Mr. TEw. It is a table that I have put together that reflects to Home State the significance of these no-equity trades. If the committee would find that report we have handed you, it, in essence, takes Home State's consolidated net worth or shareholder's equity for the period 1980 through 1983, and subtracts these no-equity trades and shows what would happen to the consolidated net worth without this stream of profits from ESM.

For instance, in 1981, Home State received $5,474,000 of these noequity trades. That assisted Home State and the parent company on a consolidated basis from reporting what an accurate report would have reported of a negative net worth of $5 million.

If you remove the day trades on a cumulative basis in 1982 they would have had an accumulated negative net worth of $1 million, 1983, $9 million, if you look at the savings bank alone in the second level of figures, you would see that if you strip out the no-equity day trades that were paid to the savings bank, the net worth drops from the reported $16 million in 1983 to the $3,300,000 net worth without the day trades.

Now, this is what I believe evidences the true mutual life support system between Home State and ESM. ESM was getting the excess collateral that it was using to stay afloat, Home State was able to report significantly earnings and in fact, from the reports of examinations, it is very interesting that the operating income or the operating losses of Home State almost annually were offset by the nonoperating securities trades with ESM, almost within $1 million annually.

Their operating losses were masked by the no-equity trades, so that the net result was that they could maintain their net worth. This led ultimately to a very important event that you have asked me to address, Mr. Chairman, the attempt by Home State to withdraw from the regulations of the Security and Exchange Commission.

In 1984, Home State had filed a registration statement on forms 2 with the Commission in order to have declared effective a series of debenture offerings that would allow them to roll over other debentures that were becoming due.

The SEC started asking some very serious questions about Home State relationship with ESM and in particular the accounting treatment that was being afforded to some of the transactions and the qualities of certain disclosures that were made by Home State. After about seven comment letters from the Commission, Home State changed its tactics, it decided to merge the parent company, holding company in to the subsidiary which was the savings and loan, and under an exemption of Federal securities law subsection 385 withdraw from the jurisdiction of the SEC, and issue the exchange over without SEC jurisdiction, which is permitted under the current Federal securities laws.

The effect of that was two things. One, it allowed them to avoid the type of disclosure document that was evidenced in a prior SEC effective registration statement done by Home State and replace it with this document, a 4-page document showing pro forma financial information and not the generally accepted accounting disclosures that are required by the SEC.

Mr. DINGELL. The first document was mandated by the SEC?

Mr. TEW. Yes, sir.

Mr. DINGELL. The second document was mandated by——

Mr. TEw. This is a document put out by the company without SEC jurisdiction because under the Federal security laws, the SEC has no jurisdiction on issues of securities by State chartered savings and loan associations.

Mr. DINGELL. Second document then was mandated the savings and loan or simply-

Mr. TEW. It was merely authored by the State. I don't think the State frankly, I don't know what the regulatory powers, approval powers they have, but the bottom line was you have a 4-page handout flier as opposed to approximately a 200-page document with financial information and other disclosures which is the differential between what the Commission would have required this registrant to do as opposed to what they were able to do.

Mr. DINGELL. So what you are saying is the merger took place for purposes of escaping SEC jurisdiction in filing the more comprehensive document.

Mr. TEW. I think that is a fair assessment. The Commission was demanding disclosure on a very telling question. The Commission said Home State, you did a series of transactions with ESM. You have $100 something million of excess collateral. The only way you can get the excess collateral back is if ESM is financially solvent enough to close the transaction when they mature.

Home State opposed that therefore on the basis that they said they did not do their trades with ESM, ESM was merely acting as agent and they engaged in a series of fictions, agency fictions with the Commission, the Commission wasn't buying it, the Commission felt that ESM was the principal that had done the trades with Home State and if for any reason ESM was not able to close the trades, Home State's would go under.

Very interesting. In questioning in the correspondence to Home State, the SEC staff asked them to explain the consequences if ESM were to go bankrupt and what claim would Home State have against the bankruptcy trustee to get their securities back, a very important question. They were right on target. They were asking the hard questions, Home State elected to withdraw the offering and to go without Federal regulation.

That permitted the maturing debenture offers to be exchanged with new debentures that unfortunately the debenture holders were holding for the State of Ohio writing the check for $34 million, would have lost their investment.

It is one of the questions, Mr. Chairman, that you asked me address is the Federal regulation as it related to Home State.

Mr. DINGELL. Without objection, the staff will review the documents and ascertain whether they should be inserted in the record at this point.

Mr. TEW. Thank you.

In 1984, another major event occurred that required ESM to find another source of excess collateral. A little known and small Government security dealer, Lyon Capitol, filed for bankruptcy in May 1984. That filing sent shock waves through the Government securities industry. Many customers of ESM like Lyon Capitol, had in essence lent money to ESM and taken back securities as collateral

but had not taken possession of the securities and foolishly left them with ESM, what they thought was a segregated account.

The same type of situation occurred at Lyon Capitol. When the various school boards and other customers of Lyon Capitol realized that they didn't have possession of their collateral and therefore were merely unsecured creditors to the Lyon Capitol bankruptcy, word spread quickly on Main Street that you better get possession of your securities, and with that, numerous customers that ESM shared with Lyon Capitol immediately demanded physical delivery of their securities, and millions, and millions, of dollars of securities ESM had to scramble and find, to deliver out to those custom

ers.

At that point enters the American Savings and Loan which became the third most, ultimately the beginning of the end of the ESM.

A little background on how American Savings became involved in the ESM is important to this committee.

American Savings and Loan is a very fine, long-term, established institution in south Florida. It was founded and has been monitored by the broad family as an excellent institution, however, in 1981, it like other institutions, were facing financial losses, as some of the other savings and loan institutions were, they were looking for capital infusion, Mr. Warner provided that capital infusion, of approximately $10 million.

In 1982, he agreed to infuse the money subject to a change in control application review by the Home Loan Bank Board, and both Mr. Warner and the Broad family agreed to place their securities in a voting trust.

In November 1983, both the voting trust and the purchase by Mr. Warner of his stock was approved by the Home Loan Bank Board. The voting trust permitted both the Broad family and Mr. Warner to each nominate six members to the Board of Directors of American. The new board was seated in January 1984. The executive committee of that board was Mr. Warner, Mr. Ronnie Ewton, who was one of Mr. Warner's six nominees to the Board of Directors, and Mr. Broad, two Misters Broad-Morris Broad and Shepard Broad.

Immediately after the creation of the executive committee, Mr. Ronnie Ewton was put in charge of the investment portfolio of American Savings and Loan Association.

Prior to that point, American Savings had done business with quality firms that had been on an approved list approved by the American Savings Board of Directors who conducted a very prudent securities trading practice.

That was soon to change. Mr. Ewton in charge of the investment portfolio, made several recommendations and ultimately in May 1984, about the same time that ESM was facing pressure from the collapse of Lyon Capitol, Mr. Warner produced a set of documents in a proposal that he had picked up the day before from ESM, proposing a $1 billion, T Bill leverage arbitrage that American would do with ESM.

There is some debate as to whether that transaction was even discussed at the Board or at any executive committee meeting. But, in May 1984, American invested approximately, May and June,

$108 million of their U.S. Treasury notes and delivered them to ESM as the down payment or equity payment on this $1.1 billion T bill arbitrage that had been proposed to American.

These securities like other transactions were delivered free and clear to ESM and permitted ESM to withstand the demand for delivery of securities by customers who had heard of Lyon Capitol's debacle. It permitted ESM to now have in its hand a fresh infusion of $108 million of working capital. That essentially kept ESM going in the early part of 1984.

Unfortunately, for ESM but fortunately for the rest of the country, Mr. Broad and Mr. Warner had a falling out. Mr. Broad returning from a trip started to look into the transactions, was suspicious about the transactions, he asked some tough questions, ultimately, at a September 5 a showdown meeting Mr. Broad demanded that ESM permit American to start to unwind and withdraw that transaction.

There was a very heated meeting. Mr. Ewton and Mr. Novak from ESM were invited. Mr. Warner and Mr. Broad and the other directors present had a heated discussion as to why ESM should allow American to break the trade and start unwinding the transaction. Interestingly enough, at that time the transaction was profitable to ESM because American was paying ESM approximately 11 percent on the money, and for the first time in a long time as you recall, interest rates had dropped in late 1984 and now ESM could borrow that money that it was lending to American at essentially 9 percent to 10 percent.

So ESM was making a profit. For reasons that we are not aware of, however, ESM agreed to start unwinding its transaction with American. That unwinding began the beginning of the end for ESM, because ESM could not find that fourth financial institution that would give it the excess collateral.

We have an insight as to what might have occurred. Because Mr. Warner and Mr. Broad broke, and had a disagreement over the acquisition of Freedom Savings and Loan, a savings of Florida, a large west coast savings and loan in Florida.

In June 1984, Mr. Warner proposed to acquire Freedom. The details of that are numerous. The bottom line was Mr. Broad allegedly without Board approval entered into four contracts to acquire major interest in Freedom from stockholders of Freedom. The Board of American learning of this, repudiated those contracts essentially and even the nominees of Mr. Warner to the Board sided with Mr. Broad in repudiating contracts that had been negotiated with the shareholders of Freedom by Mr. Warner, whereby he hoped American would acquire Freedom.

That falling out over the acquisition of Freedom led Mr. Warner, in October 26, to invoke a provision of the voting trust that permitted either party to initiate a buy out, one of the other, and the terms worked essentially this way.

The initiating party would set the terms and the price, the other party could either buy or sell the securities and the voting trust at that price, a very simple but effective method. Mr. Warner elected to be the initiating shareholder. He set the price at approximately $13-plus per share, to be paid out to him over a 4-year period, 25 percent down, the balance in three annual installments.

In December 1984, Mr. Broad I think surprised Mr. Warner and elected not to be a seller at those terms, but to be the buyer at those terms.

Effectively, on January 10, 1985, Mr. Warner's stock that was in the voting trust was redeemed by American Savings and Loan and Mr. Warner was effectively out of control of American Savings and Loan.

Within 60 days thereafter, ESM had falling into collapse, essentially because not only did it not have the fourth reverse repo participant to provide it capital, but it had had agreed to start returning money to American Savings and Loan on its transactions.

Mr. Chairman, that is an overview that addresses, I believe, most of the 11 points in your letter. Your staff has indicated there might be particular areas of concern that you may want to address more specific questions to.

Mr. DINGELL. Very well.

Well, Mr. Tew, the committee thanks you for your very helpful and complete testimony to the committee. Your assistance has been of great value and your cooperation has been of the highest quality, and although it is not my business to comment on how you have conducted yourself in your responsibility to the court, it becomes plain to us on the basis of your testimony, that you have conducted yourself with extraordinary vigor, appropriate dignity, and attention to your responsibility there.

I think that the country is indeed fortunate to have you in that responsibility.

The Chair will now recognize my colleagues. The Chair recognizes the gentleman from Oregon, Mr. Wyden.

Mr. WYDEN. Thank you very much.

As well, Mr. Tew, let me commend you for a very fine job of going through a clearly complicated set of facts.

Going back to late 1984, if I might, Mr. Tew, you pointed out Mr. Warner decided to trigger the buy/sell provision of the voting trust that he and Shepard Broad established in December of 1982.

Now, Mr. Broad, as I understand it, decided to exercise his purchase option and buy out almost 2 million shares, Mr. Warner's close to 2 million shares, for $26 million, a 32 percent premium on the then current market price.

My question to you is, Isn't this deal a classic insider preference? Mr. TEw. Well, I don't think it is as simple as that. I think the sale of a controlling block of stock can be at a premium. I think that the circumstances of the purchase as to who acquired the stock is a more important question, not the price that was made. The interesting question is the purchaser of the company did not have a chance to negotiate the price. The price was negotiated between Mr. Warner and Mr. Broad under the terms of the voting trust.

The purchaser of the company was merely given the purchase contract and the company purchased at that price. The interesting question is not the price, but the fact that the purchaser never was a party to the negotiations, it just ended up paying the bill.

Mr. WYDEN. The Federal Home Loan Bank Board approved Mr. Broad's use of American funds to buy out Warner. Isn't that an interest-free loan then to Shepard Broad.