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SECTION SIX, Part V Supervision after the 1987 Examination
1. Neil Twomey Becomes The Supervisory Agent For USAT At The End Of 1985
S1. During the majority of the time that USAT was engaged in the Wholesale Strategy, the FSLIC Supervisory Agent assigned to USAT by the FHLB-D was Neil Twomey. Tr. 23,228: 7-13; Tr. 23,236: 3-11 (Twomey). Twomey became the Supervisory Agent for USAT on December 2, 1985, when he began working for the FHLB-D, and USAT remained under his supervision until USAT was placed in receivership at the end of 1988. Id. S2. When Twomey first became responsible for the supervision of USAT his case load consisted of 90 institutions of all sizes. Tr. 23,230: 2-9; Tr. 23,234: 21 - 23,234: 5 (Twomey). By August 1987 he had become part of the "large troubled thrifts group" and his case load had declined to approximately 40 institutions. Tr. 23,235: 10 - 23,236: 2 (Twomey). In the middle of 1988, his case load changed again and he became responsible for the supervision of 25 large thrifts. Id. S3. Twomey had the assistance of between 4 and 6 analysts, who were responsible for reviewing the examination reports and correspondence received from the institutions under Twomey's supervision. Tr. 23,233: 7 - 23,234: 4 (Twomey). Ginger Baugh was the Supervisory Analyst assigned to USAT until August 1988 at which time she was replaced by Mark Dunn. Tr. 23,250: 13 - 23,251: 2 (Twomey). S4. There were three levels of supervision above Twomey. Tr. 23,236: 18 - 23,237: 4; Tr. 23,237: 16-20 (Twomey). By May 1986 Joe Selby had replaced Mr. Roy as the head of Regulatory Affairs Supervisory Regulation (Tr. 23,238: 11 - 23,239: 10 (Twomey)) and the following year Halverson was replaced as Twomey's immediate supervisor by Danny Thomas. Tr. 23,237: 5-10 (Twomey). Tr. 23,238: 3-10 (Twomey). S5. In 1985 examinations of institutions were run by the District Director, who was an employee of the FHLB-D and had responsibility for all examination functions. Tr. 23,230: 10 - 22,230: 10 (Twomey). The supervisory staff did not participate in the conduct of the examinations other than to comment on the scope of the examination and to request additional testing be done in areas of interest to supervision. Tr. 23,231: 12 - 23,232: 18 (Twomey). Tr. 23,502: 4-20 (Twomey). Twomey explained the reason USAT had not been examined more recently as follows: Tr. 23,242: 3-17 (Twomey). At the same time, the FHLB-D engaged a number of Certified Public Accountant ("CPA") firms to conduct examinations at various institutions. Tr. 23,242: 9-11 (Twomey). Between 1985 and 1988 the FHLB-D dramatically increased its examination staff, however it was not until 1988 that the District had commensurate examination staffing to deal with the problems that existed. Tr. 23,242: 18 - 23,243: 5 (Twomey). Ex. B-1046; Tab 1622, (06/17/86 Munitz letter); B-1212, Tab 1628, (09/17/86 Munitz letter); B-1354, Tab 1630, (12/12/86 Munitz letter); B-1523, Tab 1632, (03/14/87 Munitz letter); B-1668, Tab 1634, (06/19/87 Munitz letter); B-1754, Tab 1636 (09/17/1987 Munitz letter); Tr. 23,533: 17 - 23,535: 15 (Twomey). Ex. T-1059, Tab 15, (FHLBB Resolution No. 84-712) p. OW009468; Tr. 23,532: 19 - 23,533: 16 (Twomey). Tr. 23,532: 9-18; 25,534: 15 - 25,535: 6 (Twomey). Twomey played no role in considering the proposed modification; he merely facilitated the discussions by "routinely" sending letters to FDC granting the requested extensions. Tr. 23,534: 13 - 23,535: 15 (Twomey). S23. The FHLB-D Summary Report on USAT prepared for Twomey when he became the Supervisory Agent for USAT, indicated that USAT had been the object of supervisory intervention by the FHLB-D to address a liability growth violation which occurred in the latter half of 1985. Ex. A-11055, Tab 1869. S24. In about 1985, the FHLBB attempted to place limitations on the rate at which thrifts could grow and to limit the extent to which a thrift could invest in certain types of investments by passing a liability growth regulation and a direct investment regulation. Tr. 23,504: 4 - 23,506: 7 (Twomey). Twomey explained the reason for these new regulations as follows: The matter was resolved before Twomey assumed responsibility for the supervision of USAT. Tr. 23,514: 10-22 (Twomey). On May 25, 1986, Twomey recommended that the request be tentatively approved, and that final approval be subject to the results of the examination that was about to commence on May 27, 1986. Id. p. OW158130. n a letter to USAT on July 1, 1986, Twomey advised USAT that the FHLB-D had no objection to the requested increase "[h]owever, in light of the volume of activity proposed by United during recent months, the Association should prepare a comprehensive formal Business Plan for the Supervisory Agent's review and approval. Ex. B-1084, Tab 1645. Pursuant to this request, Berner sent Twomey a copy of USAT's 1986 Business Plan on August 29, 1986. According to Twomey, of the 25 large institutions he was supervising in 1988, USAT was the only one that was engaged in either MBS risk-controlled arbitrage (Tr. 23,636 :12 - 23,637: 12), high-yield bond arbitrage (Tr. 23,510: 13 - 23,511: 19; 23,637: 13-22) or equity arbitrage activities. Tr. 23,638: 1-6. S48. Throughout the entire period Twomey served as the Supervisory Agent of USAT the Institution's non-operating gains were the subject of constant supervisory concern to Twomey because without them USAT would have had negative income. Tr. 24,750: 1 - 24,751: 17 (Twomey). S49. Supervisory Agent Twomey began to express concern about USAT's reliance upon non-operating income from gains on sales of branches and direct investments as soon as he took over the supervision of USAT. In the January 8, 1986 memorandum from Twomey to PSA Green recommending that USAT's application to increase direct investments not be approved, Twomey noted that USAT had sustained operating losses in 1984 and 1985 and that the only "[a]ctivities resulting in net profits during 1984 and 1985 have been non-operating items, particularly branch sales and sales of direct investments. Ex. A-11153, Tab 1870 (01/09/86 Twomey memo) p. OW120753. S51. In a letter to USAT dated May 12, 1986, regarding the subordinated debt application, Twomey cautioned USAT that such non-operating gains should not be relied upon to offset operating expenses. Ex. B-978, Tab 1754 (05/12/86 Twomey letter). The letter states: S52. On May 21, 1986, a representative of USAT met with Twomey and Baugh for the purpose of USAT explaining its investments in corporate debt and equity securities. S53. On May 23, 1986, Twomey again expressed his concern regarding USAT reliance upon non-operating securities gains in a memorandum to PSA Green: Twomey testified that, as the Supervisory Agent, he relied upon the TFR's as the "primary source [of information] regarding the financial status of [USAT]" (Tr. 23,810: 17 - 23,811: 11) and reviewed the TFR's monthly (Tr. 23,811: 10-11) to "monitor operations" and "judge trends, shifts in asset composition of the institution, their growth, their investments. Id.; Tr. 23,590: 1-14. S56. When Twomey raised the issue of USAT's reliance upon non-operating income generated by "gains from securities transactions" (Ex. B-4001, Tab 887 (06/02/86 Baugh memo) p. OW153023), he based his observations primarily on the information that USAT had submitted to the FHLB-D in its TFR's. Tr. 23,587: 22 - 23,588: 21 (Twomey). S57. The TFR required that a thrift report separately in Section D both its "Operating" and "Non-operating Income. Ex. T-8177, Tab 1873 (Sample TFR) p. 3. Twomey explained that under the category "Non-operating Income" a thrift would list its aggregate gains from the sale of all "investment securities. Id., Tr.23,590: 10 - 25,591: 11. Tr. 23,595: 10 - 23,596: 16; Tr. 24,750: 1 - 24,751: 17 (Twomey). The TFR, however, did not identify which category of securities had been sold to generate the non-operating gains from investment securities or the reason such sales were made. Consequently, Twomey did not know whether non-operating gains from investment securities that USAT reported in its TFR were generated by the sale of treasury bonds, common stock, high-yield bonds or some other asset defined as investment securities in the TFR. Tr. 23,597: 7 - 23,598: 2; Tr. 24,883: 1 - 24,884: 22; Tr. 24,885: 15 - 24,886: 8 (Twomey). Ex. B-4287, Tab 1850, p. 450.1; Tr. 23,716: 5 - 23,718: 3 (Twomey). Twomey described the strategy as follows: Tr. 23,497: 11-17 (Twomey). S62. The FHLBB Handbook on RCA cited "Trading" as one of the risks associated with implementation of an MBS RCA portfolio and states "[t]he risk would occur if an RCA institution makes buy-and-sell decisions based on a short-term speculative intent rather than long-term consistent profitability. Ex. B-4287, Tab 1850, p. 450.3. According to Twomey he never understood that the MBSs hel