inform you of your rights and the limits on the powers of the committee.

You are aware, I am sure, that it is the practice of the subcommittee that all testimony is taken under oath. Do you or any of you desire to be represented by counsel during your appearance here? Mr. MONTGOMERY. No.

Mr. CHAFIN. No.

Mr. HYNES. No.

Mr. DINGELL. Very well. The Chair informs you that you do have that right. If you then have no objection to testifying under oath, will you each please rise and raise your right hand.

[Witnesses sworn.]

Mr. DINGELL. Gentlemen, you may each consider yourself to be under oath. If you will please proceed with your testimony, we will recognize you in such order as you might choose.

TESTIMONY OF RICHARD J. HYNES AND BRUCE F. CHAFIN, SPECIAL ASSISTANTS, SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS; AND THOMAS C. MONTGOMERY, MINORITY COUNSEL, COMMITTEE ON ENERGY AND COMMERCE

Mr. HYNES. Mr. Chairman, we appreciate the opportunity to testify before the subcommittee today. Approximately 6 months ago you asked us to investigate the completed 1989 and proposed 1991 rollups of real estate limited partnerships by the BankAtlantic Financial Corporation of Miami, Florida. Although we focused on the fairness of the rollups of the limited partners a second issue arose during the course of our investigation which is relevant to the Banking Reform Legislation now under consideration by the U.S. Congress.

BankAtlantic Financial Corporation has had control of a Fort Lauderdale Savings Bank since 1987. The structure of BankAtlantic Financial Corporation as a bank holding company which is also engaged in real estate investment activities is similar to the type of commercial bank holding company envisioned in the proposed banking reform package.

In this respect, BankAtlantic Financial Corporation serves as a case study in, not only the behavior of a fiduciary in a real estate investment, but also the behavior of a fiduciary when faced with competing responsibilities to its various holdings. One individual, Alan Levan, was responsible for resolving these interests while acting as the Chief Executive Officer and largest shareholder of BankAtlantic, Chief Executive Officer and largest shareholder of the holding company, and managing and general partner of the real estate investments.

BankAtlantic Financial Corporation began as a real estate investment company but is now primarily a bank holding company. The holding company was originally called I.R.E. Financial Corporation and was formed to manage real estate investments. In 1987, the company acquired a majority interest in Atlantic Federal Savings and Loan of Fort Lauderdale. The company changed the thrift's name to BankAtlantic, a Federal Savings Bank, and renamed I.R.E. the BankAtlantic Financial Corporation.

The Savings Bank now comprises about 98 percent of the holding company's assets. The holding company spent about $29 million in cash between 1983 and 1987 to obtain a majority interest in the bank. Since the 1989 exchange transaction, the company invested an additional $7.9 million of cash plus holding company stock to increase its ownership in the bank to 70 percent. The holding company used another $2.7 million to finance other capital infusions to the bank. Despite these investments, however, the bank operated at a loss in each of the last 3 years and reported in December of 1990 that it failed to meet its regulatory capital requirements. In fact, Mr. Levan told the subcommittee staff that buying the bank was a mistake.

Public real estate limited partnerships such as those syndicated by BankAtlantic were very common in the 1980's. They were designed to allow the small investor the opportunity to take part in the commercial real estate market. For as little as a couple thousand dollars, the small investor bought a share in one or more commercial buildings and the benefits of a commercial real estate investment.

Before the Tax Reform Act of 1986, the limited partnerships were intended to provide the investor with periodic cash distributions, tax losses or little taxable income, and significant capital appreciation when the real estate was sold, taxed at the lower capital tax gains rate. General partners who syndicated and managed the partnerships earned significant fees for their services and usually could participate in profits and appreciation when certain objectives were met.

Two significant events in the latter half of the 1980's served to reduce the attractiveness of real estate limited partnerships as an investment. First, the Tax Reform Act of 1986 eliminated most of the tax benefits of limited partnerships. Second, in the late 1980's, the commercial real estate market lost tremendous value due primarily to over building. Landlords had difficulty disposing of their properties and were often forced to lower rents in the competition to find or keep tenants, reducing cash flows as a result.

Instead of selling the real estate holdings as planned many managing general partners performed partnership rollups, exchanging stock in a new company for the net assets of the limited partnerships that they managed. Supposedly, the collection of real estate assets in a new company would achieve a synergy that limited partnerships alone did not have. The new stockholders could then sell their shares in the market to recover their investment. However, the market recognized the true value of such situations and values the stock accordingly. One study found that these securities lost almost one-half of their stated value within 120 days after the rollups had occurred.

Mr. Montgomery of the Minority Counsel's Office will complete the statement.

TESTIMONY OF THOMAS C. MONTGOMERY

Mr. MONTGOMERY. Thank you. The story of the BankAtlantic Financial partnerships is similar to many other rollups with one major exception. In 1981, the company syndicated its first public

real estate limited partnership of the decade. That partnership's objectives were to provide monthly cash distributions and long term capital appreciation, generate tax losses, build equity through mortgage reduction, and preserve and protect capital.

Properties were intended to be disposed of in 4 to 7 years and the partnership liquidated. Ten additional limited partnerships were syndicated by I.R.E. between 1982 and 1986. The first six had objectives very similar to the 1981 partnership. The last four, syndicated in 1986, did not include generation of tax losses as an objective of the investment. Instead, they concentrated on long term appreciation. All the partnerships provided significant fees to I.R.E. and its successor, BankAtlantic Financial Corporation. Between 1981 and 1990, the holding company earned over $59 million in fees from the partnerships.

At first the partnerships apparently performed as expected. For example, between 1981 and the end of 1988, the three partnerships involved in the 1989 rollup made cash distributions of over $18 million and provided tax losses of over $12 million to its partners. For its effort, the holding company or its affiliates collected fees of over $15 million. The original investment by the limited partners was approximately $62 million. But because of the loss of tax benefits in 1986 and the real estate slump of the late 1980's, the holding company proposed in 1989 that the three partnerships roll up their assets and liabilities.

Unlike other rollups, the exchange proposed by the holding company in 1989 did not involve common stock issues or the creation of a new corporation. Instead, the holding company proposed that the partnerships trade their real estate assets and liabilities for $30 million of subordinated debentures issued by the holding company. The limited partners were advised that the debentures would provide them with liquidity in the public market. The debentures paid 8 percent interest in the first year, 9 percent in the second, and are supposed to pay 10 percent until they mature in 2011. At the end of 1990, the $30 million of debentures were valued in the market at about $6 million. In the swap, the company obtained 17 properties with a net value of about $44 million and other net assets valued by the holding company at about $2 million. Subsequently, the company sold nine of the properties for about $35 million, netting about $17 million. The company is currently attempting to dispose of the other eight properties.

In January of this year the company proposed exchanging another $17 million of debentures for the assets and liabilities of four more partnerships. The 12 properties of the partnerships had net appraised values of about $23.9 million. Additionally, the partnerships had other net liabilities of about $500,000. Three of the four partnerships have approved the transaction. The holding company intends to issue $15.4 million in debentures to the three partnerships.

Without the rollups the holding company would not have had the capital it needed to finance the bank. For example, at the end of 1988 the holding company had a cash balance of $624,000. At the end of 1990, the holding company had a negative cash balance of $84,000. After paying expenses including interest of about $6 million on the debentures, the holding company has netted approxi

mately $13 million cash from the real estate sales. Of that, more than $10 million has been used to infuse the bank with capital.

Some of the limited partners believe that their general partner, Alan Levan, who is also chairman and chief executive officer of the bank holding company, took advantage of the real estate investors to provide needed cash for his bank. They have complained that Mr. Levan obtained cash and real estate, much of the real estate which he quickly converted to cash, while they were left with subordinated debentures that they call junk bonds issued by a troubled bank holding company. According to Mr. Levan, in 1988 and 1989 the holding company and bank were not able to borrow money anywhere. By trading bonds for real estate with the limited partners and selling the real estate on behalf of the holding company, Mr. Levan obtained much needed cash for his bank. The bank, however, is still not out of the woods.

The Office of Thrift Supervision, which oversees BankAtlantic, rates the bank's financial health as a three on a scale of one to five. In fact, OTS officials told us that the three rating was leaning towards four. A rating of one indicates good financial health, while a rating of five indicates insolvency. A Miami banking consultant recently described the bank in plainer terms. He called it a belowaverage thrift and under-performing thrift.

The bank is dependent upon the holding company to meet regulatory capital requirements. The rollups of the holding company's real estate partnerships apparently are intended to provide the means by which the bank and holding company will survive. In the conflict between Mr. Levan's fiduciary responsibilities as chairman and chief executive of the bank and of the holding company and managing and individual general partner of the real estate limited partnerships, the needs of the bank appear to have prevailed over his responsibility to the partnerships.

In fact, in our discussions with Mr. Levan about his responsibilities to his real estate investors, he stated that he must also consider the investors in the bank and holding company. This consideration did not exist when the investors entrusted Mr. Levan as general partner in their real estate investments. It appears the firewall between the competing interest failed and the investors got burned.

The limited investors in the real estate could not look to Federal regulators for help. The Federal agencies with regulatory responsibility for the rollups and the bank are not responsible for ensuring the deal is a good one for the investors. The Securities and Exchange Commission was responsible for assuring effective disclosure of the transactions, regardless of their merit. The bank regulators were responsible for reviewing the merits of the rollups in order to protect the interests of the bank.

Before the 1989 transaction could commence, for example, the Federal Home Loan Bank Board, the Office of Thrift Supervision's predecessor, reviewed and approved the transaction as in the best interest of the bank. The limited partners were left with little protection, however, except that they each received a 340 page prospectus reviewed and declared effective by the SEC.

The general partner primarily used the funds of the limited partners to generate the prospectus and to hire a proxy solicitor to tele

phone enough limited partners to obtain a majority decision on the rollup. Both the prospectus and the proxy solicitor informed the partners that Mr. Levan, acting as fiduciary to the bank, the holding company and the limited partners, thought the rollup was in the limited partners' best interest.

The bottom line today is that the real estate investors involved in the 1989 rollup now own debentures or junk bonds valued at about $6 million compared to their original investment of $62 million. Alan Levan, the bank and the holding company have netted approximately $17 million from the sale of the real estate, with more to come. Other partnerships have just been rolled-up, and there are plans to attempt to roll up the rest.

That concludes our statement. We would be happy to respond to any questions.

Mr. ROWLAND [presiding]. I recognize the gentleman from Virginia, Mr. Bliley.

Mr. BLILEY. Thank you. Gentlemen, how do the transactions that are the subject of this hearing differ from what are normally referred to as rollups?

Mr. MONTGOMERY. Mr. Bliley, unlike other rollups, these exchanges don't involve common stock issues or the creation of a new corporation. Instead, the holding company proposes to exchange subordinated debentures for the assets and liabilities of the limited partnerships.

Mr. BLILEY. What is the attraction to the limited partners to do this? Why would they be willing to step forward? Would you want to take a crack at that, any of you?

Mr. CHAFIN. I think there are several explanations, actually. One of the first is that the limited partners were told that the real estate had lost a lot of value, wasn't very liquid, market had crashed, et cetera, et cetera, to where they thought they were in a heck of a bind. Then, they were offered the "opportunity" to convert those real estate holdings into these debentures. They did.

Then, all of a sudden, that gloom and doom that was over the real estate market passed long enough for them to at least sell nine properties and net $17 million. Meanwhile, the debentures fall down to $6 million.

I think another aspect of it is the idea of this disclosure, informing the limited partners as to what the deal really is. As Chairman Dingell said, they sent out a prospectus the size of a telephone book. We are talking about investors like my grandmother down in Charlottesville. I don't think my grandmother is going to be able to read, digest and understand exactly all the nuances that are proposed in something that is about that size and to a large extent must rely on others to tell her whether it's a good deal or not.

Mr. BLILEY. Can you explain how Mr. Levan's fiduciary duty differs according to whether he is representing the bank or the holding company?

Mr. MONTGOMERY. As the general partner of the real estate investments his duty is to the limited partners who were the individual investors. As CEO and owner of the bank, his duty is to the bank itself. It is at least arguable that by fulfilling his duty in one capacity he necessarily breaches his duty in the other capacity,