operating results for the years 1982 and 1983 and the first eight months of 1984, limiting the scope of review to the minutes of the Board of Directors, financial statements, regulatory reports and litigation. The examination report noted that ACC provided mortgage financing to purchasers of its homes through ACMC and that ACMC granted mortgage loans at below market rates in order to stimulate sales of homes built by ACC. It also acknowledged, without comment, that ACMC issued GNMA pass-through certificates secured by pools of FHA (Federal Housing Administration) and VA (Veterans Administration) loans and, depending upon market conditions, either sold the GMMA's or held them as investments. The report also commented on ACC's profitable operations and its net income of $3.1 million and $19.1 million for 1982 and 1983, respectively, although it noted the poor performance of a minor homebuilding division of ACC. The FHLBB and the California Department jointly conducted an examination of Lincoln as of August 20, 1984. The final report of the PHLBB, sent to Lincoln on February 5, 1985, also was brief and expressed no areas of significant concern. With respect to Lincoln's real estate investments, the PHLBB and the California Department were primarily concerned with such appraisal deficiencies as the lack of market/economic feasibility studies for certain real estate projects, the need for additional valuation reserves for losses on certain properties, and the omission of an allowance or discount for holding costs of development properties, because the appraisers based their findings on the retail lot values. The examination report also suggested the need for a full-time managing officer for Lincoln and the required formation of an audit committee comprised of independent directors, both of which were complied with on October 12, 1984. The FHLBB commented on the fact that ACC provided certain services for Lincoln without authorization of Lincoln's Board of Directors, which authorization was formally given by a resolution passed October 12, 1984. The report noted that Lincoln had exceeded the commercial loans-toone-borrower limitation in connection with its investment in debt securities of one issuer; however, as acknowledged by the FHLBB, this excess was inadvertent and existed only for approximately two weeks. The FHLBB also commented on an investment by Lincoln in below investment grade corporate debt securities but indicated that such concern had been previously addressed in prior correspondence. While the FHLBB also commented on Lincoln's plans to invest up to 20% of its assets in unimproved land, the report noted that the new management under Keating had extensive experience in all aspects of the acquisition, development and sale of land and had the expertise to manage this type of investment successfully. Thus, the type of land loan and investments later criticized as "unsafe and unsound" were specifically reviewed by the PHLBB in 1984 without criticism and, indeed, with laudatory comment. The only significant concern expressed by the California Department related to Lincoln's investments in Provident and LAFICO which, it said, inadvertently exceeded the authorized investment limits established by the California Department. Although Lincoln did not meet specified capital requirements with respect to Provident as early as July 7, 1982, prior to ACC's acquisition of Lincoln, the California Department in July 1982 had authorized an additional $1 million investment without rescinding the previously granted investment authority. The California Department suggested that Lincoln simply apply for increased investment authority to cover such over-investment. On October 10, 1984, Lincoln submitted that application to the California Department, which was approved on December 7, 1984. As former California Savings and Loan Commissioner Lawrence W. Taggart said in testimony before the House Banking Committee on November 7, 1989: There was no problem with Lincoln Savings at all in '84. I met continually with the Federal Home Loan Bank in San Francisco. They were never on a monitored list that I was aware of. They never were brought to my attention that the Federal Home Loan Bank had a problem with them when I was a regulator. They were considered to be a "clean shop". VIII. .. Lincoln was never considered to be a Adoption of the Direct Investment Rule When ACC received approval to acquire Lincoln, Lincoln was investing virtually all of its deposits in refinanced or brokered home mortgage loans. As a result, Lincoln was experiencing serious financial difficulties. Under ACC's control, Lincoln's financial condition improved significantly as a result of ACC's dramatic diversification of Lincoln's portfolio. first Direct This On January 31, 1985, the FHLBB promulgated Investment Regulation, effective March 21, 1985.2 regulation imposed a limitation (applicable retroactively to December 10, 1984) upon the amount of so-called "direct investments' that any FSLIC-insured state-chartered savings and 287 50 Fed. Reg. 6928 (1985), codified at 12 C.P.R. § 563.9-8 (1986). loan association could make. Direct investments were defined generally as investments in equity securities, real estate, service corporations and operating subsidiaries. In general, an insured institution could not invest more than 10% of its assets or two times its regulatory net worth (as defined by FHLBB PHY 299s) in such investments without prior approval of the Approval could be denied if "[t]he overall policies, condition, and operation of the applicant afford a basis for objection. -307 ACC had rescued Lincoln with the expressed intent, and apparent regulatory blessing, to improve Lincoln's investments in real estate, high-yield securities and other non-traditional areas in the deregulated environment. As described above, ACC's acquisition of Lincoln was premised upon its ability to manage Lincoln consistent with the deregulation philosophies expressed both in Congress and in the California legislature. ACC and Lincoln believed strongly that the limitations set forth in the Direct Investment Regulation would impair their ability to make Lincoln a profitable institution or, indeed, to operate Lincoln in a fashion consistent with the Operating Plan. Lincoln, therefore, made the appropriate application to exceed the limit for direct investment, which was denied by the FHLBB. By its terms, on January 1, 1987, 19 Direct Investment Regulation was to expire However, on September 11, 1986, the FHLBB issued a Notice of Rulemaking requesting comments on the desirability of extending the expiration date of the Direct Investment Regulation to January 1, 1989.327 On December 23, 1986, the FHLBB further extended expiration of the existing rule until March 15, 1987 to enlarge the comment period and allow for a public hearing on the Direct Investment Regulation. 337 Lincoln submitted comments opposing the proposed Direct Investment Regulation during the initial comment period which ended on October 17, 1986. At the FHLBB's January 29-30, 1987 public hearing, the majority of the parties making presentations argued against extension of the Regulation. Lincoln participated at the hearing and presented numerous witnesses who testified against extending the Regulation. Lincoln submitted additional comments opposing the extension during the enlarged comment period ending February 13, 1987. On February 27, 1987, the FHLBB promulgated a final rule, effective April 16, 1987, adopting a modified Direct Investment Regulation for a two-year period. This modified Direct Investment Regulation severely limited Lincoln's ability to exercise its state-granted right to invest its assets in federally defined 'direct investments." These limitations on Lincoln's investment authority were even greater than the limitations under the original form of the Direct Investment Regulation. Since the Direct Investment Regulation was first proposed, scholars, businessmen, and others vehemently have opposed its institution and implementation. Experts such as Federal Reserve Board Chairman Alan J. Greenspan, former United States Assistant Attorney General William F. Baxter, and Professors George G. Kaufman, John P. Smith, Jr., and George J. Benston protested that the constraint imposed by the Direct Investment Regulation was economically inefficient, bore no causal relationship to thrift failures, constituted a bar to an investment option that is necessary to the financial health and, in many cases, the survival of savings and loan associations," and "could seriously harm the savings and loan industry.-347 | The econometric analyses that have examined the role played by direct investment in optimal thrift portfolios and the relationship between direct investment and net worth demonstrated that the optimal level of direct investment was significantly higher than the 10% limit imposed by the Direct Investment Regulation. The studies found that thrift institutions with no direct investments displayed the lowest survival rates over time, whereas those savings and loan associations with 40% of their assets in direct investment showed the highest survival rates. Direct investments enabled some less successful thrifts to diversify their portfolios to overcome the short-term difficulties inherent in more traditional loan activities and to provide higher rates of return for institutions not experiencing such problems. 347 Letter of Federal Reserve Board Chairman Dr. Alan J. These benefits also accrued to the PSLIC because direct investments prevented certain thrifts from failing, thus allowing these and other institutions whose operations were strengthened by direct investments to continue to attract depositors, resulting in higher FSLIC insurance fund premiums being paid. Lincoln was not alone in its sustained opposition to the Direct Investment Regulation. Hundreds of interested parties opposed the adoption of each form of and extension to the Regulation. Thrifts, state regulators, members of Congress, lawyers, and scholars futilely argued that the passage of the Regulation was beyond the scope of the FHLBB's authority, undermined the dual system of state and federal regulation of thrifts, subjected thrifts to unnecessary risk of economic failure, and wrongfully imbued ill-equipped federal regulators with the authority capriciously to select which thrift would be relieved of the burdens imposed by the Regulation.35/ None argued more vehemently, publicly, or frequently than Keating, ACC or Lincoln.367 As a result, as has since become apparent, none suffered more personal and official wrath of then FHLBB Chairman Edwin J. Gray, Jr. and the FHLBB. When the FHLBB disregarded the widespread opposition and first adopted the Direct Investment Regulation, it also imposed new limits on growth of the industry as a whole. The rule 35/ 36/ 62 Congressman wrote the PHLBB to object to the Regulation; Indeed, Chairman Gray's Chief of Staff, Shannon Fairbanks, testified before the House Banking Committee on November 7, 1989 that "Throughout this deliberative process, a number of institutions filed comments, but none was as outspoken or as vociferous as Lincoln Savings. |