Free Reply to Response to Motion - District Court of Federal Claims - federal

Case 1:92-cv-00550-MCW

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS __________________________________________ ) ) ) Plaintiff, ) ) v. ) ) UNITED STATES OF AMERICA, ) ) Defendant. ) _________________________________________ ) NORTHEAST SAVINGS, F.A.,

Civil Action No. 92-550C Judge Williams

PLAINTIFF'S REPLY IN SUPPORT OF MOTION FOR LEAVE TO NOTIFY THE COURT OF SUPPLEMENTAL AUTHORITY Having lost nearly every argument it made in Anchor Savings Bank, F.S.B. v. United States, 2008 WL 725518 (Ct. Fed. Cl. Mar. 14, 2008), the government now attempts ­ unsuccessfully - to pigeonhole the Court's holdings and analyses in Anchor Savings to the specific facts of that case. This Court should reject those efforts. The government clings to the position because banks, including Northeast Savings, were forced to make dramatic changes to their business models as the direct result of the government's breaches of contract, those banks should be barred, as a matter of law, from establishing that the government's wrongful conduct caused them to lose profits. As this Court repeatedly has recognized, including most recently in Anchor Savings, that argument is untenable. The government's breach eliminated more than one-fifth of a billion dollars of the regulatory capital Northeast had bargained for. If the government is correct ­ that it owes no damages because Northeast was, by some measures, not profitable at the time the government encouraged it to acquire several failing thrifts ­ then regulatory capital had no value, and the banks' victory in Winstar was chimerical. Anchor Savings exposes the fatal flaws in that argument.

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Although the facts of Anchor Savings were ­ not surprisingly ­ different than those here, the legal principles the Court applied in Anchor Savings apply here with equal vigor, namely: · A bank's historical, actual earnings are "irrelevant in a lost profits analysis."

Anchor Savings, 2008 WL 725518, *63 (emphasis added). In other words, whether the bank's historical earnings were positive, mixed, or negative prior to the government's breach is not dispositive of whether the government's enactment of FIRREA caused the bank to lose profits in the future. As Winstar and ensuing cases have recognized, FIRREA forced fundamental changes on the banks that were impacted by its passage. Any lost profits or other damage analysis must be evaluated prospectively and must endeavor to look at how the bank would have fared had FIRREA not been passed. The government's insistence that, "[a]bsent a track record of core earnings, Northeast cannot be awarded lost profits" (Govt's Brf. (Doc. 194), p. 2), simply cannot be squared with the prospective analysis this Court's jurisprudence requires. · "[P]rofits garnered by some other party" can be the appropriate yardstick

for evaluating a bank's lost profits. Anchor Savings, 2008 WL 725518, *103. The government claims this principle does not apply here because Northeast's expert, Dr. Baxter, "made no attempt to track the performance of the specific assets and liabilities" Northeast had divested in response to the government's breach." Doc. 194, p. 3. For its part, Anchor Savings had divested an entire subsidiary (Residential Funding Corporation) in response to the government's breach. Because the buyer continued to operate RFC essentially as Anchor Savings had done in the past, it was a relatively straightforward exercise for Anchor Savings' expert to track and compare the subsidiary's performance under new ownership. Here, in contrast, Northeast divested discrete assets and liabilities, on different occasions over a period of roughly two years, and to different buyers. The divested wholesale assets were also varied,

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including mortgage-backed securities, purchased residential mortgage loans, and consumer loan portfolios. The proceeds of those sales were used to reduce a comparably wide variety of wholesale funding sources (liabilities), including brokered deposits, reverse repurchase agreements, and collateralized floating rate notes. See, e.g., PX 23 (Northeast 1992 10-K) at 49; PX 154 (July 1989 Revised Business Plan) at 2; Thakor Trial Tr. 2735; Bankhead Trial Tr. 298081. See generally Northeast's Proposed Findings of Fact ¶ 332. Moreover, any of the discrete assets Northeast had sold could well have changed hands again (and conceivably multiple times) since their divestiture by Northeast in 1989-91. The government's position is that, unless the bank's expert can trace the actual performance of hundreds or thousands or tens of thousands of discrete assets and liabilities, a bank may not, as a matter of law, recover lost profits. This is not the law, and nothing in Anchor Savings even remotely suggests otherwise. Perhaps appreciating the weakness of its primary argument, the government resorts to arguing that, even if Northeast had tracked the performance of the assets and liabilities it had divested, Northeast still would not be entitled to lost profits because (the government claims) it would have divested those assets and liabilities "anyway" ­ irrespective of the breach. Doc. 194, p. 3. As Northeast explained in its post-trial briefing, this argument is belied by the facts. Northeast's December 1998 Business Plan called for the continued pursuit of wholesale banking activities. See Northeast's Proposed Findings of Fact ¶ 89; PX 146 at 17. The government's continued assertion that PX 211 establishes that Northeast had determined (prior to the enactment of FIRREA) that its regulators viewed wholesale assets and liabilities as "too risky" misreads that document. The stray remark in PX 211 on which the government relies only addresses Northeast's hedging activities (namely, interest rate swaps), not its wholesale banking

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activities generally. See generally Northeast's Post-Trial Brf. pp. 21-22; PX 192 (June 1989 FHLBB Report of Examination) at 2.1. The government also argues that "Northeast changed its assumption about the direction of interest rates" (according to the government, Northeast assumed, pre-breach, that rates would fall, then assumed, post-breach, that rates would rise), and that "even in a non-breach world, Northeast would not have retained assets that would benefit from a decrease in interest rates." Doc. 194, p. 4. This argument, however, assumes too much. Absent FIRREA, even the government agreed that, with the aid of supervisory goodwill counting toward its regulatory capital requirements, Northeast was on a successful course. It was the government's breach of its contracts that derailed Northeast's business model. To deny Northeast its foregone profits for any other reason would affirmatively reward the government for engaging in wrongful conduct. That result is all the more perverse in these Winstar cases, where the banks reconfigured their business models at the government's behest. · Lost profits were foreseeable if the government "had reason to foresee" that

a divestiture of assets would "cause lost profits." The bank need not prove that the government also had "reason to foresee how those lost profits would materialize." Anchor Savings, 2008 WL 725518, *92 (emphasis added). The government argues that, because Northeast was, by some measures, not profitable at the time the government entered in contracts with it, the government "could not have" foreseen that Northeast ever would have turned a profit. Doc. 194, p. 5. However, as just noted, the entire premise of the government's decision to enlist banks like Northeast to acquire failing thrifts in exchange for promises of regulatory goodwill is that the regulatory goodwill on their books would in fact improve their profitability. The

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government's cribbed notion of foreseeability simply cannot be reconciled with either the facts or the standard this Court applies in Winstar cases. · A "tax gross-up is appropriate when a taxable award compensates a plaintiff

for lost monies that would not have been taxable." Anchor Savings, 2008 WL 725518, *154 (quotation omitted). The government contends that the record shows that Northeast's acquisition of a credit union (DEPCO) would not have been a taxable event, meaning no tax gross-up is warranted. Doc. 194, p. 7. This assertion is not accurate. Where there is any doubt about the taxability of a damages award, the "origin of the claim" doctrine applies. Under that doctrine, one asks: "In lieu of what were the damages awarded?" Raytheon Prod. Corp. v. Commissioner, 144 F.2d 110, 133-14 (1st Cir. 1994). As explained more fully in Northeast's Post-Trial Reply Brief (pp. 60-61), in LaSalle Talman Bank, F.S.B. v. United States, 64 Fed. Cl. 90, 114-16 (2005), aff'd in relevant part, 462 F.3d 1131, 1338 (Fed. Cir. 2006), this Court rejected an argument nearly identical to the one the government makes here. · If, absent the government's breach, the bank "would have continued to

count its supervisory goodwill as regulatory capital," then increases in FDIC insurance premiums associated with a breach-induced reduction in capital are recoverable as "wounded bank" damages. Anchor Savings, 2008 WL 725518, *174. The government asserts that this proposition is inapplicable here because "Northeast's capital position was deficient even before the breach, thus justifying increased deposit insurance premiums," and because "the benefits of [its] breach far exceed the alleged increase in the premium." Doc. 194, p. 8. Neither argument has merit. As. Dr. Baxter explained, but for the government's breach, Northeast would have received a CAMEL rating of at least "3" during the relevant assessment periods. Although the bank had a rating of "4" in June 1989, that rating is not indicative of what the rating would

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have been in later years but for the breach, because none of the factors that drove the June 1989 rating would have been present but for the breach. See generally Northeast's Post-Trial Reply Brf., pp. 72-73, and citations therein. Second, with respect to the government' position that the so-called "benefits of the breach" exceeded the increase in Northeast's insurance premiums, the government failed to meet its burden of proving any such "benefits." See id., pp. 74-75. The evidence overwhelmingly established that: (a) Northeast wrote off its supervisory goodwill only because the government's breach rendered that asset valueless; and (b) Northeast reluctantly shrank its balance sheet only because the government's breach put it out of capital compliance. To say (as the government does) that the write-offs and shrinkage "benefited" Northeast is to ignore the substantial amounts of profits Northeast lost (and the substantial costs it incurred) as the result of the government's breach. In short, for all of these reasons, Anchor Savings buttresses Northeast's claims in several important respects. This Court should summarily reject the government's efforts to paint Anchor Savings as an aberrational outcome of limited applicability. Dated: May 23, 2008 Respectfully submitted, /s/ James C. Martin, James C. Martin REED SMITH LLP 435 Sixth Avenue Pittsburgh, PA 15219 412.288.3131 (phone) 412.288.3063 (fax) (Counsel of Record for Northeast Savings, F.A.)

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Of Counsel: Donna M. Doblick REED SMITH LLP 435 Sixth Avenue Pittsburgh, PA 15219 412.288.3131 (phone) 412.288.3063 (fax)

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