Circle of Greed

by Patrick Dillon

  The Republican benefiting most from Keating’s largesse was John McCain, the junior senator from Arizona. Earlier, when he served in the House of Representatives, McCain had used Keating’s vacation home on Cat Cay in the Bahamas, making nine trips on American Continental’s private jet, sometimes with his wife, daughter, and babysitter. One photo obtained by The Arizona Republic, a Phoenix newspaper, showed McCain on vacation in the islands. He was seated on a bandstand wearing a straw party hat. Next to him, swigging from a bottle, sat Keating’s son, Charles Keating III.

  As McCain and the four Democrats would learn to their eternal embarrassment, these contributions and financial arrangements came with strings attached. As far as Keating was concerned, the quid pro quo was specific: Keating wanted Ed Gray and his people off Lincoln Savings’s back. In fact, he wanted Gray removed from his job. On March 24, 1987, Keating flew to Washington and met the next morning with DeConcini, who had once floated Keating’s name as a possible ambassador to the Bahamas. Keating wanted DeConcini and McCain to accompany him to San Francisco to persuade the head of the regional FHLBB to call off the dogs. DeConcini indicated his willingness but told Keating that McCain was reluctant to do such a thing.

  “McCain’s a wimp,” Keating replied. “We’ll go talk to him.”

  The meeting with McCain was set for 1:30 P.M. By that time McCain had been apprised by a DeConcini staffer of the “wimp” comment—and didn’t appreciate it. Keating handed McCain a list of demands that he wanted the legislator to make to the regulators. McCain flatly refused to fly to San Francisco and said blandly that he’d look into whether Lincoln was getting a fair shake. An agitated Keating questioned McCain’s courage and loyalty. McCain responded heatedly that he hadn’t spent five and a half years in the Hanoi Hilton to be called a coward. Keating stormed out, but he had more cards to play, he wanted McCain to know. Almost immediately word spread around Washington that Ed Gray was planning to resign.

  On April 2, 1987, Gray received a call from Dennis DeConcini asking him to come, alone, to DeConcini’s Senate office. Immediately Gray knew he’d walked into an ambush. Waiting were Senators McCain, Glenn, and Cranston. Gray shook hands stiffly and was directed to his chair. The agenda was clear: why was Gray putting so much pressure on Lincoln Savings?

  Gray told the senators that if they were concerned about a single thrift, they should direct their inquiry to the district office. He gave them the name of James Cirona, president of the eleventh-district FHLBB in San Francisco. A week later, on April 9, Cirona, accompanied by his second in command, Michael Patriarca, and Richard Sanchez, the examiner in charge of the Lincoln Savings investigation, flew to Washington. They were joined by William Black, a government lawyer, who was about to be transferred to San Francisco, where he would become general counsel to the district FHLBB. There were no surprises this time. Gray had briefed Cirona, who was well prepared for the confrontation with the Keating-friendly senators and resolved to have the last word.

  DeConcini, the host, led off. “We wanted to meet with you because we have determined that potential actions of yours could injure a constituent,” he told the FHLBB contingent. The constituent, of course, was Keating. McCain weighed in, trying to leaven the attack. “I don’t want any part of our conversation to be improper,” he said, adding words that may well have salvaged his political career: “I wouldn’t want any special favors for them.”

  Leaning toward Cirona, Glenn, who was still struggling to pay off a $3 million debt from his ill-fated run for the 1984 Democratic presidential nomination, said: “To be blunt, you should charge them or get off their backs.”

  Sanchez began the government’s presentation. He cited a 1984 examination of Lincoln showing loan deficiencies that Keating promised to fix and did not. Lincoln had underwriting problems with all its investments, equity securities, debt securities, land loans, and direct real estate investments. For all fifty-two of the real estate loans that Lincoln had made between 1984 and 1986, the files contained no credit reports. Examiners found $47 million in loans to clients who had inadequate credit.

  “This is a ticking time bomb,” Cirona interjected.

  Patriarca sensed it was time to quit circling. “I’ve never seen any bank or S&L that’s anything like this,” he said. “They violate the law and regulations and common sense.” He paused, letting this observation sink in with the senators then detonated the bomb. “We’re sending criminal referral to the Department of Justice. This is an extraordinarily serious matter. It involves a whole range of imprudent actions. I can’t tell you strongly enough how serious this is.”

  DeConcini would not fold, pointing out that Lincoln’s accountants had also complained at the rigor and length of the regulators’ examinations. “Why would Arthur Young say these things?” DeConcini asked. “They have to guard their credibility, too. They put the firm’s neck out with this letter.”

  At that point Patriarca decided to school the senators on what was becoming an epidemic, a phenomenon that Mel Weiss and Bill Lerach had invented nearly a decade before—the presumption of scheme liability.

  “They have a client,” Patriarca said, implying that the mathematics of pure accounting was only one part of the relationship between a company and the firm it paid to consult on constructing its books—and then sign off on them.

  “You believe they’d prostitute themselves for a client?” DeConcini asked.

  “Absolutely,” replied Patriarca. “It happens all the time.”

  Ed Gray formally left his job in May. As he was packing up, ready to leave his office, Gray was asked what it might take to clean up the S&L mess. He hesitated. The number $40 billion was suggested. He shrugged, saying, “Nowhere near enough.” He was right.

  LESS THAN A YEAR earlier, on May 18, 1986, about a thousand students, along with their parents and friends, gathered for a ceremony conferring master’s degrees at the Haas School of Business at the University of California, Berkeley, to hear the guest speaker whom the students had voted to address them. Ivan Boesky, then forty-eight, tanned, and exuding flinty self-confidence, strode to the podium.

  The son of a Russian-Jewish family from Detroit whose father had owned a trio of topless bars, Boesky had become the prince of Wall Street, amassing a fortune by betting on stock price fluctuations in corporate takeovers that he had predicted. His purchases were audacious and massive, sometimes occurring just days before a corporation announced it had been acquired or was acquiring. The day he appeared at Berkeley, his portfolio was reported to be worth nearly $2 billion, and he was speaking to an audience eager for his insights. “We are riding a wave of takeovers,” he told his audience. This was truly a time of survival of the fittest, he suggested, warming to the sound of his own convictions. That year alone Wall Street could expect more than three thousand mergers and buyouts, many of them hostile, with a total worth approaching $130 billion. Huge profits were being made. Acumen, even avarice, was the coin of the realm.

  “Greed is all right by the way,” he said, pausing for effect. “I want you to know that. I think greed is healthy. You can be greedy and still feel good about yourself.”

  The audience erupted in laughter, applause, and cheers.

  Six months later, on November 14, 1986, the SEC made an announcement that shook the financial world. Ivan Boesky had been caught in an insider-trading investigation that had cracked open a classic circle of greed.

  “Ivan the Terrible,” as Boesky was dubbed for his take-no-prisoners style, cut a deal, agreeing to pay $100 million in fines, return profits, and accept life banishment from stock trading. Facing up to five years in prison, he also let regulators eavesdrop on his telephone conversations. The resulting subpoenas would ensnare other princes of Wall Street, among them junk bond magnate Michael Milken. At his zenith, in 1986, Milken awarded himself $550 million in bonuses, more than the yearly profit for Drexel Burnham Lambert, the 10,000-person company that employed him. Milken’s operation was handling 250,000 transactions a mon
th and controlling as much as $10 billion in funds through junk bonds issued by nearly one thousand companies. Through this market rose a new breed of risk takers—corporate raiders Henry Kravis, Carl Icahn, Ron Perelman, Saul Steinberg, and T. Boone Pickens; Rupert Murdoch, the global media baron; William McGowan, who made MCI one of the nation’s premier phone systems; Ted Turner, who created twenty-four-hour cable news; Frank Lorenzo, the airline takeover king—and, of course, Charlie Keating.

  Bill Lerach would sue them all, starting with Keating.

  BILL LERACH AND HIS partners Len Simon and John Stoia could hardly believe it. The more they delved into the facts of their case against Charles Keating and American Continental Corporation, the longer the list of defendants grew. It started with Milken and Boesky and just kept going; it was astonishing how many individuals and institutions aided in Keating’s scheme. All told, they would end up suing more than fifty individuals, ten banks, four accounting firms, half a dozen law firms, and just as many companies. Nearly one hundred named defendants would appear on the class action certification document when it was filed in December 1989, making the lawsuit against Keating et al the most sweeping deployment of the concept of scheme liability ever filed.

  Lerach and his firm were not only going after Keating and Lincoln Savings; they were pursuing his relatives; they were pursuing Arthur Young, Ernst & Young, Arthur Andersen, and Touche Ross and Deloitte, the accounting firms; they were pursuing Bankers Trust, Credit Suisse First Boston, Saudi Investment Bank Corp., Saudi European Bank, Lambert Brussels Associated Limited Partnership, and many others. “We just drained the sink,” Lerach would say.

  Drained the swamp was more like it. The Social Darwinism that William Jennings Bryan had feared was now a fact of American life. Ronald Reagan’s critics would label the 1980s the “decade of greed,” but the problem was more fundamental. Four decades after Frank Capra had inspired a weary nation with It’s a Wonderful Life, America’s finest universities were turning out pampered, materialistic graduates who cheered wildly for the Mr. Potters in their midst instead of the George Baileys. With the help of the nation’s politicians, American capitalism was producing a lot of Mr. Potters. Jimmy Stewart had also starred in a prewar classic called Mr. Smith Goes to Washington in which an accidental senator single-handedly stands up to political graft. In real life the ethics of mid-1980s Washington was summed up by the crass question that Dennis DeConcini posed to the Senate Ethics Committee: “What is wrong with intervention for someone who sends you a check for your campaign?” he asked. “That’s what has made me the senator I am.”

  The system’s failure seemed complete. Free market capitalism couldn’t handle being unshackled from government regulation; and despite the efforts of the federal bureaucracy, the Republican executive branch wasn’t terribly interested in performing the government’s necessary oversight role. Meanwhile members of the Democratic-controlled Congress worried more about the campaign contributions that kept them in power than about defending the interests of everyday Americans. That war heroes and national icons of both parties—John Glenn and John McCain—succumbed to this temptation demonstrated the system’s corrupting power. McCain compared assisting Charles Keating to helping “the little lady who didn’t get her Social Security.” Actually, the little old ladies involved in this case bought bogus securities from a schemer, who then turned to powerful political figures to whom he had given money for protection.

  The third branch of government had yet to be heard from, however, and in that forum Keating would answer for his crimes. The little old ladies would not only get their day in court, courtesy of Lerach, they would also get their day in the Senate offices of the Keating Five on Capitol Hill. This additional branch was the court system, among whose practitioners were crusading prosecutors and hard-eyed plaintiffs’ lawyers offended by the chicanery, collusion, and obscene excess all around them. At the vanguard, waving their banner and charging into legal battle, were Mel Weiss, Bill Lerach, and an army of like-minded trial lawyers.

  A reckoning was coming.

  * This 1982 law is often referred to as the Garn–St. Germain Act, after its chief sponsors, Senator Jake Garn, a Utah Republican, and Fernand St. Germain, a Rhode Island Democrat, who served for many years as chairman of the House Banking Committee.

  * Several authoritative books were written detailing the S&L scandal of the 1980s, the most thorough probably being Inside Job: The Looting of America’s Savings and Loans by Stephen Pizzo, Mary Fricker, and Paul Muolo (New York: HarperCollins, 1991). Given what happened to the U.S. economy in 2008 and 2009, however, the single most distressing line about the S&L crisis may have come from Martin Mayer, author of The Greatest-Ever Bank Robbery: The Collapse of the Savings and Loan Industry (New York: Collier, 1992). “Deposit insurance,” Mayer wrote, “proved to be the crack cocaine of American finance.”

  8

  INTO THE BREACH

  Following Ed Gray’s departure from the Federal Home Loan Bank Board, the tide seemed to turn in Charles Keating’s favor. On the heels of the government audit describing Lincoln as careening out of control, a new chairman was installed. M. Danny Wall, a former staff director of the Senate Banking Committee, shelved the audit and ordered jurisdiction of the Lincoln investigation transferred from San Francisco to the Washington, D.C., office.

  Wall did what Keating had wanted the group of senators—ultimately and ignominiously to be known as the Keating Five—to do, which was get the examiners off his back. In Phoenix, at American Continental’s headquarters, a celebration was in full swing. It was quite a party. One reveler hurled a computer from a second-floor balcony. Keating puffed out his chest, struck a Superman pose, and ripped open his shirt to exhibit a faux tattoo displaying a skull and crossbones over the letters FHLBB. A secretary stepped onto a desk to take photos. Robert Kielty, the company’s senior vice president and general counsel, joined her. Keating grabbed a roll of adhesive tape and wrapped it around the two, lashing their legs together. Potted plants and displays were sent crashing. Kielty popped a champagne bottle and emptied the contents down another secretary’s blouse. “Get this champagne colder!” Keating shouted.

  The reprieve gave Lincoln Savings and Loan a green light to expand its tentacles, and within the next two years its reported assets grew on paper by nearly 40 percent, to $5.46 billion. The growth was driven by risky bets in raw landholdings, unsecured construction loans, and major increases in holdings of Michael Milken’s junk bonds. By then, the media were on to American Continental. The New York Times noted, “Lincoln, with assets of $4.9 billion and 25 branches in Southern California, has been a concern to regulators of the thrift industry because of its untraditional investment activities.” All the while, its dicey debentures were being hawked to customers such as Ramona Jacobs, the conservator for her paralyzed daughter. Jacobs was destined for disappointment—and to be one of Bill Lerach’s most effective clients. The same was true for Rae Luft, a Russian immigrant in failing health, and Leah Kane, another elderly woman who purchased $15,000 of American Continental stock. Thousands more unsuspecting people did the same—solicited, according to an internal Lincoln memo to its bond sales force, precisely because they were vulnerable and unlearned. “Always remember,” the memo stated, “the weak, meek and ignorant are always good targets.” This memo would be unearthed in the relentless discovery process overseen by Bill Lerach and a platoon of allied plaintiffs’ lawyers.

  Now the chickens were coming home to roost, as Lerach was fond of saying.

  American Continental’s death spiral took only a year to complete. Wall could not sit on the Lincoln audit any longer. Under pressure, he sent a memorandum to the Justice Department recommending a criminal investigation, just as the agency’s senior examiners had done under Ed Gray two years earlier. On April 13, 1989, American Continental filed for protection under Chapter 11 of the Federal Bankruptcy Code. Immediately, it stopped making payments of interest and principal to its 23,000 investors, includ
ing Leah Kane, who’d put her life savings in it only three months before. In a statement Keating admitted that the company had foreseen no way its investors would ever see their money—estimated at more than $285 million. The following day the FHLBB seized Lincoln Savings and Loan. Leah Kane wondered if she needed a lawyer. She didn’t know it, but Bill Lerach was already representing her.

  HIGH ATOP SAN DIEGO, the expanding offices of Milberg, Weiss, Specthrie, Bershad & Lerach palpitated in a furious frenzy, emulating the atmosphere at so many Silicon Valley start-ups that Lerach and his colleagues would earn their fortunes suing. Printers whirred in continuous motion, telephones and teleconference speakers chorused voices, while lawyers and their assistants hurried through the hallways carrying documents from one office to another. The firm was now filing an average of twelve lawsuits a month. Even with the increased workload, an influx of new attorneys, and impending prospects for more revenue and even greater rewards, Lerach was customarily the first in every morning, often arriving before seven thirty A.M. His loyal assistant Kathy Lichnovsky would follow, bearing an egg, bacon, and cheese breakfast croissant she’d picked up at a downtown Jack in the Box. Lunch arrived at his desk between 11:30 and 11:45 A.M., and usually the fare was the same—ham and Swiss on rye ordered from the Westgate Hotel across the street, with Best Foods mayonnaise that he’d slather on himself from a large jar stocked in a refrigerator nearby. When he’d vary, the choice would be Braunschweiger on rye, always accompanied with this favorite brand of mayo. Unless they wanted to see the boss’s Captain Queeg imitation, his staff knew not to substitute another brand—or let the mayonnaise jar get empty. The sandwich was to be served with a can of Lipton tea, and a red Dixie cup filled with ice. Lerach was a man of habits. They weren’t all good habits: the Dixie cup would also accompany him on the drive home, this time filled with a small amount of ice and a large amount of Scotch—Johnnie Walker Blue Label. The whiskey became an inside joke at the firm. Eventually, fearful that their private joke would backfire on them publicly, Lerach’s partners created a new position, “director of transportation,” hiring veteran limousine driver Frank Cucinotta to ensure that their meal ticket arrived at his destinations promptly and safely. If Lerach did go out for lunch, he normally walked two blocks to a steakhouse named Rainwater’s, where he ordered the three-cheese meatloaf with mashed potatoes. He was back at his desk in forty minutes. The primacy of work never varied.