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August 22, 1990


Stanley Sporkin, United States District Judge.

The opinion of the court was delivered by: SPORKIN


 In this consolidated action, plaintiffs American Continental Corporation and Lincoln Savings and Loan Association seek to regain operational control of Lincoln Savings and Loan Association. Plaintiff American Continental Corporation ("ACC") is an Ohio corporation with its principal place of business in Phoenix, Arizona. Plaintiff Lincoln Savings and Loan Association ("Lincoln") is a California corporation chartered as a savings and loan institution by the State of California Department of Savings and Loans. Lincoln is a wholly owned subsidiary of ACC. The deposits in Lincoln were insured by the Federal Savings and Loan Insurance Corporation ("FSLIC"). Defendant Office of Thrift Supervision is the successor agency of the Federal Home Loan Bank Board ("FHLBB" or "Bank Board"). On April 14, 1989, the Bank Board pursuant to its statutory authority appointed a conservator to take over the management of Lincoln. On August 2, 1989, the Bank Board replaced the conservator with a receiver.


 Plaintiffs challenge the decisions of the Bank Board to appoint a conservator and a receiver for Lincoln. Specifically, plaintiffs seek an order requiring the Office of Thrift Supervision, successor to the Bank Board, *fn1" to remove the conservator that was appointed on April 14, 1989, and the receiver that was appointed on August 2, 1989. The Bank Board possesses the authority to appoint a conservator or a receiver once it makes certain findings. 12 U.S.C. § 1464(d)(6)(A). The decision to appoint a conservator for Lincoln was made after the FHLBB concluded that Lincoln was "in an unsafe and unsound condition to transact business," and that there had been a "substantial dissipation of assets or earnings due to . . . violations of law, rules, or regulations, or to any unsafe or unsound . . . practices." 12 U.S.C. § 1464(d)(6)(A). *fn2" Later, these findings coupled with the Board's conclusion that Lincoln was insolvent resulted in the appointment of a receiver.

 The relevant statutory provisions empower the Bank Board to make these appointment determinations ex parte and without notice. Id. The statute also authorizes the Bank Board to replace a conservator with a receiver without further notice or hearing. 12 U.S.C. § 1464(d)(6)(D). Once the Bank Board appoints either a conservator or a receiver, the savings and loan association that is adversely affected may seek judicial review of the action. Thus, the association is accorded the right to contest the Bank Board's actions "upon the merits" in a post-deprivation proceeding in the United States District Court for the District of Columbia or the district in which the association has its home office. *fn3" Id. In initiating this action, plaintiffs have availed themselves of this statutory right to judicial review.

 Plaintiffs here contend that they at all times managed and operated Lincoln on a sound financial basis. Plaintiffs allege that defendant was not justified in seeking and obtaining their removal from control of Lincoln which was effectuated by the Bank Board's appointment of a conservator and ultimately a receiver for Lincoln. Plaintiffs claim that the Bank Board's actions were arbitrary and capricious and that these actions were so ill founded that they precipitated Lincoln's severe financial crisis.

 Plaintiffs further assert that Lincoln would be solvent and operating today if the Bank Board had not taken the precipitous action of placing Lincoln in a conservatorship and then in receivership. It is defendant's contention that plaintiffs engaged in numerous unsafe and unsound banking practices and that as a result of these and other improper practices there had been a substantial dissipation of the thrift's assets. The Bank Board asserts that it was these practices that led to Lincoln's downfall.

 In the post-deprivation hearing conducted before this Court, the Board justified its actions by introducing proof on a number of specific transactions which it claims fully sustain its position. *fn4" Plaintiffs have countered by alleging that the transactions enumerated were perfectly proper and have introduced expert testimony to demonstrate the accounting treatment afforded these transactions fully conformed with all the professional norms that existed at the time the transactions were effected. Plaintiffs also introduced evidence from their independent auditors which plaintiffs claim fully support the accounting treatment taken.


 Here, plaintiffs challenge the decision of the Bank Board, an independent agency of the executive branch, to place Lincoln into a conservatorship and receivership. 12 U.S.C. § 1437. Plaintiffs contend that this Court must review the actions of the Bank Board under a de novo standard. In support of this position, plaintiffs make various statutory and constitutional arguments. Pl. Mem. Dec. Stand. at 4-36. Specifically, plaintiffs place great emphasis upon the language of the statute that affords them the right to initiate this action. The pertinent statutory language provides that once an action challenging the appointment of a conservator or receiver is initiated the "court shall upon the merits dismiss such action or direct the Board to remove such conservator or receiver." 12 U.S.C. 1464(d)(6)(A). *fn5"

 Prior to making a determination that testing of the administrative record was warranted, this Court noted that the purpose of such a hearing would be to determine how good the decision of the Bank Board was, that is "whether it [was], in effect, arbitrary and capricious." Motions Hearing Tr. at 84. Thus, the purpose for conducting an evidentiary hearing was to test the accuracy of the record upon which the Bank Board relied when making its decisions.

 Arbitrary and capricious review is often utilized when reviewing the decisions of an administrative action. 5 U.S.C. § 706(2)(A). This standard of review requires judicial deference to the agency's judgment. The Court must consider whether the agency's action was based on a consideration of relevant factors or whether there has been a clear error in judgment. Citizens to Preserve Overton Park, Inc. v. Volpe, 401 U.S. 402, 416, 28 L. Ed. 2d 136, 91 S. Ct. 814 (1971). "Although this inquiry into the facts is to be searching and careful, the ultimate standard of review is a narrow one. The court is not empowered to substitute its judgment for that of the agency." Id. Notwithstanding this deference, the agency must "examine the relevant data and articulate a satisfactory explanation for its action including a 'rational connection between the facts found and the choice made.'" Motor Vehicle Mfrs. Ass'n v. State Farm Mut. Auto Ins. Co., 463 U.S. 29, 43, 77 L. Ed. 2d 443, 103 S. Ct. 2856 (1983) (quoting, Burlington Truck Lines, Inc. v. United States, 371 U.S. 156, 168, 9 L. Ed. 2d 207, 83 S. Ct. 239 (1962)). The question of whether an agency has acted in an arbitrary and capricious manner turns on the extent to which the relevant statute restricts the agency's discretion. Kreis v. Secretary of the Air Force, 275 U.S. App. D.C. 390, 866 F.2d 1508, 1514 (D.C. Cir. 1989). Here, Congress has conferred a great deal of discretion upon the Bank Board. The statute provides that the Board "shall have exclusive power and jurisdiction to appoint a conservator or receiver." 12 U.S.C. 1464(d)(6)(A). The delegation of such authority is consistent with the need for effective regulation of the savings and loan industry. See Woods v. Federal Home Loan Bank Bd., 826 F.2d 1400, 1406-7 (5th Cir. 1987), cert. denied, 485 U.S. 959, 99 L. Ed. 2d 422, 108 S. Ct. 1221 (1988). This is particularly so where, as here, the accounts of a savings and loan association are insured by the federal government for $ 100,000 per account. While plaintiff ACC invested some $ 51 million to purchase Lincoln, the institution's $ 1 billion in assets came from depositors with federally insured accounts. Thus, by virtue of its insurance of Lincoln accounts, the federal government's interest in Lincoln is many times that of ACC.

 Application of arbitrary and capricious review is particularly appropriate where the central issue is whether statutory grounds existed for the appointment of a conservator or receiver at the time the Bank Board acted. *fn6" As one court has explained,

The issue, regardless of process, becomes whether the Bank Board had a reasonable factual basis for its opinion that one or more of the statutory grounds existed for the appointment of a conservator or receiver. Thus, the ultimate question is whether one or more of the statutory grounds existed at the time of the appointment of the conservator or receiver. After careful consideration, the Court concludes that the exercise of discretion by the Bank Board to appoint a conservator or receiver for a federally-insured association is a determination reviewable under the arbitrary and capricious standard.

 Haralson v. Federal Home Loan Bank Bd., 721 F. Supp. 1344, slip. op. at 10 (D.D.C. 1989).

 While this Court is convinced that the Bank Board has satisfied the "arbitrary and capricious" standard, the evidence proffered and received during the hearing satisfied each of the other standards that are utilized to review an agency action. In short, this Court finds that the Bank Board was fully justified in taking the actions that it did. *fn7"


 Before examining the specific transactions that were the subject of the evidentiary hearing, some background discussion is necessary. It is quite clear that the thrift industry has had a number of problems over the past two decades. In the 1970s, the limits that were placed on both the borrowing and investing activities of thrifts drove a number of savings and loan associations into financial difficulty. First, because of limits on the amount of interest thrifts could pay to investors, savings and loans became noncompetitive with other financial institutions. This resulted in Congress' removing the interest rate ceiling that limited the rate that thrifts could pay to the savings public. Later when Congress learned that the thrifts continued to face severe financial problems, it enacted certain deregulatory measures to provide additional investment opportunities for thrifts, aside from the traditional one of financing the purchase of single family homes. With the number of thrifts facing financial difficulties, Congress believed that it could stave off bailing out the thrift industry of its financial problems by deregulating it and thereby inducing investors to pour private funds into sick thrifts. Congress chose this tack to avoid having to bail out the industry with taxpayers' money. By thus privatizing the S & L problem, Congress thought it had solved the thrift problem with this quick fix. This scheme was devised when industry losses were of an "X" magnitude. As will later be seen by what happened with Lincoln, the privatization gambit failed miserably and today instead of an "X" factor problem, the magnitude of the S & L debacle is probably 5 to 10X and possibly more. Moreover, when the privatization effort failed, the problem then became one that had to be underwritten by taxpayers funds, because at that point there were no other "off the books" solutions available.

 Charles Keating, Jr., ("Keating"), the chairman and chief executive officer of ACC, was one of those entrepreneurs who was willing to enter the S & L industry once Congress lessened the regulatory restrictions. Keating had been affiliated with the Lindner Family in Cincinnati, Ohio, for many years, holding several senior positions with American Financial Corporation ("AFC"). It was during his tenure with AFC that Keating gained his first exposure to the S & L industry. AFC was a diversified holding company and it owned approximately three to four savings and loans. Keating remained with AFC until 1976 when Carl Lindner decided to take the corporation private. At that time, Keating decided that he no longer wanted to remain in the organization. In 1976, he arranged with Mr. Lindner to acquire a subsidiary of AFC known as American Continental Homes, this company eventually became American Continental Corporation ("ACC"). Keating moved the company to Phoenix, Arizona and continued to focus its operations on single-family home construction and development. When Keating first took over the company, it was in a loss posture. Over the years, Keating was able to turn it around to where it was moderately successful. In the late 1970s and early 1980s, ACC became very active in building large single-family housing developments in Phoenix and Denver. In addition to the actual construction of homes, ACC started a mortgage company in 1978 to assist home buyers with financing. Building on this experience, in 1981, ACC created a system for packaging and selling groups of single family home mortgages -- the investment instrument became known as mortgaged backed securities.

 With the passage of the Depository Institutions Deregulation Act of 1980, Pub. L. No. 96-221, 94 Stat. 142 (1980), and the Garn-St. Germaine Depository Institutions Act of 1982, Pub. L. No. 97-320, 96 Stat. 1469 (1982), *fn8" Keating decided to look for a savings and loan association to add to his real estate empire. After analyzing various thrifts that were for sale, Keating decided to see if Lincoln Savings & Loan could be acquired. Keating was attracted to Lincoln for three primary reasons 1) he was impressed with its fine reputation in the industry; 2) the controlling block of Lincoln's stock was owned by one family; and 3) Lincoln was a California chartered savings and loan. According to Keating's testimony, this accumulation of stock in the hands of one family would make Lincoln easier to acquire if the family was interested in selling. The fact that Lincoln had a California State Charter attracted Keating because the California legislature had embarked on a course aimed at deregulating the state's thrift industry in 1982 with the passage of the Nolan Act, 1982 Cal. Stat. c 300. *fn9" By removing restrictions that had previously been in place, the Nolan Act further broadened the field of direct investments that California savings and loans would be permitted to make.

 Although Lincoln had not been formally offered for sale, it had been losing money and the principal owners agreed to entertain an offer from ACC. After a short negotiating period, ACC agreed to acquire Lincoln for $ 51 million, which represented a premium of some $ 17 million over the institutions net worth of $ 34 million. ACC closed the Lincoln acquisition on February 24, 1984. The financing was provided through the issuance and sale in December of 1983 of approximately $ 55 million in exchangeable preferred stock. This preferred stock issue was underwritten by Drexel, Burnham, Lambert, which had previously underwritten for ACC a high yield debt offering of $ 125 million in August of 1983.

 At the time Lincoln was acquired, it was conducting a traditional savings and loan business. It was largely in the business of lending money to purchasers of single family dwelling units in Southern California. While its business was conservative, it was not thriving financially. At the time of the acquisition, Lincoln had assets of approximately $ 1 billion and a net worth of $ 34 million. When ACC took over, it was required to and did obtain approval of both the California and Federal thrift regulators. In the change of control application that ACC filed with the federal regulators prior to its acquisition of Lincoln, it stated that "While it is anticipated that the current officers of the Holding Company and the Institution [Lincoln] will remain upon consummation of the proposed transaction, the Applicant [ACC] intends to augment this management team." Change of Control Application, at 49 (Oct. 13, 1983), Def. Ex. 50. ACC also reaffirmed its commitment to maintain Lincoln's current level of community lending:

In accordance with the provisions of the Community Reinvestment Act of 1977 ("CRA"), no changes are expected in the performance by the Institution [Lincoln] after the proposed acquisition in helping to meet the credit needs of its entire service area or the communities affected by the service area, including low- and moderate-income neighborhoods. It is not expected that there will be any effect of the proposed acquisitions [sic] which will either increase or decrease the availability of credit and savings services in the communities served by the Institution. The Applicant [ACC] does not anticipate at this time an amendment to the CRA statement currently used by the institution which is incorporated by reference herein and enclosed herewith as Exhibit 20.

 Id. at 59.

 After the acquisition, the mix of Lincoln's business also changed. Lincoln cut back drastically on its single-family mortgages and it began to make all kinds of non-real estate investments. It made direct investments in equity securities and also included "high yield-high risk" bonds in its investment portfolio. It took equity participations in emerging new businesses and made a number of high risk loans to individuals engaged in speculative endeavors. While ACC employed many lawyers, accountants, and other professionals to watch over and handle Lincoln's investments, an inordinate amount of business was originated by Keating himself. This was so even though Keating held no official position with Lincoln. Numerous multi-million dollar deals were negotiated by Keating personally with ACC's staff of professionals left to work out the precise details.

 Although when ACC took over Lincoln its expectations were that it would be able to operate in a business environment that would not unduly limit the kinds of investments it could make, this deregulatory environment soon changed. In May 1984, approximately three months after ACC acquired Lincoln, the Bank Board proposed new rules aimed at restricting direct investments by savings and loan institutions. See 49 Fed.Reg. 20719 (May 16, 1984). After notice and comment, a final rule was adopted on January 31, 1985. 50 Fed.Reg. 6928 (Feb. 19, 1985) (hereinafter "Direct Investment Regulation").

 The Direct Investment Regulation, among other things, limited the extent to which a federally insured savings and loan could invest in "direct investments," as defined by the regulation. The regulation imposed a ceiling -- equal to the greater of 10% of the institution's assets or twice the institutions "regulatory net worth" -- on the amount of such investments. The Board adopted this rule because it was convinced that the deregulatory environment that was in existence prior to that time had placed at risk the insured deposits of savings and loan institutions. Edwin Gray, the Bank Board's new Chairman, sided with the old guard conservatives of the S & L industry who believed the new deregulatory environment would be disastrous to the thrift industry and could place in jeopardy the insurance fund that backed individual savings accounts up to $ 100,000 per account.

 Although ACC officials have made much about these regulations and have claimed they adversely impacted Lincoln's financial health, the record does not support their position. What eventually happened to Lincoln had very ...

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