex. T-1213, Tab 224, p. 17.

 

· December 18, 1987 – DBL held 638,024 shares of UFG common stock.  Ex. T-1213, Tab 224, p. 18.

 

· December 22, 1987 – Resolution No. 84-712, which authorized MCO and FDC to become savings and loan holding companies, lapsed.

 

· December 24, 1987 – DBL held 584,049 shares of UFG common stock.  Ex. T-1213, Tab 224, p. 18.

 

· December 31, 1987 – USAT held $343,080,000 par value of DBL-underwritten junk bonds (49.14% of the USAT portfolio by par value).  Of that amount, $290,000,000 were DBL-underwritten “coupon” junk bonds (58.53% of the USAT “coupon” bond portfolio by par value).  See J20, J22 below.

 

· March 31, 1988 – USAT held $308,2800,000 par value of DBL-underwritten junk bonds (44.16% of the USAT portfolio by par value).  Of that amount, $255,200,000 were DBL-underwritten “coupon” junk bonds (55.75% of the USAT “coupon” bond portfolio by par value).  See J20, J22 below.

 

· April 18-22, 1988 – The Milken brothers sell 41,000 shares of MCO stock.  Ex. T-1217, Tab 219.

 

· May 10, 1988 – The Milken brothers transfer their remaining 72,000 shares of MCO to their personal accounts.  Ex. T-1217, Tab 219.

 

· June 17, 1988 – DBL’s holdings of UFG stock were down to 300,000 shares, the number of shares subject to the Stock Option Agreement.  Ex. T-1213, Tab 224, p. 18.

 

· June 30, 1988 – USAT held $316,555,000 par value of DBL underwritten junk bonds (48.84% of the USAT portfolio by par value).  Of that amount, $262,475,000 were DBL-underwritten “coupon” junk bonds (59.74% of the USAT “coupon” bond portfolio by par value).  See J20, J22 below.

 

· September 30, 1988 – USAT held $289,980,000 par value of DBL underwritten junk bonds (48.58% of the USAT portfolio by par value).  Of that amount, $235,900,000 were DBL-underwritten “coupon” junk bonds (60.17% of the USAT “coupon” bond portfolio by par value).  See J20, J22 below.

 

· December 21, 1988 – DBL dismissed Michael Milken.  Ex. A-14171, Tab 2017, p. 110 (BV3 001177).

 

· December 30, 1988 – UFG common stock deleted from NASDAQ.  Ex. T-1213, Tab 224, p. 19.

 

· December 30, 1988 – USAT held $235,830,000 par value of DBL-underwritten junk bonds (48.58% of the USAT portfolio by par value).  Of that amount, $181,750,000 were DBL-underwritten “coupon” junk bonds (58.94% of the USAT “coupon” bond portfolio by par value).  See J20, J22 below.

 

· In addition to the foregoing, DBL also provided substantial reverse repurchase and dollar roll financing for USAT and UFG.  Ex. A-10566, Tab 176; Ex. A-3021, Tab 1161; Ex. A-3022, Tab 719; Ex. A-3023, Tab 79; Ex. A-3024, Tab 81; Ex. T-4398, Tab 1147; Ex. T-4428, Tab 1148; Ex. T-4436, Tab 1149; Ex. T-4449, Tab 1151; Ex. T-4478, Tab 1153; Ex. T-4501, Tab 1154; Ex. T-4512, Tab 1155; Ex. T-4514, Tab 1156; Ex. T-4536, Tab 1146.

 

II.               The Origin And Growth Of USAT’s Junk Bond Portfolio

 

A.                Initial Purchases Of Junk Bonds:  The Role of Hurwitz, FDC, And MCO

 

            J6.        On March 29, 1984, Huebsch suggested to Gerald Williams that USAT should “establish a centralized trading and investment facility staffed with full-time professionals.”  Ex. T-4061, Tab 173, p. 1.  One of the areas recommended for the attention of the investment department would be “longer-term assets like high-yield bonds and commons.”  Id.  At the time, Mr. Huebsch was an employee of FDC, not an officer of USAT.  Tr. 13,413: 4 - 13,419: 21.  He did not become an officer of USAT until February 1985.  Tr. 13,419: 1-21; Ex. A-1090, Tab 125.  He continued to be an employee of FDC at all relevant times.  Tr. 13,407: 2 - 13,408: 14.  The trading room did not actually come into existence until late in 1984, at the earliest.  Arrangements were still being discussed as late as November 30, 1984, and virtually all of the arrangements for the trading room were to be made by FDC, but were to be billed directly to USAT, except for those expenses that FDC incurred directly, such as its lease of space.  See Ex. B-391, Tab 576 (November 30, 1984 memorandum from James Paulin to Munitz with copies to Hurwitz, Huebsch, and Gerald Williams).

J7.        The trading room was physically located within the offices of FDC, Tr. 5,035: 14 - 5,036: 19, even though the equipment described in Mr. Paulin’s memorandum apparently could have been installed in the offices of USAT, since the primary requirement appears to have been telephone access.  Ex. B-391, Tab 576.  It appears that the location was more for the convenience of FDC than of USAT.  See Tr. 26,290: 19 - 26,291: 4 (Hurwitz) (“It … was  a lot cheaper and a lot more convenient” to have UFG use FDC’s pre-existing trading facilities.)  Mr. Phillips was required to maintain two offices, one at FDC and one at USAT.  See Tr. 5,037: 9-10.  He testified that he spent approximately one-third of his time in the FDC offices.  Id.  While there, he would “review the trader's logs to see what she had been shown that day, to understand what new issues might be coming to market, speaking with Mr. Huebsch about the market, and reviewing strategy with him.”  Tr. 5,037: 13-17.  Since the equipment and trader could have been located at USAT, the only factor militating in favor of locating the trading room at FDC was that Huebsch was there.

J8.        Huebsch testified that even though he was not an officer of USAT, he worked on USAT’s behalf at the request of “Gerry Williams, Charles Hurwitz, people like that.”  Tr. 13,420: 3-5.  Huebsch stated that “[O]ne of the first things [he] did [on USAT’s behalf] … was to search out and find somebody who might be capable of managing fixed-income investments.”  Tr. 13,421: 16-19.  That “somebody” turned out to be Joseph Phillips.  Id. 13,421: 20-22.  In addition to searching for a fixed-income manager, Huebsch testified that he did “planning work on mortgage backs” “in the latter half of 1984.”  Tr. 13,422: 16-20.  He also acknowledged that he  and others “talked about getting a trading facility, a trading room.”  Tr. 13,422: 22 - 13,423: 1.

J9.        Most important, however, Huebsch was instrumental in establishing the USAT junk bond portfolio prior to USAT’s hiring of Mr. Phillips.  Huebsch described the process in the following colloquy:

Q.   Did you purchase high-yield bonds on behalf of USAT at the time [the latter half of 1984, see Tr. 13,422: 16-19].

 

A.    We did purchase some high-yield bonds.

 

Q.   When you say “we,” who are you talking about?

 

A.    Well, the association.

 

Q.   The association bought some high-yield bonds?

 

A.    Yes, that’s right.

 

Q.   Okay.  Who did the research to select the bonds?

 

A.    I did some of the research.

 

Q.   Who else?

 

A.    We would – we would see – they were mainly floating rate notes.  And I would, you know, get a list of them; and I would chat with people like Mr. Hurwitz and Jerry Williams if they had any, you know, idea or merits of these credits.  You know, I would check the credits myself.  And we would, you know, reach a consensus on which ones we thought were the better.

 

Q.   Who actually asked you to research the potential investment in high-yield bonds?

 

A.    Mr. Hurwitz did.

 

Tr. 13,423: 5 - 13,424: 6.

            J10.      USAT initially sought permission from the TX S&L to purchase junk bonds on July 5, 1984.  Ex. B-355, Tab 160 (TXS&L 102806-08).  Prior to Mr. Phillips arrival, USAT had purchased $50 million par value of seven separate issues.  Ex. B-371, Tab 163, pp. 1-2; Tr. 5,023:1 - 5,024: 4.  Mr. Phillips was informed of the particular holdings through documentation supplied to him by Huebsch.  Tr. 5,025: 13-20.  At the time, Huebsch was an employee of FDC who reported to Hurwitz.  Tr. 5,025: 19 - 5,026: 13.  Crow identified Huebsch and Hurwitz as the only people associated with UFG or USAT who could have managed the junk bond portfolio prior to Mr. Phillips arrival.  Tr. 15,306: 18 - 15,307: 1.  Huebsch agreed, testifying that he knew of no one in senior management, except Hurwitz, who had any experience with high yield bonds.  Tr. 13,504: 1 - 13,506: 2.  Hurwitz, himself, did not deny that he had experience, but, as with so much of his testimony, he stated that he was unable to recall any conversations or events relating to junk bonds.  Tr.  26,143: 7-17; Tr. 26,149: 4-12; Tr. 26,205: 4-15.

            J11.      By December 6, 1984, USAT’s junk bond portfolio had grown to $108.75 million par value.  Ex. B-398, Tab 164 (CN156422); Tr. 5,028: 6-18.  The bulk of the additional $58.75 million in par value had been underwritten by DBL ($15 million Occidental Petroleum, and $25 million Metromedia Broadcasting, including $15 million Metromedia zero-coupon bonds).  See Ex. B-4251, Tab 2012, Exhibit 3.  Before undertaking those purchases, Mr. Phillips consulted with, inter alia, Huebsch.  Tr. 5,029: 6-12.  Subsequently, on December 15, 1984, USAT purchased an additional $10 million in Occidental Petroleum junk bonds underwritten by DBL.  Id. p. 22.

            J12.      As discussed above at A348 - A351, neither these nor subsequent purchases of high-yield bonds had been approved by the USAT Board of Directors.  Moreover, no officer, director, or employee of USAT had any experience or knowledge concerning high-yield bonds until Phillips and Huebsch were employed in September 1984 and February 1985, respectively.  No senior manager had the qualifications to supervise these investment managers.  Indeed, it was the consensus of the Strategic Planning Committee in April 1985 that only Hurwitz had the qualifications to monitor the investment process and determine the quality of some of the investments made by the association.  See UFG’s Mission Statement (attached to Ex. A-10560, Tab 174 (OW004596)).  See also, A312 - A318.

            J13.      From the very beginning, USAT represented that the goal of the junk bond portfolio was to manage the portfolio to provide spread income.  On December 6, 1984, Mr. Bentley wrote to the Commissioner of the Texas Savings and Loan Department enclosing documentation in preparation for a meeting later that month.  Ex. B-398, Tab 164.  The enclosed schedules showed that, when matched against brokered CD’s, the junk bond portfolio had a positive spread of 257 basis points, or 2.57%.  Id. (CN156421).  In a memorandum dated December 12, 1984, Mr. Phillips described the meeting between himself and Mr. Bentley, for USAT, and Mr. Anderson, Deputy Commissioner of the Texas Savings and Loan Department:

Mr. Bentley and I discussed … our program in corporate bonds and brokered deposits.

 

*          *          *

 

We presented Mr. Anderson with a list of the nonliquidity portfolio and a sample of the asset-liability matching analysis that I proposed for use internally.  I told Mr. Anderson that we would manage the maturity matching as well as the spread on this new business component.  Mr. Anderson informed us that a  monthly report, in arrears, describing the portfolio, and its matching would provide sufficient information for him to approve our activities without the frequent attempts at preclearance as investment opportunities may develop and disappear.

 

Ex. B-405, Tab 165; see Tr. 5,030: 13 - 5,035: 3.  Mr. Phillips explained in his testimony:

            The portfolio objective was to earn a protected spread, a spread protected by this match so that interest rate movements would not affect the return potential of the portfolio over time.  And in so doing, we would keep the portfolio balance as the durations might change or shift and that the spread would be the objective.

 

Tr. 5,034: 1-7.

 

            J14.      Mr. Phillips reported to Gerald Williams during the first six months of his employment, but “[He] consulted on virtually everything with Ron Huebsch.”  Tr. 5,035: 10-11.  During that time, all USAT junk bond trading was conducted through the trading room Huebsch had set up in the MCO office building, in the FDC/MCO suite, by a trader hired by USAT, but permanently housed in the  MCO offices.  Tr. 5,035: 12 - 5,038: 9; 5,039: 19-21.  Neither FDC nor MCO purchased any junk bonds.  Tr. 5,038: 13-20.

B.                Junk Bond Purchases By USAT From DBL

 

1.                 Expert Testimony Concerning USAT’s Junk Bond Transactions

 

J15.      The OTS and the respondents each retained an expert witness to testify concerning the transactional data relating to USAT’s junk bond purchases and sales.  Each prepared a report that calculated losses in a manner that was consistent with the legal theories of the party that had retained him or her.  There is substantial agreement between them concerning the financial effects of specific transactions; neither attacks the other’s calculations as mathematically incorrect.  Moreover, Dr. Benveniste testified that although there were, in his view, certain unspecified errors in Ms. Suder’s database, those errors were “relatively insignificant.”  Tr. 27,825: 1-11.

J16.      The differences between their reports are due to the differing scopes of their assignments.  In accordance with its legal theory that each junk bond investment must be evaluated individually, the OTS instructed Ms. Suder to calculate principal losses with respect to each junk bond on which there was a principal loss.  The respondents, who argue that the junk bond portfolio must be considered as a whole, instructed Dr. Benveniste to calculate the profitability of the junk bond portfolio as a whole and the profitability of all DBL underwritten junk bonds.  Thus, his report covers a larger universe of securities than Ms. Suder’s, and his calculations went to the net gain or loss on the portfolio as a whole and included the effects of interest payments received and the costs of financing the portfolio.  Dr. Benveniste also examined the diversification by SSIC code of USAT’s junk bond portfolio.

J17.      Not surprisingly, Ms. Suder’s calculations showed a loss, whereas Dr. Benveniste’s calculations showed a gain, in the portfolio.  Neither Ms. Suder nor Dr. Benveniste expressed an opinion as to whether the law compels the Court to accept a particular calculation of losses.  The Court accepts as factually and mathematically accurate the calculations of both Ms. Suder and Dr. Benveniste.  The Court addresses the proper application of the law to those calculations in its Conclusions of Law.

2.                 A Substantial Portion Of Junk Bonds Purchased By USAT Were Underwritten By DBL                                                                                   

 

            J18.      As noted above, Ms. Suder’s analysis limited itself to those DBL-underwritten junk bonds on which USAT incurred a principal loss.  Dr. Benveniste, however, compiled a list of all DBL-underwritten junk bonds purchased by USAT in order to assess the profitability of the portion of the junk bond portfolio that had been underwritten by DBL.  Ex. B-4251, Tab 2012, Exhibit 3.  He also compiled the quarterly balances of junk bonds, both DBL-underwritten and non-DBL-underwritten.  Ex. B-4384, Tab 2014.

            J19.      In addition, Dr. Benveniste compiled data concerning the composition of the junk bond portfolio as between DBL-underwritten and non-DBL- underwritten junk bonds at the end of each quarter from mid-1984 through the end of 1988.  The Court has extracted the following data from Ex. B-4384, Tab 2014, using the “MAXXAM data,” that is, the information provided by Ms. Suder from the LECG database as supplemented by Dr. Benveniste.  This information presents the junk bond portfolio in the light most favorable to the respondents.

            J20.      At first blush, the junk bond portfolio appears to be somewhat biased toward DBL-underwritten junk bonds, although, the respondents would argue, not overly biased given DBL’s well-documented dominance in the junk bond market.  See, e.g., Ex. A-14171, Tab 2017, p. 108 (BV3 001175).  The quarter-end par value balances[1] (000’s omitted) of DBL- and non-DBL-underwritten bonds are set forth below:

Quarter

Total (Par)

Non-DBL (Par)

DBL (Par)

DBL   as a %age of Total

 

 

 

 

 

1984-3

25,000

20,000

5,000

20.00%

1984-4

125,750

53,750

72,000

57.25%

1985-1

263,700

140,250

123,450

46.81%

1985-2

337,660

185,600

152,060

45.03%

1985-3

291,950

160,200

131,750

45.12%

1985-4

268,045

89,750

178,295

66.51%

1986-1

332,950

111,250

221,700

66.58%

1986-2

458,930

192,750

266,180

58.00%

1986-3

488,880

260,350

228,530

46.74%

1986-4

577,780

290,950

286,830

49.64%

1987-1

568,945

283,765

285,180

50.12%

1987-2

575,769

286,089

289,680

50.31%

1987-3

657,895

337,815

320,080

48.65%

1987-4

698,045

354,965

343,080

49.14%

1988-1

643,045

334,765

308,280

44.16%

1988-2

648,342

331,787

316,555

48.84%

1988-3

596,825

306,845

289,980

48.58%

1988-4

505,922

270,092

235,830

48.58%

 

See Ex. B-4384, Tab 2014 (BV3 001736- 37).

J21.      However, when “coupon” bonds[2] and zero-coupon bonds are considered separately, a very different, and much more biased, pattern emerges.  The Court considers “coupon” bonds separately from zero-coupon bonds because zero-coupon bonds typically sell at a very substantial discount from their par values, as for example, the MCO $260 million zero-coupon notes, which were sold to DBL for approximately $3.6 million.  Thus, a comparison of zero-coupon bonds with “coupon” bonds on the basis of their par values is essentially meaningless.  Nevertheless, it is useful to compare the aggregate par values of DBL-underwritten “coupon” bonds with the aggregate par values of “coupon” bonds underwritten by other investment bankers.  Similarly, it is somewhat, but less, useful to compare the aggregate par values of zero-coupon bond underwritten by DBL with the aggregate par values of zero-coupon bonds underwritten by other investment bankers, because the possible variations in terms, maturities, and imputed interest rates makes the initial values of such bonds less comparable.

J22.      The following chart, prepared based upon Dr. Benveniste’s “MAXXAM data,” shows a very sharp rise in USAT’s holdings of DBL-underwritten “coupon” bonds beginning in mid- to-late 1985, at approximately the same time as MCO and its affiliates began to engage in large-scale junk bond financing through DBL.  USAT’s end-of-quarter “coupon” bond balances (000’s omitted) were as follows according to Dr. Benveniste:

Quarter

Total Coupon (Par)

Non-DBL Coupon (Par)

DBL Coupon (Par)

DBL Coupon  as a %age of Total

 

 

 

 

 

1984-3

25,000

20,000

5,000

20.00%

1984-4

58,750

38,750

20,000

34.04%

1985-1

188,700

132,250

56,450

29.91%

1985-2

224,350

143,350

81,000

36.10%

1985-3

211,100

121,350

89,750

42.51%

1985-4

198,400

74,250

124,150

62.57%

1986-1

272,750

79,750

193,000

70.76%

1986-2

281,500

115,750

165,750

58.88%

1986-3

267,550

133,750

133,800

50.00%

1986-4

318,450

103,350

215,100

67.54%

1987-1

426,715

163,265

263,450

61.73%

1987-2

441,039

186,589

254,450

57.69%

1987-3

463,165

188,315

274,850

59.34%

1987-4

495,465

205,465

290,000

58.53%

1988-1

457,715

202,515

255,200

55.75%

1988-2

439,352

176,877

262,475

59.74%

1988-3

391,995

156,095

235,900

60.17%

1988-4

308,342

126,592

181,750

58.94%

 

See Ex. B-4384, Tab 2014 (BV3 001736-37).

J23.      At the same time, DBL-underwritten zero-coupon  bonds generally declined as a percentage of all zero-coupon bonds.  A compilation regarding zero-coupon bonds (000’s omitted) is set forth below:

Quarter

Total Zero Coupon (Par)

Non-DBL Zero-Coupon (Par)

DBL Zero-Coupon (Par)

DBL Zero-Coupon as a %age of Total

 

 

 

 

 

1984-3

0

0

0

Not Meaningful

1984-4

67,000

15,000

52,000

77.61%

1985-1

75,000

8,000

67,000

89.33%

1985-2

113,310

42,250

71,060

62.71%

1985-3

80,850

38,850

42,000

51.94%

1985-4

69,645

15,500

54,145

77.74%

1986-1

60,200

31,500

28,700

47.67%

1986-2

177,430

77,000

100,430

56.60%

1986-3

221,330

126,600

94,730

42.80%

1986-4

259,330

187,600

71,730

27.65%

1987-1

142,230

120,500

21,730

15.27%

1987-2

134,730

99,500

35,230

26.14%

1987-3

194,730

149,500

45,230

23.22%

1987-4

202,580

149,500

53,080

23.22%

1988-1

185,330

132,250

53,080

28.64%

1988-2

208,990

154,910

54,080

25.87%

1988-3

204,830

150,750

54,080

26.40%

1988-4

197,580

143,500

54,080

27.37%

 

See id.

 

III.            Gains Trading

 

            J24.      Initially, there is an intellectual resistance to the concept of “gains trading.”  As the respondents pointed out on numerous occasions during the hearing in this matter, one of the fundamental reasons for making an investment is to realize gains.  That argument, however, begs the question posed by the OTS.  The concern is not so much with trading per se, but with accounting for the securities as if they had been purchased for investment, which leads to inconsistent and misleading treatment of gains and losses.  The crux of the OTS’s allegations concerning gains trading is that the gains were in fact illusory, generated for accounting purposes, but not reflective of economic reality.  Essentially, the OTS charges that, on a regular basis, the respondents caused USAT to sell securities from an investment portfolio for an accounting gain to be recognized on its financial statements while worsening the economic position of the institution both by retaining devalued securities in the portfolio and replacing the securities sold with lower-yielding securities.  This practice both deferred recognition of the losses on the devalued securities and traded future earnings and earning power for current income.

J25.      Neil Twomey, the Supervisory Agent for USAT during much of the relevant time, described the foregoing practice as “cherry picking” or “sweeping the portfolio for profits,” Tr. 23,607: 16 - 23,608: 13, which meant that “you might sweep the account by picking the [bonds] with the most profits and selling them so you could realize a gain which would then impact on your bottom line.”  Tr. 23,607: 14 - 23,608: 4.

J26.      This concern is hardly a figment of the regulatory imagination.  The practice of gains trading and other speculative securities activities were prevalent enough in the industry to cause the Federal Financial Institutions Examination Council to issue a Supervisory Policy Statement on the subject in early 1988.  Ex. B-4193, Tab 1180.  The background section stated:

The depository institution regulators have become aware of speculative activity which has taken place in a number of depository institutions’ investment portfolios.  Certain of these institutions have failed because of the speculative activities, and other institutions have been weakened significantly as their earnings and capital have been impaired and the liquidity of their securities have been eroded by the depreciation in their market value.

 

Id. at CN101326.  The Statement described a number of objectionable investment practices:

Depository institution directors are responsible for prudent administration of investments in securities.  An investment portfolio has traditionally been maintained by a depository institution to provide earnings, liquidity, and a means of diversifying risks.  When investment transactions are entered into in anticipation of taking gains on short-term price movements, the transactions are no longer characteristic of investment activities and should be conducted in a securities trading account.  Securities trading of the types described in section I of the attached appendix will be viewed as unsuitable activities when they are conducted in a depository institution’s investment account.  Securities trading should take place only in a closely supervised trading account and be undertaken only by institutions that have strong capital and current earnings positions.

 

Id. at CN101328 (emphasis added).

J27.      The Appendix to the FFIEC Supervisory Policy Statement dealt generally with trading in an investment portfolio and also defined objectionable practices, including “gains trading.”

I.       TRADING IN THE INVESTMENT PORTFOLIO

 

Trading in the investment portfolio is characterized by a high volume of purchase and sale activity, which when considered in light of a short holding period for securities, clearly demonstrates management’s intent to profit from short-term price movements.  In this situation, a failure to follow accounting and reporting standards applicable to trading accounts may result in a misstatement of the depository institution’s income and a filing of false regulatory reports and other published financial data.  It is an unsafe and unsound practice to record and report holdings of securities that result from trading transactions using accounting standards which are intended for investment portfolio transactions; therefore, the discipline associated with accounting standards applicable to trading accounts is necessary.  Securities held in trading accounts should be marked to market or the lower of cost or market, periodically with unrealized gains or losses recognized in current income.  Prices used in periodic reevaluations should be obtained from sources that are independent of the securities dealer doing business with the depository.

 

The following practices are considered to be unsuitable when they occur in a depository institution’s investment portfolio.

 

A.    “Gains Trading”

 

“Gains trading” is a securities trading activity conducted in an investment portfolio, often termed “active portfolio management.”  “Gains trading” is characterized by the purchase of a security as an investment and the subsequent sale of that security at a profit within several days or weeks.  Those securities initially purchased with the intent to resell are retained as investment portfolio assets if they cannot be sold at a profit.  These “losers” are retained in the investment portfolio because investment portfolio holdings are accounted for at cost, and losses are not recognized unless the security is sold.  “Gains trading” often results in a portfolio of securities with extended maturities, lower credit quality, high market depreciation and limited practical liquidity.

 

Id. at CN101330 (emphasis added).

J28.      For the reasons set forth below and in Section Six at S68 - S83 and S133 - S143, the Court finds that the Respondents did knowingly and intentionally cause USAT to engage in the unsafe and unsound practice of “gains trading” in USAT’s junk bond “investment” portfolio and that they knowingly and intentionally concealed that practice from the regulators.

A.                The Junk Bond Portfolio Was Managed To Generate Accounting Gains To Satisfy The Minimum Net Worth Requirement While Concealing The Failure To Achieve Real Economic Gains                                                             

 

J29.      There is clear evidence, both documentary and testimonial, that sales of junk bonds at a gain was an important source of income to USAT.  To begin with, Exhibit T-4192, Tab 565, a memorandum from Crow to Gross and Gerald Williams dated April 24, 1986, discusses the need “to bolster second quarter profits.”  Crow’s memorandum further states that he was “unaware of any significant opportunities to take additional bond profits ( as we did in the first quarter)…”  Id.  In September 1986, Crow submitted a memorandum to Gross and Gerald Williams enclosing a schedule presenting “our best estimate of gains that will be needed for quarterly earnings,” and indicating that “[W]e are proceeding with taking these gains.”  Ex T-4251, Tab 567 (OW011294).  The attached schedule indicates that there was a need for $11.4 million in securities gains to offset an estimated $10.4 million operating loss for the third quarter of 1986.  Six million of  the needed gains were to come from sales out of the junk bond portfolio.  Id. (OW011295).

J30.      The following November, Crow wrote a memorandum (Ex. T-4302, Tab 566) to Bruce Williams in which he stated:

We had a discussion at the Investment Committee on selling junk bonds for profits for purposes of quarterly earnings.  Ron Huebsch made an impassioned plea to get the word now if we are going to need a lot of profits because the market is favorable right now to getting out of some bonds taking a profit and getting back into some good yielding stuff. He is probably absolutely correct.  GRW and I stated that we would need “major amounts of profits” because we cannot depend on such things as a branch sale, loan servicing sale, and consumer loan sale to pull us out of the fire.  Charles [Hurwitz] asked to see some projections on the quarter prior to making a definitive decision.  Would you start pulling together what you think the quarter will look like without extraordinary gains?

 

 

Id.  Gerald Williams was asked with respect to the above memorandum:  “So, does that memo reflect that sales were being made out of the junk bond portfolio to generate profits for purposes of increasing quarterly earnings?”  Tr. 6,381: 18-21.  He responded:  “Yes, sir.”  Tr. 6,381: 22.

J31.      Two of the respondents also testified, somewhat reluctantly, that the junk bond portfolio was managed to generate gains to bolster quarterly earnings.  Crow testified that, as part of the planning of quarterly income, portfolio managers were instructed to make sales of junk bonds to generate gains to bolster quarterly earnings.  Tr. 15,682: 15 - 15,684: 5.  Similarly, Berner testified that there were discussions at the Investment Committee of sales of junk bonds for purposes of quarterly earnings.  Tr. 19,359: 5-8.  He further testified that “some sales” were made out of the junk bond portfolio for the purpose of generating gains to bolster quarterly earnings in 1986.  Tr. 19,359: 15-19.

J32.      Most telling, however, was the testimony of Mr. Phillips, the junk bond portfolio manager at USAT from September 1984, Tr. 5,022: 19-20, until approximately November 1986.  See Tr. 5,090: 3-6.  Mr. Phillips recalled being instructed to take gains from the junk bond portfolio at year-end 1984 and 1985.  Tr. 5,066: 7-10.  Mr. Phillips also recalled that he was given quarterly instructions to take gains from the junk bond portfolio.  Tr. 5,071: 5-15.  He further testified that when he was so instructed, he was verbally given a target amount of gains to be realized.  Tr.  5,070: 3-7, 8-12; 5,071: 1-4. 

            J33.      The record of junk bond transactions is somewhat limited, in that comprehensive transactional data is available only for the DBL-underwritten junk bonds.  A review of the transactions in DBL-underwritten junk bonds reflected in Exhibit 3 to Dr. Benveniste’s report, Ex. B-4251, Tab 2012, reveals a disturbing pattern of short-term trading beginning in early 1985.  In some cases, the short-term trading resulted in principal gains, but in other cases, it made no economic sense at all, as it either resulted in a principal loss or ended with a sale at the same price as the original purchase.  The data in Exhibit 3 to Dr. Benveniste’s report demonstrate in great detail that a significant portion of USAT’s junk bond portfolio was traded regularly on a short-term basis.

1.                 USAT Begins Trading Junk Bonds

 

            J34.      USAT’s pattern of trading began with a junk bond called Occidental Pete UTS.  See Ex. B-4251, Tab 2012 (Benveniste Report), Exhibit 3, p. 22.  On November 26, 1984, USAT purchased $5 million par value Occidental Pete UTS for an aggregate of $3,894,000.  On December 15, 1984, USAT purchased an additional $10 million par value for a price could not be ascertained from the documentation available to Ms. Suder in compiling the DBL transactional database.  On January 25, 1985, USAT sold $10 million par value for $7,714,000, and on February 5, 1985, USAT sold its remaining $5 million par value for $3,794,000.  Thus, USAT acquired and disposed of these junk bonds in a matter of slightly more than two months.  While the gain or loss on these particular trades cannot be calculated because certain price information is unavailable, these trades were the precursor of the pattern that later emerged..

2.                 The Most Egregious Case:  Phillips Pete Co SB

 

            J35.      On February 15, 1985, USAT made its first purchase of what was to become the most heavily traded issue in its junk bond portfolio, Phillips Pete Co SB 14.75%, maturing March 15, 2000.  Ultimately, there were 70 purchases and sales of this security between February 1985 and December 1987.  Id. pp. 24-26.  The par value of USAT’s holdings of Phillips Pete swung wildly over the course of two years as sales were made to accrue profits at quarter-end and the same securities were repurchased just days or weeks later, only to be sold again to book additional profits.

J36.      As discussed below, USAT traded this security very actively in 1985, holding as much as $26 million and as little as $5 million, engaging in several in-and-out purchases and sales, finally reducing its holdings to zero in October 1985.  In the first quarter of 1986, the par value of Phillips Pete Holdings started at zero, increased to $45 million and fell to $5 million as sales were made to take profits.  The following quarter, the par value held rose to $62 million and then fell to $41.5 million as additional sales were made to take profits.  Further sales were made to take profits in the third quarter of 1986 and the first quarter of 1987.

            J37.      As a general matter, the respondents have sought to justify sales from the junk bond portfolio as responding to changes in credit quality.  That excuse is certainly not a credible explanation for the transactions described below.  No issuer’s credit quality could change so frequently as to justify the constant in-and-out trading of this security, and, indeed, if it did change that frequently, the Court would have to question how investing in the securities of such an issuer could possibly fall within the principles of safety and soundness.  Moreover, since the price of the bonds increased and all of the sales were made at a profit, the Court must assume that the credit quality of Phillips Pete improved rather than deteriorated.  Thus, a sale for reasons of “credit quality” would be counter-intuitive.  It would appear that USAT was selling its best quality bonds, while retaining its more problematic ones.

a.                 1985 Trading In Phillips Pete

 

J38.      On February 15 and March 8, 12, and 15, 1985, USAT purchased $26,634,160 par value.  Of that amount, $25 million par value was purchased for an aggregate of $25,354,000, a slight premium over par. [3]  On March 20 and 21, 1985, USAT sold $16.5 million par value for an aggregate of $16,981,950, bringing its holdings down to $10,134,160.  Four days later, it repurchased $10 million par value of the same issue for $10,287,500, bringing its holdings up to $20,134,160 par value.

J39.      The trading in Phillips Pete Co. SB continued into the second quarter of 1985.  On April 2, 1985, USAT sold $134,160 par value for $138,695, bringing its holdings to an even $20 million par value.  On April 10, 1985, USAT purchased another $5 million for $5,187,500, bringing its holdings to $25 million par value.  One week later, on April 11, 1985, USAT sold $20 million par value at prices above 104, the highest trading value to date, for an aggregate of $20,838,000, presumably realizing a profit on the trade.  One week later, however, USAT repurchased $10 million par value at a price of 105 in two transactions for a total purchase price of $10,500,000, bringing its holdings back up to $15 million par value.  Six days later, USAT repurchased another $5 million par value at 103.88 for a total purchase price of $5,194,000, bringing its balance up to $20 million par value.

J40.      A scant five months later, USAT sold all of its Phillips Pete Co SB at prices over 106, well above the earlier purchase prices.  On September 25 and October 2, 1985, USAT sold $10 million par value at 106.5 for a total price of $10,650,000, and on October 15, 1985, USAT sold $10 million par value at 106.25 for a total of $10,625,000.  Thus, USAT disposed of its last $20 million of Phillips Pete Co SB for a total of $21,275,000.  Working backward from the zero balance (that is, using the first-in, first out method), the cost of the last $20 million par value acquired by USAT (on April 10, 18, and 24) had been $20,881,500.  Accordingly, USAT realized a profit of $393,500 on the four sales in September and October 1985.

b.                 1986 Trading In Phillips Pete

 

J41.      USAT, however, was not done with this security.  It began purchasing Phillips Pete Co SB 14.75% again in February 1986.  In the period February 10, 1986 through March 12, 1987, USAT engaged in 24 purchases and 18 sales, which are summarized below in Appendix J-One.  In aggregate, these transactions resulted in gains (calculated using the FIFO method) of $3,700,225.  The trading pattern was as follows:  In the nine-day period from February 10 through February 18, 1986, USAT purchased $45 million par value for an aggregate of $47,194,750.  Appendix J-One, lines 1-9.  On February 28 and March 4, 1986, USAT sold $15 million par value $16,112,750 realizing a gain of $431,250.  Id., lines 10-12.  On March 10, 1986, USAT repurchased $12 million par value bringing its holdings back up to $42 million par value.  Id., lines 13-15.  On March 21 through 26, 1986, USAT sold $37 million par value for an aggregate of $39,936,500, realizing profits of $896,450, id., lines 16-19, for a quarterly profit of $1,327,700.  Id., line 20.

J42.      Less than three weeks later, after the beginning of the second quarter, USAT once again began purchasing Phillips Pete Co. SB.  From April 16, 1986 through May 7, 1986, USAT made twelve separate purchases of this junk bond, bringing its holdings from $5 million par value to $62.25 million in exactly three weeks at a total additional cost of $62,306,250.  Id., lines 21-32.  On May 29 and 30 and June 26, 1986, USAT sold $20.75 million par value of this issue, id., lines 33-36, for a total quarterly profit of $294,000.  Id., line 37.

J43.      The following quarter, there was one sale of Phillips Pete Co SB.  On August 21, 1986, USAT sold $10 million par value for $10,950,000, realizing a profit of $55,000.  Id., lines 38-39.  USAT realized total profits of $1,677,600 on its sales of Phillips Pete Co SB in 1986.  Id., line 40.

J44.      During the first quarter of 1987, USAT sold off all but $10 million par value of Phillips Pete Co SB, id., lines 41-46, for an additional profit of $2,032,625.  Id., lines 47-48.  During the period February 1986 through March 1987, USAT realized profits of $3,700,225 on 42 transactions involving Phillips Pete Co SB junk bonds.  Id., line 49.

J45.      Subsequently, there were a few additional transactions in this security.  On July 24, 1987, USAT purchased $500,000 par value Phillips Pete Co SB for 538,550, bringing its holdings to $10,500,000 par value.  Ex. B-4251, Tab 2012, Exhibit 3, p. 26.  On August 24, 1987, there were two sets of matched transactions of no economic substance as USAT purchased and then sold $10 million and $500,000, respectively, in wash sales in which the purchase and sale prices were the same.  Id.  The prices on the two sets of matched transactions were significantly different, even though they took place on the same day.  The $10 million transactions took place at 102.87, while the $500,000 transactions took place at 107.6.

J46.      The final transaction took place on December 24, 1987, when USAT sold $500,000 par value of Phillips Pete Co SB junk bonds for $500,000.  If this transaction is matched against the July 24, 1987 purchase of $500,000, USAT lost $38,500.  On a FIFO basis, disregarding the August wash sales, the loss would be matched against a portion of USAT’s April 26, 1986 purchase at 108, see Appendix J - One, line 31; Ex. B-4251, Tab 2012, Exhibit 3, p. 25, for a basis of $540,000 and a loss of $40,000.

3.                 Other Short-Swing Trading

 

J47.      In addition to the securities trading, discussed above, there are numerous other instances of short term trading of DBL-underwritten junk bonds.  Out of six securities listed on the very first page of Exhibit 3 to Dr. Benveniste’s report, five were purchased and sold within six months or less, and of those five, three were sold in March 1986, the end of the first quarter, shortly before Crow’s April 1986 memorandum (Exhibit T-4192, Tab 565) concerning the need to bolster profits for the following quarter.  See J29 above.  The transactional listing in Exhibit 3 to Dr. Benveniste’s report is replete with additional examples of opportunistic trading for the purpose of recognizing accounting gains in a manner that is utterly inconsistent with USAT’s representations as to its investment strategy and the nature of its junk bond portfolio.

J48.      Eugene Stodart, who managed the junk bond portfolio from April 1987 until USAT was placed in receivership, Tr. 25,650: 16-19; Tr. 25,761: 11-16, testified that the USAT junk bond portfolio was an investment portfolio intended to earn a spread income over time; he described it as “a credit arbitrage.”  Tr. 25,659: 12 - 26,570: 5.  He specifically denied that sales were made out of the junk bond portfolio to generate gains to bolster quarterly profits while he managed the portfolio.  Tr. 25,664: 10-14.  For the most part, he was right.  The data in Dr. Benveniste’s report demonstrate that there was significantly less of such activity after Mr. Stodart came to USAT, but the report does show a few short-term trades shortly after Mr. Stodart’s arrival.  For example, the July 24, 1987 and August 24, 1987 Phillips Pete Co SB transactions took place when Mr. Stodart was in charge.  The issues of BCI Holdings listed on pages 2 and 3 of Exhibit 3 to Dr. Benveniste’s report were also sold on a short-term basis during Mr. Stodart’s management of the portfolio – indeed, in one case (BCI Holdings Exch JR), $5 million par value was purchased and resold at a profit the same day, July 31, 1987, and three weeks later the pattern was repeated as $15 million par value was purchased and resold at a profit on the same day, August 20, 1987, only to be repurchased four days later at a price that was higher than the sales price for $10 million of the $15 million sold four days before.

4.                 USAT/UFG Performance Report Data

 

J49.      Performance reports for UFG and USAT, in the record, give an incomplete picture of the trading of junk bonds in the USAT portfolio.  Indeed, there is no comprehensive information concerning trading of junk bonds in performance reports until mid-1986.  Even then, the securities are not specifically identified as high yield or junk bonds; rather, they are identified as “corporate securities,” a category that could include investment grade debt securities or equity securities as well as high yield securities.  Accordingly, even when the securities that were the source of gains are specifically identified, it is necessary to ascertain from some other source whether they were junk bonds or some other type of corporate security.  Similarly, there is no indication in the performance reports of the holding period of the securities sold, and, thus, it would be necessary to refer to other sources to ascertain whether the account was being run as a trading, rather than an investment, account.  Nevertheless, the information available is consistent with the Court’s calculations and observations with respect to the data obtained from Dr. Benveniste’s report and demonstrates the importance of the junk bond profits as a constituent of USAT’s net income.  Moreover, as discussed at A 412 [Bruce’s section G] The December 1986 Performance Report strongly supports the OTS’s analysis of the pattern of taking investment securities gains at quarter’s-end.

J50.      Some examples of the incomplete and ambiguous nature of the performance reports follow:  To begin with, there was no specific mention in the January 1985 Performance Report of USAT’s first junk bond sale, the January 25, 1985 sale of $10 million Occidental Pete UTS.  Rather there is only a vague reference to gains on sales of securities of some $259,000 (which, the report stated, exceeded planned gains of $42,000 by $217,000).  See Ex. A-5002, Tab 549.

J51.      The first performance report in the record that specifically discusses profits on sales of securities that can be identified as junk bonds was the June 1985 report, which revealed total gains on sales of securities of $1.8 million, the bulk of which arose from the sale of two securities, Consumers Power[4] (a gain of $810,000) and Long Island Lighting (a gain of $593,000).  Exhibit A-5003, Tab 550, p. 3.  The earliest purchase of Consumers Power shown in Dr. Benveniste’s compilation was in January 1985, which would indicate a holding period of less than six months before the sale.  See Ex. B-4251, Tab 2012, Ex. 3, p. 8.

J52.      UFG’s First Quarter 1986 Performance Report indicates that there were gains of $8.8 million on sales of corporate securities , but only identifies one specifically, SCI Holdings Debentures, which were sold at a gain of some $2.2 million.  Ex. A-5010, Tab 557, (US 0001729).  Page 31 of Exhibit 3 to Dr. Benveniste’s report shows purchases of $15 million par value of SCI Holdings 12 YR SR on November 11, 1985, $5 million par value on January 7, 1986, and $5 million on  January 8, 1986.  There were sales of $10 million par value on March 25, 1986 and $5 million par value on March 26, 1986.  Using the FIFO method (as above), the gains on the March sales were $1,329,000 (proceeds of $16,125,000 minus the purchase price of $14,796,000) after a holding period of approximately 4 months.

J53.      The June 1986 Performance Report listed, for the first time,[5] all of the “investment securities” sold, but, as discussed above, without identifying them as to type or reporting them by portfolio.  Ex. A-5011, Tab 558, Schedule DJ.  The list includes mortgage-backed securities and U.S. Treasury Bills, as well as investment-grade corporate securities issued by entities such as Citicorp and General Motors Acceptance Corporation, in addition to securities that can be identified as junk bonds by reference to Dr. Benveniste’s report.  Id.  For example, Schedule DJ includes lists sales of Phillips Petroleum Debentures, which can be matched to page 25 of Exhibit 3 to Dr. Benveniste’s report.  On trade dates May 29 and 30 and June 26, 1986, USAT sold an aggregate of $20,750,000 of Phillips Pete SB, which matches precisely the amount reported for June 1986 in the performance report.  (The May transactions would have settled in June.)  The performance report indicates that the profit on the transactions was $424,000, significantly more than the Court calculated in Appendix J-One.  Other corporate securities that can be identified as DBL-underwritten junk bonds by reference to Exhibit 3 to Dr. Benveniste’s report include SCI Holdings Debentures (p. 31), BCI Holding’s Debenture (pp. 2-3), Wickes (pp. 38-39), Pace Group (pp. 22-23).

J54.      The reporting of sales of investment securities in USAT or UFG performance reports continued to group all securities together on Schedule DJ or, later, Schedule DH, through November 1988.[6]/  A large number of the securities listed (in addition to those discussed above), however, can be identified as junk bonds by reference to Dr. Benveniste’s report.

B.                Gains Trading In The Junk Bond Portfolio Reduced The Yield On The Portfolio And Resulted In Market Losses On A Significant Portion Of The Portfolio                                                                                                                    

 

            J55.      As might be expected, when USAT sold its most valuable securities for current gains, it reduced its expected future income substantially.  By December 1986, the spread had been reduced from 360 basis points to 220 basis points according to a memorandum of the Strategic Planning Committee meeting of December 17, 1986.  Ex. T-4320, Tab 569.  The author of that memorandum, Douglas Hansen, agreed in his testimony that his memorandum “implied” if it did not state explicitly that: “[S]ales were made out of the high-yield bond portfolio that resulted in profits, reported profits to USAT that had the effect of reducing its spread income in the high-yield bond portfolio.”  Tr. 12,593: 8-12.  Subsequently, Mr. Stodart reported to the Investment Committee that in May 1987, the month after he came to USAT, the spread on the junk bond portfolio had fallen to 88 basis points.  Ex. A-1493, Tab 1218, p.2.  By January 1988, however, under Mr. Stodart’s management, the spread had been increased to 300 basis points.  Id.

            J56.      UFG management was aware of the potential problems relating to gains trading.  Indeed, in January 1986, Gross had stated the issue with great clarity in a memorandum to Gerald Williams with copies to Munitz and Hurwitz:

            Before I comment on the Investment Department Bonus Plan, the type of thing that I am especially interested in looking at, is Schedule SF, page 2.  H deals with the profit contributions from the mortgage backed securities.  In trying to determine the profitability aspect, I think, first of all you need to know the rate of pay-down on the mortgage backed securities.  Whether you are really earning this interest income that he is showing, or whether the fact is that the early pay-offs have cut into that interest income.  The second thing that you need to know is again on the sale of securities whether these are real sales or just window dressing sales.  Are these really honest to goodness sales that still leave us with the same yield that we had before, reather [sic] than a lower yield?  We need to take a look at it.  I [sic] is even going to be more important on the junk bonds.  I [sic] we take a $10 million profit, but choke down 50 basis points on our spread, we have penalized our profits for the next five to ten years on our portfolio to get that profit.  I can’t see paying a bonus on that.

 

Ex. A-10599, Tab 856 (emphasis added).  Notwithstanding Gross’ prophetic analysis of the potential problem, USAT’s gains trading continued and the spread on the junk bond portfolio deteriorated, as USAT ultimately “choked down” 272  (360 b.p. - 88 b.p.) basis points on its spread for the sake of current accounting profits.

IV.             USAT’s Losses On DBL-Underwritten Junk Bonds

 

A.                Ms. Suder’s Conclusions

 

            J57.      Ms. Suder’s report concluded that “[t]he principal loss on [DBL]-underwritten, below-investment-grade bonds, purchased by USAT, was $47,096,688.”  Ex. A-14001, Tab 1352, p. 1.  In reaching this conclusion she did not consider “those [DBL]-underwritten, below-investment-grade bond sales which resulted in a principal gain,” sales of bonds not underwritten by DBL, “interest earned, payments-in-kind (“PIKs”), or cost of funds.”  Id.  Ms. Suder noted in her direct testimony that Dr. Benveniste had criticized the inclusion of three particular junk bonds in her calculation because they involved purchases made after USAT had been placed in receivership and agreed that, if the respondents were not legally responsible for losses relating to those particular bonds, then her loss calculation should be reduced by approximately $1.8 million to $45,918,938.  Tr. 14,339: 20 - 14,340: 10; 14,409: 10 - 14,410: 5; Ex. B-4251, Tab 2012, pp. 3-4.

B.                Dr. Benveniste’s Criticisms of Ms. Suder’s Calculations

 

            J58.      Dr. Benveniste’s fundamental criticism of Ms. Suder’s report was that “Suder [did] not provide a meaningful picture of the performance of USAT’s total or [DBL]-underwritten high yield bond portfolio.”  Ex. B-4251, Tab 2012, p. 3.  Dr. Benveniste’s criticism, however, is entirely irrelevant, because Ms. Suder did not purport to do so, and OTS’s legal claim is not predicated on the performance of the portfolio.  Likewise, the diversification of the portfolio is not in issue.  Rather, as discussed above, and in the Court’s Conclusions of Law, the OTS seeks recovery of losses related to specific issues based upon the relationship among DBL, UFG, and MCO/FDC.  Thus, the issue in this case is not the prudence or imprudence of USAT’s management of the junk bond portfolio as a whole, but whether the purchase of DBL-underwritten securities violated the regulations governing transactions between savings associations and their affiliates.

            J59.      One of Dr. Benveniste’s specific criticisms of Ms. Suder was that she included in her calculation losses that occurred after the date of the USAT receivership on bonds that were purchased before the date of the receivership.  His approach was to mark USAT’s junk bond portfolio to market as of December 30, 1988.  Tr. 27,665: 4 - 27,666: 8.  In marking the junk bonds to market, Dr. Benveniste argued in his direct testimony that “it seemed to [him] not appropriate to consider market effects on bonds that happened after the time that USAT was involved with the portfolio.”  Tr. 27,665: 19-22.  Under cross-examination, however, Dr. Benveniste retreated, stating:  “I think the issue of whether or not USAT should be held responsible for the losses afterwards is a legal one and not one that I’m taking a position on.”  Tr. 27,755: 18-21.  He admitted that he did not know the applicable law, and stated that he had no position either as to “whether or not the insurance fund [had], as a matter of law, to bear those losses [incurred after the date of the receivership]” or as to whether the receiver had to dispose of the bonds immediately in order to avoid bearing the risk of loss in the insurance fund.”  Tr. 27,756: 6-13.

J60.      Dr. Benveniste further stated that he was not an expert in the calculation of damages.  Tr. 27,759: 6-11.  This became very clear when he was cross-examined concerning a third criticism of Ms. Suder’s calculations.  Dr. Benveniste testified that he believed that it was necessary to take into account the interest received on the junk bond portfolio.  Tr. 27,669: 8-17.  OTS’s cross-examination demonstrated that Dr. Benveniste confused cash flow with actual losses in his analysis.  During cross-examination about various hypotheticals concerning interest and principal, Dr. Benveniste steadfastly, and disingenuously, quibbled over whether a deficiency in the repayment of principal was a “loss.”  The final colloquy concerning these hypotheticals epitomizes Dr. Benveniste’s disingenuous view:

Q.   [L]et’s just assume for the moment that you lose your job and you can’t make your mortgage payment.

 

      What’s going to happen?

 

A.    Well, I’ll probably lose the house.

 

Q.   That’s right.  And if the house isn’t worth enough to pay off the outstanding balance on the mortgage, the lender is going to sue you, isn’t he?

 

A.    Yes, they will.

 

Q.   And they will say that’s because they lost money because there is a deficiency between the amount that they recovered on the house and the amount that you owe?

 

A.    There is a contractual difference between what I owe them and what they receive, and that’s a difference between saying they lost money and what they might be entitled to get otherwise as stated by the contract.

 

Tr. 27,781: 2-20.

            J61.      Similarly, when asked whether he would tell a hypothetical buyer who paid $100,000 for a bond and sold the same bond for $80,000 that he had not lost money on the transactions, Dr. Benveniste stated:  “I’m not sure – when you say he hasn’t lost money, that’s a very subjective question.”  Dr. Benveniste further stated that he believed that determining whether there has been a loss “all has to be relative to something else.”  Tr. 27,778:  18-19.

            J62.      Notwithstanding Dr. Benveniste’s careful calculations of the effect of the net interest received, his position on the inclusion of net interest received is academic.  Dr. Benveniste testified that the “real economic loss” on the “Suder loser” portfolio after all adjustments was $25,420,000.  Tr. 27,856: 21 - 27,857: 7; see Tr. 27,692: 17-22; Ex. B-4389, Tab 2015 (“Real Cash Flow” analysis of “Suder’s Selected Drexel Underwritten” using USAT Cost of Funds).  Further, he testified that the amount of the losses would be correspondingly greater if his mark-to-market adjustment of $21,200,076, which was based upon the market value of the portfolio as of December 30, 1988,[7] did not apply.  The loss without the mark-to-market adjustment would be $46,620,076, which is $701,138 more than the figure supplied by Ms. Suder, $45,918,938.

C.                The Court’s Conclusions

 

J63.      For the reasons set forth in the Court’s Conclusions of Law, the Court finds that it is not appropriate to mark the junk bond portfolio to market as of December 31, 1988.  Similarly, for the reasons set forth in the Court’s Conclusions of Law, the Court finds that net interest should not be included in the calculation of loss on the junk bond portfolio.  As discussed above at A 39 - A 47, A 66 - A 124, J 4 - J 5, DBL was an affiliated party of USAT, and for the reasons set forth in the Court’s Conclusions of Law, the Court determines that the loss on the junk bond portfolio is the aggregate principal losses calculated by Ms. Suder, $45,918,380.

APPENDIX J-ONE

 

USAT PURCHASES AND SALES OF PHILLIPS PETE SB

FEBRUARY 1986 THROUGH MARCH 1987

(DATA FROM PP 24-26 OF EXHIBIT 3 TO BENVENISTE REPORT)

 

 

Trade Date

Quantity Purchased (Sold)

 

Running Balance

Amount (Paid) Received

Portfolio Basis (FIFO)[8]/

FIFO Gain (Loss)[9]/

1

02/10/86

5,000,000

5,000,000

(5,225,000)

5,225,000

 

2

02/10/86

5,000,000

10,000,000

(5,225,000)

10,450,000

 

3

02/11/86

5,000,000

15,000,000

(5,231,500)

15,681,500

 

4

02/11/86

5,000,000

20,000,000

(5,231,250)

20,912,750

 

5

02/12/86

5,000,000

25,000,000

(5,231,500)

26,144,250

 

6

02/13/86

5,000,000

30,000,000

(5,231,500)

31,375,750

 

7

02/18/86

10,000,000

40,000,000

(10,550,000)

41,925,750

 

8

02/18/86

2,000,000

42,000,000

(2,107,600)

44,033,350

 

9

02/18/86

3,000,000

45,000,000

(3,161,400)

47,194,750

 

10

02/28/86

(5,000,000)[10]

40,000,000

5,356,500

41,969,750

131,500

11

02/28/86

(5,000,000)[11]

35,000,000

5,356,250

36,744,750

131,250

12

03/04/86

(5,000,000)[12]

30,000,000

5,400,000

31,513,250

168,500

13

03/10/86

1,000,000

31,000,000

(1,070,000)

32,583,250

 

14

03/10/86

10,000,000

41,000,000

(10,763,000)

43,346,250

 

15

03/10/86

1,000,000

42,000,000

(1,072,500)

44,418,750

 

16

03/21/86

(5,000,000)[13]

37,000,000

5,425,000

39,187,500

193,750

17

03/21/86

(5,000,000)[14]

32,000,000

5,419,000

33,956,000

187,500

18

03/25/86

(10,000,000)[15]

22,000,000

10,775,000

23,449,500

269,500

19

03/26/86

(17,000,000)[16]

5,000,000

18,317,500

5,377,700

245,700

20

First  Quarter 1986 Profits

 

 

 

 

 

 

1,327,700

*********

 

 

 

 

 

 

 

21

04/16/86

4,500,000

9,500,000

(4,938,750)

10,316,450

 

22

04/16/86

8,000,000

17,500,000

(8,770,400)

19,086,850

 

23

04/17/86

2,500,000

20,000,000

(2,743,750)

21,830,600

 

24

04/17/86

2,750,000

22,750,000

(3,018,125)

24,848,725

 

25

04/18/86

5,000,000

27,750,000

(5,437,500)

30,286,225

 

26

04/18/86

6,250,000

34,000,000

(6,796,875)

37,083,100

 

27

04/24/86

1,250,000

35,250,000

(1,353,125)

38,436,225

 

28

04/24/86

7,250,000

42,500,000

(7,848,125)

46,284,350

 

29

04/24/86

7,250,000

49,750,000

(7,830,000)

54,114,350

 

30

04/25/86

250,000

50,000,000

(270,000)

54,384,350

 

31

04/26/86

5,000,000

55,000,000

(5,400,000)

59,784,350

 

32

05/07/86

7,250,000

62,250,000

(7,899,600)

67,683,950

 

33

05/29/86

(2,250,000)[17]

60,000,000

2,480,625

65,262,275

58,950

34

05/29/85

(5,000,000)[18]

55,000,000

5,525,000

59,836,875

99,600

35

05/30/86

(5,000,000)[19]

50,000,000

5,525,000

54,352,675

40,800

36

06/26/86

(8,500,000)[20]

41,500,000

9,418,000

45,030,225

95,550

37

Second Quarter  1986 Profits

 

 

 

 

 

 

294,900

*********

 

 

 

 

 

 

 

38

08/21/86

(10,000,000)[21]

31,500,000

10,950,000

34,135,225

55,000

39

Third Quarter 1986 Profits

 

 

 

 

 

 

55,000

*********

 

 

 

 

 

 

 

40

Total 1986 Profits

 

 

 

 

 

1,677,600

*********

 

 

 

 

 

 

 

41

01/16/87

(250,000)[22]

31,250,000

295,000

33,863,350

23,125

42

01/16/87

(6,250,000)[23]

25,000,000

7,375,000

27,082,725

594,375

43

02/27/87

(5,000,000)[24]

20,000,000

5,875,000

21,670,225

462,500

44

02/27/87

(5,000,000)[25]

15,000,000

5,875,000

16,269,600

474,375

45

03/02/87

(2,500,000)[26]

12,500,000

2,937,500

13,569,600

237,500

46

03/12/87

(2,500,000)[27]

10,000,000

2,940,750

10,869,600

240,750

47

First Quarter 1987 Profits

 

 

 

 

 

 

2,032,625

*********

 

 

 

 

 

 

 

48

Total 1987 Profits

 

 

 

 

 

2,032,625

*********

 

 

 

 

 

 

 

49

Total Profits Feb 1986 through Mar 1987

 

 

 

 

 

 

 

3,700,225

*********

 


[1]               The quarter end balances reflect only the net effect of activity during each quarter.  Dr. Benveniste compiled separately transactional data for DBL-underwritten junk bonds in Exhibit 3 to his report, which will be discussed below.  Interestingly, reference to Ex. B-1770, Tab 1615 (CN468061- 64), indicates that USAT’s purchases of high yield bonds from DBL as a percentage of total purchases of high yield bonds (37.548% in 1985, 40.117% in 1986, and 24.0535% in the first nine months of 1987) was less than its proportionate holdings.  Since USAT’s proportionate holdings of DBL underwritten junk bonds was in all years higher than the proportion of purchases from DBL, it appears that USAT was more likely to hold DBL-underwritten junk bonds and trade in non-DBL-underwritten junk bonds.  Moreover, USAT’s holdings of DBL underwritten junk bonds was in all cases higher than DBL’s proportionate share of the junk bond market, even without considering zero-coupon and “coupon” bonds separately.  When compared to the percentage of DBL-underwritten “coupon” bonds, the difference is substantial and significant.  See J22, below.

[2]               “Coupon” in this case refers to bonds that pay interest periodically, as differentiated from zero-coupon bonds which pay off at maturity at par, which includes an interest factor.  See Tr. 27,743: 1-6.

 

[3]               Prices on two of the transactions totaling $1,634,160 par value are unavailable, which makes the calculation of gain or loss on the earliest transactions impossible.  However, it is possible to calculate gain or loss on the later transactions using a first-in, first-out (“FIFO”) method, as seen below.

 

[4]               While it is not clear from Dr. Benveniste’s compilation of data which issue was involved, Consumers Power is shown as a DBL underwriting client.  See Ex. B-4251, Tab 2012, Ex, 3, p. 8.

 

[5]               Only three other performance reports (July, August, and September 1986) actually list all of the securities sold.  Ex. A-5012, Tab 559; Ex. A-5013,Tab 560; Ex. A-5014, Tab 561.  Subsequently, the schedule of investment securities sold had an entry denominated “Other Securities.”  See, e.g., Ex. A-5015, Tab 562 (Oct. 1986).

 

[6]               See Ex. A-5012, Tab 559 (July 1986); Ex. A-5013, Tab 560 (Aug. 1986); Ex. A-5014, Tab 561 (Sept. 1986); Ex. A-5015, Tab 562 (Oct. 1986); Ex. A-5016, Tab 563 (Nov. 1986); Ex. A-5017, Tab 564 (Dec. 1986); Ex. A-5018, Tab 1337 (Jan. 1987); Ex. A-5019, Tab 1338 (Feb. 1987); Ex. A-5020, Tab 1339 (March 1987);Ex. A-5021, Tab 1340 (Apr. 1987); Ex. A-5022, Tab 1341 (May 1987); Ex. A-5023, Tab 1342 (June 1987); Ex A-5025, Tab 1344 (Aug. 1987); Ex. A-5025, Tab 1344 (Sept. 1987); Ex A-5026, Tab 1345 (Oct 1987); Ex A-5027, Tab 1346 (Nov 1987); Ex. A-5028, Tab 883 (Dec. 1987); Ex. A-5029, Tab 1265 (Jan. 1988); Ex. A-5030, Tab 1266 (Feb. 1988);Ex. A-5031, Tab 1267 (Mar. 1988); Ex. A-5032, Tab 1268 (Apr. 1988); Ex. A-5033, Tab 1269 (May 1988); Ex. A-5034, Tab 1270 (June 1988); Ex. A-5035, Tab 1271 (July 1988); Ex. A-5036, Tab 324 (Aug. 1988); Ex. A-5037, Tab 325 (Sept. 1988); Ex. A-5038, Tab 1272 (Oct. 1988); Ex. A-5039, Tab 1273 (Nov. 1988).

[7]               $45,918,938 - $24,718,862 = $21,200,076.  See Ex. B-4251, Tab 2012, p. 4, ¶ 1.

 

[8]               The portfolio basis is calculated as the cumulative purchase prices minus the FIFO basis of the shares sold.

 

[9]               The gain or loss is the amount received minus the FIFO basis of the shares sold.

 

[10]             Basis: 5,225,000 (5MM par at 104.5) from line 1.

 

[11]             Basis: 5,225,000 (5MM par at 104.5) from line 2.

 

[12]             Basis: 5,231,500 (5MM par at 104.63) from line 3.

 

[13]             Basis: 5,231,250 (5MM par at 104.625) from line 4.

 

[14]             Basis: 5,231,500 (5MM par at 104.63) from line 5.

 

[15]             Basis: 10,506,500 = 5,231,500 (5MM par at 104.63) from line 6 plus 5,275,000 (5MM par at 105.5) from line 7.

 

[16]             Basis: 18,071,800 = 5,275,000 (5MM par at 105.5) from line 7 plus 2,107,600 (2MM par at 105.38) from line 8 plus 3,161,400 (3MM par at 105.38) from line 9 plus 1,070,000 (1MM par at 107) from line 13 plus 6,457,800 (6MM par at 107.63) from line 14.

[17]             Basis: 2,421,675 (2.25MM par at 107.63) from line 14.

 

[18]             Basis: 5,425,400 = 1,883,525(1.75MM par at 107.63) from line 14 plus 1,072,500 (1MM par at 107.25) from line 15 plus 2,469,375 (2.25MM par at 109.75) from line 21.

 

[19]             Basis: 5,484,200 = 2,469,375 (2.25MM par at 109.75) from line 21 plus 3,014,825 (2.75MM par at 109.63) from line 22.

 

[20]             Basis: 9,322,450 = 5,755,575 (5.25MM par at 109.63) from line 22 plus 2,743,750 (2.5MM par at 109.75) from line 23 plus 823,125 (0.75MM par at 109.75) from line 24.

 

[21]             Basis: 10,895,000 = 2,195,000 (2MM par at 109.75) from line 24 plus 5,437,500 (5MM par at 108.75) from line 25 plus 3,262,500 (3MM par at 108.75) from line 26.

 

[22]             Basis: 271,875 (0.25MM par at 108.75) from line 26.

 

[23]             Basis: 6,780,625 = 3,262,500 (3MM par at 108.75) from line 26 plus 1,353,125 (1.25MM par at 108.25) from line 27 plus 2,165,000 (2MM par at 108.25) from line 28.

 

[24]             Basis: 5,412,500 (5MM par at 108.25) from line 28.

 

[25]             Basis: 5,400,625 = 270,625 (0.25MM par at 108.25) from line 28 plus 5,130,000 (4.75MM par at 108) from line 29.

 

[26]             Basis: 2,700,000 (2.5MM par at 108) from line 29.

 

[27]             Basis: 2,700,000 = 270,000 (.25MM par at 108) from line 30 plus 2,430,000 (2.25MM par at 108) from line 31.