Free Memorandum of Contentions of Fact and Law - District Court of Federal Claims - federal

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS _______________________________________ ) ) ) ) Plaintiff, ) ) v. ) ) THE UNITED STATES, ) ) Defendant. ) ) _______________________________________) ASTORIA FEDERAL SAVINGS & LOAN ASSOCIATION

No. 95-468C (Judge Wheeler)

PLAINTIFF'S MEMORANDUM OF CONTENTIONS OF FACT AND LAW

Frank Eisenhart Counsel of Record Catherine Botticelli Tara R. Kelly Catherine Stahl Dechert LLP 1775 I Street, N.W. Washington, D.C. 20006 202.261.3306 202.261.3333 (Fax) Attorneys for Plaintiff Astoria Federal Savings & Loan Association February 15, 2007

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TABLE OF CONTENTS TABLE OF AUTHORITIES...................................................................................................iii INTRODUCTION.............................................................................................1 CONTENTIONS OF FACT.................................................................................2 The Savings and Loan Crisis of the Early 1980s­ Some Economic History..................2 Fidelity New York, F.S.B...........................................................................9 Suburbia Federal Savings and Loan Association................................................10 Fidelity's Acquisition of Suburbia................................................................12 Operation of Fidelity Between 1984 and 1989..................................................16 Fidelity's Capital is Decimated by FIRREA....................................................20 Fidelity's January 1990 Capital Plan.............................................................22 OTS Approval of the Capital Plan................................................................23 Life Under the Capital Plan........................................................................24 Fidelity Converts to a Stock Institution and Escapes the Capital Plan.......................27 Merger with Astoria.................................................................................29 Astoria Files Suit Against the United States.....................................................30 CONTENTIONS OF LAW.................................................................................31 I. Fidelity Is Entitled to Lost Profits........................................................31 A. B. C. Fidelity's Lost Profits Were Foreseeable by the Parties When They Entered into the Contract.........................................................32 Fidelity's Lost Profits Were Proximately Caused by the Government's Breach..............................................................................37 Fidelity's Lost Profits Are Established with Reasonable Certainty.........44

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II. III. IV. V.

Fidelity Is Entitled to Restitution Damages to Restore It to Where It Would Have Been Had There Never Been a Contract................................................50 Plaintiff Is Entitled to Wounded Bank Damages.......................................53 Plaintiff Is Entitled to Reliance Damages...............................................57 The Government's Actions Constitute a Taking of Fidelity's Property Rights Under the Takings Clause of the Fifth Amendment...................................62 A. B. C. Fidelity Had Valid and Enforceable Property Rights as a Result of Its Contract with the Government...................................................63 The Government's Actions Constitute a Compensable Regulatory Taking..............................................................................64 Plaintiff Is Entitled to Damages as a Result of the Taking of Fidelity's Property Without Just Compensation..........................................67

CONCLUSION...............................................................................................68

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TABLE OF AUTHORITIES CASES Ambase Corp. v. United States, 58 Fed. Cl. 32 (2003)..................................................67 American Capital Corp. v. United States, 472 F.3d 859 (Fed. Cir. 2006)...................50, 58, 61 Bluebonnet Sav. Bank, F.S.B. v. United States, 266 F.3d 1348 (Fed. Cir. 2001)......32, 39, 44, 54 Branch v. United States, 69 F.3d 1571 (Fed. Cir. 1995)................................................67 California Fed., F.S.B. v. United States, 43 Fed. Cl. 445 (1999).................................53, 57 California Fed., F.S.B. v. United States, 245 F.3d 1342 (Fed. Cir. 2001)........................34, 40 California Fed., F.S.B. v. United States, 395 F.3d 1263 (Fed. Cir. 2005)...................39, 40, 44 Castle v. United States, 48 Fed. Cl. 187 (2000)..........................................................34 Castle v. United States, 301 F.3d 1328 (Fed. Cir. 2002)................................................62 Cinega Gardens v. United States, 331 F.3d 1319 (Fed. Cir. 2003)....................................64 Citizens Fed. Bank, F.S.B. v. United States, __ F.3d __, 2007 WL 162820 (Fed. Cir. 2007)......38 Citizens Fed. Bank, F.S.B. v. United States, 59 Fed. Cl. 507 (2004)..................................33 Citizens Fin. Servs., F.S.B. v. United States, 64 Fed. Cl. 498 (2005).............................33, 39 Coast Fed. Bank F.S.B. v. United States, 48 Fed. Cl. 402 (2000).....................................34 Columbia First Bank, F.S.B., Inc. v. United States, 60 Fed. Cl. 97 (2004)...........................33 Commercial Fed. v. United States, 59 Fed. Cl. 338 (2004)...........................32, 33, 34, 47, 48 Eastern Enterprises v. Apfel, 524 U.S. 498 (1998)......................................................65 Energy Capital Corp. v. United States, 302 F.3d 1314 (Fed. Cir. 2002)..............................32 First Fed. Lincoln Bank v. United States, 73 Fed. Cl. 633 (2006).........36, 39, 41, 42, 43, 47, 48 Glendale Fed. Bank, F.S.B. v. United States, 43 Fed. Cl. 390 (1999)................................34

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Glendale Fed. Bank, F.S.B. v. United States, 378 F.3d 1308 (Fed. Cir. 2004)....44, 53, 54, 57, 61 Glendale Fed. Bank, F.S.B. v. United States, 239 F.3d 1374 (Fed. Cir. 2001).........52, 57, 58, 60 Glendale Fed. Bank, F.S.B. v. United States, 54 Fed. Cl. 8 (2002) ..........................54, 57, 58 Globe Sav. Bank, F.S.B. v. United States, 65 Fed. Cl. 330 (2005)...........................32, 39, 41 Goldblatt v. Hempstead, 369 US. 590 (1962)............................................................66 Hansen Bancorp, Inc. v. United States, 53 Fed. Cl. 92 (2002).........................................58 Hansen Bancorp, Inc. v. United States, 367 F.3d 1297 (Fed. Cir. 2004).............................61 Home Sav. of America, F.S.B. v. United States, 57 Fed. Cl. 694 (2003)..............................32 Hughes v. United States, 71 Fed. Cl. 284 (2006)....................................................44, 60 Hughes Comm. Galaxy, Inc. v. United States, 271 F.3d 1060 (Fed. Cir. 2001)......................58 Landmark Land Co. v. United States, 256 F.3d 1365 (Fed. Cir. 2001)...............................58 LaSalle Talman Bank, F.S.B. v. United States, 64 Fed. Cl. 90 (2005).......................33, 36, 40 LaSalle Talman Bank, F.S.B. v. United States, 317 F.3d 1363 (Fed. Cir. 2003)............44, 50, 58 LaVan v. United States, 382 F.3d 1340 (Fed. Cir 2004)................................................32 Lingle v. Chevron, 544 U.S. 528 (2005).........................................................64, 65, 66 Locke v. United States, 283 F.2d 521 (Ct. Cl. 1960)....................................................44 M&J Coal Co. v. United States, 47 F.3d 1148 (Fed. Cir. 1995).......................................63 Mobil Oil Exploration & Producing S.E., Inc. v. United States, 530 U.S. 604 (2000).............50 NRG Co. v. United States, 30 Fed. Cl. 460 (1994)......................................................68 Nat'l Australia Bank v. United States, 55 Fed. Cl. 782 (2003).........................................63 Old Stone Corp. v. United States, 450 F.3d 1360, 1377 (Fed. Cir. 2006)............................58 Penn Central Transp. Co. v. New York City, 438 U.S.104 (1978)...........................64, 65, 66

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Pennsylvania Coal Co. v. Mahon, 260 U.S. 393 (1922)................................................65 Precision Pine & Timber v. United States, 72 Fed. Cl. 460 (2006)....................................32 Sacramento Mun. Util. Dist. v. United States, 63 Fed. Cl. 495 (2005)................................63 Seuss v. United States, 74 Fed. Ct. 510 (2006)...........................................................39 Slatterly v. United States, 69 Fed. Cl. 573 (2006)..............................................44, 57, 58 Southern Ca. Fed. Sav. & Loan Assoc. v. United States, 57 Fed. Cl. 598 (2003)...................54 Southern Ca. Fed. Sav. & Loan Assoc. v. United States, 422 F.3d 1319 (Fed. Cir. 2005).........55 Stern v. Dunlap Co., 228 F.2d 939 (10th Cir. 1955)......................................................44 System Fuels, Inc. v. United States, 65 Fed. Cl. 163 (2005).......................................63, 64 United States v. Winstar, 518 U.S. 839 (1996)..................................................30, 33, 34 Westfed Holdings, Inc. v. United States, 407 F.3d 1352 (Fed. Cir. 2005)...................58, 59, 61 Yuba Natural Resources, Inc. v. United States, 904 F.2d 1577 (Fed. Cir. 1990)....................68 STATUTES AND RULES Financial Institutions Reform, Recovery, and Enforcement Act, Pub. L. No. 101-73, 103 Stat. 183 (1989).....................................................................................................20 Gran-St.Germain Depository Institutions Act of 1982, 12 U.S.C. § 266, Pub. L. No. 97320................................................................................................................6 SECONDARY SOURCES Arthur Linton Corbin, CORBIN ON CONTRACTS (2002)................................................35 Martin Lowy, HIGH ROLLERS: INSIDE THE SAVINGS AND LOAN DEBACLE, (1991)..........4, 5, 7, 8 E. Alan Farnsworth, FARNSWORTH ON CONTRACTS (3d ed 2004).....................................40 RESTATEMENT (SECOND) OF CONTRACTS (1981)...............................31, 32, 50, 53, 57, 58, 61 RESTATEMENT OF THE LAW, RESTITUTION § 1...........................................................50.

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INTRODUCTION This action arises out of the 1984 acquisition by Fidelity New York, F.S.B. ("Fidelity") of Suburbia Federal Savings and Loan Association ("Suburbia"). Suburbia was a troubled thrift, teetering on the edge of insolvency, and the subject of deep regulatory concern. Fidelity was a moderately successful thrift that hoped to prosper by expanding its franchise. Fidelity acquired Suburbia on October 31, 1984 in a supervisory merger, with the approval of the Federal Home Loan Bank Board ("FHLBB") and with assistance provided by the Federal Savings and Loan Insurance Corporation ("FSLIC"). Fidelity was permitted by regulators to book supervisory goodwill in the amount of $160 million as part of its accounting for the merger and to amortize that goodwill over 30 years. Without the goodwill, Fidelity would have been rendered insolvent by its merger with Suburbia. After the merger, Fidelity operated the merged institutions as a single entity under the Fidelity name. With the passage of FIRREA in August 1989, Fidelity was deprived of the ability to count some $71 million of supervisory goodwill remaining from the Suburbia merger as regulatory capital, and Fidelity was rendered instantly insolvent. For the next three and one-half years, Fidelity struggled to survive under a highly conservative Capital Plan in an oppressive regulatory environment, while it sought to rebuild its capital account. Remarkably, Fidelity survived and was finally able, in 1993, to convert to a stock institution, selling sufficient stock to achieve capital compliance once again and to be free of the onerous Capital Plan. While able to breathe again, however, Fidelity was far from vigorous. Its management concluded in late 1993 that Fidelity had been too wounded by its years under the Capital Plan to compete effectively with local institutions who had not been similarly hamstrung and who were

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flush with cash from public offerings that were vastly more successful than Fidelity's had been. Management concluded that the only prudent course of action was to seek a buyer for Fidelity. They did so, and in 1994, Fidelity was acquired by Astoria, a local competitor. Prior to its acquisition by Astoria, Fidelity's management had engaged counsel to investigate the filing of a lawsuit against the Government for the wrongful taking of Fidelity's capital. Subsequent to the merger, Astoria concluded that such a lawsuit had potential merit and that favorable developments in other Winstar-type cases warranted the filing of a claim. This action followed. CONTENTIONS OF FACTS The Savings and Loan Crisis of the Early 1980s­ Some Economic History The ills that beset the savings and loan industry generally, and Suburbia in particular, did not spring to life fully formed in 1984. To understand the forces that dragged Suburbia down, and which ultimately gave rise to this litigation, it is helpful to have some history. On January 3, 1831, the Oxford Provident Building Association opened its doors in the Frankford section of Philadelphia. It was the Nation's first savings and loan association. A few months later the Association issued its first mortgage loan, in the princely sum of $500, to one Comly Rich for the purchase of a house at 4276 Orchard Street in Philadelphia.1 Throughout the years that followed this humble beginning, the savings and loan industry was the engine that drove the American dream ­ ownership of one's own family home. By its 150th anniversary, however, the savings and loan industry was an industry in crisis, the roots of which lie in part in the basic structure of the industry. Historically, S&Ls had always
1

Federal Home Loan Bank Board Journal Annual Report 1980, p. 2.

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"borrowed short" and "lent long." They took in deposits which were considered "short-term money," since they could be withdrawn at any time at the election of the depositor. However, they lent out those deposits in the form of mortgages which returned a fixed rate of interest over a long (typically 30 years) period of time. Indeed, S&Ls were largely forbidden by law from long-term borrowing, just as they were largely forbidden by law from making anything other than long-term mortgage loans. The structural flaw of S&Ls was mandated by law. For many years, however, this structural flaw was not problematic. Those who lend money typically demand a higher return when they lock up their funds for a long period of time, so long-term interest rates are usually higher than short-term interest rates. S&Ls could therefore earn a profit so long as interest rates either remained stable or did not rise too quickly. Their rate of return on the long-term mortgages would exceed the rate they had to pay to attract the shortterm deposits needed to fund those mortgages. So long as this "spread" exceeded their operating costs, S&Ls would remain profitable. However, in the 1960s things began to change. The Johnson Administration decided in the 1960s that America could afford both guns (the Vietnam War) and butter (the Great Society). The result was inflation and rising interest rates, just the scenario to play havoc with the structural flaw in the S&L industry. However, Congress thought it had the fix. In order to protect S&Ls from having to pay higher interest rates to attract deposits, Congress in 1966 instituted interest rate controls on savings deposits at all federally insured S&Ls. By putting a ceiling on the rates the S&Ls could pay to depositors, thereby eliminating any incentive for depositors to pull their funds and seek a higher return elsewhere, Congress in essence tried to allow the S&Ls to "borrow long" just as they "lent long." As a strategy, however, it would work only so long as the depositors who were earning the

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capped interest rates (and who were thus bearing the cost of the entire arrangement) were content to leave their savings where they were.2 By the end of the 1970s it was clear that interest rate regulation no longer worked, if indeed it ever had worked. Inflation had driven interest rates well beyond the 5.5 percent cap on passbook accounts, and passbook savers were waking up and discovering that they had other options. By 1978, Treasury bills were paying over 9 percent, as were money market mutual funds, which had come into vogue in the 1970s. Money began to flow out of S&Ls. The regulators responded by letting S&Ls offer six-month Certificates of Deposit, with rates that floated a half percent over Treasury bills. While this helped stem the outward flow of funds, it substituted one problem for another. S&Ls were still locked in, on the asset side, to lowyielding, long-term, fixed rate mortgages. They could not afford to pay the market rates of interest required on the new CDs and still hope to earn a profit. Pertinent to this case, New York was one of the markets hardest hit. State usury laws kept down the rates S&Ls could charge to mortgage borrowers,3 but sophisticated depositors quickly moved their savings to the higher yielding CDs. The S&Ls were caught in a squeeze.4

2

Martin Lowy, High Rollers: Inside the Savings and Loan Debacle, Praeger Publishers (1991), pp. 14-17. Of the various books written about the S&L crisis of the 1980s, books ranging from the tabloid sensational to the scholarly dense, Lowy's is probably the most readable and informative. Lowy, a New York lawyer, at various times represented banks and thrifts, as well as their trade associations and regulators. He also served from 1986 through 1989 as Vice-Chairman of a large New York bank. Relief from state usury laws came in March 1980 when Congress passed the Deposit Institutions Deregulation and Monetary Control Act of 1980. Among other things it preempted state usury laws for residential mortgage loans. The Act also provided for a gradual phaseout of deposit interest rate regulation and gave S&Ls the power to offer NOW accounts and to make various types of consumer loans which carried higher rates of return than traditional mortgages. While these stabs at deregulation on both sides of 4

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The final leg of the crisis fell into place in 1979 when Paul Volker, the new Chairman of the Federal Reserve, introduced a marked change in monetary policy. The Fed began to place less weight on controlling interest rates and more emphasis on shrinking the money supply to choke off inflation. The end result was highly volatile interest rates, which soared to new highs in 1980.5 The prime rate increased sharply, reaching a record 20 percent in early April. After declining to a low point of 10.75 percent in July, it again surged upward to a new record 21.5 percent in December.6 Richard Pratt, Chairman of the Federal Home Loan Bank Board, described the situation in 1980 in these words: The behavior of the Nation's economy during 1980 can best be described as erratic. Continued inflation and unprecedented fluctuations in interest rates spelled difficult times for the savings and loan industry, times in which both the numbers of loans originated and the total earnings of the industry fell substantially. . . . The situation is exacerbated by the fact that most S&Ls carry a volume of seasoned low-yielding loans, carrying interest rates which were fixed in less inflationary times and which may have many years of life remaining. The ability of associations to function is being put to the test as they face competition for savings capital from money market funds, Treasury securities, and other investments yielding current market rates. Savers are more sophisticated; they shy away from accepting interest rates that are not competitive and do not keep pace with inflation. Deposit flows in the industry remain depressed, particularly in relationship to demands for housing credit."7

the balance sheet made good policy sense, they were too little, too late in terms of preventing the thrift industry crisis than soon ensued. Id. at pp. 19-20.
4 5 6 7

Id. at pp. 14-17. Id.; Federal Home Loan Bank Board Journal Annual Report 1980, p. 6. Federal Home Loan Bank Board Journal Annual Report 1980, p. 20. Id., p. 6.

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These conditions began to take a toll on the Nation's S&Ls. In 1980, the FSLIC had to intervene in 11 institutions and was appointed conservator or receiver of insured savings institutions in five cases.8 During the last seven months of 1981, the FSLIC was called upon to resolve 23 problem S&Ls with assets totaling $12.3 billion.9 The year 1982 started out looking bleak. Interest rates, which had begun to decline in the second half of 1981, spiked upward again, and during the first half of 1982 net operating losses of the S&L industry reached $3.2 billion. As Chairman Pratt noted in his 1982 Annual Report: "At that rate of decline, the virtual elimination of the S&L industry as a main provider of financial services became more than a theoretical possibility."10 Relief came in the second half of 1982, with lower inflation and a dramatic downturn in interest rates. This reversed the trend, and by December the industry as a whole was again profitable (though industry losses for the year were about $1.5 billion).11 While the 1982 decline in interest rates allowed short-run survival, longer term survival was addressed through the passage of the Garn-St.Germain Act.12 This Act removed all federal and state law restrictions on the conversion of mutual thrifts to federal stock S&Ls.13 Between 1983 and 1989, over 300 mutual S&Ls insured by the FSLIC converted to stock form and raised an aggregate of $5 billion of new capital ­ an amount greater than the whole industry's tangible
8 9 10 11 12 13

Id., pp. 12-14. Federal Home Loan Bank Board 1981 Annual Report, p. 8. Federal Home Loan Bank Board Annual Report 1982, pp. 4, 19. Id., p. 4. Id. Gran-St.Germain Depository Institutions Act of 1982, 12 U.S.C. § 266, Pub. L. No. 97320.

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capital in 1982. More significantly, however, the Act also gave expanded powers to S&Ls to make commercial loans, commercial real estate loans and consumer loans.14 These new powers, it was hoped, would add zest in the form of higher rates of return to the asset side of the S&L balance sheet. Other measures intended by the FHLBB to relieve the pressure on undercapitalized S&Ls included the Appraised Equity Capital rules, which allowed thrifts to count as part of their capital the appraised equity in buildings owned by the thrift, various new rules regarding amortization of loan premiums, discounts and credits and the treatment of gains and losses in the sale of real estate,15 and Net Worth Certificates, which allowed an institution with less than three percent capital to secure promissory notes from the FSLIC that it could then use to raise its regulatory capital level sufficiently to allow it to stay in business.16 Interest rates continued their decline during the early part of 1983, and there seemed to be cause for optimism. The industry was again profitable, S&Ls were growing, and the number of S&L failures was down sharply from the prior year.17 However, despite the rosy overall outlook, trouble persisted in the bottom half of the industry. Fifty percent of S&Ls lost money overall in 1983, and 35 percent lost money in the second half of 1983, when the positive impact of declining interest rates should have been fully recognized.18 The industry's profits, it turned out, were not coming from operations. The industry's spread for the year was a mere 130 basis

14 15 16 17 18

Lowy, supra note 2, at p. 49-50. Federal Home Loan Bank Board Annual Report 1982, p. 4. Federal Home Loan Bank Board 1984 Annual Report, p. 6. Lowy, supra note 2, at p. 59. Id. at p. 61. 7

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points ­ not enough to cover operating expenses. The profits, it turned out, were coming from the sale of loans and securities that had appreciated when rates came down.19 The FSLIC was required in 1983 to resolve 53 problem institutions, with assets totaling $17.6. This represented almost 37 percent of all assets ever resolved up to that time with FSLIC assistance. In six of these institutions, the FSLIC was required to appoint itself as Receiver to liquidate the institution and transfer its assets to other institutions. This represented a third of all insurance settlement cases in the FSLIC's history up to date.20 Indeed, by the end of 1983, the number of institutions that were insolvent under regulatory accounting principles ("RAP") was back to about what it had been at the end of 1982, and 900 institutions, with $263 billion in assets (almost a third of the industry), had under 3 percent net worth according to generally accepted accounting principles ("GAAP").21 So, while 1983 had seemed on the surface to be a good year, in reality it had been anything but. Thrifts grew in 1984 at their fastest pace since the early 1950s. Taking advantage of deregulation and using their new powers acquired under the Garn-St.Germain Act, thrifts increased both deposits and borrowings and used these funds to significantly expand their asset base. Unfortunately, many of these assets proved to be substandard, and many thrifts were unable to manage effectively their rapid growth. In the process of increasing their assets, many thrifts increased their credit risk by lowering underwriting standards. Overall, thrift industry profitability declined in 1984, proving both the fragility of the industry's recovery from the large

19 20 21

Id. 1983 Federal Home Loan Bank Board Annual Report, pp. 17-18. Lowy, supra note 2, at p. 61.

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operating losses of 1981 and 1982 and the industry's continued vulnerability to increases in market interest rates.22 As thrifts tried to use their new powers to grow their way out of the hole, the FSLIC began to see increasing numbers of institutions with asset quality problems in addition to the interest rate imbalance problems common throughout the early 1980s. As a result, the FSLIC was in 1984 forced to place nine institutions ­ a third of all the problem cases resolved in 1984 ­ into liquidating receiverships. Together with the six such receiverships instituted in 1983, these 15 cases equaled the total number of liquidating receiverships in FSLIC's entire previous history.23 Such then was the history of America's savings and loan industry in the time periods relevant to this lawsuit. Against this backdrop, let us now look at the institutions directly involved in this litigation. Fidelity New York, F.S.B. Fidelity was founded in 1924 as Floral Park Co-operative Savings and Loan Association, a New York chartered co-operative association, headquartered in Floral Park, a Long Island suburb of New York City. It converted to a federal charter in 1934 and, after a series of name changes, came, in 1986, to be known as "Fidelity New York, F.S.B."24 As of 1984, Fidelity had 8 branches, 6 in Nassau County and 2 in New York City. As of June 30, 1984, Fidelity had

22 23 24

Federal Home Loan Bank Board 1984 Annual Report, p. 7. Id., p. 23. Fidelity Subscription Offering Circular (Mar. 24, 1993), AST064170-318, at AST064189.

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assets of $475.2 million and net worth of $21.4 million or 4.5% of assets. Its net income for the six months ending June 30, 1984 was $2.4 million.25 Historically, Fidelity, like most thrifts, had operated as a financial intermediary, taking in deposits from members of its community, and lending those back in the form of long-term, fixed-rate mortgage loans. By the early 1980s, it had become apparent that such a strategy was problematic in an era of deregulation and volatile interest rates. Fidelity therefore began to diversify its loan portfolio into a more interest-rate sensitive portfolio of one-to four-family adjustable rate mortgages and, to a lesser extent, prime rate multi-family, commercial real estate loans, and construction loans.26 Suburbia Federal Savings and Loan Association Suburbia was a federally chartered mutual association founded in 1935 as Lynbrook Federal Savings and Loan Association. It was headquartered in Garden City, another Long Island suburb of New York City, and it had 12 branches, 7 in Nassau County and 5 in Suffolk County.27 Suburbia had been a supervisory concern to the Federal Home Loan Bank of New York ("FHLB-NY") since 1981 because of continuing losses caused by high interest rates. Suburbia experienced the classic interest rate mismatch between returns on its portfolio of fixed-rate, long term mortgages and its cost of funds.28 Between July 1, 1981 and June 30, 1984, Suburbia had
25 26

FHLB-NY S-Memorandum (Oct. 5, 1984), AA 0000193-208, at AA 0000193. Fidelity Subscription Offering Circular (Mar. 24, 1993), AST064170-318, at AST6418990. FHLB-NY S-Memorandum, (Oct. 5, 1984), AA 0000193-208, at AA 0000198. FSLIC I-Memorandum (Oct. 15, 1984), AA0000177-81, at AA 0000177. 10

27 28

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sustained operating losses totaling $37.5 million.29 Suburbia's asset portfolio was mainly thirtyyear single family mortgage loans.30 As of June 30, 1984, Suburbia had assets of $656.1 million and a regulatory net worth of $3.5 million or 0.5 % of assets.31 By August 1984, Suburbia's assets had grown to $696 million, but its net worth had declined to $1.8 million, a mere 0.25 % of assets. However, even that miniscule capital level overstated Suburbia's true condition. Suburbia's net worth included $5.0 million of Appraised Equity Capital and $9.2 million of Net Worth Certificates. Without these, Suburbia's net worth was a negative $12.4 million or negative 1.8 % of assets.32 Taking into account as well deferred losses of $44.2 million, Suburbia would have had a $55 million capital deficit.33 On June 30, 1984, Suburbia had a $360 million negative gap position for the upcoming year, meaning that its maturing liabilities in that year would exceed its maturing assets by $360 million.34 The regulators recognized that Suburbia's management was making an effort to lessen this negative gap by restructuring assets and reducing interest rate risk. However, their ultimate

29 30

FHLB-NY S-Memorandum (Oct. 15, 1984), AA 0000193-208, at AA 0000193. Deposition, Andrew Kane, Jr. (July 27, 2000), pp. 16-17. Suburbia did attempt in the early 1980s to do some consumer lending, because these loans carried higher interest rates and were of shorter duration than mortgage loans. However, it met stiff competition in this area from commercial banks, and the results of the program were disappointing. Id. at pp. 63-64. FHLB-NY S-Memorandum (Oct. 15, 1984), AA 0000193-208, at AA 0000193. FSLIC I-Memorandum (Oct. 15, 1984), AA0000177-81, at AA 0000177. FHLB-NY S-Memorandum (Oct. 15, 1984), AA 0000193-208, at AA 0000193. Id., at AA 0000194.

31 32 33 34

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conclusion was that "Suburbia's impaired financial condition present[ed] a seemingly insurmountable obstacle to successful completion of this goal."35 Brent Beesley, who headed up the FSLIC in the early 1980s, testified in his deposition, and is expected to testify at trial, that the regulators could not indefinitely postpone dealing with an institution whose capital was depleted. Once an institution's capital approached zero ("I don't think we actually ever let an institution get to zero"), it was incumbent on the regulators to act.36 As noted, by August 1984 Suburbia's regulatory capital had fallen to 0.25 percent of assets, only 25 basis points above zero, and if one were to strip away its Net Worth Certificates and Appraised Equity Capital, Suburbia's capital position was decidedly negative. Clearly the regulators were at the point where they had to take action with respect to Suburbia. Fidelity's Acquisition of Suburbia The FHLB-NY had urged Suburbia as early as 1981, in light of its operating deficits and depleted net worth, to try to find a merger partner or an investor capable of making a major capital infusion.37 None could be found.38 Andrew Kane, Suburbia's Chairman and CEO in the early 1980s, recalled that potential investors did not see a way Suburbia could become a profitable venture so long as interest rates stayed high.39 Plaintiff will prove at trial that even falling interest rates, such as were experienced in 1982 could not have saved Suburbia, so deep was the hole in which it found itself.
35 36 37 38 39

Id. Deposition, Horace Brent Beesley (July 26, 1999), pp. 33-34. FHLB-NY S-Memorandum (Oct. 15, 1984), AA 0000193-208, at AA 0000198. Deposition, Andrew Kane, Jr. (July 27, 2000), pp. 39-40. Id.

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The FSLIC held a bidder's conference for Suburbia on December 20, 1982. At the conference, information packets giving details about Suburbia were given to 22 institutions and individuals, and subsequent to the conference to an additional three potential acquirors. This resulted in proposals by four New York savings institutions to acquire Suburbia at a cost to the FSLIC ranging from $17.9 million to $33.9 million. However, because Suburbia had become eligible for capital assistance in the form of Net Worth Certificates, the regulators did not pursue any of these proposals.40 The regulators thus opted for the "cheap fix." Rather than spend the money at the end of 1982 to merge Suburbia into another institution, the regulators opted simply to paper over its capital deficiencies. Another proposal to merge Suburbia was received in March 1983, but the regulators did not deem this proposal to be viable.41 In April 1984, Suburbia and Fidelity submitted a merger proposal to the regulators under the Voluntary Assisted Merger Program ("VAMP"). The FHLB-NY could not approve this proposal, because it required accounting forbearances, including supervisory goodwill, which could not be authorized at the district level. The proposal was therefore resubmitted as a request for an assisted supervisory merger to the FSLIC/FHLBB in Washington.42 In its evaluation of the Fidelity merger proposal, the FSLIC calculated that the cost savings to the Government over the present value liquidation cost was $131.9 million ($147.9 million present value liquidation cost minus $16 million cash assistance to Fidelity).43 The

40 41 42 43

FSLIC I-Memorandum (Oct. 15, 1984), AA0000177-81, at AA 0000178. Id. Id., at AA 0000178-79. Id. at AA 0000180; FHLBB Institution Analysis 1984, WFZ009 0020-28, at WFZ009 0021.

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FSLIC listed the alternatives to the Fidelity proposal as either liquidation, which it rejected as too costly, or soliciting other bids.44 Noting that Suburbia had incurred additional operating losses in excess of $10 million since 1982, the FSLIC concluded that soliciting additional bids or re-bids on Suburbia was not likely to result in proposals more favorable (less costly) than the Fidelity proposal.45 Suburbia had already been extensively shopped, and the FSLIC thought there was no reason to believe that another bid, should one materialize, would be less costly than Fidelity's bid. There was additionally the risk that the Fidelity bid might come off the table in the meantime.46 Neither the FSLIC nor the FHLBB suggested or attempted to calculate the cost of any solutions for Suburbia other than the Fidelity merger or liquidation. The Department has a favorite shell game that it plays in the Goodwill litigation when it comes to comparing the actual cost of resolving a troubled institution to estimated liquidation costs. It has consistently maintained throughout the Goodwill litigation that the FSLIC never liquidated institutions, and that there were always alternative solutions for a problem institution other than liquidation (though it usually declines to say what these were or what they cost). Plaintiff expects the Department to repeat this mantra in this case. Plaintiff will prove at trial that the FSLIC did in fact liquidate institutions in the early 1980s. Plaintiff will also prove that the FSLIC regularly tracked its average actual cost of "resolving" problem institutions and compared this on both an absolute and a percentage basis to the estimated cost of liquidation. The Court will therefore
44 45 46

FSLIC I Memorandum (Oct. 15, 1984), AA0000177-81, at AA 0000180. Id. at AA 0000178. Id. at AA 0000180. Andrew Kane, Suburbia's Chairman, also agreed that by 1984 Suburbia had exhausted every possibility for raising capital other than the Fidelity merger. Deposition, Andrew Kane Jr. (July 27, 2000), pp. 39-40, 115.

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have evidence available with which it can compare the cost of the Fidelity merger to both the FSLIC's calculated cost of liquidating Suburbia (the only alternative it considered in 1984) and to the FSLIC's actual cost of all resolutions of problem institutions in the relevant time periods. Fidelity merged with (acquired) Suburbia as of 11:59 PM on October 31, 1984. The merger was deemed by the FHLBB in Resolution No. 84-582 to be for supervisory reasons. The FHLBB authorized $16 million of FSLIC cash assistance which could be booked as a direct credit to Fidelity's net worth, and it authorized any intangible assets resulting from the merger (goodwill) to be amortized over thirty years.47 Fidelity put on its books supervisory goodwill from the Suburbia merger in the amount of $160,093,066.48 The Resolution permitted Fidelity to accrete the loan discount over a thirty year period as well. However, Fidelity came back after the fact and asked that it be allowed to accrete the loan discount over the estimated life of the loans, i.e., according to Generally Authorized Accounting Principles ("GAAP"). The FHLBB approved this change, which it found to be less liberal than what it had been prepared to approve.49 The ability to book Suburbia's excess liabilities as supervisory goodwill and count that goodwill as part of its capital was an essential part of the deal as far as Fidelity, and its accountants at Peat, Marwick, Mitchell, and Company were concerned. Without it, the merger with Suburbia would have destroyed Fidelity.50 The regulators felt the same way. One of the
47

FHLBB Resolution No. 84-582, (Oct. 25, 1984), WOF003 0481-82; Assistance Agreement (Oct. 31, 1984), AST122791-20. Letter, Bruno Greco to Angelo Vigna (Oct. 30, 1989), WON730 0525-26. Memorandum, Edward J. O'Connell, III to Angelo Vigna (Jan. 8, 1985), AA005 175455. Deposition, Thomas Dixon Lovely (July 10-11, 2000), pp. 75-81. 15

48 49

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officials at the FHLB-NY likened the thirty-year amortization period for the goodwill to buying a house with a thirty-year mortgage. Mr. Lovely recalled his words: "Mr. Lovely, you bought yourself a bank. You're gonna pay it off in a 30-year mortgage like a house and you've done the government a favor and you now have a new . . . bank."51 Mr. Lovely, who will testify at trial, will explain why he thought that made perfect sense. Operation of Fidelity Between 1984 and 1989 Fidelity's Chairman and CEO at the time of the merger with Suburbia was Thomas Dixon Lovely. Mr. Lovely had an academic background and had joined Fidelity's Board in the 1970s. By 1980, he had become CEO of Fidelity.52 Fidelity's President and COO was Bruno Greco. Both Mr. Lovely and Mr. Greco will testify at trial. Mr. Lovely and Mr. Greco, with the encouragement of the regulators, embarked Fidelity on a program of commercial lending, including acquisition, development and construction loans on condominium and co-operative units. Fidelity encountered problems with some of these commercial loans, and it was eventually required by the regulators to establish sizable reserves against losses from these activities.53 Fidelity was not unique in this respect. Richard Pratt, who served as Chairman of the FHLBB from 1981 to 1983, and who will testify at trial, testified in his 1998 "common deposition" (and is expected to testify at trial) that there were two distinct problems that afflicted the thrift industry in the 1980s. The first was the interest rate mismatch in the early 1980s
51 52 53

Id. at 76. Id. at 10-11. Deposition, Thomas V. Powderly (July 20, 2000), pp. 58-63.

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between high-rate, short-term deposits and low-rate, long-term mortgages. The second occurred when a conscious effort was made by the Government to beef up the deposit base in the thrift industry in order to help thrifts "grow out" of their problems. This effort led the industry to grow from $600 billion at the end of 1982 to some $1.4 trillion by 1988 or 1989. However, Mr. Pratt noted, there were not enough quality assets to absorb this deposit growth, and the flood of money tended to depreciate the value of all assets to the point where even well-conceived and wellexecuted loans could face problems. So, in the late 1980s, many thrifts started to experience problems related to asset quality.54 Angelo Vigna, Fidelity's Principal Supervisory Agent at the FHLB-NY, who will also testify at trial, noted in his deposition that he had always had some reservations about the strength of Fidelity's management team and thought that Mr. Lovely and Mr. Greco needed to strengthen the senior management team.55 In mid-1986, Fidelity added three new members to its senior management team, Thomas Powderly, William Wesp and Frederick Meyer.56 Mr. Powderly had considerable commercial real estate experience and took over the running of Fidelity's real estate division, including supervision of Fidelity's troubled commercial loan and real estate portfolio.57 Mr. Wesp came to Fidelity from another thrift where he had been Senior

54

Deposition, Richard T. Pratt (Dec. 2, 1998), pp. 143-45. See also Federal Home Loan Bank Board Journal Annual Report 1984, p. ii, where then FHLBB Chairman Edwin Gray discusses measures taken by the Board "to arrest the skyrocketing growth undertaken by too many institutions." Deposition, Angelo A. Vigna (Aug. 2, 2000), p. 400. Fidelity Subscription Offering Circular (Mar. 24, 1993), AST064170-318, at AST064190. Deposition, Thomas V. Powderly (July 20, 2000), pp. 12-14.

55 56

57

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Vice President and Investment Officer. He took over Fidelity's investment operations.58 Mr. Meyer took over the retail side of the bank.59 Mr. Powderly determined, after reviewing the commercial loan portfolio, that Fidelity should cease commercial real estate lending, which had been hit hard by the Tax Reform Act of 1986.60 As he will explain in detail at trial, once Mr. Powderly got the green light to implement this change, commercial loans were not renewed and developers with lines of credit were urged to go elsewhere. In addition to curtailing loan originations, Fidelity reduced its existing commercial loan portfolio from $370.9 million at September 30, 1986, to $207.9 million at December 31, 1989. They did this by discouraging loan renewals and selling loan participations.61 In the financial area, the key player was Mr. Wesp. He will explain at trial the strategy he conceived and implemented to rely less on the origination of mortgage loans and more on the purchase of those loans in the form of mortgage-backed securities. This was a means both of controlling the bank's credit risk and managing its interest rate risk. Buying mortgages "in bulk" in this fashion also offered Fidelity a way to deal with the intense competition in its geographic

58 59

Deposition, William E. Wesp (July 19, 2000), pp. 12-13. Deposition, Fredrick J. Meyer (July 24, 2000), pp. 8-10. There initially was some overlap between Mr. Meyer and Mr. Powderly in the supervision of Fidelity's lending functions. This was eliminated in time, with Mr. Powderly taking on all responsibility for the commercial lending portfolios and Mr. Meyer retaining responsibility only for consumer lending. Id.; Thomas V. Powderly (June 20, 2000), pp. 69-71. Thomas V. Powderly (June 20, 2000), pp. 27-28; Fidelity Subscription Offering Circular (Mar. 24, 1993), AST064170-318, at AST064190. Fidelity Subscription Offering Circular (Mar. 24, 1993), AST064170-318, at AST064190.

60

61

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area for origination of one- to four-family mortgage loans.62 Mr. Wesp observed that there were times when he could buy AA rated or agency mortgage-backed securities with yields higher than those on mortgages originated in the local market.63 In October 1988, Fidelity adopted a Three Year Business Plan for 1989 to 1992.64 This was put together by Messrs. Powderly, Wesp, and Meyer.65 The plan called for "no quantum leaps forward, just steady growth." The salient points were: · · · · · · · · · · Increase capital, particularly GAAP capital. Grow the balance sheet at approximately 8 to 10% per annum. Reduce loan concentrations and increase credit quality. Increase return on assets to a stable 50 to 70 basis point range. No new lines of business and no untested earning streams. Reduce exposure to venture and commercial lending. $7.2 million in pretax capital gains from Freddie Mac stock. Increase of $10.5 million per quarter in Home Equity loans. Increase of $11.25 million per quarter in consumer lending. Reduce overhead and marketing expenses, with any consequent shortfall in asset growth to be made up by purchases of securities of like maturity, duration, and collateral.

62 63 64 65

Id. at AST064190-91. Deposition, William E. Wesp (July 19, 2000), p. 116. Fidelity Three Year Business Plan (Oct. 1988), AST056376-93. Deposition, William E. Wesp (July 19, 2000), pp. 23-24.

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· ·

Regulatory net worth to increase to $122.7 million (5% of assets). GAAP net worth to increase from $33.4 million to $48.25 million from retained earnings.

· ·

Deposits to grow 8.8% over the three years to $1.5 billion. Total borrowings, including FHLB borrowings, to grow to $794.48 million, 32% of liabilities.

Management noted that the biggest single risk to successful implementation of the plan was potential regulatory treatment of capital.66 Mr. Powderly and Mr. Wesp will both testify that they were concerned about this as early as 1988 and anticipated in all of their planning that there would likely be some punitive treatment of supervisory goodwill.67 They also began to be opportunistic in selling appreciated assets to bolster capital. This was all done in anticipation of what eventually emerged as FIRREA.68 Fidelity's Capital is Decimated by FIRREA FIRREA was enacted on August 1, 1989; its implementing regulations took effect on December 6, 1989. At the stroke of the Governmental pen, Fidelity could no longer count $93 million of supervisory goodwill as regulatory capital.69 Fidelity was instantly rendered capital

66 67

Fidelity Three Year Business Plan (Oct. 1988), AST056376-93, at AST056379. Deposition, William E. Wesp (July 19, 2000), pp. 26-27., July 19, 2000; Deposition, Thomas V. Powderly (July 20, 2000), pp. 58-62, 196-97. See e.g., Deposition, William E. Wesp (July 19, 2000), pp. 26, 70; Deposition, Thomas V. Powderly (July 20, 2000), pp. 58-62. Letter, Thomas Dixon Lovely to Walter Amend (Oct. 18, 1991), AST002747-59, at AST002747.

68

69

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deficient and insolvent.70 On December 6, 1989, Fidelity had regulatory capital of $125 million and GAAP capital of $62 million. The next day, as a result of FIRREA, it estimated that its tangible capital was negative $29.6 million, its core capital was negative $2.2 million, and its risk based capital was negative $2.2 million.71 The Department has admitted in this litigation that the taking of Fidelity's capital related to the Suburbia acquisition by FIRREA was a breach of the contract Fidelity made with the FHLBB and FSLIC when it acquired Suburbia in 1984. On February 2, 1990, Fidelity received formal notice from Angelo Vigna, now District Director of the new Office of Thrift Supervision ("OTS"),72 stating that the agency considered Fidelity to be insolvent.73 The letter notified Fidelity that it was now subject to heightened regulatory scrutiny and directed Fidelity to make no new loans or investments without the prior written approval of the District Director unless they fell within certain narrow guidelines. Fidelity's only recourse was to submit a Capital Plan to OTS. If OTS approved the plan, Fidelity could continue to exist subject to the strictures of the plan. If OTS did not approve the plan, or if Fidelity did not comply with any aspect of an approved plan, Fidelity was subject to regulatory seizure and liquidation.74

70

Letter, Angelo Vigna to Fidelity Board of Directors (Feb. 2, 1990), AST0704292-95; Fidelity Subscription Offering Circular (Mar. 24, 1993), AST064170-318, at AST064191. Fidelity New York, F.S.B., Capital Compliance Plan (Jan.1990), AST0705436-5624, at AST0705445. As part of FIRREA, OTS replaced the old FHLBB as the primary regulator of thrifts. Letter, Angelo Vigna to Fidelity Board of Directors (Feb. 2, 1990), AST0704292-95. Fidelity Subscription Offering Circular (Mar. 24, 1993), AST064170-318, at AST064193; Deposition, William E. Wesp (July 19, 2000), pp. 55-56.

71

72 73 74

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Fidelity's January 1990 Capital Plan Fidelity submitted its Capital Plan on January 3, 1990.75 Mr. Wesp, who was the primary author of the Plan, will describe at trial the process by which it was put together and by which it was to be implemented. Fidelity's Capital Plan was a conservative, no-growth plan. It set very specific capital goals for each quarter for the next five years.76 Fidelity would have to meet each and every one of those goals if it wanted to continue to operate. As Mr. Wesp noted, "the alternative was the extinction of the institution."77 The Capital Plan aimed to achieve capital compliance by the end of 1994 by retaining earnings while amortizing goodwill. The Plan projected no growth in early years and modest shrinkage of the balance sheet in 1993/94. Fidelity had reduced goodwill by over $90 million since 1985, and it projected an additional decrease of "$40 million over the plan period through amortization and earnings retention."78 The Capital Plan does at one point state that Fidelity would continue doing what it had been doing. The Department pounces on this one line and uses it to argue that Fidelity was in no way damaged by FIRREA and the loss of its capital ­ after all, says the Department, "it was going to keep right on doing what it had been doing." Even the most cursory comparison of the Capital Plan to Fidelity's pre-FIRREA Three Year Business Plan puts the lie to this argument.

75

Letter, Thomas Dixon Lovely to Linda Mercurio-Swan (Jan. 3, 1990), enclosing Fidelity New York, F.S.B., Capital Compliance Plan (Jan.1990) and related documents, AST0705432-5624. Id. at AST0705453-57. Deposition, William E. Wesp (July 19, 2000), pp. 55-56. Fidelity New York, F.S.B., Capital Compliance Plan (Jan. 1990), AST0705432-5624 at AST0705437.

76 77 78

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The Capital Plan was based on "zero growth and modest shrinkage."79 Compare this to the preFIRREA Three Year Business Plan which called for Fidelity to "[g]row the balance sheet at approximately 8 to 10% per annum."80 There are other significant differences as well, and Mr. Wesp, Mr. Powderly and others will address these differences in their trial testimony.

OTS Approval of the Capital Plan Fidelity engaged in a dialogue with the OTS concerning its Capital Plan. On February 21, 1990, Fidelity provided OTS with some additional information, clarifying aspects of its Capital Plan. It did not expect any significant outflow of deposits, because its deposit base was fairly stable. It did not have brokered CDs81 or significant amounts of jumbo CD's. Its contemplated sales of investments would result simply from taking a "value" approach to mortgage-backed securities, selling when there appeared to be significant value that might deteriorate over time. It noted that its portfolio was $950,000,000, and it was only budgeting $750,000 a quarter for income from sales of investment securities.82 Angelo Vigna, the newly appointed Northeast Regional Director of OTS, in fact, thought Fidelity might be a survivor. As early as May 1990, he sought to mitigate concerns expressed by
79 80 81

Id. Fidelity Three Year Business Plan (Oct. 1988), AST056376-93 at AST056378. Brokered Certificates of Deposit ­ CDs placed with an institution by an investment broker on behalf of customers ­ had become troublesome. They tended to fuel rapid deposit growth that sometimes resulted in lower quality investments. They were also "hot money" in that such deposits were purely rate-driven and could disappear as fast as they appeared. See, Chairman's Report of Edwin J. Gray, Federal Home Loan Bank Board Journal Annual Report 1985, p. iv. Letter, Thomas Dixon Lovely to John Griffin (Feb. 21, 1990), INT01634-43 at INT01634-35.

82

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the Federal Deposit Insurance Corporation ("FDIC")83 about Fidelity's Capital Plan, a plan which he thought had a reasonable chance of success.84 In his words, Fidelity was not "going to be doing anything that would create any additional losses and in fact, [was] on a monthly and quarterly basis actually reducing the deficit."85 Fidelity's Capital Plan was approved by OTS on May 18, 1990.86 Life Under the Capital Plan The letter from OTS approving Fidelity's Capital Plan outlined a series of exceedingly harsh restrictions on Fidelity's activities while the Plan remained in effect. For example, Fidelity could not: · Without advance approval by the OTS District Director, engage in an activity not specifically allowed by the plan;87

83

As part of FIRREA, the FDIC, which had long insured national banks, absorbed the FSLIC and was now responsible for insuring S&Ls as well as banks. The FDIC did not know thrifts and did not particularly welcome its new role as the insurer of thrifts. This will become apparent from the testimony and documentary evidence concerning Fidelity's operation under the Capital Plan. The contrast between the supportive attitude of the OTS (which knew and understood thrifts) and the hostile attitude of the FDIC (which did not) is stark. Letter, Angelo Vigna, to Nicholas Ketcha (May 21, 1990), WON732 1915-16; Deposition, Angelo A. Vigna (Aug. 2, 2000), pp. 413-14. Deposition, Angelo A. Vigna (Aug. 2, 2000), p. 414. Letter, Angelo Vigna to Fidelity Board of Directors (May 18, 1990), AST007677-89. For example, if the plan said a certain type of loan would comprise 5 % of Fidelity's assets, it would be a "material violation" for Fidelity to exceed that planned percentage by more than 5 %, i.e., to allow that type of loan to exceed 5.25 % of its assets. Id., at AST007678.

84

85 86 87

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·

Increase its assets in excess of the levels in the plan and in no event by more than interest credited;

· ·

Make capital distributions; Pay executive officers and directors more than $900 per month without regulatory approval;

· · · · · ·

Pay bonuses; Make or extend any loans secured by real estate; Make any commercial loans; Make any investments in real estate or equity securities; Enter into joint ventures or limited partnerships; Enter into any contract or purchase anything, even in the ordinary course of business, in excess of $10,000;

· · · · · ·

Borrow money, except to maintain liquidity; Incur any material obligation or contingent liability not specifically permitted; Employ any new officers, directors or senior managers; Hire any employee whose employment was not terminable at will; Open any new branch office; Accept any uninsured deposits.

Manifestly, and as Plaintiff's witnesses will explain in some detail, this was not "business as usual." Indeed, Fidelity CFO (later President) Mr. Wesp would note in 1993, looking back on

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the years of operation under the Capital Plan, "we had basically been out of business since '89."88 Life for Fidelity under the Capital Plan was made even more difficult by the harsh regulatory environment in which it operated. While Mr. Vigna was supportive and thought Fidelity had a good chance to be "a survivor,"89 the same could not be said for his counterparts at the FDIC, which, after FIRREA, had backup regulatory authority over Fidelity. The FDIC urged OTS not to approve Fidelity's Capital Plan, expressing skepticism that Fidelity could generate sufficient earnings to make the plan work, and predicting that "the probability of near term failure [of Fidelity] is extremely high."90 FDIC examiners (and OTS examiners too) regularly demanded huge reserves on prospective loan losses, putting severe strains on Fidelity's ability to generate profits and replace its depleted capital, and forcing Fidelity to sell assets (its home equity portfolio and investment securities, for example) to generate earnings. While these assets were profitable, they would have become even more profitable, and Fidelity would not have sold them when it did, but for the intense regulatory pressure.91 The FDIC was relentless. In an April 1992 letter, remarkable for its vindictive and petty tone, the FDIC notified Fidelity that it was considering revocation of Fidelity's deposit insurance, a virtual "death sentence" since without deposit insurance Fidelity would be out of business. The letter dismissed as irrelevant Fidelity's loss of $93 million of capital through FIRREA. It likewise dismissed as irrelevant the fact that Fidelity had met every one of its
88 89 90 91

Deposition, William E. Wesp (July 19, 2000), p.150. Deposition, Angelo A. Vigna (Aug. 2, 2000), pp. 413-14. Letter, Nicholas Ketcha to Angelo Vigna (May 8, 1990), EAA005 2166-67. Deposition, Thomas V. Powderly (July 20, 2000), pp. 75-78, 87-88.

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quarterly targets under the Capital Plan.92 Mr. Vigna thought the FDIC position on Fidelity was "ultra-conservative" and wrong. He thought the threat to terminate deposit insurance was, to some degree, bureaucratic "cover" for the FDIC if things went wrong, but he had to take the threat seriously, because of the potentially dire consequences for Fidelity.93 It took strong intervention by OTS at very senior levels to persuade the FDIC to back down.94 Fidelity Converts to a Stock Institution and Escapes the Capital Plan One of the fundamental weaknesses of the thrift industry in the years leading up to the 1980s was the large number of mutual institutions and the capital weakness of those institutions. Mutual institutions were theoretically owned by their depositors. Unlike stock institutions that had the benefit of capital invested by their shareholders, mutuals had no source of capital other than retained earnings. Thrift regulators had consequently never required mutuals to have much in the way of capital, and those institutions consequently had little capital cushion to fall back on when problems arose.95 One cure for this systemic weakness was to convert mutual thrifts to a stock form of ownership. Stockholders provided stock institutions with much-needed capital. Operation in stock form also provided opportunities for profit incentives to flow to thrift management. Mr. Pratt believed strongly that one of the ways to deal with the capital

92

Letter, Nicholas Ketcha to Fidelity Board of Directors, Fidelity (April 21, 1992), AST097644-66. Deposition, Angelo A. Vigna (Aug. 2, 2000), pp. 427-30. Letter, Angelo Vigna to John Downey (Jun. 2, 1992), WON736 0996-98; Letter, John F. Downey to John Stone (Aug. 5, 1992), WON736 0107-08. Deposition, Richard T. Pratt (Dec. 2, 1998), pp. 22-26.

93 94

95

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inadequacy of the thrift industry was to make it easier for mutual thrifts to convert to stock form.96 As Fidelity met or exceeded its Capital Plan goals and its tangible capital grew, its management began to look again at the possibility of converting from a mutual to a stock institution.97 Fidelity had previously considered converting in the years prior to FIRREA, but problems in its commercial real estate portfolio and, later, the effects of FIRREA (on Fidelity in particular and the thrift industry in general) made conversion impossible.98 At its October 21, 1992 meeting, the Fidelity Board approved the retention of Merrill Lynch and Salomon Brothers as underwriters for a potential public offering and adopted a resolution directing the CEO and his designees to pursue the prospect of raising capital by converting from mutual to stock form. The resolution noted the capital impact of FIRREA and the fact that, even though Fidelity had successfully operated in accordance with its Capital Plan, it still found itself in need of additional capital.99 At a special meeting on December 9, 1982, the Fidelity Board approved a Plan of Conversion.100 The offering proceeded, and on May 3, 1993,

96 97

Id. Deposition, Thomas V. Powderly (July 20, 2000), pp. 148-150; Deposition, William E. Wesp (July 19, 2000), pp. 100-02. OTS would not approve a capital plan that was dependent on conversion to achieve capital compliance. Deposition, William E. Wesp (July 19, 2000), p. 101. However, once OTS had determined that a capital plan was viable, as Fidelity's was, and once the institution had made good progress toward compliance, as Fidelity had, OTS would permit the institution to convert and use the infusion of capital from conversion to complete its goal of capital compliance. Deposition, Angelo A. Vigna, (Aug. 2, 2000), pp. 442-44. Deposition, Thomas Dixon Lovely (July 10-11, 2000), pp. 123-25. Minutes, Fidelity Board of Directors Meeting (Oct. 21, 1992), AST127673-79, at AST127678-79. Minutes, Special Fidelity Board of Directors Meeting (Dec. 9, 1992), AST127683-85.

98 99

100

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Fidelity converted from mutual to stock form. It issued 5,170,839 shares of common stock at $11.50 per share, raising over $57 million of new capital.101 On May 14, 1993, Angelo Vigna advised Fidelity that, as a result of the successful public offering, Fidelity was now considered "well capitalized" under the capital regulations, and the Capital Plan and all related operating restrictions were terminated.102 Merger with Astoria Although Fidelity had survived, emerged from under its Capital Plan, and achieved "well capitalized" status under regulatory guidelines, it was not a strong company, certainly not as strong as it would have been absent the breach. Shortly after Labor Day 1993, Mr. Powderly, Mr. Wesp and Mr. Meyer met in Fred Meyer's office to talk about where the company ought to go. Fidelity now had capital, but it did not have much excess capital. It was an institution that for more than three years had been severely precluded in its operations, to the point of being virtually non-functioning. It operated in a highly competitive environment, and its management could look at local institutions, such as Astoria, that had had highly successful public offerings and were flush with cash. The three, who now were Fidelity's senior management,103 did not

101

Fidelity Proxy Statement (Nov. 16, 1994), AST0732630-722, at AST0732637; Deposition, Angelo A. Vigna (Aug. 2, 2000), pp. 444-45. Letter, Angelo Vigna to Fidelity Board of Directors (May 14, 1993), AST000082; Deposition, Angelo A. Vigna (Aug. 2, 2000), pp