Full opinion text
FINDINGS OF FACT AND CONCLUSIONS OF LAW HILTON, District Judge. This case involved two private mortgage guaranty insurance companies seeking to rescind mortgage insurance contracts covering loans originated by EPIC Mortgage, Inc. (“EMI”) and sold by EMI to unaffiliated third parties in the form of whole loan pools and mortgage pass-through certificates. The action brought by United Guaranty concerns the validity of certificates of mortgage insurance issued by United Guaranty to EMI. United Guaranty contends that its insurance was obtained by fraud and misrepresentation, and that it is entitled to rescind that coverage. The action brought by Foremost seeks to rescind its insurance certificates, alleging fraud, misrepresentation, omissions and RICO violations on the part of EMI and Community. Defendant Dominion Federal contends that it is entitled to recover on the certificates of insurance, and for other damages, under principles of contract law, estoppel, and because the certificates became “unconditionally enforceable” once the loans were sold by EMI to Dominion; FNB contends that its certificateholders were entitled to recover on the certificates of insurance, and for other damages, based on principles of contract law, and because Foremost had violated sections 10(b) and 17(a) of the Securities Acts of 1933 and 1934, had aided and abetted any underlying fraud which may have been committed by EMI and had committed common law fraud, misrepresentation or constructive fraud; PSFS asserted that it was entitled to recover on the certificates of insurance, and for other damages, on essentially the same theories as those asserted by FNB, except that it did not assert liability for aiding and abetting securities fraud. The EPIC product loans at issue in this litigation are loans which were either (a) acquired by the non-EPIC defendants herein prior to August of 1985 or (b) in the possession of EMI or CSL at the time the Maryland conservatorship was imposed. All or virtually all of the EPIC product loans at issue in this litigation are in default. These proceedings began as five separate cases, two of which were filed originally in this district and three others filed elsewhere. All cases were sent to this court by the panel on multi-district litigation for discovery and were consolidated for trial by order of this court on July 24, 1987. The court now makes the following findings of fact and conclusions of law, pursuant to Rule 52, Federal Rules of Civil Procedure. FINDINGS OF FACT 1. Plaintiff United Guaranty Residential Insurance Company (United Guaranty) is a stock mortgage insurance company, organized and existing under the laws of the State of Iowa with its principal place of business at 201 North Elm Street, Greensboro, North Carolina. United Guaranty is engaged in the business of writing private mortgage insurance, and is approved to do so by the Federal Home Loan Mortgage Corporation (FHLMC). United Guaranty maintains offices in several locations, including Annandale, Virginia. 2. Foremost Guaranty Corporation (“Foremost”) is a stock mortgage insurance company, organized and existing under the laws of the State of Michigan with its principal place of business at 131 West Wilson Street, Suite 801, Madison, Wisconsin. Foremost maintains offices in several locations throughout the United States. Foremost is in the business of writing private mortgage insurance, and is approved to do so by the FHLMC. 3. Defendant Dominion Federal Savings and Loan Association, which purchased whole loans from EMI, is a federally chartered savings and loan association with its principal place of business at 7799 Lees-burg Pike, Tysons Corner, Fairfax, Virginia. 4. Defendant First National Bank of Maryland, Trustee (“FNB”), is a national banking association with its principal place of business at 25 South Charles Street, Baltimore, Maryland. FNB serves as trustee for certificate-holders pursuant to certain pooling and servicing agreements. In connection with this litigation it is trustee for: (a) The Philadelphia Saving Fund Society (“PSFS”), now Meritor Savings Bank, a savings bank organized under the laws of the Commonwealth of Pennsylvania, with its principal place of business at 1212 Market Street, Philadelphia, Pennsylvania; (b) Silverado Banking (“Silverado”), a savings and loan association organized under the laws of the State of Colorado, with its principal place of business at 3900 E. Mexico Avenue, Denver, Colorado; (c) Home Federal Savings & Loan of Xenia, Ohio (“Home Federal”), a federally chartered savings and loan association organized under the laws of the United States of America, with its principal place of business at 36 W. Detroit Street, Xenia, Ohio. In August, 1985, Unity Loan and Building Company (and/or its assets) was purchased by Home Federal; and (d) Anchor Savings Association (“Anchor”), a savings and loan association organized under the laws of the State of Kansas, with its principal place of business at 8200 State Avenue, Kansas City, Kansas. 5. Silverado, Anchor, and Home Federal are not currently named defendants herein, but have agreed to be bound by whatever final judgment is reached as to FNB. 6. Defendant EPIC Mortgage, Inc. (“EMI”) was a Delaware corporation with its principal place of business at 5111 Lees-burg Pike, Suite 800, Falls Church, Virginia. 7. Defendant Community Savings and Loan (“Community”) was a savings and loan association organized under the laws of the state of Maryland and insured by the Maryland Savings Share Insurance Corporation. Its principal place of business was in Bethesda, Maryland. 8. In September of 1985, Community was placed in conservatorship under the laws of the state of Maryland. The conser-vatorship was subsequently converted to a receivership. The Maryland Deposit Insurance Fund (“MDIF”) is currently the receiver of Community. 9. All defendants herein, other than EMI or CSL (the “non-EPIC defendants”), purchased either mortgage pass-through certificates (“certificateholders”) or whole loans (“whole loan holders”). 10. EMI was a mortgage banking corporation which, among other things, originated the mortgage loans on the properties acquired by the EPIC partnerships (“EPIC product loans”). EMI was an indirect subsidiary of Community. 11. EMI ultimately sold the EPIC product loans to, among others, the non-EPIC defendants. 12. Equity Programs Investment Corporation (EPIC) was founded in 1974 based upon the concept that model homes could be purchased and leased back to builders. The EPIC Program, as of July 1981, was “national in concept and in practice.” 13. EPIC was founded by Mr. Tom Bill-man in 1975. Mr. Billman held a substantial interest in EPIC and its affiliated organizations until approximately late February 1985, when the EPIC organization was restructured. Prior to February 1985, Bill-man owned 80% of EPIC Holdings, Ltd. (the ultimate parent of CSL and the EPIC group of companies); McCuistion owned 20%. 14. EPIC was in the business of organizing, syndicating, operating, and serving as general partner of certain real estate limited partnerships (“the EPIC partnerships”). 15. In the earlier years of EPIC, the houses bought by EPIC limited partnerships were typically model homes, which would then be leased back to the seller/builder. Those leases would call for rent greater than that available from the public. Positive cash flow was generated, and those partnerships were therefore called “income partnerships.” 16. In the latter years of EPIC’s operation (including the time-period in which Foremost dealt with EPIC), the EPIC limited partnerships primarily bought “production” rather than “model” houses. Those houses would be leased to the general public at rates inadequate to cover expenses; accordingly, the limited partner investors sought and received tax deductions as one benefit of their investments, and these partnerships were called “tax partnerships.” Typically these were “two-to-one” deals, whereby (for example) a limited partner might invest $10,000 and be entitled to take a $20,000 deduction on his tax return. 17. In its first full year of operation, 1975, EPIC purchased sixty-eight model homes at a total capitalized cost of approximately $4,000,000. EPIC had developed a novel idea of promoting the purchase and syndication of model homes. It perceived that home builders would be interested in selling their model homes to EPIC and leasing them back at an agreed upon rent. EPIC entered these sale-leaseback transactions with the intent to syndicate the homes into real estate limited partnerships. The limited partners would realize tax benefits and the possibility of appreciation in the properties. The EPIC system was described as a six step process: (1) evaluate builders’ model homes; (2) enter into sale-leaseback agreements with builders; (3) arrange for financing of model home purchases; (4) syndicate the limited partnership interests to the public; (5) manage the properties during the partnership; and (6) arrange for disposition of the properties upon dissolution of the partnerships. 18. The liability of limited partners for partnership debts was limited to the capital contributions and undistributed profits (i.e., appreciation of the homes). EPIC, as general partner, was liable for all debts above the limited partners’ contributions and undistributed profits. 19. In 1976, EPIC purchased approximately $10,700,000 worth of builder model homes on behalf of thirteen limited partnerships and one general partnership. EPIC also formed two wholly-owned subsidiaries, EPIC Realty Corporation, and EPIC Securities. EPIC Realty was to act as a commissioned broker/agent in real estate transactions among EPIC, EPIC partnerships, other entities and the general business public. EPIC Securities was to deal in securities. 20.In 1977, EPIC Mortgage, Inc. was formed to borrow and lend money. During 1977, EPIC purchased approximately $16,-500,000 in builder homes and lots. During 1978 and 1979, EPIC created two additional wholly-owned subsidiaries, EPIC Financial, Inc. and ESI Securities, Inc. As of December 31, 1979, EPIC was a managing general partner in two partnerships and a managing general partner for eighty-one limited partnerships. 21.EPIC’s growth (and apparent success) was explosive between 1977 and 1984. When Frank Bossle, EPIC’s Senior Vice President of Marketing, began working at EMI, the Company had 15 employees. By the time of default, EMI had grown to approximately 200 employees. During the eight-year period between 1977 and 1984, the number of homes acquired by EPIC (and therefore the number of loan origina-tions by EMI) increased dramatically each year: Acquired in 1975 1 77,200.00 Acquired in 1976 20 934,375.00 Acquired in 1977 119 6,191,271.15 Acquired in 1978 250 15,880,266.00 Acquired in 1979 314 25,345,737.67 Acquired in 1980 481 39,411,190.84 Acquired in 1981 1058 104,874,219.00 Acquired in 1982 2537 213,247,344.00 Acquired in 1983 5010 370,171,093.24 Acquired in 1984 6860 501,897,117.75 22.In 1981, EPIC projected acquisitions and dispositions for 1981 through 1985 as follows: 1981 1982 1983 1984 1985 Projected $85 $120 $160 $200 $250 Property mil. mil. mil. mil. mil. Acquisitions Projected $13.5 $36 $60 $120 $175 Property mil. mil. mil. mil. mil. Dispositions 23.EPIC projected loan originations by EMI of: $855 million in 1984; $1.015 billion in 1985; $1,280 billion in 1986; $1,430 billion in 1987; and $1,510 billion in 1988. 24. EPIC had doubled its asset base for every year between 1978 and 1988. 25. Over the years, EPIC formed a variety of subsidiaries and affiliates, all devoted to handling some aspect of the EPIC Partnership Program. Chief among these were EPIC Realty Services, Inc. (“ERSI”), which served as property manager for the homes owned by the EPIC partnerships; EPIC partnerships to purchase their properties; ESI Securities, Inc. (“ESI”), which wholesaled the limited partnership interests in the EPIC partnerships; and EPIC Residential Network, Inc. (“ERNI”), which was charged with disposing of partnership properties. Another significant player in the EPIC story was Community Savings and Loan (“Community”), a Maryland-chartered savings and loan which EPIC acquired in March 1983. 26. Community, a stock savings and loan, was formed in 1958 as Republic National Building & Loan Association, Inc. (Republic National). In 1971, the association was moved to Montgomery County, Maryland and opened for business in 1973. With its move to Montgomery County, the association changed its name to “Community.” 27. In October, 1982, Billman and McCuistion, through Equity Acquisitions, Inc., offered to purchase all of Community’s stock for $3.50 a share. The Community Board reviewed and accepted the offer by Billman and McCuistion. By the end of October 1982, Equity Acquisitions had acquired eighty-five percent of Community’s stock. On March 1, 1983, that percentage had increased to 99.4%. EPIC Acquisition, Inc. was a subsidiary of EPIC Holdings Limited (“EHL”). Billman and McCuistion owned EHL and through that company, owned all of the subsidiary companies. 28. On February 27, 1985, Equity Acquisitions, Inc. was merged out of existence into its immediate parent, EHL. Therefore, Community’s immediate parent became EHL. 29. On February 28, 1983, Maryland banking officials gave preliminary approval to the acquisition subject to six conditions including submission of a letter from counsel concerning conflicts of interest under Maryland law between any subsidiary of EPIC and any officer of the company. Community was notified on March 8, 1983 that the acquisition would be approved. 30. By mid-1985, EPIC’s affiliate, ERSI, was managing over 18,000 partnership homes with a total purchase price of approximately $1.4 billion. Over 357 EPIC limited partnerships had been formed by this point. EMI was recognized by the American Banker in 1984 as the seventh largest mortgage servicing gainer in the entire country. 31. EMI was the first lender in the country to issue a mortgage-backed pass-through certificate rated by Standard and Poors on non-owner occupied residential real estate. The security involves a pool of first mortgage loans on model homes purchased by EPIC as general partner in various limited partnerships. The mortgages on these homes serve as collateral for a certificate which was rated “A” and “AA” by Standard & Poor’s and placed privately with a New England savings institution. 32. EPIC’s reputation in early 1985 was that it had the strongest collection of talent in the business in the entire country and had an unblemished financial record. 33. Between 1983 and 1985 the officers of EMI were Kemp (executive vice-president and then president), Meltz (president), Bossle (senior vice-president), Swindell (vice-president, general counsel, and secretary), Deerin (vice-president), Jaffe (vice-president), and Mathias (treasurer). 34. Between 1983 and 1985, the officers of EPIC were Billman (president and chairman), McCuistion (executive and senior vice-president, and treasurer) Frazier (vice-president), Deerin (vice-president (and then president), general counsel, and secretary), and Meltz (executive vice-president and then president). 35. Several key EPIC employees were well known to United Guaranty and Foremost. Frank Bossle had worked for Loyola Federal, one of the largest lenders in the Baltimore area. Lenny Meltz had previously worked for TMIC (known at the time as Ticor Mortgage Insurance Company) in California. 36. EMI was approved for its loan origi-nations by a variety of government entities, including the FHA, VA and GNMA, and was also approved by Fannie Mae and Freedie Mac. 37. EPIC made a practice of hiring the best people in each field it entered and was approached by investment bankers seeking out EPIC’s business. 38. Up until August 1985, EPIC had not had a default upon its entire portfolio of EPIC Product loans, a portfolio in excess of $1 billion. EPIC used the fact that it had never had a default on a mortgage loan as a selling point. 39. In August 1985, EPIC defaulted on a loan portfolio worth approximately $1.4 billion. 40. In late 1984 — early 1985, the EPIC organization was restructured. The reorganization and recapitalization agreement is a lengthy and complex document with numerous exhibits. 41. Epicenter Consolidated, Ltd. (“Epicenter”) was a holding Company which was the ultimate parent of EPIC, CSL, and EMI after the restructuring referred to above. Its principal place of business was 5111 Leesburg Pike, Falls Church, Virginia. As of May 24, 1985, the structure to the holding company which controlled Community consisted of two companies: Epicenter and EHL. Epicenter wholly owns EPIC Holdings and has no other subsidiaries. 42. EPIC and EMI were direct subsidiaries of a company called Community Financial Services, Inc. (“CFSI”) which was a wholly-owned subsidiary of Community. 43. As of February 28, 1985, EPIC Holdings Limited owned 100% of the stock of Community Savings and Loan. 44. After the reorganization referred to above, Mr. McCuistion’s interest increased. Mr. Billman’s decreased. Stock was acquired by other officers and directors of EPIC and its affiliated organizations. 45. In the restructuring referred to above, stock in Epicenter was sold to executives of EPIC-related companies, including among others, Clayton McCuistion, Gene Isaacs, Mike Shomper, and Barbara Ann McKinney from March 1, 1985 through June 1, 1985. 46. By March 1985, it appeared unlikely that EPIC would meet its acquisition projections for the first six months of the year. Bob Kemp’s calculations were that EPIC would need to acquire $175 million of properties in June 1985 in order to meet the six-month $300 million goal. The actual acquisitions in June 1985 were less than $33 million. 47. Between February 1985, and July 1985, EPIC purchased approximately $150,-000,000 worth of property. 48.The level of acquisitions by EPIC partnership properties in 1985 was as follows: Month Number of Units Purchase Price January 48 3,479,475. February 156 10,765,950. March 662 52,175,447. April 152 9,973,575. May 681 44,055,368. June 433 32,935,470. July 212 14,498,375. August 6 540,700. 49. On May 10, 1985, during the Maryland savings and loan crisis, the Community Executive Committee directed Meltz and Frazier of EPIC to accelerate EPIC’s normal process for acquiring properties, because the acquisition process generated significant cash to fund operations. 50. On May 14, 1985, directors of Community Savings & Loan resolved to seek a voluntary conservatorship from the MSSIC to limit to $2000 withdrawals of funds from accounts at Community. 51. On May 15,1985, one day after Governor Hughes issued the proclamation restricting the withdrawal of funds from accounts at MSSIC-insured Maryland savings and loans, the Community Board of Directors rescinded its May 14, 1985 resolution seeking the imposition of a voluntary conservatorship. 52. Community paid dividends on its common stock of $6,762,000 in May and June 1984, of $8,000,000 in February 1985, and of shares of common stock of Crysopt Corporation in kind on February 27, 1985. The $6.8 million dollar payment was declared and ratified on July 23, 1985 pursuant to a Community written record of action stating that the original minutes authorizing the payments were lost. The $8 million payment was declared on February 6, 1985 pursuant to a Community written record of action. 53. Community paid eleven dividends of $977,617,000 on its Series A and Series C preferred stock for the period March 14, 1983 through March 31, 1985. The payments were ratified on May 1, 1985 pursuant to a Community written record of action. 54. During the crisis, the FHLBB examined Community for admission into the federal insurance system. 55. The Federal Home Loan Bank Board refused to insure Community unless it divested itself of EPIC. As a result of the denial of FSLIC coverage, EPIC’s business “ground to a halt.” 56. On August 13, 1985, Bob Kemp, of EMI informed Wilcox (of FNB) that the partnerships were going to default on their mortgage loans. Kemp represented to Wilcox that he did not know why the partnerships were not passing through the money needed in order to make mortgage payments. 57. On August 13, 1985, the same day that FNB approved a $10 million warehouse line of credit to EMI, FNB was informed of the EPIC default. 58. On September 5, 1985, immediately prior to Community (and thereby EPIC and the EPIC partnerships) being placed into conservatorship by the state of Maryland Deposit Insurance Fund, most of the EPIC partnerships were placed into bankruptcy. 59. Despite the proliferation of EPIC-related companies over the years, the same group of individuals remained in control of the entire EPIC enterprise. Throughout their tenure at EPIC, their varied positions involved them in all facets of the operation of the EPIC Program. These people included: Tom J. Billman. Mr. Billman was the founder of EPIC. He served at various times as President of EPIC, President and Chief Executive Officer of Community Savings and Loan, Inc. and EPIC Holdings, Ltd., and sat on the Boards of Directors of EPIC, EPIC Mortgage, Inc., ERSI, ERNI, ESI Securities, EPIC Financial Services, Community Savings and Loan, and other EPIC-related companies. He served at various times as Chairman of the Boards of Directors of both Community and EPIC. Mr. Billman also sat on the Community Executive Committee and the Community Loan Committee. Clayton C. McCuistion. Mr. McCuistion was President and Chief Financial Officer of Community Savings and Loan. He sat on the Boards of Directors of EPIC, EPIC Mortgage, ERSI, ERNI, ESI Securities, EPIC Financial Services and other EPIC-related companies. In addition, he was a member of a number of committees, including the Community Executive Committee and the Community Loan Community and the EPIC Asset/Liability Management Committee. Leonard Meltz, Jr. Mr. Meltz was employed by Community Financial Services Corporation, the parent company of EPIC, until September 1985. Mr. Meltz was President of EMI from January 1980 until the spring of 1982, when he became President of EPIC. In the spring of 1983, he became Executive Vice President of Community Savings and Loan and President of Community Financial Services, Inc. Mr. Meltz was on the Boards of Directors of EPIC, EMI, ESI and ERNI. He served on Community’s Executive, Finance and Loan Committees. The Presidents of EPIC and EMI reported directly to Mr. Meltz. Each of these individuals invoked his Fifth Amendment privilege with respect to all substantive questions posed at his deposition. Other highly placed EPIC officials who relied upon their privilege against self-incrimination were Barbara A. McKinney and Joseph Cunningham. Ms. McKinney was the Vice-President for Finance and General Counsel of EPIC Holdings, Ltd., which was one of the parent companies of EMI and EPIC. She also sat on Community’s Executive Committee. Mr. Cunningham was the Treasurer of EPIC. 60. EPIC was in the business of forming limited partnerships in which it served as general partner. The partnerships would then acquire single-family homes with mortgage loans from EMI, typically 95% loan-to-value ratio. Individuals invested in these limited partnerships, primarily for tax benefits. The EPIC properties were to be held for rental until sold. Financial institutions purchased the loans originated by EMI. 61. The average property acquisitions consist of from 50 to 100 dwelling units for a purchase price from $4,000,000 to $8,000,-000 for each syndication. These syndicated partnerships are composed of from one to 35 limited partners with each having an initial capital investment, with the balance being paid over a three year period in quarterly installments. 62. EPIC’s standard operation rule of thumb was that roughly $4,000,000.00 worth of property would be put into one limited partnership. EPIC would open a number of limited partnerships and then assign property acquisitions to the various partnerships that were open. 63. ESI operates out of one office but distributes the EPIC real estate partnership investment opportunities through a nationwide network of financial planners and broker/dealers. The subsidiary receives 15% of the partnerships capital contributions as a commission for setting up the syndications with 8% to 10% being paid to the financial planners. 64. EPIC prepared documents called Private Placement Offering Memoranda (“Partnership PPOMs”) in connection with its sale of limited partnership interests. 65. When a partnership was formed, it had a negative cash flow, also known as an operating deficit. 66. The structure of the EPIC limited partnerships called for contributions by limited partners to be made to the partnership over its lifetime. The contributions were typically calculated to be one-half the anticipated tax losses of the partnership in any given year, resulting in a “two-to-one deal”. 67. EMI’s policy was not to lend without a forward commitment to buy the mortgage. 68. EMI originated the mortgage loans so that EPIC on behalf of the limited partnerships could acquire the real estate properties. As of March 31, 1985, EMI was servicing loans on the “EPIC Product” totaling $1,241,708,255 secured by 17,689 non-owner occupied residential dwelling units. 69. As of March 31, 1985, there were 357 syndicated partnerships consisting of 6,090 limited partners owning 17,689 rental or non-owner occupied residential dwelling units located throughout the nation. Each of these dwelling units represents the security for the mortgages used by the partnerships to acquire these properties. The mortgages are originated and serviced by EPIC Mortgage, Inc. (EMI), another wholly owned subsidiary of CSL, that sells the financing instruments to permanent institutional investors, principally savings and loan associations throughout the nation. As of this date, there are 20,486 mortgages being serviced by EMI totaling $1,434,918,-490 of which 17,689 (86.3%) totaling $1,241,-708,255 (86.5%) represent the “EPIC Product”. 70. Kimberly Trombley was responsible for the mechanics of closing EPIC loans and for the disposition of proceeds from such closings. With respect to closing EPIC product loans, Trombley received loan packages from the acquisitions department. After she determined which forward commitments the loans would close under, (i.e., to which lender the loans would be delivered), Trombley’s staff would obtain title commitments, surveys, certificates of occupancy, termite certificates, notes and deeds of trust, and mortgage insurance would be obtained. 71. EPIC Realty Services, Inc. (“ERSI”) was the company which was utilized to rent the EPIC properties, collect rent and supervise repairs, among other things. ERSI was owned by Messrs. Billman, McCuistion, and Isaaca. For every house, $50 per month was paid to EPIC for property management, of which $35 per month was paid by EPIC to ERSI. 72. ERSI managed the rental units of the EPIC limited partnerships. It received $35 per unit per month from each of the 17,689 limited partnership rental units, plus one month’s rent for each yearly lease and one half month’s rent for each lease renewed. 73. Partnerships acquired all of their properties and began business before they were syndicated. It was the policy of EPIC that the limited partnership conducted business for the life of the partnership no matter how many limited partners there were. 74. There were three critical sources of funds available to cover the monthly mortgage payments of the partnerships: the rent, the rental deficit contribution (the “RDC”) (or builder rebate) and the limited partner contributions. If these three streams dried up, advances from the general partner were available. It was the understanding of key EMI and EPIC personnel, however, that such advances were needed only in the later years of the partnerships, or were used only where a home had not been rented or had not been sold at the expected time. 75. Partnerships were generally structured so that the homes would be sold after the fourth year. 76. EPIC’s final obligation as general partner was to dispose of the partnership properties. 77. Typically, after four years, partnerships would stop receiving capital contributions from the limited partners. Then, EPIC could sell homes, could resyndicate a partnership by grouping it with other partnerships in a new partnership, or could continue the partnerships, but EPIC would have to pick up the losses of the partnerships. 78. In theory, when an EPIC limited partnership reached the end of its expected 4-to-5 year lifetime, its houses were to be sold. The sale proceeds were to be used first to pay the expenses of sale; next to pay the mortgage loans; next to repay advances (if any) from EPIC; next to repay limited partner capital contributions; and finally, to pay profits, if any, to EPIC and the limited partners according to an agreed formula. 79. As the EPIC Program was structured, it was intended that the partnerships would own the houses for four to five years and that the homes would be sold at the conclusion of that period. 80. EMI represented that the rents and the rental deficit contribution and the partner contributions would be sufficient to carry the partnership mortgages for four to five years. 81. The rental deficit contribution was to be used for cash flow purposes to fund the differences between the rent received and the total mortgage payment for the house. In other words, in the production home context, it would have the same economic effect as a triple net lease (i.e. that it would cover all expenses). Thus, the RDC was meant to subsidize the partnership for the period of time in which it was holding the home. 82. The worksheet for the rental deficit contribution that EPIC provided to the mortgage insurers shows that the entire purpose of the rental deficit contribution was to make up the shortfall between the monthly mortgage payment and various expenses and investor contributions received. The worksheet calculates EPIC’s cost to carry the property and nets that against the estimated rent and partner contributions. The RDC figure was supposed to be the present value of the difference calculated over a three-year period. 83. How the rental deficit contribution funds would be maintained was critical to United Guaranty and Foremost. EPIC represented to United Guaranty and Foremost that the rental deficit contribution would be held exclusively for the benefit of the particular partnership which had generated it. 84. Charles Kipp, Jim Ring, and Peter Ostrowski were on EMI’s marketing staff in late 1984 and early 1985. 85. Ostrowski had a standard presentation that he made to potential investors, in which he advised that there were three streams of income available to satisfy EPIC product loan mortgage obligations: capital contributions by limited partners; rents; and a rental deficit contribution. 86. Ostrowski represented that the RDC became part of the partnership’s assets, as opposed to EPIC accounts, and that it was used to cover the difference between the rent and the mortgage payment. 87. Ostrowski understood that the RDC was sufficient to carry the cost of the mortgage for a minimum of 86 months. 88. Jaffe and Kipp had the same understanding of the program as Ostrowski did. The presentations of other marketing representatives of EMI was significantly the same as Ostrowski’s. All of the marketing representatives got their information on and understanding of the program from Frank Bossle. 89. While Kipp was at EMI, he was frequently asked where the RDC went and he answered that the money was earmarked for the specific piece of property. He told all people the same story. His answers did not vary. He did not distinguish between the money being held in a specific account and the money being commingled but accounted for separately. 90. When Kipp made a sales presentation to a potential institutional purchaser of EPIC product loans, he gave them promotional information on EPIC, financial statements, annual reports, sample commitment letters, sample pass-through documents, sample partnership agreements, and letters from private mortgage insurers stating how much in EPIC product loans they had insured without a single claim. 91. Kipp also told lending institutions that the rentals on the houses were a source of income for payment of the mortgage. 92. Kipp sold approximately $960,000,-000 in product loans in the six and a half years that he was at EPIC. 93. EPIC made identical representations about the rental deficit contribution, in writing, to the Federal National Mortgage Association. 94. A similar representation was made by EPIC in response to an inquiry from a savings and loan association. A highly placed EPIC officer stated that [t]he explanation of the rental deficit contribution is that it’s left in the Partnership to help cover debit service over the anticipated life of the loan. I believe this is explained in Section XII of the Partnership Memorandum under Compensation and Fees to the General Partner. 95. The same statement was made by EPIC to the Federal Home Loan Bank Board. EPIC told the FHLBB in the context of Community’s application for FSLIC insurance that the RDC was designed to carry the mortgage for a four-year period. The May 24,1985 examination of Community explicitly states that the RDC is designed to meet the “costs of carrying the property by the limited partnership over the four-year anticipated holding period”. 96. That the rental deficit contribution was held for the benefit of the partnership generating it was also the understanding of the EMI officials who were responsible for explaining the EPIC Program to lenders, insurers and others. Mr. Kemp, the President of EMI, assumed that the rental deficit contribution, being an asset of the partnerships, went to the individual partnership. 97. Mr. Bossle, EMI’s Senior Vice-President of Marketing, thought right up until August 1985 that there was money in the rental deficit contribution cash flow to carry the partnership. 98. EPIC purchased its properties pursuant to a form contract known as a Residential Rental Purchase Agreement. This document was provided to United Guaranty to identify each home securing a loan which it insured. Every Residential Rental Purchase Agreement stated that: On the closing date, seller shall pay to the purchaser a sum equal to the percentage as set forth on Exhibit “A” hereof of the purchase price of each property as a contribution towards rental deficits (herein referred to as the “Rental Deficit Contribution”). Exhibit “A” listed each home individually and the RDC amount received on each purchase. 99. EPIC represented to United Guaranty and Foremost that the RDC would be held in escrow. 100. The same thing was told to Empire of America. That institution received a summary of terms for a $20 million purchase of EPIC loans. The summary stated, with respect to “Debt Service Coverage Sources” the following: 1) Rental and/or lease income 2) Limited partnership contributions 3) Rental Deficit Contribution (Average 25% of sales price of house and is held in escrow by EPIC. 4) Interest advance by EPIC (if necessary) 101. MGIC was also told (by Tom Bill-man) that the RDC was placed in escrow. 102. This was also the understanding of FNB. Mr. Wilcox of FNB stated at his deposition that he understood that certain sums of money were placed in an escrow account by the builder for funding over a minimum of a year period. 103. Dominion Federal understood that the funds of the partnerships would be held in escrow. 104. After the default, Dominion even wrote EPIC asking where the RDC funds were being held. A Dominion officer, writing EMI about an EPIC project known as Cedar Ridge in Hurst, Texas, stated that the rental deficit funds were to be “dedicated to the sole purpose of supplementing the tenant rental payments on a month-to-month basis for purposes of making the monthly mortgage payments on the note for Cedar Ridge.” Dominion inquired as to where the funds were maintained and the current balance in the account. 105. Others shared this understanding. For example, First Federal Savings and Loan Association of Kokomo inquired whether “there are any funds left in escrow subsidizing rent deficiencies?” The residential rental purchase agreement for the Cedar Ridge project is virtually identical to the later residential rental purchase agreements received by United Guaranty. 106. Winner of PSFS, understood that the partnerships received, from the seller of property, rental deficit contributions to be used while the partnerships owned the properties, to support debt flow obligations. 107. Winner also understood that limited partnership contributions, rental income and the RDC would be enough to pay debt service on the loans for the term of the partnership. 108. Winner was satisfied by EMI’s representations that the RDC’s had been paid for use by the partnerships for as long as they owned the properties; he made no independent search for rental deficit contributions to the limited partnerships. Winner was satisfied that there would be adequate funds available to the borrower to pay the debt service on the mortgages. 109. A similar inquiry was made by Shadow Lawn savings and Loan Association. In a letter to Frank Bossle, Shadow Lawn said that “[t]he private placement offering statement stated that the builders had provided $992,398.12 as rental deficit contributions. Have any of these funds been used to make the mortgage payments and what balance of these funds is currently in the hands of the partnership mortgagor/mortgagors ? ’ ’ 110. The handwritten notes of the individual at Silverado Banking responsible for the EPIC purchasers also indicate a belief that these funds would be held separately. 111. EMI and Community represented to their other loan purchasers and prospective purchasers that the RDC was to be segregated for payment of the mortgage debt. 112. Kipp told purchasers that the RDC was a source of income to support the properties within a partnership and that it was left in the partnership to help cover debt service. Kipp explained this to an officer of Colony First Federal Savings and Loan and confirmed it in a letter dated November 12, 1984. 113. Empire of America made five purchases of EPIC product loans from EMI of $55 million total. Empire received a proposal from EPIC through Bear-Stearn’s dated May 14, 1985, relating to one of its transactions. The proposal states that the debt service will be covered by a rental deficit contribution held in escrow, lease income, limited partnership contributions, and a interest advance by EPIC (if necessary). 114. Shadow Lawn Savings and Loan is a New Jersey savings and loan association which is the owner of EPIC Mortgage Pass-Through Certificate Number 1, Series 85-11, dated February 19, 1985. Shadow Lawn owned a 100% interest in the pool which was backed by fifty-three (53) mortgage loans. On August 26, 1985, subsequent to the EPIC defaults, Christopher Widdis, Vice President of Shadow Lawn Savings and Loan wrote to Frank Bossle of EPIC Mortgage, Inc. inquiring as to the whereabouts of funds to make mortgage payments and stated as follows: The Private Placement Offering Statement stated that the builders had provided $992,398.12 as rental deficit contributions. Have any of these funds been used to make the mortgage payments and what balance of these funds is currently in the hands of the partnership mortgagee/mortgagors? 115. A copy of this letter was also sent to FNB, as trustee. It was Shadow Lawn’s understanding, based on the representations made to them and in the private placement offering statement that builder rental deficit contributions would be available to make the mortgage payments by Shadow Lawn. 116. EPIC Partnership PPOM’s also represented that the RDC would be available. For example, Schedule D for limited partnership 84-76 shows that this partnership should have enough money to pay its bills (without general partner advances) for a period of time, greater than 15 months. See also, descriptions made in the limited partner PPOM’s, the pool PPOM’s (Builder rebates are referred to as “cash” in the section of the private placement offering memorandum headed “Maximum Leverage.”) 117. EMI and Community represented to other mortgage insurers that the RDC was to be segregated for payment of the mortgage debt. For example, Tom Billman explained to Lacy, of MGIC, that the RDC was a contribution into escrow that came out of the acquisition of property. The RDC was used to pay the deficiency between income and the payments on the mortgage debt. The RDC either came out of the proceeds of the sale or was paid by the builder. 118. Representatives of EPIC and Community met with Pollack of MGIC and discussed “the kinds of reserves that were established and funds that were segregated out of the closing proceeds to fund negative cash flows.... ” 119. The following description appears in the EPIC informational brochure: The Appeal of EPIC’s Mortgage Pass-Through Certificates: An additional source of cash flow for the Limited Partnership involves the collection of a rental deficit contribution (RDC) from the proceeds of each property. This cash contribution is realized in the purchase of non-model homes or Builder production units. It generally totals 16 percent to 20 percent of the purchase price of each property. The RDC is utilized to help maintain ongoing cash flow requirements for the life of the Partnership. 120. The representations about how the RDCs were treated were false. Rental deficit contribution funds were not held for the benefit of any particular partnership. 121. The second critical component of the partnership cash flow was the money paid in by investors purchasing EPIC limited partnership units. It was represented that these funds would also be held for the benefit of the partnership to which they were attributable. These funds were approximately 20% of the purchase price of the home. These funds were not held separately. They were commingled with EPIC’s general funds. 122. EPIC represented that the rents it received were generally 7 to 9 percent of the purchase price of the unit. 123. Rentals of the EPIC properties were handled by an EPIC affiliate, EPIC Reality Services, Inc. (“ERSI”). ERSI was owned by Tom Billman, Clayton McCuistion and Eugene Isaacs. ERSI received a fee of $35.00 a house per month from EPIC for managing the properties. 124. EPIC represented that the rents, like the RDC and the limited partners’ contributions, would be held for the benefit of the partnership entitled to receive them. 125. United Guaranty and Foremost agreed to insure the EPIC Program based on their understanding that the partner contributions and rents and rental deficit contributions for each partnership would be held for the benefit of such partnership —separately. The specific representations made to United Guaranty and Foremost on this subject are discussed below. 126. United Guaranty’s first contact with EPIC Product loans was in late 1983 or early 1984, when it agreed to reinsure some EPIC Product loans. 127. Under this reinsurance exposure, United Guaranty’s liability would have arisen only to the extent that the lender’s losses were greater than 25 percent of the loan amount. This first 25 percent of the risk would be borne by the primary insurer. And even if the loss penetrated beyond that initial 25 percent, United Guaranty’s exposure would have been limited to one-third of the excess loss. 128. On August 27, 1984, United Guaranty issued a master policy to EMI for its single-family residential business. This master policy was not issued for the purpose of accepting the EPIC partnership loans for insurance. In fact, United Guaranty rejected a package of partnership loans submitted by EPIC because they had not been approved. 129. The issuance of a master policy does not constitute a commitment of insurance until subsequent actions are taken when specific loans are submitted for approval. 130. The decision to insure EPIC partnership loans is one that United Guaranty weighed for several months over a series of meetings with EPIC Mortgage. United Guaranty did not insure its first EPIC product loan until approximately five months after the issuance of the master policy. 131. United Guaranty gave more time and attention to its decision to insure the EPIC loans than to its decisions to insure routine, owner-occupied loans. 132. In making its decision to insure loans originated by a lender with which the insurer has had no prior experience, the insurer looks to the reputation of the lender. It attempts to determine its track record in the industry and how its current delinquencies are running. EPIC’s record was flawless. Another indicator of quality is a lender’s approval by the Federal Home Loan Mortgage corporation or the Federal National Mortgage Association. EPIC was approved by both. In addition to EPIC’s explanation of its program, these were facctors that United Guaranty considered in deciding whether to take the EPIC risk. This evaluation of the character and ability of a lender is the most important element of mortgage underwriting. Mortgage insurers also look to the identity of the institutions purchasing the loans originated by the lender. EPIC sold to some of the biggest and most respected lenders in the business. 133. The Federal Home Loan Mortgage Corporation’s eligibility requirements for private mortgage insurance companies recognize that the key element of mortgage insurance underwriting is the review of the lender as opposed to the review of the individual loans. 134. United Guaranty’s agreement to insure the EPIC partnership loans was a “negotiated transaction”. In the context of a negotiated transaction, the insurer and the lender agree in advance regarding the insurance of a set of loans that will have agreed upon terms and features. These types of loans may not be subject to the same type of review as the standard “spot loans” (i.e. owner occupied loans) which mortgage insurers also insure. Generally announced policies or guidelines do not apply to negotiated transactions, which rest upon negotiated parameters. The Federal Home Loan Mortgage Corporation’s eligibility requirements for private mortgage insurance companies do not apply to negotiated transactions. Mortgage insurers examine insured loans only in a “review” capacity. They check to confirm that certain required documents have been prepared, but never attempt to determine the accuracy of data submitted to them. 135. United Guaranty conformed with industry standards in its agreement to insure EPIC partnership loans. 136. The first substantive meeting between United Guaranty and EPIC took place in April 1984. Guy Luno, United Guaranty’s Vice-President of Risk Management, met with EPIC representatives in Falls Church, Virginia along with Kerry Rainey, a United Guaranty Regional Vice-President. Frank Bossle discussed with them what EPIC was doing as a company. 137. United Guaranty personnel attended two later “due diligence” meetings with EPIC. These meetings held by EPIC were an opportunity to allow potential participants in the EPIC Program — such as mortgage insurers, investment bankers and savings and loans — to see the inner goings-on of the EPIC organization as well as to meet the principal officers of the various EPIC companies. Generally the President or the second or third person from a particular company would speak. 138. Mr. Gillison attended a due diligence meeting at the EPIC offices in November 1984. He met with Frank Bossle, who explained EPIC and how the various EPIC entities worked. Officers of various EPIC companies came in and talked about their particular functions. Mr. Gillison met with Bob Kemp (of EMI), Gene Isaacs (of ERSI) and John Frame (of ESI). 139. Mr. Gillison was told that the funds available to pay the mortgage loans would be the rental deficit contribution, rentals and limited partner cash contributions. Mr. Bossle said that the funds available to the partnership would be sufficient to carry the mortgages for the first five years. Mr. Gillison was further told that EPIC was doing fine in selling partnership interests to investors. 140. The entire thrust of Mr. Bossle’s presentation to Mr. Gillison was that the “whole EPIC wheel was turning and just working great. That everything was working like it was supposed to”. 141. Mr. Gillison was impressed with what he had seen during the November meeting. Based upon the presentations by EPIC personnel, the EPIC business appeared to be good solid business. 142. If United Guaranty had known that the EPIC companies depended on acquisitions of new properties and formations of new partnerships to generate funds to pay the obligations of older partnerships, as it subsequently discovered, it would not have insured the EPIC loans. 143. Following the November 1984 meeting, Mr. Gillison also looked at the December 31, 1983 financials for Community Savings and Loan. He saw no red flags and nothing out of order in that document. He also observed nothing in the 1983 Community financials to indicate that the advances to the partnerships were not collectible. 144. Mr. Gillison also reviewed a document entitled “The Appeal of EPIC’s Mortgage-Backed Pass-Through Certificates” and that confirmed Mr. Bossle’s discussion of the rental deficit contribution. 145. Following the November 1984 meeting, Mr. Gillison sent United Guaranty’s Vice-President of Risk Management, Guy Luno, back to meet with EPIC again. 146. Mr. Luno and Kerry Rainey of United Guaranty met with Frank Bossle and other officers of EPIC. Various department heads, including Mr. Isaacs and Mr. Meltz, explained what their function was and what their departments were doing. Frank Bossle told Mr. Luno at the January meeting that the rental deficit contribution was placed into escrow, and that it would be used to fund deficiencies during the partnership period of three to five years. 147. EPIC represented that each one of the partnership deals was separate and apart from any other deal and that the individual partnerships were self-supporting and could stand on their own. Mr. Luno was told that the rent along with the other payments put into escrow were sufficient to carry the mortgage debt. 148. There were no statements made at the January meeting that EPIC had the ability or authority to borrow from the partnerships. 149. United Guaranty would not have insured the EPIC loans if it had known that the new partnership acquisitions were generated, and the funds of such partnerships were being appropriated, to pay the debts of old partnerships (as it subsequently discovered). 150. Based upon the representations at the January meeting, Mr. Luno formed a conclusion that there was adequate protection during the initial term of the partnership. He told Mr. Gillison that he had concluded that there was safety in the deal. 151. Prior to making the decision to insure EPIC, Mr. Gillison talked to the officials of other mortgage insurers about EPIC. It was common at this time for mortgage insurance companies to trade information in this manner. The President of MGIC told Mr. Gillison that their experience with EPIC had been very good and that they would be doing more business with EPIC before too long. MGIC is the private mortgage insurance industry’s acknowledged market leader. Bill Simpson, the President of RMIC, another mortgage insurer doing business with EPIC, said that he was still actively doing business with them and that they were fine and that he had had no problems or losses with them. Bob Cohen, Mr. Gillison’s contact at TMIC, said that he knew nothing derogatory about EPIC. At the time, Mr. Cohen was the chief financial officer of TMIC. 152.A few months later, Mark Pollack of MGIC told Mr. Gray (United Guaranty’s General Counsel) that the reasons MGIC was not doing business with EPIC was that they had taken enough risk for EPIC and that they wanted to let some time pass. Mr. Pollack said, however, that their experience had been “excellent.” MGIC had received no claims from EPIC at that point. 158. The representations by MGIC were not true. They resulted from a deliberate agreement between EPIC and MGIC to mislead other members of the mortgage insurance industry. 154. In February 1983 MGIC had recognized that until EPIC could sell partnership properties, it could generate sufficient revenues only by making more acquisitions. Memorandum from Gordy Steinbaeh to Mark Pollack, dated February 1, 1983. 155. MGIC had had an internal discussion about discontinuing its insurance of EPIC Product following a meeting with EPIC on June 27, 1983. At this meeting, Bill Lacy, the President of MGIC, stated, “[w]e have to get away from this account— how do we do it?” Memorandum from Gordy Steinbaeh to Mark Pollack, dated August 9, 1985. 156. Following this display of concern, officials of MGIC had met with Lenny Meltz, Bob Kemp and Dick Deerin at EPIC’s offices. MGIC indicated at this meeting (which took place on August 11, 1983) their desire to discontinue insuring the EPIC Product, in part because of their concern about the lack of sales by EPIC from previous partnerships. The EPIC people accepted the decision, but were concerned that if other mortgage insurers heard of MGIC’s decision, that it could have adverse consequences for EPIC. MGIC “agreed that if anyone inquires as to whether MGIC is still doing product/inventory business for EPIC we will say that we are.” Memo from Mark Pollack to File, dated August 25, 1983. 157. The true reason why MGIC had discontinued insuring EPIC was never disclosed. At a meeting with United Guaranty in Greensboro in May 1985, Larry Pratt of EPIC told United Guaranty that MGIC had quit insuring EPIC because of concentration of risk problems. 158. The concerns of MGIC and EPIC’s other major mortgage insurers had reached such a high degree that in a meeting on May 22, 1985, they had requested that an “[ojverall Workout Program ... be in place within ninety days.” Memorandum from Lenny Meltz to Billman, McCuistion and Deerin, dated May 23, 1985. In Meltz’s view, these companies were serious about “getting out”. Id. 159. At this meeting Mr. Meltz told Gary Bradford, the President of TMIC, that if EPIC could not continue to get mortgage insurance that “the whole house of cards would come down ” Mr. Meltz also revealed that EPIC had a severe cash flow problem. None of this was disclosed to United Guaranty, even though EPIC officers met with United Guaranty the very next day. 160. As a result of its meeting with its primary mortgage insurers, Community agreed to immediately reduce its projected acquisition volume for the calendar year 1985 to $500,000,000. It further agreed to analyze its cash flows to determine whether a further reduction in this amount could be made. Letter from Lenny Meltz to John Hooff dated May 31, 1985. 161. Mr. Gillison decided to insure the EPIC loans on a limited basis in January 1985, after Mr. Luno’s meeting at EPIC’s offices. He instructed that all the business should come through a single office so that it could be monitored on a regular basis. Mr. Gillison received weekly reports on the EPIC account. 162. It is common in the mortgage insurance business for an insurer to take loans for insurance on a trial basis, with the idea of developing an experience with the lender. 163. United Guaranty officers met with Frank Bossle and Larry Pratt of EPIC on May 23, 1985 in United Guaranty’s offices in Greensboro. The presentation at the May 23 meeting was essentially the same as what Mr. Gillison had heard in November of 1984- In other words, all the representations made in May had also been made prior to the time United Guaranty began insuring EPIC. In attendance for United Guaranty in May 1985 were William L. Hemphill, the President and Chief Executive Officer of United Guaranty’s parent company; William H. Gillison, the President of United Guaranty; Guy Luno, United Guaranty’s Vice-President of Risk Management; Robert Rosenblum, United Guaranty’s Vice-President of Operations; Richard L. Gray, United Guaranty’s General Counsel; and Chris Avren, United Guaranty’s National Sales Manager. 164. Mr. Bossle described the history of EPIC and how well they had done. He emphasized that EPIC was selling loans to FMMA and had already sold about $120 million of loans to FNMA. He mentioned EPIC’s relationship with Salomon Brothers and pointed to a “blue ribbon” group of lenders to which EPIC had sold loans over the years. 165. Mr. Bossle stated that EPIC had never had a mortgage insurance claim in its history. 166. Mr. Bossle explained that since the rent from the houses was insufficient to cover the mortgage debt, that EPIC obtained a rental deficit contribution from the builders. Bossle indicated that this RDC averaged 18.1 percent or 18.2 percent of the purchase price of the home. Mr. Bos-sle explained that the typical partnership would hold 40 to 50 houses worth $4 million to $5 million. With respect to the limited partner contributions, Mr. Bossle stated that these would be approximately 20 percent of the purchase price of the homes. 167. Mr. Bossle said that each partnership “stood on its own.” It was significant to United Guaranty that these partnerships were separate entities because the funds in the individual partnerships were needed to pay the mortgage loans held in those partnerships. Mr. Bossle said that these funds would be held separately within each partnership for this purpose. He affirmatively stated that there was no commingling of funds. This was critical to United Guaranty because the rental deficit contributions which had been individually computed for each property had to be there when if was needed. Mr. Bossle used the words “in escrow” and “in trust” in describing the funds of the partnerships. 168. Mr. Bossle indicated on a blackboard in the United Guaranty conference room that the funds would be held in escrow to pay the mortgage debt for the first five years. Mr. Hemphill made calculations to satisfy himself that the funds were there to carry the partnership into its fifth year of existence. Without this understanding, United Guaranty would not have insured the EPIC loans. 169. Mr. Bossle indicated no difficulties in disposing of the properties. He said nothing about any difficulty in selling properties coming out of older partnerships. With respect to the sales of homes, Mr. Bossle stated that the partnerships were just starting to roll out of the old partnerships. There was no statement made by Mr. Bossle to indicate that EPIC was experiencing problems in selling partnership properties in late 1984. Had United Guaranty known that EPIC was having difficulty selling partnership properties, it would have changed the nature of the risk. 170. Mr. Bossle indicated no difficulty selling limited partnership interests. He said they had been successful for a long period of time and were doing well. If United Guaranty had been told that EPIC was having difficulty selling partnership units, this would have changed the nature of the insurance risk. 171. Mr. Bossle stated that the financial condition of the EPIC group of companies was sound and that their partnerships were doing well. As demonstrated elsewhere, however, the entire EPIC enterprise was experiencing severe financial problems for weeks before this meeting. 172. Mr. Hemphill learned nothing in the May 23 meeting that caused him any concern. 173. Mr. Gray’s recollection of the May 23 meeting is similar to that of Mr. Gillison and Mr. Hemphill. Mr. Bossle identified the three major sources o