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

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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 RESPONSE TO DEFENDANT'S MOTION FOR LEAVE TO NOTIFY THE COURT OF SUPPLEMENTAL AUTHORITY Pursuant to the Court's Order dated January 15, 2008, Plaintiff, Northeast Savings, F.A. ("Northeast"), hereby respectfully submits this response to Defendant's Motion for Leave to Notify the Court of Supplemental Authority ("Motion"). The government's motion fails, on every level of analysis, to provide any meaningful assistance to this Court in connection with its resolution of the damages issues presented in this case. Not only does the motion trumpet a decision -- the Federal Circuit's January 8 decision in Granite Management Corp. v. United States, No. 07-5054, ____ F.3d ___ (Fed. Cir. Jan. 8, 2008) -- that is utterly irrelevant to such damages issues, it also mischaracterizes both the import of the Federal Circuit's holding in Granite and the nature of our arguments in this case. What is perhaps more telling, however, is that while the government seeks to convince this Court that the irrelevant Granite decision is somehow "directly relevant to the damages claims presented in this case," Motion at 1, the government completely ignores a different damages decision, issued on the same day as Granite, that is in fact "directly relevant" to Northeast's expectancy damages

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claims -- Astoria Federal Savings & Loan Association v. United States, No. 95-468C, ___ Fed. Cl. ___ (Jan. 8, 2008) (copy attached). As the Federal Circuit made clear in multiple places in its Granite opinion, the only issue addressed in Granite was whether, absent the breach in that case, the plaintiff would have been allowed to transfer contractual goodwill in connection with a sale of the thrift. See Granite at 5. See also id. at 4, 6. Plaintiffs in that case sought damages on the theory that the thrift " `could have been sold for more if it had included the "supervisory goodwill." ' " Id. at 4 (quoting Granite Management Corp. v. United States, 416 F.3d 1373, 1384 (Fed. Cir. 2005). The Federal Circuit held only that the Court of Federal Claims' factual finding that thrift regulators would not have approved such a goodwill transfer was supported by substantial evidence, and thus Plaintiff would not have received a higher sale price. Id. at 5. Obviously, the damages claim asserted in Granite, and the Federal Circuit's disposition of that claim, have absolutely nothing to do with the claims asserted by Northeast in this case. Northeast has not sought damages based on the claim that it would have received a higher sale price when the thrift was sold to Shawmut. The government tries to manufacture relevance both by implying that Granite holds that supervisory goodwill is valueless in all contexts and that Northeast's damages claim is premised upon the proposition "that the fact of the breach, i.e. the phase-out of goodwill, is sufficient to prove that damage has in fact occurred." Motion at 1. Neither suggestion is remotely accurate. The Federal Circuit's observations regarding the "fictitious" nature of supervisory goodwill came solely in the context of its discussion of whether there was substantial evidence that the regulators would have exercised their contractual right to refuse to approve the transfer of goodwill. Slip op. at 6-7. The Federal Circuit did not purport to hold that goodwill never has

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value. Indeed, it took pains to make clear that it was not so holding, as it noted that the fact that Granite had not proved the damages claim it was pursuing did not mean either that it had not been damaged by the breach or that goodwill has no value. See Granite, slip op. at 8. As for Northeast's arguments in this case, the government ignores the record when it suggests that our position is that the fact of the breach itself is sufficient to prove damages. The only point Northeast has made is that the government's argument that its breach not only did not harm Northeast but actually helped Northeast is (to put it kindly) implausible in light of both the magnitude of the breach and the facts proved at trial regarding the impact of the breach on Northeast's operations and business strategies. Indeed, we made this point in the very paragraph of our post-trial brief that the government cites in its motion. There, after discussing in some detail the facts establishing the impact of the breach on Northeast, we noted that "[g]iven the magnitude of the government's breach and the straightforward facts underlying Northeast's damages claim, one who is not familiar with the government's litigation strategies in the Winstar cases might have legitimately expected that while the government may dispute certain aspects of Dr. Baxter's damages calculations, it would never dispute the basic proposition that its breach had a crushing impact on Northeast." Plaintiff's Post-Trial Brief, Doc. No. 163, at 10 (Jan. 22, 2007) (emphasis added). Remarkably, while the government uses the irrelevant Granite decision to knock down various strawmen, it ignores a decision issued the same day that awards damages on claims quite similar to Northeast's claims. In Astoria, Judge Wheeler awarded $14.6 million in lost profits and $1.4 million in so-called "wounded bank" damages. Astoria, slip op. at 45. As is the case here, the lost profits claim in Astoria was premised on the proposition that absent the breach, the plaintiff thrift would have held additional assets and liabilities on which it would have earned a

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positive spread. Id. at 33-34. Again like this case, the additional assets and liabilities that the plaintiff would have held absent the breach consisted primarily of wholesale assets and liabilities. Id. at 34-35. In addition, as is also the case here, the wounded bank claim in Astoria included a claim for increased deposit insurance premium assessments caused by the breach. Id. at 40. 1 Judge Wheeler held that the plaintiff in Astoria had proven all of the elements for the recovery of expectancy damages. With respect to foreseeability, the Court noted that that requirement "is satisfied where regulators knew or should have known that a bank intended to leverage its supervisory goodwill and capital credit." Id. at 32.2 With respect to the reasonable certainty requirement, Judge Wheeler noted that that element "is satisfied when the evidence adduced enables the Court to make a fair and reasonable approximation of the damages." Id. (citations and internal quotation marks omitted). Finally, the Court concluded that the plaintiff had established causation "under either the `but for' or the `substantial factor' standard of causation." Id. at 36. 3 While every damages case must of course be decided on its own facts, and while claims for lost profits and wounded bank damages are in many respects particularly fact-intensive, the decision in Astoria is nevertheless instructive. The Court there awarded damages on claims that, for the reasons discussed above, are in many respects quite similar to Northeast's. Indeed, in at least one respect, Astoria's damages claim was much more aggressive than Northeast's, as As1

While Judge Wheeler rejected the plaintiff's claim for $100 million in additional lost profits, he did so on grounds that are not applicable here. The additional claimed lost profits were premised on the notion that the plaintiff would have been able to transfer its goodwill in the no-breach world, a proposition that Judge Wheeler, like the Federal Circuit in Granite, rejected. Slip op. at 4. See also id. ("The cases acknowledge that government regulators expected thrifts to profit from the use of supervisory goodwill on their books after government-assisted mergers."). 3 See also id. at 31 ("Even when the `but for' causation standard is applied, the law does
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toria's claim was premised on claims of continued asset growth. Astoria, slip op. at 34. In contrast, Northeast's claim does not depend upon a demonstration that, absent the breach, the bank would have been larger than it actually was prior to the breach.

February 1, 2008

Respectfully submitted,

/s/ Charles J. Cooper Charles J. Cooper COOPER & KIRK, PLLC 1523 New Hampshire Avenue, NW Washington, D.C. 20036 (202) 220-9600 (202) 220-9601 (fax) Counsel of Record Of Counsel: Michael W. Kirk Vincent J. Colatriano David H. Thompson COOPER & KIRK, PLLC 1523 New Hampshire Avenue, NW Washington, D.C. 20036 (202) 220-9600 (202) 220-9601 (fax)

not require the plaintiff to show that the breach was the sole cause for the loss of profits.")

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CERTIFICATE OF SERVICE I hereby certify that on this 1st day of February 2008, copies of the foregoing were filed electronically. Notice of this filing will be sent by operation of the Court's electronic filing system to all parties indicated on the electronic filing receipt. Parties may access this through the Court's system.

/s/ Charles J. Cooper Charles J. Cooper COOPER & KIRK, PLLC 1523 New Hampshire Ave., NW Washington, D.C. 20036 (202) 220-9600 (202) 220-9601 (fax) [email protected]

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In the United States Court of Federal Claims
No. 95-468C (Filed: January 8, 2008) ************************************* * * ASTORIA FEDERAL SAVINGS & LOAN * ASSOCIATION, * * Plaintiff, * * v. * * THE UNITED STATES, * * Defendant. * * ************************************* *

Winstar Damages Claim; Expectancy, Restitution and Reliance Damages; Causation, Foreseeability, and Reasonable Certainty of Lost Profits; "Wounded Bank" Damages.

Frank J. Eisenhart, with whom were Catherine Botticelli, Tara R. Kelly, Catherine Stahl, and Craig Falls, Dechert LLP, Washington, D.C., for Plaintiff. John H. Roberson, with whom were Michael F. Hertz, Deputy Assistant Attorney General, Jeanne E. Davidson, Director, and Kenneth M. Dintzer, Assistant Director, United States Department of Justice, Commercial Litigation Branch, Civil Division, Washington, D.C., Arlene Pianko Groner, Elizabeth M. Hosford, Brian A. Mizoguchi, John J. Todor, and Sameer Yerawadekar, Of Counsel, for Defendant. OPINION AND ORDER WHEELER, Judge.1 In this Winstar case, the Court must determine the damages due Plaintiff from Congress's passage of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, Pub. L. No. 101-73, 103 Stat. 183 (1989) ("FIRREA"). The legal theory in Winstar This case was transferred to Judge Thomas C. Wheeler on June 1, 2006, pursuant to Rule 40.1(b) of the Rules of the Court of Federal Claims.
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cases is that FIRREA's restrictions on the inclusion of goodwill in regulatory capital constitute a breach of the Government's Assistance Agreement created when one thrift institution acquired another during the savings and loan industry crisis in the 1980s. See United States v. Winstar Corp., 518 U.S. 839 (1996). The present case arises from the October 31, 1984 acquisition of Suburbia Federal Savings & Loan Association ("Suburbia") by Fidelity New York, F.S.B. ("Fidelity"). Plaintiff, Astoria Federal Savings & Loan Association ("Astoria") later merged with Fidelity on January 31, 1995, and in so doing, acquired the right to assert the present claim on behalf of Fidelity. These three institutions were based on Long Island, New York. The parties have stipulated to the existence of a contract between the Government and Fidelity, and the Government does not contest Plaintiff's breach of contract claim involving the accounting treatment of goodwill and a capital credit. (Stipulation, filed February 21, 2003). Plaintiff thus has established Defendant's liability for breach of contract. The remaining disputes concern the amount of damages to be awarded to Plaintiff because of Defendant's breach.2 The Court conducted a 28-day trial in Washington, D.C. during the period April 19, 2007 through May 29, 2007. The Court's evidentiary record consists of the testimony of 20 witnesses, 750 exhibits, and 5,886 transcript pages. The Court accepted the deposition testimony of four other witnesses who were deceased or unable to testify at trial. The parties filed post-trial briefs on August 6, 2007, and reply briefs on October 5, 2007. The Court heard closing arguments on November 2, 2007. The 20 trial witnesses in order of appearance were: Dr. Richard Pratt, former Chairman of the Federal Home Loan Bank Board ("FHLBB"); Michael Spaid, a financial analyst from the Federal Savings & Loan Insurance Corporation ("FSLIC"); Carlos Fiol, an FSLIC financial analyst; Thomas Powderly, a Fidelity executive; Roger Teurfs, a certified public accountant from Peat Marwick; H. Brent Beesley, former Director of the FSLIC; Angelo Vigna, a regulator from the Federal Home Loan Bank of New York ("FHLB-NY") and the Office of Thrift Supervision ("OTS"); Thomas Dixon Lovely, a Fidelity executive; William Wesp, a Fidelity executive; Dr. Donald Kaplan, Plaintiff's expert; Vito Caporusso, a Fidelity executive; Peter Stearns, former Director of the FSLIC; Robert Albanese, a regulator from the FHLB-NY and OTS; Peter Finn, an Astoria executive; Walter Amend, a regulator from the FHLB-NY and OTS; George Engelke, an Astoria executive; Neal Moran, a financial analyst from OTS; and three defense experts, Dr. David Rochester, David In an earlier decision, issued on August 22, 2006, the Court denied Defendant's motion for summary judgment on Plaintiff's damages claims. Astoria Fed. Sav. & Loan Ass'n v. United States, 72 Fed. Cl. 712 (2006). -22

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Kennedy, and Dr. Andrew Carron. The four witnesses whose deposition testimony the Court received were: Henry Drewitz, an Astoria executive; Bruno Greco, a Fidelity executive; Andrew Kane, Jr., a Suburbia executive; and Christopher Quackenbush, an investment advisor to Astoria. In acquiring Suburbia on October 31, 1984, Fidelity recorded on its books approximately $160 million in supervisory goodwill that it intended to amortize on a straight line basis over 30 years, through 2014. The Government agreed that Fidelity could count the goodwill as regulatory capital in meeting its capital requirements. Five years later, however, the Government breached its agreement with Fidelity. When FIRREA became effective on December 7, 1989, Fidelity could no longer include the goodwill in regulatory capital as it had done previously, and it had to phase out all of the goodwill before the end of 1994. The new law immediately rendered Fidelity capital deficient and a "troubled thrift." Fidelity operated under a restrictive, government-monitored Capital Plan from January 1990 until May 1993, when Fidelity raised approximately $57 million in new capital in a successful conversion from mutual-to-stock ownership. In a partially rehabilitated state following the conversion, but still not as strong as its major Long Island competitors, Fidelity merged with Astoria on January 31, 1995. Plaintiff claims breach of contract damages under three alternative theories of recovery. First, Plaintiff seeks expectancy damages of $115.1 million in lost profits, consisting of $17.9 million for the period prior to the 1995 merger, and $97.2 million for the years 1995-2014. Second, Plaintiff claims restitution damages of $128.3 million, intended to compensate Fidelity for the benefit it conferred upon the Government in acquiring Suburbia. This benefit is measured in net avoided liquidation costs that the Government did not incur. Third, Plaintiff claims reliance damages of $140.4 million, to put Fidelity in as good a position as if the contract had not been made. This amount is measured in terms of Fidelity's cost of net liabilities assumed in acquiring Suburbia, and consists of the supervisory goodwill recorded on Fidelity's books less the cash assistance received from the Government. Plaintiff also claims $1,431,730 in "wounded bank" damages under each of the alternative theories of recovery. For the reasons explained below, the Court grants Plaintiff's expectancy damages claim in part, but rejects Plaintiff's restitution and reliance claims as being legally and factually deficient under the circumstances presented. The Court concludes that Plaintiff may recover a total of $16,042,887, consisting of $14,611,157 in expectancy damages, and $1,431,730 in "wounded bank" damages. The expectancy damages are lost profits for the period January 1, 1990 through January 31, 1995. This period begins when the Government required Fidelity to operate under a Capital Plan as a "troubled thrift," and extends until Astoria merged with Fidelity five years later. The Court finds that the lost profits during this -3-

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period were the proximate result of the Government's breach, that the lost profits were foreseeable, and that Plaintiff proved the damages with reasonable certainty. See Globe Sav. Bank, FSB v. United States, 65 Fed. Cl. 330, 345 (2005), and cases cited therein. Lost profits beyond January 31, 1995 are not recoverable, because both the existence and amount of additional damages are speculative. Even in the absence of the Government's breach, Fidelity would not have been permitted to transfer its supervisory goodwill to Astoria when the two entities merged. Any expected benefit to Fidelity from counting the goodwill as regulatory capital would have ended on January 31, 1995. The "wounded bank" damages of $1,431,730 are to compensate Fidelity for the actual costs it paid to the OTS for higher examination assessments, and to the Federal Deposit Insurance Corporation ("FDIC") for insurance premiums, when Fidelity was a "troubled thrift." Fidelity would not have been a "troubled thrift" if the Government had not breached its contract with Fidelity through passage of FIRREA. Findings of Fact3 A. The 1980s Crisis in the Savings & Loan Industry

Beginning in late 1979, the Federal Reserve Board allowed interest rates to rise in an effort to combat inflation. (Beesley, Tr. 1147-49).4 The prime interest rate peaked at an alltime high of 21.5 percent in 1981. (Pratt, Tr. 69-71). While thrift institutions were realizing an average yield of eight percent on long-term mortgages, the Federal Government was paying 12 or 13 percent on risk-free obligations. Id. Consequently, passbook savers at banks and savings and loan institutions began to withdraw their deposits to invest in higher-yielding money market and other investment options. Id. Thrift institutions attempted to stem the loss of depositors by raising their deposit interest rates, and soon began paying more money in depositors' interest rates than they were earning in long-term mortgages. (Beesley, Tr. 114749). The losses associated with paying higher deposit interest rates, and losing depositors

This statement of the facts constitutes the Court's principal findings of fact under Rule 52(a) of the Court. Other findings of fact and rulings on mixed questions of fact and law are set forth in the later analysis. In this opinion, the Court will refer to the trial transcript by witness and page as "Name, Tr. __," and to trial exhibits as "PX __" for Plaintiff's exhibits, and "DX__" for Defendant's Exhibits. The expert witnesses presented their expert analyses through demonstrative exhibits, which the Court will refer to as "PDX __" for Plaintiff, and "DDX __" for Defendant. The parties' pretrial stipulations of fact, filed on April 2, 2007, are referred to as "Stip. __." For lengthy exhibits, page citations include the last four digits of Bates numbers where available, or otherwise an actual page number. -44

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to other investment options, caused a reduction in capital and directly impacted a thrift's capital account. Id. The FHLBB required thrifts to maintain a minimum capital level, and prohibited thrifts from operating with a negative capital account. (Beesley, Tr. 1150-51). Many thrifts insured by the FSLIC in the early 1980s had less capital than indicated on their books. (Beesley, Tr. 1154-55). Specifically, the asset amounts shown on a thrift's balance sheet were not an accurate assessment of the assets' true value. (Beesley, Tr. 1150). For example, thrifts carried loans on their balance sheets at the original book value or historical cost, instead of at fair market value. Id. If the loans had been evaluated using their true value, the capital to assets ratio of thrifts would have been substantially less, or negative. (Beesley, Tr. 1151). The FSLIC evaluated a thrift's solvency based upon the percentage of capital held in relation to its assets, and intervened to assist troubled or failing institutions. (Beesley, Tr. 1147, 1151). If a savings and loan institution did fail, the FSLIC insured the accounts of depositors so that they would not suffer a loss. (Beesley, Tr. 1144-45). The FSLIC managed an insurance fund comprised of premiums paid by member institutions and income earned from invested assets. (Beesley, Tr. 1152). This insurance fund did not contain any government or taxpayer money. Id. Avoiding a complete thrift industry failure would have required a massive bailout from Congress or falling interest rates. (Beesley, Tr. 1152-54). Government policy in the early 1980s assumed that market interest rates eventually would decline and alleviate in part the problems in the thrift industry. (DX 1147 at 25). Decreased interest rates alone, however, would not have reduced insolvency problems for all thrifts, as asset quality problems also existed. (Beesley, Tr. 1241). Moreover, some thrifts had been so weakened by the stress of interest rate volatility that their survival remained precarious even when interest rates began to fall. (Beesley, Tr. 1193). The FSLIC employed "stopgap" measures in an effort to buy time until interest rates declined. (Pratt, Tr. 115-16). In 1982, the FSLIC maintained a list of alternatives for dealing with troubled or failing thrifts, which included in order of preference: (1) the introduction of new capital into the thrift from outside the Government; (2) various forms of mergers, whereby weak institutions would merge into stronger institutions; (3) the introduction of new capital assistance from the Government; (4) mergers involving Government assistance; (5) the "Phoenix Program," where two or more troubled thrifts were combined into a new thrift; and (6) liquidation. (See PX 35 at 0002; PX 112 at 6239-43; PX 1341 at 1235; Pratt, Tr. 141, 147; Vigna, Tr. 1511-13).

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From 1982 through 1984, the FSLIC did not have sufficient funds to consider liquidating all troubled thrifts. (Pratt, Tr. 128). In March 1983, for example, the FSLIC reported assets of $6.42 billion, but if the FSLIC had wanted to liquidate all troubled thrifts at one time, it would have required at least $180 billion. (PX 1352 at 280; Pratt, Tr. 126-27). Later in 1983, the FSLIC reported that it had 53 cases requiring supervisory resolution with total assets of $17.6 billion, but the FSLIC's primary reserve was only $5.7 billion. (PX 286 at 17, 76). In dealing with the savings and loan crisis, the FSLIC employed liquidation only as a last resort, and generally only for smaller institutions. In 1982, the FSLIC placed 14 institutions into receivership, with deposits totaling $3.7 billion. (PX 113 at 13; Beesley, Tr. 1190-91). In 1983, the FSLIC liquidated only six small institutions, whose assets cumulatively totaled $295 million. (PX 286 at 18, 20-21; Beesley, Tr. 1234-36). In 1984, the FSLIC liquidated only nine institutions with combined deposits of $829 million. (PX 342 at 1356). In 1985, the FSLIC liquidated only ten institutions, with an average of $189 million in deposits. (PX 375 at 27). None of these institutions were located in the Northeast. Id. Between 1980 and 1989, the FSLIC did not liquidate any New York-based thrifts under Mr. Vigna's supervision. (Vigna, Tr. 1503; Albanese, Tr. 4127-28). In July 1981, Congress began exploring ways of expanding lending and investment alternatives available to the savings and loan industry. Among the alternatives considered were: broadening thrifts' real estate powers, expanding consumer and commercial lending, engaging in equipment leasing, increasing service corporation investments, and allowing greater flexibility for mutual and stock conversions. (Pratt, Tr. 85-89; PX 1336 at 51-56). In 1982, Congress passed the "Garn-St. Germain Depository Institutions Act," Pub. L. No. 97-320, 96 Stat. 1469 (1982). (Pratt, Tr. 92, 104; PX 1352B). Pursuant to this new statute, the FHLBB authorized the issuance of Net Worth Certificates for thrifts to count as capital. As Dr. Pratt explained, "[w]e didn't have the cash to inject, so we created paper, that's what the Net Worth Certificates were." (Pratt, Tr. 107). Under the net worth certificate program, a failing thrift could issue certificates to the FSLIC in exchange for promissory notes. The thrift could count the certificate toward its capital requirements. The FSLIC ultimately had to repay the thrift in cash. (Beesley, Tr. 1171-73). The FSLIC also created a new asset called Appraised Equity Capital to allow thrifts to book the appreciated value of real property without selling the property. (Beesley, Tr. 1174-75). This strategy also assisted thrifts in staying afloat. Id. Even with the adoption of these measures, however, many thrifts still were in jeopardy of not surviving. (Pratt, Tr. 98-99).

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B.

Fidelity's Acquisition of Dollar Federal

Fidelity acquired a Long Island thrift known as Dollar Federal Savings & Loan Association ("Dollar Federal") on June 30, 1982. Fidelity's acquisition of Dollar Federal consisted of a takeover of assets and the assumption of liabilities existing as of the date of the acquisition. (Stip. 1). At the time of this acquisition, Dollar Federal had approximately $105 million in assets. As a result of the Dollar Federal acquisition, Fidelity increased its branch offices from four to eight, and increased its deposits from $204.7 million to $273.4 million. (Stip. 2). In this merger, Fidelity acquired Dollar Federal's real estate loans to condominium developers. (Vigna, Tr. 1397-98). Fidelity experienced losses on these and other commercial real estate loans in later years. (Vigna, Tr. 1508-10). Fidelity accounted for the acquisition of Dollar Federal as a purchase. The goodwill generated in this acquisition, or the excess cost over fair market value of Dollar Federal's net assets acquired, was $25.815 million. (Stip. 3; Teurfs, Tr. 1050; PX 1283 at 0064). Fidelity planned to amortize this amount as an expense over 30 years using the straight line method. (Stip. 3; Teurfs, Tr. 1076-77; PX 1283 at 0064). Fidelity recorded $28.041 million in discounts on the mortgage loans acquired from Dollar Federal. These discounts were to be accreted to income over ten years using the sum-of-the-months digit method. (Stip. 4; PX 1283 at 0064). In 1989, FIRREA's capital restrictions required Fidelity to phase out the remaining Dollar Federal goodwill on its books as a component of regulatory capital. (PX 526 at 8365). The remaining Dollar Federal goodwill at the end of 1989 was approximately $19.3 million. Id. FIRREA thus negated Fidelity's plan to amortize Dollar Federal's goodwill over 30 years. Astoria has no claim from Fidelity's loss of Dollar Federal's goodwill. C. Fidelity's Acquisition of Suburbia

Like Fidelity, Suburbia was a Long Island thrift. In 1983, Suburbia had approximately $656 million in assets. (PX 1245 at 0484). Suburbia was larger than Fidelity in terms of assets, savings, mortgages, and branches. Id. Suburbia had been profitable until 1979 or 1980, when it began experiencing "interest rate spread," where the cost of obtaining funds through deposits was exceeding its low interest return on long-term loans. Because of interest rate spread, Suburbia, like many other thrifts, began operating at severe losses which was "fairly rapidly eroding capital." (Vigna, Tr. 1249-50, 1502-03; Albanese, Tr. 4122-23; DX 3113 at 2534). Suburbia also faced an extremely competitive Long Island market. (Kane Dep., Tr. 21-22). Suburbia did not have any serious asset quality problems, and its management team was not a concern to federal regulators. (Vigna, Tr. 1503; Albanese, Tr. 4123; DX 3141 at -7-

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0008). Yet, due to the effects of interest rate spread, Suburbia began to experience mounting losses after 1979. (Kane Dep., Tr. 16-17, 24-25). Mr. Kane, Suburbia's CEO and Chairman of the Board, testified that, if interest rates had declined in the early 1980s, Suburbia would not have faced an operating deficit and would have returned to favorable operating results. (Kane Dep., Tr. 22). Suburbia sustained net losses in each of its fiscal years 1980 through 1984 as follows: 1980 ­ $1.666 million, 1981 ­ $6.869 million, 1982 ­ $17.547 million, 1983 ­ $9.167 million, and 1984 ­ $7.427 million. (Stip. 35). Each of these Suburbia net losses reduced Suburbia's capital. (Stip. 36). Suburbia's regulatory net worth would have been negative $12.4 million as of August 31, 1984 if Net Worth Certificates and Appraised Equity Capital were excluded from the calculation of Suburbia's net worth. (Stip. 37, 38). On December 20, 1982, FSLIC held a bidder's conference to solicit proposals for the assisted acquisition of Suburbia. FSLIC distributed bidders' packages to 22 associations and individuals, and later to three other potential acquirers. (Stip. 5; PX 102 at 0463; PX 232 at 0206; PX 237 at 0178). Four New York thrift institutions submitted bids to acquire Suburbia: Albany Savings Bank, Anchor Savings Bank, Long Island Savings Bank, and Poughkeepsie Savings Bank. (Stip. 6, 7; Vigna, Tr. 1330; PX 237 at 0178). FSLIC estimated the present value cost of these bids between $17.9 million (Anchor) and $33.9 million (Long Island). (Stip. 8, 10, 12, 14; Spaid, Tr. 202; PX 237 at 0178). The present value cost estimate for the second low bidder, Albany Savings Bank, was $20.6 million. (Stip. 8; PX 237 at 0178). The bidders also requested cash or other assistance from FSLIC. (Stip. 9, 11, 13, 15). Suburbia, however, became eligible for capital assistance from FSLIC through the Garn-St. Germain Act, and efforts to negotiate a merger with the four bidders were discontinued. The FHLBB and FSLIC did not accept any of the four bids. (Stip. 6). On February 18, 1983, Suburbia's Board of Directors passed a resolution that Suburbia was eligible for FSLIC assistance through Net Worth Certificates, and that it was in the best interests of Suburbia to apply for such assistance. (Stip. 16). On March 21, 1983, Suburbia entered into a Master Agreement with FSLIC for issuance of Net Worth Certificates. (Stip. 17). As a participant in the Garn-St. Germain Net Worth Capital Assistance Program, Suburbia issued Net Worth Certificates totaling $9.2 million through August 31, 1984. (Stip. 21). Suburbia's Board of Directors explored the prospects of a merger with Heritage Federal Savings & Loan Association ("Heritage") as early as September 1982. (Stip. 22). At Suburbia's March 18, 1983 Board of Directors meeting, Mr. Kane reported on the progress of the Suburbia-Heritage merger application. (Stip. 23). On June 1, 1983, the FHLBB denied the Suburbia-Heritage merger application. (Stip. 24).

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In 1984, the FSLIC did not have the resources to liquidate Suburbia, and thus liquidation was not a viable option. (Albanese, Tr. 4185-87). On February 17, 1984, Suburbia's Board of Directors unanimously approved a resolution for management to continue investigating a proposed merger with another financial institution. (Stip. 27). On April 25, 1984, Fidelity's Board of Directors approved the pursuit of a merger or acquisition with Suburbia under FSLIC's Voluntary Assisted Merger Program ("VAMP"). (Stip. 28). In May 1984, Suburbia and Fidelity submitted to the FHLBB Supervisory Agent a proposal for a voluntary VAMP merger. (Stip. 31; PX 186 at 1793; PX 232 at 0206). Mr. Vigna thought that Suburbia would be eligible for VAMP assistance, and he recommended a maximum FSLIC contribution of $16 million, or 2.5 percent of Suburbia's assets. (PX 169 at 2713-14). Mr. Kane did not fear that Suburbia would be liquidated if it did not merge with Fidelity. (Kane Dep., Tr. 40). Mr. Kane explained instead that "maybe we would have an unfriendly merger set up by the efforts of the FSLIC, [and] have no control over any of our destinies." (Kane Dep., Tr. 98). Mr. Kane viewed a merger with Fidelity as a "friendly merger," in which "we were going to have some of our directors on a combined board" and "all our management would stay in place." Id. The FHLBB could not approve the Fidelity-Suburbia VAMP merger proposal because Fidelity requested certain accounting forbearances that the Principal Supervisory Agent ("PSA") could not grant. Specifically, the PSA could not approve Fidelity's request that the value of any intangible assets resulting from accounting for the merger in accordance with the purchase method be amortized by the straight line method over 30 years. (Stip. 32; PX 237 at 0178-79; DX 406A at 0368-69). The PSA also could not approve Fidelity's request that FSLIC's cash contribution to the resulting association be booked as a credit to net worth. Id. In July 1984, Fidelity submitted another proposal to merge with Suburbia. (Stip. 33; PX 185 at 0820). This proposal was based upon the earlier VAMP proposal and the related business plan which the FHLBB had reviewed previously. (PX 186 at 1793). Fidelity requested the same $16 million cash assistance from FSLIC, as Fidelity had proposed for the VAMP merger. (See PX 185 at 0821). Fidelity did not pay any cash in the acquisition of Suburbia. (Teurfs, Tr. 1112; PX 1283 at 0063). According to a 1984 FHLBB Institutional Analysis, the present value cost to FSLIC of merging Suburbia with Fidelity was $15.906 million. (Stip. 39; Spaid, Tr. 174; PX 1243 at 0022). In contrast, the present value cost to FSLIC of liquidating Suburbia was $147.9 million. (Stip. 40; Spaid, Tr. 170; PX 1243 at 0021). Fidelity was willing to merge with Suburbia, despite the fact that Suburbia's liabilities exceeded its assets, because of the favorable treatment of supervisory goodwill. (Greco Dep., Tr. 66). -9-

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The FHLBB approved the merger plan for Suburbia and Fidelity through Resolution No. 84-582, dated October 25, 1984. (Stip. 46). FSLIC agreed to contribute $16 million in cash to Fidelity as stated in the FSLIC-Fidelity Assistance Agreement dated October 31, 1984. (Stip. 48, 51). The FHLBB determined that it needed to provide financial assistance to prevent the probable default of Suburbia. The FSLIC regarded Fidelity's proposal as the least costly option for resolving the problem of Suburbia's mounting losses. (Stip. 41). Acceptance of Fidelity's proposal would benefit the Government in avoiding the expense and disruption of Suburbia's possible liquidation. (Vigna, Tr. 1386). For a $700 million thrift such as Suburbia suffering mainly from the effects of interest rate spread, liquidation was not an acceptable option. Id.; see also PX 237 at 180-81. Fidelity's acquisition of Suburbia on October 31, 1984 increased Fidelity's assets from $556.6 million to $1.3 billion, and its deposits from $393.2 million to $1.0 billion. (Stip. 58). Fidelity also added 12 Suburbia branch offices, giving Fidelity a total of 20 branch offices. Id. Fidelity accounted for the Suburbia merger transaction under the purchase method of accounting in which Suburbia's assets and liabilities were re-priced according to their market value. (Stip. 59). Fidelity recorded $160.093 million of goodwill as a result of the merger with Suburbia. (Stip. 61). This amount represented the excess cost over fair market value of net assets acquired. The goodwill was to be amortized over 30 years using the straight line method. Id. The FHLBB sent a forbearance letter to Fidelity after the merger had been approved confirming these terms. (PX 274 at 9019-21). The key terms of Fidelity's acquisition of Suburbia, agreed upon by the Government, were: (1) Fidelity received a $16 million cash payment from the Government; (2) Fidelity was permitted to count the $16 million payment as regulatory capital; (3) Previous notes issued to Suburbia and related Net Worth Certificates totaling $9.2 million were transferred to Fidelity and counted toward Fidelity's regulatory capital; (4) The $160 million in goodwill created by the use of the purchase method of accounting was to be amortized on a straight line basis over 30 years; (4) Goodwill was not to be deducted from Fidelity's net worth to determine capital compliance; and (5) Discounts on Suburbia's loans and securities resulting from a mark-to-market valuation process, totaling $105 million, were to be accreted to income over the remaining lives of the assets. (Kaplan, Tr. 2907, 2916; PDX 20, 22). The accounting firm of Peat Marwick provided an opinion regarding the key components of the Fidelity-Suburbia merger. (Teurfs, Tr. 1027, 1042-43; PX 1247A at 7226). Fidelity derived benefits from its merger with Suburbia. Fidelity's management was familiar with Suburbia, and Fidelity's CEO believed that Suburbia was a valuable franchise. (Lovely, Tr. 1621). The merger more than doubled Fidelity's asset and deposit bases. (DX 3148 at 0101). Fidelity acquired branch offices in new locations, particularly in Suffolk -10-

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County, Long Island, an area with growing population, income, and home values. (Lovely, Tr. 1630). By combining with Suburbia, Fidelity could expand services to depositors, such as: discount brokerage services, life insurance, debit cards, statement savings, mortgage banking, consumer loans, business loans, home improvement loans, student loans, and individual retirement account loans. (DX 3148 at 0101). Through these additional services, Fidelity could compete with commercial banks and money market funds, and attract more capital into the thrift. Id. Fidelity also reduced operating expenses through consolidation and elimination of duplicative departments. (PX 335 at 2383). Fidelity anticipated that the accretion income from loan discounts would exceed goodwill amortization, at least for the first 8-10 years after the merger. (Lovely, Tr. 1633-34; Wesp, Tr. 1748-50; Teurfs, Tr. 110810). D. Fidelity's Growth Prior to FIRREA

Earnings in the thrift industry tend to be cyclical, fluctuating upward and downward generally in correlation to interest rate movements. When interest rates were at historical highs in 1981 and 1982, thrift industry earnings were negative, but earnings turned positive when interest rates fell. Interest rates increased again in 1987-1990, causing negative earnings, but earnings improved when interest rates again started to fall. (Kaplan, Tr. 273133; PDX 7). Fidelity's earnings, however, were positive each year from 1980 to 1993. Fidelity was profitable even when the thrift industry as a whole was not profitable. (Kaplan, Tr. 2735-38; PDX 7, 8). From 1979 to 1989, Fidelity grew from a $200 million thrift to a $2 billion thrift. (PDX 4). Fidelity's compound annual growth rate from December 1979 to June 1989 was 28.9 percent. Id. Even without the Dollar Federal and Suburbia acquisitions, Fidelity still achieved an internal growth rate during this period of approximately 14-15 percent. (Kaplan, Tr. 2701-04). Dollar Federal had been involved in commercial real estate lending before being acquired by Fidelity. (Lovely, Tr. 1568, 1578). When Fidelity acquired Dollar Federal, it took over Dollar Federal's real estate loans to commercial real estate developers such as Gerald Guterman. (Lovely, Tr. 1568, 1578, 1670-74; PX 1242 at 9182). In 1984, prior to Fidelity's merger with Suburbia, the FHLBB urged Fidelity not to concentrate commercial loans with just three or four borrowers. (Greco Dep., Tr. 28, Albanese, Tr. 4143-44; PX 183 at 9213). Commercial real estate loans are more risky than single-family mortgages. (Powderly, Tr. 379). In 1985, with an enhanced cash position following its acquisition of Dollar Federal and Suburbia, Fidelity expanded its commercial real estate loan business. (PX 986 at 4218). The majority of these loans were concentrated in condominium and cooperative conversion projects in Manhattan. (Greco Dep., Tr. 80, 99-100; DX 63 at 1296). Ultimately, some of Fidelity's real estate loans failed, Fidelity foreclosed, and the properties became real estate owned ("REO") by Fidelity. (PX 711 at 2941-42).

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Fidelity's chief executives during this period, Thomas Dixon Lovely and Bruno Greco, began managing Fidelity when it was a "vanilla, traditional savings and loan." (Vigna, Tr. 1510). Mr. Lovely's background was in education, and the regulators at the FSLIC and the FHLBB questioned the experience and ability of Mr. Lovely and Mr. Greco to run a billion dollar financial institution. (Vigna, Tr. 1510-11). As Fidelity expanded into more sophisticated business transactions, Mr. Lovely recognized the need to strengthen Fidelity's management. (Lovely, Tr. 1556-57). In mid-1986, Fidelity hired Thomas V. Powderly, William A. Wesp, and Frederick J. Meyer. These new managers quickly saw that Fidelity's planning, budgeting, and management controls needed substantial improvement. (Wesp, Tr. 1746-47). Fidelity hired Mr. Powderly in June 1986 as Executive Vice-President in charge of retail banking, operations, investments, and accounting. Mr. Powderly later became President and Chief Executive Officer. (Stip. 63). Fidelity hired Mr. Meyer in July 1986, and he became Executive Vice-President in December 1986, responsible for the savings division, facilities management, office services, and marketing functions. (Stip. 64). Fidelity hired Mr. Wesp in June 1986 as a Senior Vice-President in charge of investments and financial planning. (Stip. 65). Fidelity also hired Vito L. Caporusso in September 1986 as a Vice-President. (Stip. 66). These persons brought expertise to Fidelity in commercial real estate management, development and lending, investment portfolio management, and retail banking. (Stip. 62). In the Viability Analysis performed prior to Fidelity's merger with Suburbia, the FSLIC projected that the combined institution would grow at a rate of 6.8 to 8.5 percent per year for the ten years following the merger. (PX 210 at 0028). From November 1984 through 1988, Fidelity's growth exceeded the FSLIC's projections. (Kaplan, Tr. 2936-41; PDX 30).5 Fidelity's earnings and capital ratios also exceeded the FSLIC's projections during 1984 through 1989. (Kaplan, Tr. 2942-46). During this period, Fidelity's total assets grew by an average of 12.6 percent annually, its tangible assets grew annually by an average of 14.7 percent, its deposits and borrowings grew annually by an average of 11.9 percent, and its mortgage-backed securities (all types) grew annually by an average of 41 percent. (Kaplan, Tr. 2952-54; PDX 35). Fidelity's success was more pronounced after the arrival of the new management team. In the two years after the Suburbia acquisition, 1985 and 1986, Fidelity grew at a rate of 9 percent. (Kaplan, Tr. 2939; PDX 30). During the following two years, 1987 and 1988,
5

The FSLIC's projections assumed that loan discounts would be accreted to income on a level yield basis over 30 years, rather than over the life of the loan, as Fidelity elected to do. This accounting change had the effect of accelerating income recognition in the early years after Fidelity's merger with Suburbia. (Kaplan, Tr. 2942-44). -12-

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after the change in management, Fidelity's growth rate accelerated to 16 percent annually. (Kaplan, Tr. 2939-40; PDX 30). The FHLBB employed a "MACRO" rating system in its periodic examinations of thrift institutions. The regulators assessed a thrift with ratings of "1" to "5" in five component areas: Management, Asset Quality, Capital, Risk Management, and Operating Results. The term "MACRO" is an acronym comprised of the first letters of the five component areas. A "1" rating is the highest, and is seldom used, while "4" and "5" ratings are the lowest, and indicate material regulator concerns. A "5" rating was reserved for "institutions with an extremely high immediate or near-term probability of failure." (DX 1448 at 0834; PX 509 at 1970). A "4" rating was defined as "[m]ajor and serious problems and unsound conditions . . . which are not being satisfactorily resolved by the institution." Id. In its October 1987 examination of Fidelity, the regulators assigned Fidelity a composite MACRO rating of "4." (DX 1411 at 0419). The individual component ratings were "3" for management, "4" for asset quality, "2" for capital, "2" for risk management, and "2" for operating results. Id. The regulators based the composite "4" rating on the concentration of problem commercial real estate loans where Fidelity had classified assets of $81.5 million. (Albanese, Tr. 4159-60; DX 69A at 0106; DX 1411 at 0419).6 After joining Fidelity in June 1986, Mr. Powderly reviewed Fidelity's loan portfolio and decided that Fidelity should terminate its commercial real estate lending as promptly as possible. (Stip. 67). Mr. Lovely and Mr. Greco initially resisted Mr. Powderly's efforts to stop Fidelity's commercial real estate lending, but Mr. Powderly gained the support of Fidelity's Board of Directors and eventually became Fidelity's President in 1990 replacing Mr. Greco. (Powderly, Tr. 353-55, 655-56). In early 1987, Fidelity's augmented management team recognized the potential for problems in developing Fidelity's commercial real estate, construction, and commercial business loan portfolios, in part as a result of the

The assignment of ratings by the federal regulators appears to have been an inexact and subjective process. (Albanese, Tr. 4164). As is shown by the October 1987 ratings for Fidelity, a simple average of equally weighted component scores would have produced a composite rating of "2.6," not "4." Accepting that a "1" rating is seldom used, Fidelity actually received high "2" ratings in three of the five categories. The record does not contain a credible explanation of how the components may have been weighted, or why the "4" rating for asset quality should have driven the overall composite rating for Fidelity. -13-

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Tax Reform Act of 1986.7 (Stip. 68). Through Mr. Powderly's efforts, Fidelity reduced its commercial loan portfolio from $370.9 million in September 1986 to $207 million in December 1989. (PX 986 at 4174). In 1987, as Fidelity moved away from commercial real estate loans, it began to invest available funds in high quality mortgage-backed and mortgage-related securities, and U.S. Government obligations. This practice was in contrast with the traditional thrift practice of originating residential mortgage loans. (Stip. 69). Fidelity's management chose this strategy as a means of controlling its overall credit risk and managing interest rate risk. Id. Fidelity's management also decided to de-emphasize traditional one-to-four-family mortgage lending due to severe competition in its market area, which made the returns generated by securitized mortgage assets more attractive. Id. In October 1988, Fidelity adopted a three-year Business Plan that had the following principal objectives: (1) an increase in capital, and particularly GAAP capital;8 (2) balance sheet growth of 8-10 percent per year; (3) reduced loan concentrations and increased credit quality; and (4) an increased return on assets to a stable 50-70 basis points9 range. (Stip. 70). Fidelity regarded an 8-10 percent growth rate as a realistic and modest growth rate, typical of the thrift industry. Fidelity had exceeded this growth rate in years prior to 1988. (Powderly, Tr. 361­62; Kaplan, Tr. 2956). Increasing profitability to a stable 50-70 basis points also was a readily achievable goal. (Kaplan, Tr. 2957). At the time it adopted the October 1988 Business Plan, Fidelity had been maintaining a positive earnings spread by borrowing from depositors, Wall Street, or the Federal Home Loan Bank at low interest levels, by making safe returns on investments in residential mortgages through loan originations or the purchase of mortgage-backed securities, and by

The Tax Reform Act of 1986 ("the Act") took away the tax advantages for investors who purchased co-operative units, making it less attractive to hold highly leveraged commercial real estate. (Powderly, Tr. 332-33; Wesp, Tr. 1742; PX 986). The Act was "the number one reason" why commercial real estate loans became problem assets in the late 1980s. The Act changed the economic viability of the projects funded by the loans. (Finn, Tr. 4004). "GAAP capital" is capital determined in accordance with Generally Accepted Accounting Principles. Fidelity's Mr. Wesp expected the thrift industry to move toward GAAP accounting which would have the effect of eliminating Fidelity's goodwill. (Wesp, Tr. 1790-91, 1827). A "basis point" is a unit of measure used in finance to describe the percentage change in the value or rate of a financial instrument. A "basis point" is 1/100th of one percent. Thus, there are 100 basis points in one percent. -149 8

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significantly reducing operating expenses. (Powderly, Tr. 358-61). Fidelity provided its October 1988 Business Plan to the FHLBB as requested. (Wesp, Tr. 1789; PX 447 at 1312). Mr. Wesp included a statement in the Business Plan calling for "no quantum leaps forward, just steady growth." (PX 447 at 1315). Mr. Wesp added this phrase to communicate that Fidelity did not intend to mimic thrifts that were growing too large too fast and likely would need to be bailed out. (Wesp, Tr. 1798-99). Fidelity included in the October 1988 Business Plan its intention to use wholesale markets. When commenting on the economic environment that Fidelity was likely to face, the Business Plan states: Either the wholesale or retail market can be used to add assets to the balance sheet. For instance, there will be periods when it is more cost efficient to buy mortgage backed securities rather than to originate [loans] at punitive teaser rates. It is our intention to utilize the more efficient market. (PX 447 at 1316). Mr. Wesp's market expertise allowed Fidelity to be "very opportunistic as well as flexible." (Wesp, Tr. 1815-16). Fidelity recognized that any business plan must be altered to account for changed circumstances. Thrifts regularly re-evaluate business plans when unanticipated events occur. (Powderly, Tr. 970). However, when a thrift has enough capital, it is generally protected from having to change course due to unanticipated events. (Powderly, Tr. 971-73). Mr. Wesp developed a plan to invest approximately $100 million that Fidelity had acquired through the sale of Suburbia's loans. (Wesp, Tr. 1728-29). Mr. Wesp began investing in conservative notes and bonds from entities such as General Motors, IBM, and General Electric. (Wesp, Tr. 1729-31). Mr. Wesp focused his investment strategy on meeting the 8-10 percent annual growth projection in the October 1988 Business Plan. (Wesp, Tr. 1750-53). To achieve ten percent annual growth, Fidelity used a combination of consumer loans, adjustable rate mortgage home equity loans, and conservative investments. (Wesp, Tr. 1758-59). In the competitive Long Island market, Fidelity could not meet its annual growth projections using only the traditional one-to-four family home mortgages. (Wesp, Tr. 1750-53). Mortgage-backed securities are marketable securities that are secured by a pool of mortgages. The Government National Mortgage Association ("GNMA" or "Ginnie Mae"), Federal Home Loan Mortgage Corporation ("FHLMC" or "Freddie Mac"), and Federal National Mortgage Association ("FNMA" or "Fannie Mae") are issuers of mortgage-backed -15-

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securities. (Wesp, Tr. 1756-58). Fidelity began investing in mortgage-backed securities as a way to add significant earnings to its balance sheet. (Wesp, Tr. 1758-61). Mortgagebacked securities had the same interest rate risk as other investment vehicles, such as notes or bonds from government or corporate securities. (Wesp, Tr. 1759). As Fidelity curtailed its commercial real estate loans, it expanded investments in mortgage-backed securities to achieve growth. (PX 462 at 3558; PX 618 at 1646; PX 986 at 4174). Fidelity funded its purchases of mortgage-backed securities first with the proceeds from selling Suburbia's loans, and then with customer deposits and borrowings from the Federal Home Loan Bank and Wall Street. (Wesp, Tr. 1761-62, 1787). Using the investment talents of Mr. Wesp, Fidelity achieved higher returns through mortgage-backed securities than it could through traditional loans. (Powderly, Tr. 396-97). Such investments could be made without the pressures of local market competition, and without incurring added overhead or branch costs. (Wesp, Tr. 1763-65). By October of 1988, Mr. Wesp was "anticipating a whole new set of risk-based capital requirements, [and] a huge piece of legislation out of Congress." (Wesp, Tr. 1814; PX 447 at 1316). In this regard, Fidelity's October 1988 Business Plan stated: We view the area of most significant risk to the forecast to [be those] issues dominated by the U.S. Congress as it grapples with the recapitalization of the FSLIC in the spring of 1989. At this time it is impossible to forecast what quid pro quos might be extracted from the thrift industry but almost certainly, the agenda will include new regulation and additional financial support for the FSLIC. We will follow these developments closely. Id. As Fidelity's Mr. Wesp recalled at trial, "I knew that we weren't going to like the goodwill treatment. I just never actually believed that [they] would make us write it off on one day." (Wesp, Tr. 1814). Fidelity discussed the substance of the potential FIRREA legislation only once during its six Board of Directors meetings from January 1989 through June 1989. (Powderly, Tr. 772-786; DX 2334, 2338, 2347, 3348, 2353). At no time prior to the August 9, 1989 passage of FIRREA did Fidelity's Board ever discuss whether it should change its business plan to react to the potential legislation. Id. Even after FIRREA's passage, Fidelity did not know how the December regulations would affect the treatment of goodwill capital. (Powderly, Tr. 792). At the August 1989 Board meeting after FIRREA's passage, Mr. Powderly urged Fidelity's management to "operate from a position of strength for whatever our future may hold." (Powderly, Tr. 786; DX 73 at 2878). Fidelity continued to focus on implementing the -16-

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four main points of its October 1988 business plan, but modified its 8-10 percent growth plan to a low-risk no-growth strategy. (Powderly, Tr. 356-57, 791; Wesp, Tr. 1842-43). Only after FIRREA's implementing regulations were issued on November 7, 1989 did Fidelity see how its goodwill capital would be affected and "make some changes." (Powderly, Tr. 792; Vigna, Tr. 1410; PX 511 at 4525). E. Changes Required by FIRREA

Congress enacted FIRREA on August 9, 1989. (Vigna, Tr. 1407; DX 557 at 2718). As part of FIRREA, the OTS replaced the FHLBB as the primary regulator of thrifts, and the FDIC became the OTS's back-up regulator. (Vigna, Tr. 1445). FIRREA required the Director of OTS to promulgate regulations establishing "tangible" capital requirements, "core" capital requirements, and "risk-based" capital requirements for thrift institutions. (DX 557 at 2835). The OTS issued implementing regulations on November 8, 1989 and they became effective on December 7, 1989. (Vigna, Tr. 1410; PX 511; Stip. 73). FIRREA required a savings institution to maintain tangible capital in an amount not less than 1.5 percent of the institution's adjusted total assets. 12 U.S.C. § 1464(t)(2)(B); 12 C.F.R. § 567.9(a). Id. Tangible capital could not include any intangible assets, such as goodwill. 12 U.S.C. § 1464(t)(9)(c). (Stip. 74). FIRREA and its regulations required an institution to maintain core capital of three percent of its adjusted total assets. 12 U.S.C. § 1464(t)(9)(A); 12 C.F.R. § 567.8. (Stip. 75). Core capital was defined to exclude any unidentifiable intangible assets, including goodwill. 12 U.S.C. § 1464(t)(9)(A); 12 C.F.R. § 567.5(a)(1)-(2). (Stip. 76). FIRREA permitted a thrift to include specified amounts of "qualifying supervisory goodwill" in the calculation of core capital. Such goodwill initially was limited to 1.5 percent of total assets. The permitted amount of goodwill declined gradually each succeeding year and was phased out entirely by December 31, 1994. 12 U.S.C. § 1464(t)(3)(A); 12 C.F.R. § 567.5(a)(1)-(2). (Stip. 77). FIRREA required savings institutions to maintain risk-based capital in an amount greater than or equal to 6.4 percent of risk-weighted assets at December 31, 1989, 7.2 percent of risk-weighted assets as of December 31, 1990, and 8.0 percent of risk-weighted assets as of December 31, 1992. 12 U.S.C. § 1464(t)(2)(c); 12 C.F.R. §§ 567.2(a)(1)-(b), 567.6. (Stip. 78). As with core capital, specified amounts of qualifying supervisory goodwill initially could be counted towards the risk-based capital requirement, but would be phased out over five years. 12 U.S.C. § 1464(t)(2)(c). (Stip. 79).

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The new OTS District Director, Mr. Vigna, notified Fidelity of FIRREA's capital requirements on November 13, 1989. (PX 511). The new regulations required each thrift institution to meet three capital criteria: tangible capital, core capital, and risk-based capital. Id. Prior to the passage of FIRREA, Fidelity was in compliance with applicable capital regulations, having a capital-to-assets ratio of 5.44 percent. (PX 618 at 1642; Powderly, Tr. 392). On December 6, 1989, the day before FIRREA's capital requirements became effective, Fidelity had $125 million in regulatory capital and $62 million of GAAP capital. (DX 78 at 5445). When FIRREA took effect on December 7, 1989, Fidelity did not meet any of the three capital requirements. (Powderly, Tr. 379, 392, 408; DX 78 at 5445; PX 509 at 1966; PX 618 at 1642-43). As of December 31, 1989, Fidelity's tangible capital was negative $29.686 million. Under FIRREA and its regulations, Fidelity was required to have tangible capital of $27.456 million. Fidelity's tangible capital deficit therefore was $57.142 million. (Stip. 82). Fidelity's core capital, including the permitted portion of supervisory goodwill, was negative $2.230 million. Fidelity was required to have core capital of $54.912 million. Fidelity's core capital deficit therefore was $57.142 million. (Stip. 83). Fidelity's risk-based capital, including the permitted portion of supervisory goodwill, was negative $2.230 million. Fidelity was required to have risk-based capital of $59.271 million. Fidelity's risk-based capital deficit therefore was $61.501 million. (Stip. 84). FIRREA instantly turned Fidelity from a profitable institution into an unprofitable institution. (Greco Dep., Tr. 89).10 Consistent with the above capital shortfalls caused by FIRREA, the newly created FDIC determined that as of September 30, 1989, a $57.8 million capital infusion would be necessary to bring Fidelity into capital compliance with the capital and core capital requirements prescribed by FIRREA. (Stip. 80). In a September 30, 1989 Report of Examination, the FDIC gave Fidelity a composite rating of "5," placing Fidelity in a category reserved for institutions with an "extremely high" immediate or near term probability of failure. (Stip. 81). FIRREA caused the "Capital" component of Fidelity's rating to drop from a "2" to a "5." (DX 1411 at 419; Vigna, Tr. 2764-66, 2832-33).

Some of the regulatory capital that Fidelity lost through FIRREA is non-contractual, and is unrelated to Fidelity's merger with Suburbia. The goodwill acquired in the Dollar Federal merger, for example, amounted to $19.33 million at December 31, 1989, but is not at issue in this lawsuit. Approximately 25 percent, or $34.207 million, of Fidelity's regulatory capital was noncontractual as of December 31, 1989. (PX 502 at 259-60; PX 526 at 8366; Lovely, Tr. 1619). -18-

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F.

Fidelity's Operations After FIRREA

On December 18, 1989, OTS sent a memorandum to each thrift institution, including Fidelity, that was projected to fail one or more of the new capital standards. (Vigna, Tr. 1419-23; PX 520). Attached to the memorandum were Thrift Bulletin 36, containing instructions for preparation of a Capital Plan, and Thrift Bulletin 36-1, providing guidance on interest rates, prepayment rates, and loan origination rates that could be used in preparing a Capital Plan. (PX 520). The OTS required Fidelity to submit a Capital Plan by January 7, 1990. (Vigna, Tr. 1423­24; PX 520 at 4305). Thrift Bulletin 36 specified that a thrift filing a Capital Plan must show that it could achieve capital compliance within a reasonable time, but not later than December 31, 1994. (Vigna, Tr. 1430-37; PX 520 at 4311-4314). Thrifts were cautioned not to rely upon consultants to develop Capital Plans. Id. Thrifts were required to submit a report to OTS within 20 days after the end of each quarter listing any variances from the Capital Plan, and comparing actual capital to target capital. Id. Fidelity's Board of Directors adopted the Capital Compliance Plan on January 3, 1990, and submitted it for approval to OTS. (Stip. 85, 86). This Plan described how Fidelity intended to comply with the capital requirements of FIRREA. (Stip. 86). Fidelity's Plan stated that "[t]he Plan contains zero growth and modest shrinkage in 1993/94." (Stip. 87). Due to Fidelity's mutual-to-stock conversion in 1993, this moderate shrinkage never occurred. (Powderly, Tr. 904; PX 986 at 4176). Fidelity filed its Capital Plan on January 8, 1990. (PX 539). On February 2, 1990, the OTS notified Fidelity that it was "insolvent" as defined in Regulatory Bulletin 3a-1, entitled "Policy Statement on Growth for Savings Associations" ("RB 3a-1"). Under RB3a1, "associations `requiring more than normal supervision' or `subject to greater restrictions' will be permitted little to no growth under this policy, subject to District Director discretion and waiver authority." (Stip. 89). RB3a-1 defined associations "requiring more than normal supervision" as "those with a composite MACRO rating of 4 or 5, associations failing any one of their minimum regulatory capital requirements, or associations otherwise identified as in need of more than normal supervision by supervisory personnel." (Stip. 90). RB3a-1 defined associations "subject to greater restrictions" as associations that were insolvent, among other things. (Stip. 91). As an insolvent institution, investments without the permission FIRREA also jeopardized Fidelity's Fidelity lacked sufficient net worth. Fidelity was not permitted to make new loans or of the OTS District Director. (Vigna, Tr. 1439-41). opportunity to borrow in the capital markets because (Greco Dep., Tr. 164). -19-

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Fidelity likely would not have participated in the Suburbia merger had it known that FIRREA would later take away Fidelity's ability to count the goodwill toward capital requirements. (Lovely, Tr. 1572-73). From the standpoint of Fidelity's management, the Government enticed Fidelity to acquire Suburbia by promising that it would be stronger as a result of the merger, but through FIRREA, the Government took away the benefits of its agreement with Fidelity. Id. In effect, FIRREA left Fidelity with the burdens of Suburbia's excess liabilities, but not the offsetting supervisory goodwill for Fidelity to avoid viol