BULL STREET - The art of the Con

Call Me Mr. Keating, Sonny

Charles Keating was a former swimming champion and worked as a lawyer for raider Carl Lindner. It was from Lindner that he started his ball rolling by buying American Continental Corporation, a house-building company in Ohio in 1978.  From there, he raised the money to acquire Lincoln Savings and Loan of California (Lincoln) through a junk bond offering floated by Drexel Burnham ([116]).  In his commitment to the regulatory officials that controlled the thrift's license, Keating promised faithfully to stay with the course with the same management that existed before the takeover for the reason that the regulators felt that they had done such a good job.  Moreover, the California regulators also extracted the promise form Keating that he would not sell jumbo CD's to facilitate the thrift's growth nor would he go out of the Savings & Loan's principal business of issuing home mortgages.  Faster than you could say “liar, liar, your house is on fire”, Keating had fired the incumbent management, issued jumbo CDs and started working in concert with developers to get into massive proprietary real estate projects.

Once Charles became president of Lincoln and sold worthless bonds to 23,000 people, primarily California residents directly from the thrift’s branches, by causing them somehow to believe that the United States Government had guaranteed them.  ([117]) When Lincoln was forcibly closed in 1989, only slightly more than 2% of the over $5 billion dollars in assets that Lincoln reported were in residential mortgage loans, almost 70% in risky land deals and eventually cost the taxpayers of the United States over $2.5 billion.

Lincoln’s investment philosophy under Keating’s guidance included takeover stocks, hotels, junk bonds, financial futures, and high-risk loans, which ultimately accounted for over 60% of the S & L’s assets ([118]).  Keating took these investors for everything they invested, but that wasn’t all, the bailout paid for by American Citizens required another $2.5 billion before the loop was closed.  Lincoln became the largest S & L failure in U. S. History and its conspirators were charged with concealment of illegal cash payments, securities fraud, racketeering, conspiracy, transporting stolen property, forgery, and false and misleading statements made to the regulators.

An example of the activities that were taking place during Keating’s reign at Lincoln is the following story that describes it to perfection:

“One of the most scrutinized of Lincoln’s multimillion-dollar real estate deals was the large Hidden Valley transaction that took place in the spring of 1987. On March 30, 1987, Lincoln loaned $19.6 million to E. C. Garcia & Company. On that same day, Ernie Garcia, a close friend of Keating and the owner of the land development company bearing his name, extended at $3.5 million loan to Wescon, a mortgage real estate concern owned by Garcia’s friend, Fernando Acosta, The following day, Weson purchased 1,000 acres of unimproved desert land in central Arizona from Lincoln for $14 million, nearly twice the value established for the land by an independent appraiser one week earlier. Acosta used the loan from Garcia as the down payment on the tract of and signed a non-recourse note for the balance. Lincoln recorded a profit of $11.1 million on the transaction—profit that was never realized, since the savings and loan never received payment on the non-recourse note.

In fact, Lincoln never expected to be paid the balance of the non-recourse note, Lincoln executives arranged the loan simply to allow the savings and loan to book a large paper gain. Garcia later testified that he agreed to become involved in the deceptive Hidden Valley transaction only because he wanted the $19.6 million loan from Lincoln. Recognizing a profit on the Hidden Valley transaction would have openly violated financial accounting standards if Garcia had acquired the property directly from Lincoln and used funds loaned to him by the savings and loan for his down payment. Acosta eventually admitted that his company, Wescon, which prior to the Hidden Valley transaction had total assets of $87,000 and a net worthy of $30,000, was only a “straw buyer” of Hidden Valley property. In a Los Angeles Times article, Acosta reported that Wescon “was too small to buy the property and that he signed the documents without reading them to help his friend, Ernie Garcia”[119]

Keating couldn’t have stolen $250 million without substantial help.  Three accounting firms, Arthur Anderson & Company, Touché Ross & Company and Arthur Young and Company, along with three law firms, Kaye Scholer; Sidley and Austin and Jones Day, stock broker, Drexel Burnham Lambert and Michael Milken individually paid over $240 million in settlements regarding their actions in regard to Lincoln’s failure.  These firms were charged with allowing Lincoln Savings and Continental to hide the truth about the real state of affairs underlying their financial data ([120]).

Keating could personally spend Lincoln’s money as fast as it could come in the Lincoln’s door. His lavish parities were the envy of the jet set and a literal cross section of Who’s Who would be present whenever it became known that Charlie was going to throw another bash. American Taxpayers, directly paid for spending of this nature, because Keating wrote a voucher for literally every nickel he ever spent and would turn them in and get re-paid back from Lincoln as a company expense. Luxury vacations, private jet planes and lavish lunches and dinners were only the start. Keating lived the good life on money illegally drawn down from Lincoln.

Keating also had a team of U. S. Senators to whom he had transferred $1.3 million in campaign contributions who would plead his case at the drop of a hat.  Arizona’s DeConcini and former presidential candidate McCain, Cranston of California, Riegle of Michigan and former astronaut Glenn of Ohio became known as the “Keating Five” for their cozy relationship with him. He was also able to secure a job on the Bank Board as Commissioner to man that was substantially in debt to his institution. Talk about conflicts, it was the Bank Board that regulated Lincoln. He was also able to hire, now Chairman of the Federal Reserve to lobby for him to increase Lincoln’s “direct investments.” Eventually, Greenspan wrote a letter to a California bank regulator regarding Lincoln management stating: “seasoned and expert with a long and continuous track record of outstanding success in making sound and profitable direct investments.”

Keating remained arrogant until the end and once again we can sum up his attitude with a quote from the man himself:

“One question, among the many raised in recent weeks, has to do with whether my financial support in any way influenced several political figures to take up my cause. I want to say in the most forceful way I can: I certainly hope so.” ([121])

Keating collected other famous people in the same way he was able to draw in the senators, at his trial among the 120 letters were submitted by notables in his defense.  One, from Calcutta; sent by Mother Teresa pleaded his case by pointing out how generous to the Indian poor he had been.  Mother Teresa should have given some thought to the poverty his schemes had created in the United States.  The money that was spent by the American people to rectify the damage caused by Keating could have fed every man, woman and child in the City of Calcutta for over a decade. 

Their theory was that the Farm Home Loan Bank Board Chief, Edward Grey and other regulators were too tough on Lincoln.  The ammunition for the theory was provided by an Arthur Young analysis, which gave Lincoln high operational marks.  Incidentally, the author of the Arthur Young analysis, Jack Atchison, soon left for the employ of Mr. Keating at Lincoln at three times the salary ([122]).

 Congress asked a lot of question regarding Atchison’s dual role and in particular, Congressman Lehman was grilling an Arthur Young senior official, William L. Gladstone:

Congressman Lehman:       Did anyone at Arthur Young have any contact with Mr. Atchison after he left and went to work for Lincoln?

Mr. Gladstone:                     Yes Sir.

Congressman Lehman:       In the course of the audit?

Mr. Gladstone:                     Yes

Congressman Lehman:       So he went from one side of the table to the other for $700,000 more?

Mr. Gladstone:                     That is what happened,

Congressman Lehman:       And he—just tell me, what his role was in the audits…when he was on the other side of the table.

Mr. Gladstone:                     He was a senior vice-president for American Continental when he joined them in May 1988.

Congressman Lehman:       Did the job he had there have anything to do with interfacing with the auditors?

Mr. Gladstone:                     To some extent, yes.

Congressman Lehman:       What does “to some extent” mean?

Mr. Gladstone:                     On major accounting issues that were discussed in the Form 8-K, we did have conversations with Jack Atchison.

Congressman Lehman:       So he was the person Mr. Keating had to interface with you in major decisions?

Mr. Gladstone:                     Him, and other officers of American Continental

It was unquestionable a conflict for Young to be interfacing with one of their former employees in their role as Independent Auditor for Lincoln. They had made some terrible mistakes and apparently didn’t know how to handle the resolution of them and were literally floundering. Kenneth Leventhal was asked to act as an independent forensic evaluator of what had occurred. They never mentioned anyone by name but there was no question to any one reading what they had to say as to who they felt the villains in matter really were.  

 “Seldom in our experience have we encountered a more egregious example of misapplication of generally accepted accounting principles? This association (Lincoln) was made to function as an engine, designed to funnel insured deposits to its parent in tax allocation payments and dividends. To do this, it had to generate reportable earnings. It created profits by making loans. Many of these loans were bad. Lincoln was manufacturing profits by giving money away.” ([123])

In their, take no prisoners report, Leventhal laid the blame where it should well have been placed. Arthur Young countered with the fact that, by number Leventhal had only check 15% of the real estate transactions that Lincoln had made and that under the circumstances, without getting a greater cross section, Leventhal retorted that their check covered approximately 50% of the transactions the Lincoln was involved in and there for Young was literally trying to blow smoke. In addition, they pointed out that of the transactions that they went over, something was literally wrong with every one.

Congressman Leach even found a problem with Young relative their approach with the investigating committee:

Congressman Leach:          I am going to be very frank with you, that I am not impressed with the profession ethics of your firm vis-a-vis the United States Congress. Several days ago, my office was contacted by your firm, and asked we would be interested in questions to ask of Leventhal. We said. “Surely”. The question you provided were of an offensive nature. They were to request of Leventhal how much they were paid, implying that perhaps based upon their payment from the U.S. Government that their decisions as CPA’s would be biased. I consider that to be very offensive.

Now, in addition, one of the questions that was suggested I might ask of the Leventhal firm was: Could it be that their firm is biased because a partner in their firm did not make partner in your firm?

Mr. Gladstone:                     I do not know who contacted you and I certainly do not know how the questions were raised.

               

In effect, one of the senior partners of Young was indicating that he wasn’t sure that it was a Young employee or whom it was that provided the questions. Naturally, it would have extremely odd for the defense team representing Young not to have gone of the matters relating to Gladstone’s potential questions and answers from Congress. It was later determine of course, that it indeed was one of the people from Young that had provided the questions to the panel. Leach had time to reread the report and countered with:

Congressman Leach:          I read that report very carefully, and I found no angry vengeful sweeping statement. But I did find a conclusion that Arthur Young had erred rather grievously. In any regard, what we are looking at is an issue that is anything but an accounting kind of debate. One of the techniques of Lincoln vis-ŕ-vis the U. S. government was to attack the opposition. You are employing the same tactics toward Leventhal…. I think that is unprofessional, unethical and, based upon a very careful reading of their statement, irresponsible. Now, I would like to ask you if you would care to apologize to the Leventhal firm.

Mr. Gladstone:                     First, Mr. Leach, I stated in my opening remarks that I believed that their report was general and sweeping and unprofessional, because (what) I would call unprofessional about it is the statement that looking at 15 transactions that therefore they would conclude that nothing Lincoln did had the substance—

Congressman Leach:          I have carefully read their report, and they note that they have just been allowed to look at 15 transactions. They could not go into more detail, but they were saying that American Continental Corp. (Lincoln’s owner) batted 15 for 15, that all 15 transactions were unusual, perplexing, and in their judgment in each case breached ethical standards in terms of generally accepted accounting principles.  Your firm in effect saying, “We think that there may be some legal liabilities. There, we are gong to stonewall, an we are going to defend each and every one of these transactions.” I believe that you are one of the great firms in history of accounting. But I also believe that big and great people and institutions can sometimes err. And it is better to acknowledge error than to put one’s head in the sand. I think before our committee you have righteously done that.                                                                    

Of particular interest is the fact that both the accounting and law firms involved had impeccable reputations both before and after the Lincoln debacle.  If they had not cooperated, the repercussions of this felony would certainly have been less devastating.  Keating, found guilty of felonies, is in prison and has declared bankruptcy.  I am sure this has not assuaged his victims.

During the congressional hearing that had been enabled to take a look at the thrift industry in general and Lincoln in particular in order that it could be determined what went wrong. During the hearing Congressman, Jim Leach named everyone as guilty parties:

“I am stunned. As I look at these transactions, I am stunned at the conclusion o an independent auditing firm. I am stunned at the result. And let me just tell you, I think that this whole circumstance of a potential $2.5 billion cost to the United States taxpayers is a scandal for the United States Congress. It is a scandal for the Texas and California legislatures. It is a scandal for the Reagan administration regulators. And it is a scandal for the accounting profession.” ([124])

The Securities and Exchange Commission started an investigation on the various securities problems that had been inherent in the entire Lincoln mess. The biggest of the violations occurred when Lincoln set up offices in their facilities to push debt instruments, which most people were led to believe, were guaranteed by the government. Richard Breeden was particularly vocal about the fact that Arthur Young was not helping the SEC in any way with their investigation:

Commissioner Breeden:     We subpoenaed the accountants (Arthur Young) to provide all of their work papers and their back-up.

Congressman Hubbard:     Do you know if they were forthcoming and helpful in helping you resole some of these questions, or helping the SEC resolve some of these questions?

Commissioner Breeden:     No. I would characterize them as very unhelpful, very unforthcoming, and very resistant to cooperate in any way, shape or form. ([125])

Remember Lance Ito, the California Judge that received so much publicity during the O. J. Simpson trial. Ito also was the presiding judge in the Lincoln case. Well, Ito was no Keating fan and sentenced him to 10-years in jail for securities. In a concurrent case running in federal court, it must have been felt that Keating had gotten away with murder under Ito’s guidelines and they handed him an additional 12 years behind bars for good measure.

But Keating was if anything, a gladiator, he appealed the Ito decision claiming that incorrect instructions were given to the jury. He was found to be correct and Ito was overturned on appeal. This same judge was simultaneously hearing an appeal of the federal case on the same grounds. If he overturned one, how could he not overturn the other and he did. It seems that both cases did not check to see if any of the jurors were aware of his conviction in the rival case and because some had been aware of what had gone on before, it was determined that Keating did not receive a fair trial.

By this time, Keating had already been jail waiting the outcome of his various appeals. The government announced that rather than see Keating walk, they were going to retry the case. When push came to shove, no one really wanted to do that whole thing all over again and just before the trial was to reconvene, both sides worked out a deal. Keating would agree that he had indeed done something terribly wrong ([126]) and for their part, the government would agree that he had been in jail long enough and would let him go.

Out of a total of 22-years in sentences that Keating had been given, he only served approximately 25% of that time in jail. In the meantime, everyone else involved with Keating suffered substantially in the derivative lawsuits that had been brought again one and all for helping to create the disaster. Three accounting firms were involved with Keating and Lincoln in one way or the other and the costs to all of them were not insubstantial. Young’s defense was a disaster waiting to happen and it did. They really came out looking like the villains in the case because of the hardball manner that they conducted their defense. In the end, it did them little good and made the firm look like the villain, not an innocent party that had been set up by and ogre.

 

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