'Looted, Pillaged' : Inside Jobs: New War on Bank Fraud

Times Staff Writers

As Judge Ann C. Williams prepared to sentence Daniel Walker in federal court here late one afternoon last fall, it was clear that she had little sympathy for the San Diego-bred son of a sailor who rose to become governor of Illinois in 1973.

The Walker in court that Nov. 19 was a puffy-faced and broken figure who had pleaded guilty to loan fraud and perjury in connection with his ownership and operation of First American Savings & Loan in suburban Oak Brook.

"It's clear to this court . . . ," the judge told the 65-year-old former governor, "that you, Mr. Walker, thought this bank was your own personal piggy bank to bail you out whenever there was a problem to be solved or you needed money to keep your businesses afloat."

Then, Williams stung the erstwhile politician, who ran for governor as a liberal reformer in the Democratic Party, with a seven-year jail term and ordered him to pay $231,609 in restitution to First American Savings.

Walker personifies a new breed of lenders who are feeling the pain of stepped-up U.S. government efforts--belated efforts, some say--to prosecute an unprecedented wave of insider fraud that has burrowed its way like a tapeworm into the nation's banking system.

From Los Angeles and Chicago to Cheyenne and Dallas, criminal activity in bank executive suites has begun to get center-stage treatment. It now rates equal billing with defense industry and health-care rip-offs as a top priority in the fraud section of the U.S. Justice Department.

"We've had an unprecedented proliferation of these kinds of cases," said Terree A. Bowers, head of the fraud section for the U.S. attorney's office in Los Angeles.

Law enforcement officials regard these new-style bankers as robbers who ruin the financial institutions they operate through reckless lending and insider dealing. This kind of behavior has "looted and pillaged" the savings and loan industry, according to Edwin J. Gray, a former chief federal regulator of the industry.

These are "crimes of greed," said Anton R. Valukas, the U.S. attorney here. "Some person is sitting there making a calculation of the likelihood of getting caught and of going to jail."

Unlike simple embezzlements where employees walk off with a bank's funds, the modern-day rip-offs are often sophisticated, hard-to-trace transactions committed by high-level insiders and their outside business associates, prosecutors and bank regulators say.

The wrongdoings run the gamut from falsification of financial reports to reimbursement of exorbitant business expenses to a particularly damaging lending practice known as the "land flip." These practices have allowed some lenders to live in regal style on fabulous pay packages even as their financial institutions are going down the drain.

Prosecutors say the wave of bank fraud reflects the same general decline of honesty among business executives that contributed to the insider-trading scandals on Wall Street. "It's a deficit of ethics," said Richard A. Stacy, chief federal prosecutor in Wyoming.

The trouble first surfaced in 1984 and 1985 after deregulation of the banking system in the early 1980s expanded the way in which savings and loan firms could invest their money. The legislation took many thrifts from the safe world of single-family mortgage lending into the treacherous realm of real estate development.

Only in recent months, though, have prosecutors scored noteworthy victories in the thrift industry that they hope will deter future criminal behavior.

In addition to the Walker conviction, scores of indictments and convictions have been obtained against people with ties to Empire Savings in Texas and Centennial Savings in Northern California. The two S&Ls; were among the more egregiously run financial institutions in the nation until regulators seized them.

Fraud Role in Failures

The House Government Operations Committee's subcommittee on commerce, consumer and monetary affairs said fraud and misconduct played a role in half the 210 S&L; failures of the last 3 1/2 years.

What's more, a staff study said, fraudulent misconduct has cost all federal deposit insurance funds at least $4.5 billion since 1984. The actual number is "probably much more," the study added.

The Federal Deposit Insurance Corp., which insures savings at commercial banks, estimates that the failures of nearly 100 banks between 1985 and the middle of 1987 showed evidence of fraud or insider abuse. The FDIC estimated the losses from these failures at $676 million.

Even the insurance fund for credit unions is not immune. The National Credit Union Administration estimates that insider abuse caused nearly $44 million in losses at failed or problem credit unions in recent years.

So pervasive has the problem become that it has overloaded the criminal justice system with cases that are both numerous and complex. "It was a crisis for which we were unprepared," prosecutor Valukas said in an interview.

The Los Angeles office of the FBI paces the nation in bank fraud investigations, with 289 major cases pending. The Dallas FBI office is second with 219, followed by Houston with 150 and New York City with 125. San Francisco followed with 121 pending cases, while Chicago had 120.

Fund Declared Insolvent

So many savings and loans have failed that the deposit insurance fund for these financial institutions, the Federal Savings and Loan Insurance Corp., was declared insolvent in 1987 by government auditors.

"It is my opinion that insider abuse, not economic problems, is the major factor" behind FSLIC's insolvency, federal savings and loan regulator Jerry L. Gosse wrote in a memo last summer that was quoted in a Nov. 17 internal report by the subcommittee staff.

New life was breathed into the fund when Congress passed a bill designed to add $10.8 billion in industry funds to FSLIC during the next three years. But some now see a taxpayer bailout of FSLIC as a possibility once the $10.8 billion runs out.

Fraudulent lending has also played a role in the development of gluts of office buildings and condominiums in parts of Texas, hammering real estate values. "You can't give away a condominium in Dallas," said Terence J. Hart, lead prosecutor in a pending criminal fraud case against Empire Savings.

The S&L; was a major lender for hundreds of unsold condominiums that litter the roadside along Interstate 30 about 15 miles from downtown Dallas. Most are being rented, but some remain unfinished and some are being torn down.

The severity of the criminal problem in Texas was underscored in recent months when the Justice Department dispatched 10 staff attorneys from Washington to assist in investigations there. But some believe, as former S&L; regulator Gray does, that the move "has been too little, too late. It's too bad the situation has to become so egregious to get people's attention in the government."

To cloud matters, the House subcommittee has unearthed numerous cases in which the justice system has not functioned properly because of frictions and antagonisms between various enforcement agencies.

Lack of Resources

Prosecutors say that bank regulators sometimes do not bring criminal behavior to their attention, while regulators say the FBI does not react quickly enough or reacts only when it has a slam-dunk case. All complain that the lack of resources is a major problem but add that communications have improved considerably in recent months.

The shortcomings--and subsequent improvements--have been spotlighted in two public hearings held in recent months by Rep. Doug Barnard Jr. (D-Ga.), a one-time banker who is now chairman of the commerce, consumer and monetary affairs subcommittee.

Subcommittee papers detail how several investigations have been derailed or pushed back by delays and snafus, including probes in Southern California at Beverly Hills Savings, Hancock Savings, Ramona Savings and Newport Harbour National Bank.

The documents show that 23 financial institutions in Los Angeles and Orange counties are now under active criminal investigation. Convictions have been obtained in four of these cases, the documents show.

Prosecutors complain that, unlike straightforward embezzlements or robberies, banking fraud cases often take several years to investigate and prosecute.

One concern now is that the five-year statute of limitations may run out on these bank-fraud crimes before the investigations are completed. "That's why we're trying to move those cases as quickly as possible," prosecutor Bowers said in Los Angeles.

A criminal investigation into the failure of Newport Harbour Bank was aborted partly because the statute of limitations had run out. The financial institution, which catered largely to a wealthy clientele in Newport Beach, failed in 1983 because of heavy real estate loan losses.

"The FBI informs me that it closed the case due to insufficient resources and . . . the late receipt of criminal referrals," Los Angeles U.S. Atty. Robert C. Bonner stated in a recent letter to Barnard.

Then, there was the case of Los Angeles-based Hancock Savings & Loan, whose management waited several years before reporting a case of insider fraud to criminal authorities allegedly because the financial institution wanted to recover civil monetary damages, the subcommittee said. In the meantime, the statute of limitations ran out on some of the crimes.

'Prosecution Prevented'

"As a result," a subcommittee memo said, "prosecution was prevented on several transactions, but was successful on others."

Hancock Savings Chairman Daniel E. Wolfus told The Times that the crimes--which involved kickbacks of about $60,000 on loans of more than $1 million--were reported to regulators as soon as they were uncovered, though he confirmed that no one notified the FBI for two years. In any case, the loan officer who received the payments was ultimately convicted of most of the illegal transactions and was sentenced to a short prison term, Wolfus said.

Records at the House subcommittee also illustrate the confusion that arises when criminal prosecutors and bank regulators don't talk to each other.

Take the case of Ramona Savings & Loan, whose former owner, John Lee Molinaro, pleaded guilty in November to four criminal fraud charges. He admitted in court that he approved $10 million in loans to business associates who passed on the money to another friend who wanted the money to buy the S&L;, based in Orange, Calif.

In mid-1986, the California Department of Savings and Loan filed a lawsuit against a Tustin-based accountant named Mike Sage for filing "inaccurate certified and audited financial statements" that caused Ramona to "incur further losses to the detriment of Ramona and its depositors."

A year later, a confidential House subcommittee report elaborated on the story:

Sage's accounting firm--known as Mike Sage & Co.--prepared a financial statement for the thrift stating that Ramona Savings had a net worth of $8.3 million when in fact the financial institution had a negative net worth of nearly $20 million, the committee report said. The Sage company's financial report allowed the S&L; to pay a $2-million dividend to its owner, the subcommittee said.

Sage, in turn, "was secretly paid over $100,000, often in $50 and $100 bills," the subcommittee said, adding that the accountant fled the area even though one regulatory official had recommended that Sage and his company be investigated for "any criminal acts."

Even then, regulators apparently did not notify the FBI. Instead, they "hired a private detective firm to try to locate him," but the search was unsuccessful, the report said.

According to officials at the California Department of Savings and Loan, Sage never answered the charges in the civil suit filed against him. A spokesman for the Los Angeles office of the FBI last week declined to comment on the case other than to say that no warrant has been issued for Sage's arrest.

Beverly Hills Savings is the largest and most visible of the institutions under investigation in Southern California, records show. It failed nearly three years ago but has been kept open ever since under new management in a specially supervised regulatory program.

Its debts now exceed its assets by $841 million, rendering the institution hopelessly insolvent. It would cost FSLIC nearly $1 billion--mainly to absorb bad loans--to close the S&L;, regulatory figures show.

The probe into the failure of Beverly Hills Savings has been hampered by understaffing at federal agencies and a lack of communications between them. Though the case has long been under active investigation, no criminal charges have been filed.

Shelved for Months

Subcommittee records indicate that one part of the probe was shelved for months because an assistant U.S. attorney was tied up on another case.

Although prosecutor Bowers generally declined to discuss specifics, he did volunteer during an interview that "we never did get a criminal referral on Beverly Hills Savings." Bank regulators are supposed to file detailed referral reports with criminal authorities if they find evidence of what they believe is illegal behavior.

Interviews also show that an investigation of San Marino Savings got off to a slow start because regulators apparently lost track of what loan documents were found in which executive's office. This apparently irritated Bonner, the U.S. attorney in Los Angeles.

"Bonner was upset because it was unclear where the documents had come from," said William K. Black, attorney for the Federal Home Loan Bank of San Francisco.

San Marino Savings was one of the first major thrifts in the post-deregulation era to be seized by banking regulators due to questionable lending practices. The thrift was placed into conservatorship in early 1984 and was closed less than a year later.

Prosecutors say they must be able to show a jury that bank executives knew about the fraudulent loan practices because the applicable loan documents were in their offices. "Otherwise," said Bowers, who works for Bonner, "they try to insulate themselves (from any crime) with a lack of knowledge and lack of intent."

Bowers did acknowledge that "we have had at least one case where document control did severely affect the case." The criminal investigation into San Marino's failure is continuing, subcommittee records show.

Land flips are at the heart of an indictment in the case of Empire Savings, which failed nearly four years ago. The seven defendants, all of whom have pleaded not guilty, include Empire's former chief executive as well as several real estate developers and appraisers who had close business ties with the S&L.;

In a land flip, buyers and sellers, acting in concert, pump up the value of a piece of property through a series of bogus sales during a matter of weeks or even days. Each sale is supported by appraisals, which themselves are fraudulent.

The big winners in this style of fraud are the original owners, who are paid vastly inflated sums for their property. The big losers are the lenders, who get stuck with a loan that is secured by real estate worth only a fraction of the appraised value.

According to the Empire indictment, the defendants used the flips to "convey and reconvey the land numerous times within a short period of time, before the land was sold to a purchaser for a price that vastly exceeded the original purchase price."

Empire Savings is also a telling example of the time needed to prosecute a complex case. The criminal investigation began 2 1/2 years ago and the capstone indictment was handed down in October. But the trial probably won't start until this spring or summer and may extend into 1989, according to prosecutor Hart.

"The complexity of these cases makes them very manpower-intense and the issues often lack the clarity of obvious criminal intent," said William C. Hendricks III, chief of the Justice Department's fraud section.

"The so-called 'paper' case is simply not as sensational as a bank robbery, kidnaping or a spy case," U.S. Atty. Henry K. Oncken of Houston said.

New Techniques

As a result, prosecutors are increasingly resorting to new techniques, such as using hidden tape recorders on undercover FBI agents who have gone to work for financial institutions where criminal fraud is suspected.

"If we can react early enough, we can interdict the activity and prevent the fraud entirely," Bowers said.

What happened at First American Savings, former Illinois Gov. Walker's thrift, followed a familiar script that has allegedly been acted out in some form or another at many financial institutions. According to court records and transcripts of the trial, the high-living Walker drove First American Savings into insolvency through risky lending and illegal insider loans while serving as chief executive and principal shareholder.

The case had added public interest because of Walker himself, who had stellar careers in the military, law and politics before his business dealings brought him down.

The son of a U.S. Navy enlisted man, Walker was valedictorian of his 1940 high school class in San Diego, graduated from the Naval Academy in 1945 and was second in his class at Chicago's Northwestern Law School in 1950.

He won an upset victory in the 1972 Democratic gubernatorial primary over Paul Simon--now a U.S. senator from Illinois and presidential aspirant--and then beat popular Republican incumbent Richard B. Ogilvie in the general election. Wearing a red bandanna and hiking boots, Walker walked the state during the primary campaign.

His years in the public eye were a raucous and colorful time during which he quarreled frequently and loudly with the late Chicago Mayor Richard J. Daley. He gained national attention--and Daley's animosity--when a commission he headed accused the Chicago police of staging a riot of their own during the city's tumultuous Democratic convention in 1968.

According to court documents, Walker's thrift sustained heavy losses by investing depositor funds in a chain of franchised quick-oil-change centers--a business in which Walker also had an interest.

Financial statements show First American Savings had a negative net worth of $6.11 million at the end of 1985, a figure that grew by $11 million in 1986 after regulators reduced the value of the thrift's assets to their real market value.

But it was a series of loans to Walker family members and friends that eventually got Walker into serious trouble. In one case, court records show, Walker had his son apply for a $14,000 loan, then the father used half the money to pay personal obligations, including alimony to his former wife.

In another case, Walker had an old classmate from the Naval Academy apply for an unsecured $99,000 loan, the proceeds of which were used to finance construction of Walker's oil-change centers. No disclosure of the arrangement was made to First American's board of directors.

Walker also had his old Navy pal obtain another $75,000 unsecured loan from First American, more than half of which was used to pay expenses on a yacht--known as "The Governor's Lady"--that Walker owned in Florida.

Walker acquired the 76-foot yacht with an $875,000 loan from a Florida savings and loan for use as a "public relations" tool for his businesses, according to his attorney, Thomas A. Foran. But the boat turned into financial quicksand, court records show, and was eventually seized by the lender--filthy and in major disrepair--after the loan went into default.

The yacht was the "final nail in the coffins of (Walker's) ambitions. . . ," Foran said in a pre-sentencing memo. "The yacht was a bottomless pit of expense for repairs and maintenance and a rotten deal for public relations. His personal financial situation got worse and worse."

'Spoiled by Success'

Foran further stated that Walker "had been spoiled by success, the perquisites of office, the ego-massaging of his associates and staff. His ideas were mostly good but he ran too fast and fell on his face."

Judge Williams had a less charitable view, though, as reflected by her sentence. The seven-year prison term given Walker--convicted of misapplication of funds, perjury and loan fraud while head of First American Savings--was more than double the incarceration meted out recently to confessed inside trader Ivan F. Boesky.

"You were and you lived the American dream," Williams told Walker before sentencing him, "and in this court's view that wasn't enough for you."

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