Grant Thornton, Llp v. F.D.I.C.

CourtUnited States District Courts. 4th Circuit. Southern District of West Virginia
Citation535 F.Supp.2d 676
Docket NumberCivil Action No. 1:00-0655.,Civil Action No. 1:03-2129.,Civil Action No. 1:04-0043.
PartiesGrant THORNTON, LLP, Plaintiff, v. FEDERAL DEPOSIT INSURANCE CORPORATION, Defendant; and Federal Deposit Insurance Corporation, Plaintiff, v. Grant Thornton, LLP, Defendant; and Gary Ellis, Plaintiff, v. Grant Thornton, LLP, Defendant.
Decision Date14 March 2007
535 F.Supp.2d 676
Grant THORNTON, LLP, Plaintiff,
v.
FEDERAL DEPOSIT INSURANCE CORPORATION, Defendant; and
Federal Deposit Insurance Corporation, Plaintiff,
v.
Grant Thornton, LLP, Defendant; and
Gary Ellis, Plaintiff,
v.
Grant Thornton, LLP, Defendant.
Civil Action No. 1:00-0655.
Civil Action No. 1:03-2129.
Civil Action No. 1:04-0043.
United States District Court, S.D. West Virginia.
March 14, 2007.

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Andrew J. Morris, Mark W. Ryan, Mayer Brown, Washington, DC, Catherine L. Doyle, Stanley J. Parzen, Mayer Brown, Chicago, IL, John H. Tinney, John H. Tinney, Jr., Kimberley R. Fields, The Tinney Law Firm, Charleston; WV, for Plaintiff.

Brad A. Harman, Clint R. Latham, David Mullin, John M. Brown, John G. Turner, III, Mullin Hoard & Brown, Amarillo, TX, Charles T. Miller, Stephen M. Horn, U.S. Attorney's Office, Charleston, WV, John A. Davidovich, John Wessling, Mary P. Davis, Federal Deposit Insurance Corporation, Washington, DC, for Defendant.

FINDINGS OF FACT AND CONCLUSIONS OF LAW

DAVID A. FABER, Chief Judge.


INTRODUCTION

A bench trial was held on May 17, 2004, through June 10, 2004. Closing arguments were held on August 20, 2004. Set forth herein are the court's findings of fact and conclusions of law pursuant to Fed. R.Civ.P. 52.

Because this case was tried before the court as a bench trial, the court's findings are presumed to be based on admissible evidence. Fishing Fleet, Inc. v. Trident Ins. Co., Ltd., 598 F.2d 925, 929 (5th Cir. 1979); see also Chicago Title Ins. Co. v. IMG Exeter Associates Ltd. P'ship, 985 F.2d 553, 1993 WL 27392 at *4 (4th Cir. 1993) (unpublished); see also Harris v. Rivera, 454 U.S. 339, 346, 102 S.Ct. 460, 70 L.Ed.2d 530 (1981) ("In bench trials, judges routinely hear inadmissible evidence that they, are presumed to ignore when making decisions."). Accordingly, the court finds it unnecessary to rule on each separate objection raised by the parties. The court has considered those objections relating to the evidence supporting the findings contained herein and, to the extent such objections relate to the evidence which the court cites in support of its findings, such objections are hereby overruled.

FINDINGS OF FACT
I. Background

1. The First National Bank of Keystone ("Keystone" or the "Bank") located in Keystone, McDowell County, West Virginia, was incorporated in 1904 under the National Banking Act GT Ex. 22. Prior to 1992, Keystone was a small community bank servicing primarily McDowell County and the surrounding area. Keystone was a national banking association within the Federal Reserve System, the deposits of which were insured by the Federal Deposit Insurance Corporation ("FDIC"). Keystone's principal place of business was in West Virginia. Prior to his death in 1997, J. Knox McConnell, the Bank's president and its largest shareholder, controlled Keystone. FDIC Ex. 431 at 2-3.

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2. From at least 1992 through October 1997, Keystone's board of directors consisted of two inside directors, J. Knox McConnell and Billie Cherry, and outside directors Michael Gibson, a local attorney; Andres Rago, a local doctor; Julian Budnick, a retired furniture salesman; and Louis Pais, a retired beer distributor. When McConnell died in October 1997, Terry Church replaced him on the board. At the same time, Billie Cherry became president of the Bank, and Melissa Quizenbeury, a long-time employee, became a director. Gibson, May 20, 2004, Tr. at 7, 10; FDIC Exs. 90, 124, 248 at 2; GT Exs. 208, 625. After McConnell's death, Church controlled every material aspect of the Bank's operations. Carney, May 19, 2004, Tr. at 69-71; Quay, June 4, 2004, Tr. at 13-14; FDIC Ex. 417 at 3. Church was also the executrix of McConnell's estate, giving her control of the largest single block of Keystone stock. FDIC Ex. 248 at 2.

3. In December 1998, Julian Budnick resigned from the board and was replaced by his son Victor Budnick, an attorney. Budnick, May 18, 2004, Tr. at 86-88; Gibson, May 20, 2004, Tr. at 10. In March 1999, two new directors were elected: Bernard Kaufman, a retired attorney and investor, and Daniel Halsey, a local car dealer. Most of the outside directors owned sizable blocks of Keystone stock, and outside director Gibson actually bought more stock during the last few months of the Bank's existence. Gibson, May 20, 2004, Tr. at 58; FDIC Ex. 248 at 2, FDIC Exs. 263, 880.

4. This civil action arises from the fraudulent operation and eventual collapse of Keystone. The fraud was conceived and perpetrated by senior bank management and continued for years until detected. In addition to McConnell, who died in October, 1997, before the Bank was closed, the principal perpetrators of the fraud, all Keystone insiders, were Terry Church, Michael Graham and Billie Cherry. FDIC Exs. 431, 432. Church, Graham and Cherry have all been convicted of numerous felonies, their convictions have been affirmed on appeal, and all three were sentenced to lengthy terms of incarceration.1 FDIC Exs. 430, 433, 434, 435, 558, 560, and 579. For several years the wrongdoers successfully concealed the fraud from the public, from the Bank's examiners, from the Bank's board of directors, and even from some of Keystone's own senior management.

5. Central to the fraud was an investment strategy that involved securitization of high risk mortgage loans. Beginning in 1992, Keystone originated nineteen securitizations over a six-year period. GT Ex. 514. Keystone would acquire Federal Housing Authority ("FHA") or high loan to value real estate mortgage loans from around the United States, pool a group of these loans, and sell interests in the pool through underwriters to sophisticated investors. GT Ex. 22. The pooled loans were serviced by third-party loan servicers; principal among these servicers were Advanta and Compu-Link. GT Ex. 22. Keystone retained residual interests ("residuals") in each loan securitization. GT Ex. 22. The residuals were subordinated securities that would receive payments only after all expenses were paid and all investors in each securitization pool were paid. GT. Ex. 22. In short, Keystone stood to profit from a securitization only after everyone else was paid. The residuals were assigned a value that was carried on the books of the Bank as an asset. Over time, the residual evaluations came to represent a significant portion of the Bank's book value. GT Ex. 22.

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6. From 1993 until 1998 when the last loan securitization was completed, .the size and frequency of these transactions expanded from about $33 million to approximately $565 million, for the last one hi September 1998. FDIC Ex. 431 at 3. All told, Keystone acquired and securitized over 120,000 loans with a total value in excess of $2.6 billion, FDIC Ex. 431 at 3. Keystone appeared to be an exceptionally profitable bank, whose assets purportedly grew from $107 million in 1992 to over $1.1 billion in 1999. FDIC Ex. 431 at 3; GT Ex. 22.

7. In reality, the securitization program proved highly unprofitable. Owing to the risky nature of many of the underlying mortgage loans, the failure rate was excessive. As a result, the residual interests retained by the Bank, proved highly speculative and, in actuality, they did not perform very well. Malami, May 26, 2004, Tr. at 77-134; Potter, May 26, 2004, Tr. at 159-60; Potter, May 27, 2004, Tr. at 34-36. Keystone's valuation of the residuals was greater than their market value. Quay, June 4, 2004, Tr. at 29; FDIC Ex. 286. McConnell, Church, and others concealed the, failure of the securitizations by falsifying the Bank's books. FDIC Ex. 431. Bogus entries hid the true financial condition of the Bank from the Bank's directors, shareholders, depositors and regulators. FDIC Ex. 431. Among the bogus documents were false remittance reports, prepared by Graham and given to examiners from the Office of the Comptroller of the Currency ("OCC"). At the same time, the wrongdoers embezzled large sums from the Bank, covering their theft with other false entries in the Bank's books. FDIC Ex. 431.

8. The embezzlement of funds and the falsification of Keystone's financial records were both integral parts of the fraudulent scheme. The scheme participants booked false credits to interest income to make it appear that Keystone was highly profitable and booked false debits to loans to fraudulently inflate assets and capital — which made this a very common ("a garden variety") form of fraud. These fraudulent entries, and their reflection in the Bank's financial statements, enabled Keystone's corrupt management to continue to embezzle funds and conceal their earlier embezzlements. Carmichael, May 24, 2004, Tr. at 36-41; Carmichael, May 25, 2004, Tr. at 30-31; Goldman, June 9, 2004, Tr. at 83-84.

9. One of the boldest acts of fraud designed to conceal the Bank's true financial condition occurred when approximately $515 million in loans were sold by Keystone, but continued to be carried on the Bank's books as assets. FDIC Ex. 431; GT Ex. 22. Discovery of these fraudulent entries would have revealed at once the fraud and the. Bank's insolvency, resulting in the Bank's immediate seizure and closure by federal regulators. Johnson, May 17, 2004, Tr. at 148; C. Wilson, May 17, 2004, Tr. at 240.

II. Hiring of Grant Thornton

10. Keystone had a long history of conflict with federal bank examiners and regulators. GT Ex. 22. In May, 1998, the OCC sought civil money penalties against Keystone's management and board for repeatedly filing inaccurate call reports. Casey, June 1, 2004, Tr. at 105; Gibson, May 20, 2004, Tr. at 12; FDIC Ex. 64 at 5; FDIC Ex. 182 at 31; FDIC Ex. 183 at 48. Call reports are detailed statements of a bank's financial condition that must be filed with the FDIC at the end of each quarter. Carney, May 19, 2004, Tr. at 103; FDIC Exs. 106, 171, 270, 323.

11. In examinations from 1995 to 1998, the OCC...

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