Full opinion text
MEMORANDUM AND ORDER SAFFELS, District Judge. In this case, Franklin Savings Association (“Franklin” or “the institution”) and Franklin Savings Corporation (“FSC”) challenge the Office of Thrift Supervision’s (“OTS” or “the regulator”) February 15, 1990, decision to appoint the Resolution Trust Corporation (“RTC”) as conservator for the institution. Franklin attacks the legality of the appointment and seeks removal of the conservator, pursuant to Section 5(d)(2)(E) of the Home Owners’ Loan Act (“HOLA”), as amended by Section 301 of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIR-REA), 103 Stat. 292 (to be codified at 12 U.S.C. § 1464(d)(2)(E)). This case was filed on March 12, 1990, and was placed on an accelerated docket, given the crucial importance of timely action regarding this matter. An 18-day trial to the court was conducted between June 25, 1990, and July 20, 1990. In addition to considering the testimony and evidence presented at trial, the court has read numerous depositions submitted by the parties and has thoroughly examined the three volume administrative record compiled by OTS regarding the appointment of conservator. The court is now prepared to rule. As an initial matter, the court wishes to comment that this is not a case involving an infamous or notorious savings and loan association, the likes of which the public has recently become more than familiar. This is not a case involving fraud, corruption, or self-dealing by the management or directors of Franklin. There has been no allegation or even hint of illegal or unethical conduct by Franklin’s management or directors. Essentially, this case boils down to a dispute over accounting practices. With that said, the following constitutes the court’s findings of fact and conclusions of law pursuant to Rule 52(a) of the Federal Rules of Civil Procedure. I. THE PROPER ROLE OF THE COURT. Before discussing the specific findings and conclusions in this case, it is necessary for the court to address exactly what role it is to play when a savings association challenges the regulator’s appointment of a conservator. Legal questions must be resolved regarding the standard of review to be applied in reviewing the regulator’s actions; the burden of proof; and what evidence the court can consider in resolving this case. In FIRREA Congress specifically provided for judicial review of the regulator’s appointment of conservator. A. Standard of Review. The provision of FIRREA which allows judicial review of the OTS’s decision to appoint a conservator does not expressly define the scope or standard of that review. Since the statute does not specifically define the standard of review to be used in examining regulator’s action, the court must look to the Administrative Procedures Act for guidance on this issue. See Washington Federal Savings & Loan Ass’n v. FHLBB, 526 F.Supp. 343, 350, 353-54 (N.D.Ohio 1981). Section 706 of the Administrative Procedures Act (“APA”) sets forth the standard of review appropriate for a court reviewing an administrative agency’s action. The APA provides that an agency action must be set aside if the action was “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law” or if the action failed to meet constitutional, statutory, or procedural requirements, 5 U.S.C. § 706(2)(A), (B), (C), (D). Although the APA allows for de novo review in limited situations, 5 U.S.C. § 706(2)(F), the court finds that it is not applicable to the present case and that the standards set out in 5 U.S.C. § 706(2)(A), (B), (C) and (D) apply in the present proceeding. Under the arbitrary, capricious and abuse of discretion standard, the agency’s decision is entitled to a presumption of regularity. The presumption, however, does not shield the agency’s action from “a thorough, probing, in depth review.” Citizens to Preserve Overton Park v. Volpe, 401 U.S. 402, 415, 91 S.Ct. 814, 823, 28 L.Ed.2d 136 (1971). The court must consider whether the OTS’s decision to appoint a conservator was based on the consideration of the relevant factors and whether there has been a clear error of judgment. Id. at 416, 91 S.Ct. at 823-24. “Although this inquiry into the facts is to be searching and careful, the ultimate standard of review is a narrow one. The court is not empowered to substitute its judgment for that of the agency.” Id. Notwithstanding this deference, the agency must “examine the relevant data and articulate a satisfactory explanation for its action including a ‘rational connection between the facts found and the choice made.’ ” Motor Vehicle Mfrs. Ass’n v. State Farm Mut. Auto Ins. Co., 463 U.S. 29, 43, 103 S.Ct. 2856, 2866, 77 L.Ed.2d 443 (1983) (quoting, Burlington Truck Lines, Inc. v. United States, 371 U.S. 156, 168, 83 S.Ct. 239, 245-46, 9 L.Ed.2d 207 (1962)). B. Burden of Proof. The general rule is that the party challenging an agency’s action has the burden of proving error. Telegraph Savings & Loan Ass’n v. FSLIC, 564 F.Supp. 862, 870 (N.D.Ill.1981) (citing Pacific States Co. v. White, 296 U.S. 176, 56 S.Ct. 159, 82 L.Ed. 138 (1935)). A presumption of validity exists for the agency’s action. When an agency acts ex parte, as in the present case, its decision is still entitled to presumption of correctness, albeit a lesser one. Telegraph Savings & Loan, 564 F.Supp. at 870. Thus, the burden is on Franklin to overcome this presumption and to show by the preponderance of the evidence that the agency’s decision lacked any basis in fact or law or was arbitrary, capricious, or an abuse of discretion. C. Evidence the Court Can Properly Consider. Throughout this case, the parties have disputed what evidence the court may properly consider in making its judicial review of the OTS’s action. The OTS contends that the court is limited to reviewing solely the administrative record which OTS has prepared and filed with the court. The OTS argues that the court must determine if the agency’s action is supported by the administrative record. Franklin insists that the court consider evidence outside the administrative record to determine the appropriateness of the conservatorship. The court has received an extensive amount of evidence outside the administrative record during the trial of this case, but took under advisement the issue of whether such evidence could be considered in determining the issues before the court. After considering the parties’ arguments and reviewing much case law, and some of the facts established in this case, this court finds, and is convinced, that evidence outside the administrative record may be properly considered. First, the court notes that the statutory scheme for judicial review set out in FIRREA calls for review “upon the merits.” Courts interpreting this “unusual” phrase have reached a variety of conclusions on its meaning and what type of review is required by the phrase “upon the merits.” Some courts find that the phrase should be given no different effect than the phrase “on the record,” and thus, apply the traditional arbitrary and capricious standard of review, in which the court simply reviews the administrative record and determines whether, based on that record, the agency’s action was arbitrary and capricious or an abuse of discretion. See Woods v. Federal Home Loan Bank Board, 826 F.2d 1400, 1406-07 (5th Cir.1987), cert. denied, 485 U.S. 959 (1988); Guaranty Savings & Loan Ass’n v. Federal Home Loan Bank Board, 794 F.2d 1339, 1342 (8th Cir.1986). Other courts have held that this language in effect provides a de novo review of the agency’s decision. See Fidelity Savings & Loan Ass’n v. FHLBB, 540 F.Supp. 1374, 1377 (N.D.Cal.1982) (“If it means nothing more, the term ‘on the merits’ reveals that a proceeding under the statute is more in the nature of a de novo review than an appellate review.”); Telegraph Savings & Loan Ass’n v. FSLIC, 564 F.Supp. 862, 869-870 (N.D.Ill.1981); A third view is advocated in Collie v. Federal Home Loan Bank Board, 642 F.Supp. 1147, 1150-52 (N.D.Ill.1986). The Collie court determined that the “upon the merits” language provides for a hybrid type of review in which the court would continue to apply the arbitrary and capricious standard of review, but that the record on which the review would be based is expanded. The challenging party is provided an opportunity to present evidence in addition to the administrative record. As the Collie’s court properly surmised: A reasonable reading of the phrase “upon the merits” is rather that it means a review in which the FHLBB [predecessor of OTS] does not necessarily control the evidence which reaches the reviewing court. “Upon the merits” contrasts with the more usual “on the record.” Congress must not have intended for judicial review always to be confined to an administrative record_ [T]he challenging association should have the opportunity to submit evidence whether or not that evidence was considered by the Board, and to develop any facts bearing on the question of whether any of the statutory grounds existed. “Upon the merits” means that both parties to the reviewing action have the right to develop the judicial record. Nevertheless, it does not follow from that conclusion that review “upon the merits” is the equivalent of either a de novo hearing or de novo review of the evidence.... The FHLBB’s opinion that insolvency, violations or unsound practices existed therefore must carry some weight. Collie, 642 F.Supp. at 1151 (citations omitted). The essence of the “upon the merits” language is that the savings association is provided with a meaningful opportunity to present its case in opposition to the appointment of the conservator at some point during the process leading to the appointment. If such meaningful opportunity has not been provided, “then the court should provide that opportunity.” Id. at 1152. This court agrees with the Collie court’s interpretation of the phrase “upon the merits.” To allow the government to seize control of plaintiffs’ business and assets in an ex parte nature without a previous adversarial hearing would deny plaintiffs any meaningful opportunity to present their position. The court finds that to allow this sort of seizure of property without at least allowing plaintiffs a post-seizure opportunity to present evidence supporting their case in opposition of the conservatorship, would definitely raise serious constitutional due process concerns. See, infra, Conclusion of Law No. 15. The court chooses to interpret this statutory language in a manner that will allow it to withstand a constitutional challenge. The statutory scheme grants OTS the exclusive power to place the institution in conservatorship ex parte and without notice. Section 5(d)(2)(E) of HOLA as amended by Section 301 of FIRREA, Pub.L. No. 101-73 (to be codified at 12 U.S.C. 1464(d)(2)(E)). This scheme is acceptable in light of the necessity that the regulator must act quickly and decisively in reorganizing, operating and dissolving failed institutions. See Woods at 1407. However, such an ex parte regulatory, scheme may be allowed only if the seized institution is provided with an opportunity to later present its position. This court reads the judicial review provision in FIR-REA as providing such an opportunity by judicial review on the merits after the agency’s action. To provide a meaningful review, the court must consider evidence outside the administrative record. Therefore, the court concludes that the “on the merits” review provides the plaintiffs with an opportunity to present evidence outside the administrative record in support of their case and for the court to consider such evidence. However, this hybrid standard of review does not provide for de novo review, but for review on whether the agency’s action was based on statutory grounds or was arbitrary and capricious or an abuse of discretion after the court has reviewed all evidence presented. Aside from the “on the merits” statutory language, the court also finds that evidence outside the administrative record may be considered under other general principles of administrative law. Generally, judicial review of an agency action is limited to review of the record on which the administrative decision was based. Thompson v. U.S. Dept. of Labor, 885 F.2d 551, 555 (9th Cir.1989) (citing Citizens to Preserve Overton Park v. Volpe, 401 U.S. at 420, 91 S.Ct. at 825-26). Judicial review should be based on the full administrative record in existence at the time of the agency decision. Public Power Council v. Johnson, 674 F.2d 791, 794 (9th Cir.1982) (citing Camp v. Pitts, 411 U.S. 138, 142, 93 S.Ct. 1241, 36 L.Ed.2d 106 (1973)). The Ninth Circuit Court of Appeals has expounded on what constitutes the “whole administrative record” by stating: The whole administrative record, however, “is not necessarily those documents that the agency has compiled and submitted as ‘the’ administrative record.” “The ‘whole’ administrative record, therefore, consists of all documents and materials directly or indirectly considered by the agency decision-makers and includes evidence contrary to the agency’s position.” Thompson v. U.S. Dept. of Labor, 885 F.2d at 555 (emphasis in the original) (citations omitted.) Also, the court may consider evidence outside the designated administrative record to determine the adequacy of the designated record. Animal Defense Council v. Hodel, 840 F.2d 1432, 1436 (9th Cir.1988). After considering the evidence presented at trial, the court is convinced that the three volume administrative record as designated by the OTS is not the “whole administrative record” relied on by the agency in reaching its decision to appoint a conservator. The court finds that many documents and matters considered and reviewed by OTS personnel in reaching the decision to appoint a conservator were excluded from the administrative record. The court finds that evidence of additional material considered by the OTS which was not made part of the designated administrative record was properly presented to the court for its consideration in reaching the decision made today. The administrative record presented to the court was a selective compilation of documents considered by OTS and not the “whole administrative record” reviewed and considered by OTS personnel in reaching its decision to appoint a conservator. Moreover, the court finds that the extensive amount of testimony presented at the trial explaining finance accounting principles and various types of securities can be properly considered by the court in reaching its decision regarding the appropriateness of the conservatorship. Supplementation of the administrative record is appropriate if necessary to explain technical terms or complex subject matter involved in an agency’s action. Animal Defense Council v. Hodel, 867 F.2d 1244 (9th Cir.1989) (amending 840 F.2d 1432, 1436 (9th Cir.1988)). The OTS’s decision to appoint a conservator was based on its decisions regarding the accounting principles and practices employed by Franklin and Franklin’s involvement in certain security transactions. To adequately review the OTS’s actions, the court, by necessity, had to acquire a basic understanding of finance accounting principles and the types of securities in which Franklin was involved. Therefore, the court has properly considered general evidence on these matters. Also, to conduct a legitimate review of the agency’s action, the court had to acquire an understanding of the accounting methods used by Franklin and those advocated by the regulator. Thus, the court finds that due to the complex subject matter involved in this case and the technical terms involved, evidence outside the administrative record is appropriate for the court’s consideration. Finally, in addition to the reasons set forth above, the court finds that additional evidence outside the administrative record is admissible and may be considered due to the fact that this case concerns disputes over the interpretation of regulations. See Apex Constr. Co. v. United States, 719 F.Supp. 1144, 1147, n. 1 (D.Mass.1989); Exxon Corp. v. Dept. of Energy, 91 F.R.D. 26, 40-42 (N.D.Tex.1981). For all the foregoing reasons, the court finds that it is not limited, in its review, to the three volume administrative record as designated by OTS. The court has, and properly so, accepted and considered evidence outside of the three volume administrative record. II. FINDINGS OF FACT. A.General Background. 1. Plaintiff Franklin Savings Association is a federally insured, stock savings and loan association chartered by the state of Kansas in 1889 with its principal place of business in Ottawa, Kansas. Plaintiff Franklin Savings Corp. is a Kansas corporation that holds approximately 94 percent of the issued and outstanding guarantee stock of Franklin. The Ernest Fleischer family is the beneficial owner of 55 percent of FSC. The Ted Greene family is the beneficial owner of the remaining 45 percent. FSC has no material assets other than its Franklin stock. The approximately remaining 6 percent of Franklin’s stock, which is not owned by FSC, is owned by Franklin’s employees under an employee stock ownership plan or is publicly traded on the National Association of Securities Dealers Automated Quotation (“NASDAQ”). 2. Franklin’s primary business is earning income based on the net spread between the interest income on mortgage related assets and the cost inherent in acquiring and carrying those assets. Mortgage related assets generally consist of loans secured by an interest in real estate and the cash flows from such loans evidenced by pass through certificates, which represent ownership interests in a pool of mortgaged loans, guaranteed by the United States government or its instrumentalities; mortgaged derivative products secured by such pass through certificates; and private mortgage participation certificates which have received one of the two highest ratings of the rating categories of a nationally recognized rating organization. 3. Defendant Office of Thrift Supervision is an agency of the United States of America. OTS was created in 1989 with the enactment of FIRREA. The director of OTS has all the powers that had been vested in the Federal Home Bank Board prior to the enactment of FIRREA, except for those powers which were transferred to other agencies. Among the powers vested in the director of OTS is the power to appoint a conservator or receiver for a savings association. 12 U.S.C. § 1464(d)(2)(E). 4. David A. Douglass is the commissioner of the Kansas Savings and Loan Department, a state agency responsible for regulating and monitoring the activities of state chartered savings and loan associations. 5. On February 15, 1990, M. Danny Wall, then director of OTS, appointed the Resolution Trust Corporation as conservator of Franklin based on his findings that: A. Franklin was in an unsafe and unsound condition to transact business, including having substantially insufficient capital or otherwise; B. Franklin had incurred or was likely to incur losses that would deplete all or substantially all of its capital, and that there was no reasonable prospect for Franklin’s capital to be replenished without federally funded assistance; C. There was a violation or violations of laws or regulations, or unsafe or unsound practice or condition which was likely to cause insolvency or substantial dissipation of both assets or earnings, or was likely to weaken the condition of the association or otherwise seriously prejudice the interest of its depositors. 6. On February 15, 1990, Commissioner Douglas gave written approval that one or more of the statutory grounds specified for the appointment of a conservator for Franklin existed. 7. On March 12, 1990, FSC and Franklin filed this lawsuit contesting OTS’s appointment of the RTC as conservator and seeking interim injunctive relief preventing OTS from appointing a receiver. 8. Ernest M. Fleischer served as chairman of the board of Franklin Savings Association until the appointment of conservator on February 16, 1990. Mr. Fleischer has a bachelor of arts degree, a bachelor of science degree in business administration and a masters degree in business administration from Washington University in St. Louis, Missouri. He also has a law degree from Harvard Law School. In 1957 Mr. Fleischer passed the certified public accountant (CPA) examination. 9. Mr. Fleischer practiced tax law from 1959 to 1985 and has been involved in the regulation and operation of the thrift industry since the 1960s in connection with his law practice. 10. In 1967 Mr. Fleischer acquired 25 percent interest in General Savings Association. Mr. Fleischer, Carson Cowherd and Ted Greene were the owners of General Savings Association. Following an exchange of stock between Messrs. Cowherd and Fleischer, Mr. Fleischer relinquished his interest in General Savings Association and acquired an interest in Franklin Savings Association. 11. In 1974 Franklin reported an accounting loss. Thereafter, Harry Coffman, a member of Franklin’s board of directors, commented on the inherently risky nature of the business of operating a savings and loan association. Coffman noted that the risk in the thrift industry resulted from the fact that thrift institutions had to solicit from the public short term deposits to invest in long term fixed rate assets. If interest rates increased, the savings and loan would have to pay increasing rate on deposits even though it had been previously locked into a fixed rate of return on its assets portfolio of long term home loans. If interest rates increased, the association would also face a potential credit crunch because depositors would withdraw their money from the savings and loan institution, whose maximum interest rate at that time was set by regulation, and invest it in institutions offering higher rates of return. 12. Another risk to which Franklin and other thrifts are exposed is prepayment risk. Prepayment risk results from the option included in home mortgages which allows the home mortgagor to prepay the mortgage obligation. The mortgagor will more likely exercise this option if the prevailing interest rate drops below the rate of the mortgage note. 13. In the late 1970s and early 1980s, interest rates rose dramatically from about 8 percent to about 18 percent, a change of 1000 basis points. A basis point is Vioo of 1 percent change in interest rate. A change in 100 basis points equals a change of 1 percent in the interest rate. This period of dramatic escalation of interest rates caused the true thrift crisis in the United States. 14. At the time of these rapidly rising interest rates, the balance sheet of Franklin appeared favorable based on GAAP figures, under which its assets were carried at a historical cost, rather than current market value. Franklin knew, however, that if interest rates remained high, capital would soon become depleted because depositors would invest their funds at new higher rates as their deposits matured with Franklin. 15. During the late 1970s and early 1980s, Congress responded to the crisis in the thrift industry by deregulating that industry and allowing thrifts to enter broader categories of business and to no longer cap the rate at which the institutions could pay interest on deposits. See generally The Depository Institutions Deregulation Act of 1980, Pub.L. No. 96-221, 94 Stat. 142 (1980); and The Garn-St Germain Depository Institutions Act of 1982, Pub.L. No. 97-320, 96 Stat. 1469 (1982). 16. During this period, Franklin discovered that it had economic losses in place that ranged from $40-60 million. To address these losses, Franklin retained Dr. Wayne Angelí, then a professor of economics and finance at Ottawa University in Ottawa, Kansas. Dr. Angelí was retained to determine whether Franklin could earn back the losses already in place and continue to operate as a profitable business. 17. In 1981 Dr. Angelí determined that Franklin could earn a safe profit on the purchase of Government National Mortgage Association (“GNMA”) mortgage backed securities (“MBS”). Dr. Angell’s analysis indicated that these securities could be purchased at a value that far exceeded the cost of funds to carry those assets. 18. In 1982 Franklin began buying deep discount Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corp. (“Freddie Mac”) mortgage backed securities. These securities, unlike the GNMA assets, were not backed by the full faith and credit of the United States government, but carried federal agency status. Franklin decided to acquire these securities because at that time the market for such securities did not present a credit risk to Franklin. Also at that time, Franklin began to sell its deep discount GNMA securities, since the Fannie Mae and Freddie Mac securities provided a better investment for Franklin. 19. In 1982 Franklin was initially contacted by the consulting firm of Smith, Breeden & Associates (“Smith, Breeden”). Smith, Breeden instructed Franklin that it could hedge the risk present from the repricing of its liabilities and thus manage the institution’s interest rate risk. 20. Smith, Breeden advised Franklin to hedge interest rate risk in the financial futures market. As a condition to receiving advice from Smith, Breeden, Franklin agreed not to enter the financial futures market for purposes of speculation. 21. Franklin initially used Smith, Bree-den’s services to hedge the maturity mismatch between its assets and liabilities. In this hedging program, if interest rates increased, Franklin would experience gains from its positions in the futures market which would be used to offset its increased cost for funding deposit liabilities at a new higher rate of interest. Conversely, if interest rates declined, the losses suffered in the futures market would be offset by the gains from the repricing of the liabilities. 22. In 1984 interest rates were very high and a demand was created in the market for very long term (longer than 30 years) zero coupon bonds. Since the very long term rates were lower than the 30 year treasury rate, a market opportunity existed for Franklin to issue such long term obligations. Franklin filed an application with the Federal Home Loan Bank Board (the regulatory predecessor of the OTS) to issue such a bond obligation. The application was approved and Franklin issued $2.9 billion in zero coupon bonds. 23. From June 1984 until the spring of 1985, interest rates declined significantly. This decline caused the deep discount assets in Franklin’s portfolio to approach par. As a consequence, the prepayment option in the home loan pools owned by Franklin was no longer solely favorable to Franklin. Franklin found itself in a position in which it needed protection from both the risk of increasing and decreasing interest rates. Thus, Franklin took short positions in the futures market, as it had done with respect to the repricing of liabilities, and also took steps to repurchase from the market the prepayment option that the home owner possessed in order to manage the prepayment risk. 24. In an effort to purchase options to hedge the prepayment risk, Smith, Breeden recommended that Franklin purchase current coupon obligations. During 1985, Franklin sold the deep discount loans in its portfolio. Current coupon loans were purchased when Franklin began purchasing put and call options. A put option is the right to deliver a security at a fixed price so that if interest rates go up and the value of the security goes down, Franklin can collect the higher price. A call option gives a party the right to buy an obligation at today’s price, even if interest rates decline and the price of the security increases. 25. In December 1985 Dr. Angelí determined that Franklin needed to purchase more call options to protect against the possibility of declining interest rates. He reported these findings to Franklin’s officers in early 1986. 26. After determining the number of options it needed to purchase to be fully hedged, Franklin learned that if such options were purchased, Franklin would have virtually no net income for 1986. This finding was consistent with Dr. Angell’s findings in the early 1980s that a par value loan cannot be fully hedged by a thrift and produce economic value. 27. After Franklin purchased the options enabling it to be hedged, interest rates went down in early 1986. The options which it had purchased were due to expire in May 1986. Franklin sold these options and realized a gain from these sales. The sales resulted in approximately $140 million in option gains that were recognized at that time and not deferred over future years. 28. In its annual report for the year ended June 30, 1986, Franklin reported the gain from the options’ sales under GAAP and noted that the sales distorted the firm’s income pattern since it caused an immediately recognized gain which otherwise would have come in ratably over approximately a 7-10 year period. 29. Following the 1986 options sales, Franklin began acquiring longer term assets to match its longer term liabilities. Franklin bought federal agency zero coupon obligations which had maturity dates of approximately the same as the zero coupon bonds issued by Franklin in late 1984. Since these agency obligations were bought and sold in a market at a very tight spread over the U.S. Treasury rate, it was difficult for Franklin to make money on the agency zero coupon obligations. Thus, Franklin sought to replace these obligations with home loan cash flows which could match the interest rate sensitivity of the agency zero coupon bonds. 30. To replace the agency zero coupon bonds, Franklin assembled several hundred million dollars of mortgage backed securities and ultimately issued a one billion dollar collateralized mortgage obligation (“CMO”). A CMO consists of a series of traunches into which home loan cash flows are carved. 31. Some traunches in the CMO represent the early payments that come due on the home loans represented in the CMOs. Other traunches represent the later payments on the home loans. The traunches comprising the earliest payments represent very certain cash flows which can be sold at a very tight spread over the treasury yield curve. The traunches representing the later payments, and which Franklin retained in its portfolio, represent less certain cash flows having a wider spread to the treasury yield curve. Franklin benefited from retaining these later payments because the value sensitivity of these later payments is similar to the sensitivity of the zero coupon obligations which Franklin sought to replace and which matched Franklin’s long term liabilities. 32. With respect to the $1 billion CMO, Franklin sold two traunches representing cash flows due during the first four years of the home loans in the CMO. These were sold in the summer of 1986. These early payment traunches accounted for approximately $600 million; whereas the later payment traunches retained by Franklin accounted for approximately $400 million in cash flows. 33. At this same time, Franklin acquired another $1 billion in mortgage backed securities to create and issue another similar CMO. Franklin financed these acquisitions through Merrill Lynch at a short term rate that changed every 30 days. To hedge this financing expense, Franklin sold short positions in the futures market. When Franklin determined that it was not necessary to issue the additional CMO, it sold the billion dollars worth of home loans, closed out the associated liabilities and terminated the short positions. Franklin reported both the gains recognized from the sales and the hedged losses at the same time on its financial statements for the year ended June 30, 1987. 34. In August 1986, FHLBB-Topeka raised various questions concerning the initial CMO issued by Franklin. At that time, Franklin had planned to issue one CMO each month. While FHLBB-Topeka stated in February 1987 that they were satisfied with the manner in which Franklin had issued the CMO, Franklin had decided by that time not to issue additional CMOs. 35. Instead of issuing additional CMOs, Franklin determined in 1987 to purchase principal-only obligations. Franklin concluded that these type of obligations better accomplish the intended purpose of a second CMO. A principal-only obligation (“PO”) represents the principal payments on a stream of pooled mortgage cash flows. . 36. In 1985 Franklin considered entering the business of acting as a retailer for Smith, Breeden’s hedging package. Before entering such business, Franklin insisted that the firms to which it would provide counseling service have the same information and software available to them as did Franklin. Smith, Breeden determined that the Smith, Breeden software, then in Franklin’s possession, should be returned. After returning the software, Franklin determined that it was uncomfortable operating without knowing the assumptions that were in the software. These assumptions could only be understood by examining the software and having it continually available. 37. In late 1986, Franklin began the search to hire an individual to lead and develop a research division, in house, at Franklin. The research division was to replace the services that had been provided by Smith, Breeden. In the fall of 1987, John Scowcroft began working at Franklin. Mr. Scowcroft had formerly been the head of the research department at Merrill Lynch. 38. Mr. Scowcroft successfully assembled a highly skilled and talented cadre of professionals in Franklin’s newly created research department. This department was comprised of individuals having PhDs in finance and economics and MBAs, and having practical experience at many of the top finance and brokerage firms in the nation. These individuals included Mas-soud Heidari, who had a PhD from MIT in engineering and who had previously worked at First Boston; Steve Hotopp, who had a PhD from the University of Illinois; and Dick Kazarian, who had a MBA from the University of Chicago and who had worked at Drexell. All these individuals worked on developing Franklin’s computer models. Franklin also recruited Liz Kearns, MBA Farleigh, Dickinson University, who had worked at Merrill Lynch and Standard and Poore. Ms. Kearns was hired to work with liability management. Ramine Rouhani,, PhD from Stanford in engineering and economics, had worked at Goldman Sachs and CitiCorp, and was hired by Franklin to work with management, hedge analysis and interest rate models. Furthermore, Franklin was successful in recruiting Michael Smirlock, PhD from Washington University, who had been a tenured professor at the Wharton School of Business. Smirlock was in charge of Franklin’s asset acquisitions. Also, Franklin hired William Marshall, PhD from Washington University. Mr. Marshall previously had been co-manager of Goldman Sachs’s financial strategies group. 39. On June 30, 1987, Franklin acquired the investment banking firm of L.F. Rothschild & Co. This investment was unsuccessful and in 1989 Franklin took steps to close the Rothschild activity. As a result of the L.F. Rothschild acquisition, Franklin experienced a $35-37 million loss for the fiscal year ended June 30, 1989. If not for the one time loss resulting from the L.F. Rothschild investment, Franklin would have reported a profit for fiscal year 1989, rather than a $9 million loss. B. Regulatory History Preceding the 1989 Examination. 40. From 1980 through August 10, 1988, Franklin was periodically examined by federal and state regulators. From 1984 through August 10, 1988, the Federal Home Loan Bank Board (“FHLBB”) had given Franklin a composite rating of “2” in each yearly examination. A “2” rating is the normal rating for a safe and sound institution and indicates that the regulators believe that the institution is fundamentally sound. 41. Franklin received a composite rating of “2” on August 5, 1985, even though the amount of futures losses as of June 30, 1985, was slightly greater than the amount of Franklin’s capital on that date. 42. At the time of the 1988 Franklin examination, Franklin owned approximately the same amount of mortgage derivative securities as it did on the date of the imposition of the conservatorship. 43. During the course of the 1988 examination, the FHLBB retained as special consultant, Dr. William C. Handorf. Handorf examined Franklin’s hedge correlation accounting policy and its application. The policy examined by Dr. Handorf included the absolute value method which had been in effect at Franklin since April 1988. Dr. Handorf issued his report on September 16, 1988. 44. Dr. Handorf concluded that Franklin had implemented “a defensible hedging program.” However, Dr. Handorf raised some concerns about the correlation policy Franklin used in its hedge program. Dr. Handorf was somewhat troubled by the seven year assumed life of the assets used in the hedge program. He felt the assets duration was shorter. Dr. Handorf was also troubled by the disallowance of the first month’s result in determining hedge correlation. Dr. Handorf’s report further concluded that there was no evidence that Franklin was involved in any type of speculation on the futures market. Dr. Handorf summarized his conclusions by stating that the hedging program implemented by Franklin appeared reasonable, and although the method of calculating correlation is generally acceptable, certain rules should be revised. Dr. Handorf recommended that the FHLBB conduct a “limited” or “special” examination prior to the end of fiscal year 1989 regarding his concerns about the correlation policy. 45. In the fall of 1988, Jerry Mayne, Franklin’s chief administrative officer, was contacted by a consultant who had been the executive vice president of the Federal Home Loan Bank of Topeka to determine if Franklin would be interested in bidding on failed thrifts in Missouri. While no Missouri thrift was available for Franklin’s bid, the Federal Savings and Loan Insurance Corp. informed Franklin of the possibility of bidding on Beverly Hills Savings & Loan, a failed California thrift. In the fall of 1988, Franklin notified FHLBB-Topeka of its interest in bidding on Beverly Hills Savings & Loan. The Kansas Savings and Loan Department in its exercise of regulatory jurisdiction over Franklin reviewed the intended Beverly Hills’ acquisition. 46. Franklin retained the investment banking firm of Goldman Sachs to assist Franklin in reviewing Beverly Hills Sayings & Loan in preparation of its bid. In December 1988, Franklin learned from Jay Jupiter, of FSLIC, that FHLBB-Topeka had determined that Franklin was not a qualified bidder for the Beverly Hills institution. FHLBB-Topeka had withdrawn its approval of Franklin as a qualified bidder for Beverly Hills Savings & Loan. In January 1989, representatives from Franklin met in Washington, D.C., with FHLB representatives, including Tommie Thompson and Darrell Dochow. At that meeting, Franklin stated that it would resolve any of the regulator’s concerns if FHLB would allow Franklin to go ahead and acquire Beverly Hills. FHLB incorrectly interpreted Franklin’s offer to resolve differences as a sign of desperation. 47. Immediately following the Beverly Hills episode, the Office of Regulatory Activities (“ORA”) of FHLBB in Washington, D.C., generated a list of hedge accounting issues concerning Franklin. The FHLBB ultimately pursued only one of these issues, the issue concerning the hedge accounting by Franklin for its zero coupon bonds. 48. The chief accountant’s office of FHLBB in Washington conducted an extensive follow-up on Dr. Handorf’s report and examined Franklin’s accounting practices. FHLBB accounting fellow, Julie Gerschick, prepared draft reports to Tommie Thompson of FHLBB-Topeka raising various questions. 49. The Topeka regulators elected to pursue two issues with Franklin. One involved the amortization period for futures gains and losses and the other involved amortization of hedge losses on zero coupon bonds. 50. Ultimately, the issue which the regulators pursued against Franklin was the hedge accounting for zero coupon bonds. This issue was resolved for all practical purposes in Franklin’s favor. 51. After December 1988 and the failed attempt to acquire Beverly Hills Savings & Loan, Franklin began a series of monthly meetings with federal regulators. Franklin proposed these meetings in order to keep the regulators up to date on what Franklin was doing and so that Franklin could hear any regulatory concerns. 52. In early 1988 Franklin began discussions with Goldman Sachs to explore raising additional capital. Franklin sought this additional capital to obtain a very high interest grade rating. Because of adverse regulatory action against Franklin in connection with the Beverly Hills’ matter, and because of the pending FIRREA legislation, Goldman Sachs advised that it would be highly unlikely that Franklin could raise the desired additional capital during that year. 53. In the spring of 1989, Franklin decided that it would reduce its size by approximately $5 billion so that it could achieve an 8 percent capital level which was necessary to obtain a high investment grade rating. 54. Following the resolution of the hedge loss amortization issues on the zero coupon bonds following the 1988 examination, OTS-Topeka wrote a letter to Franklin stating that it still had concerns about certain aspects of its hedge accounting program. This letter caused Franklin and its outside auditors to be concerned about Franklin’s annual report (Form 10K) for the fiscal year ended June 30, 1989. 55. After many discussions, Louis V. Roy, deputy district director of OTS-Topeka, wrote Franklin on September 27, 1989, and stated that OTS was not in a position to make supervisory objections to Franklin’s hedge accounting practices at that time. His letter stated that OTS “will continue to review and analyze Franklin's hedge accounting practices in the future.” Franklin considered this statement to be consistent with OTS’s ongoing regulatory duties and not a statement that any issues remained open. Mr. Fleischer understood this letter, together with the 1988 examination of Franklin, as indicating that as of September 1989 OTS had no legitimate concerns regarding Franklin’s past accounting practices. C. The Regulatory Examination of October 1989 Through February 1990. 56. Commencing October 16, 1989, a concurrent joint regular examination of Franklin Savings Association was conducted by the OTS, KSLD and the Federal Deposit Insurance Corp. (FDIC). 57. In late 1988 some members of the FHLBB-Topeka staff were highly criticized for their handling of Silverado Savings & Loan, a Colorado thrift, and were informed by Chairman M. Danny Wall that their jobs were in jeopardy if their performance did not improve. Some of these same individuals were later involved in the October 1989 Franklin examination. 58. The analyst in charge of Silverado, Thomas O’Rourke, was assigned to work full time on the Franklin examination and matters relating to Franklin beginning July 1, 1989. 59. Mr. O’Rourke noted that Franklin had in its portfolio similar assets to those formerly held by Silverado. This similarity probably slanted Mr. O’Rourke’s view against Franklin and Franklin’s system of operations. 60. Mr. O’Rourke reviewed and read Franklin’s Form 10K (annual report) for the period ended June 30, 1989.' Mr. O’Rourke had previously read only one Form 10K and was unaware of the disclosures required in such a document. O’Rourke misperceived the cautionary disclosures of “material adverse risk” in the Form 10K as projections that the institution would experience difficulties. However, Franklin made these disclosures to fulfill its duty under federal securities laws. Such disclosures were included in earlier lOKs filed by Franklin. After reviewing the Form 10K, Mr. O’Rourke drafted a memorandum changing Franklin’s internal OTS classification from “healthy” to “marginal.” 61. The disclosures presented in Franklin’s 10K for the period ended June 30, 1989, were proper. The conclusions O’Rourke and OTS reached after reviewing the 10K, that the risks disclosed were likely or probable to occur, were arbitrary and capricious and without reasonable basis. 62. Members of the OTS-Topeka staff appeared to lack adequate training and understanding to evaluate the nature of Franklin’s operation. The written analyses and memoranda prepared by the Topeka staff, including portions of Franklin’s report of examination (Administrative Record Document 36), Mr. O’Rourke’s review of Franklin’s Form 10K (Exhibit 825), and the recommendation memo (“S Memo”) dated February 12, 1989 (Administrative Record Document 6, also in evidence as Exhibit 469), contained fundamental factual errors as well as material errors of interpretation and analysis. 63. During the course of the 1989 examination, Franklin cooperated fully with OTS regarding each general and specific request for information. 64. On November 3, 1989, OTS-Topeka provided Franklin with a supervisory directive, which Franklin fully responded to by letter dated December 19, 1989. (Exhibits 314, 598). This December 19, 1989, letter was not made part of the administrative record designated by OTS. 65. On December 21, 1989, members of the OTS-Topeka staff met with Franklin representatives and informed Franklin that the OTS had calculated that Franklin must take approximately $248 million in capital write-downs because Franklin had inappropriately deferred that amount of hedging losses. At that meeting, OTS provided Franklin with a document entitled “Hedge Correlation Analysis Methodology” which set forth the way in which OTS had reviewed Franklin’s hedges. 66. Franklin’s hedge correlation policies were discussed between representatives of OTS, FDIC, Franklin and Deloitte and Touche at the January 8, 1990, examination exit conference; a meeting held on January 18, 1990; and a meeting held on February 8, 1990. The OTS, however, rejected all the justifications Franklin offered for its hedge correlation policy and reaffirmed its tentative conclusion that a large capital adjustment must be made regarding this issue. 67. At the time OTS presented the “Hedge Correlation Analysis Methodology” document to Franklin, representatives from OTS informed Franklin that OTS had recalculated Franklin’s hedge correlation using the methodology described in the hedge accounting memorandum. (Pretrial Order stipulation (j)). The “Hedge Correlation Analysis Methodology” document was not included in the administrative record. (Pretrial Order stipulation (k)). 68. In January 1990 Louis Roy informed Franklin that its proposal for reducing its portfolio of TB 12 assets as outlined in Franklin’s December 19, 1989, letter was unsatisfactory. In response to this statement, Franklin prepared a letter dated February 8, 1990, outlining in detail the sensitivity of Franklin’s TB 12 assets portfolio, as well as Franklin’s proposal to reduce the size of its TB 12 portfolio and total assets over the coming months. (Exhibit 316.) This February 8, 1990, letter was not made a part of the administrative record designated by OTS. This letter indicates that OTS should have known that Franklin could have remained in compliance with all regulatory capital requirements, even if the financial statement adjustments ordered by OTS were ultimately upheld. 69. On January 8, 1990, representatives from OTS, KSLD and FDIC met with Franklin representatives to conduct an examination exit conference, as stated above. At this conference, OTS informed Franklin of the examination’s preliminary results. Franklin would be required to make write-downs for inappropriate hedge accounting, and for improper over-valuation of property involved in Franklin’s credit enhancement program. The OTS alleged that Franklin would fail its regulatory capital requirements as a result of these write-downs. Franklin resisted the proposed write-downs contending that the write-downs were invalid and lacked legal or factual basis. 70. Following the exit conference, Franklin’s chief financial officer, Dennis Katzer, reviewed Franklin’s bond indentures to determine if there were any problems. On January 11, 1990, Franklin informed OTS of the possibility of collateral substitution or legal defeasance of certain zero coupon bonds if the contested adjustments were ultimately upheld. 71. Prior to January 11, 1990, OTS had engaged in discussions with Franklin management with respect to the imposition of an individual minimum capital requirement (“IMCR”) for Franklin. (Pretrial Order stipulation (n)). OTS’s consideration of an IMCR for Franklin ceased sometime after Franklin’s disclosure of the potential bond defeasance. (Pretrial Order stipulation (o)). Upon learning of the potential bond defeasance, OTS’s internal classification for Franklin changed from “distressed” to “resolution I.” (Pretrial Order stipulation (p)). 72. On January 22, 1990, Franklin met with OTS representatives to discuss OTS’s apparent inaction with regard to various issues raised by the examination and to present OTS with certain alternative courses of action. Franklin did not at this meeting or any subsequent time consent to an appointment of a conservator or receiver. 73. Mr. Fleischer’s draft letter of January 22, 1990 (Exhibit 623), does not evidence any consent to a conservatorship or receivership. The draft letter simply was used to discuss all possible outcomes. This draft letter was not part of the administrative record. Moreover, the legal memorandum (“L-memo”) (Administrative Record Document 3) shows that OTS expected litigation if a conservator was appointed. The legal memorandum indicates that OTS knew Franklin had not consented to such an appointment. The legal memorandum stated: “OTS/legal believes that there may be a challenge to the proposed transaction.” 74. The recommendation memo, or “S-memo,” (Administrative Record Document 6) went through several drafts before the final form was executed. The draft preceding the final version was changed, on specific advice and instruction of OTS-Topeka district counsel, Brian McCormally. McCormally indicated that it was necessary to “point the finger” at Franklin’s management. See handwritten instruction on Exhibit 826, p. 33 (T0026063). No factual or legal basis exists for McCor-mally’s instruction. This action is indicative of arbitrary, capricious and unreasonable conduct. 75. On February 14, 1990, Franklin issued its Form 10Q (Quarterly Report) for the quarter ended December 31, 1989. Pri- or to issuing this Form 10Q, Franklin provided it to OTS for review. OTS reviewed and discussed this Form 10Q with Franklin before it was filed. (Pretrial Order stipulation (r)). The Form 10Q clearly states that Franklin believed that OTS’s proposed adjustments were not valid and that Franklin intended to oppose those adjustments by “all appropriate means.” (Exhibit 624, p. 20.) The Form 10Q was not a report of capital failure and did not trigger any collateral substitution or legal defeasance remedies for the bond trustee under the indenture for the zero coupon bonds. 76. The OTS had initially scheduled to appoint the conservator for Franklin on February 14, 1990. OTS had scheduled a meeting with Franklin’s board of directors for that date to provide the report of examination and to impose the conservatorship. On February 13, 1990, OTS director M. Danny Wall decided to impose a conservator for Franklin, but decided to postpone the takeover until after the release of Franklin’s Form 10Q. 77. At the direction of Director Wall, the Franklin board meeting was rescheduled for February 16, 1990. At this meeting, OTS presented Franklin with the report of examination and informed Franklin that a conservator had been appointed for Franklin. 78. On February 14, 1990, Mr. Fleischer had spoken with a representative of the bond trustee, IBJ Schroder, concerning whether the publication on that day of Franklin’s Form 10Q would constitute an event of default triggering the collateral substitution or legal defeasance provision of the bond indenture. The representative of IBJ Schroder informed Fleischer that the Form 10Q did not constitute an event triggering the default. During this conversation, the IBJ Schroder representative and Fleischer further discussed the possibility of a bond exchange which would in any event avoid or greatly lessen the loss from any collateral substitution or legal defea-sance. 79. The following day, February 15, 1990, Mr. Fleischer informed Thomas O’Rourke of the conversation with IBJ Schroder, and that the bond trustee was of the view that the Form 10Q did not constitute an event triggering default and also of the possibility of a bond exchange. Mr. O’Rourke was instructed by OTS district counsel McCormally not to follow-up on this information. 80. OTS had no contact, no conversation, and no correspondence with the bond trustee concerning any matter arising in connection with the zero coupon bond indenture prior to February 16, 1990. (Pretrial Order stipulation (t), (u) and (v)). Also, OTS did not contact the bond trustee to inquire whether any event had occurred or was about to occur that would trigger the collateral substitution or legal defea-sance of the bonds. (Pretrial Order stipulation (w)). 81. At the February 16, 1990, board of directors meeting, OTS district counsel Brian McCormally informed Franklin that OTS’s outside counsel had provided an opinion that the Form 10Q as published and the report of examination constituted an event of default allowing the bond trustee to begin collateral substitution or legal defeasance. This was erroneous. 82. No formal administrative hearing was held prior to the appointment of the conservator. (Pretrial order stipulation m 83. Following the imposition of the conservator, OTS sent a letter, dated February 20, 1990, directing RTC/Franklin to make a $119 million write-down for inappropriate deferred hedging losses, a $46 million write-down due to inadequate valuation allowances for properties involved in Franklin’s credit enhancement program, and a $185 million write-down on the basis that the bond defeasance was an event likely to occur. The RTC did make the $119 million and the $46 million write-downs. The RTC, as conservator for Franklin, at that time and subsequent times, resisted the proposed bond defeasance write-downs as not appropriate in view of its power under FIR-REA to repudiate the bond indentures. Franklin has never filed a report showing capital failure, and thus bond defeasance has never been an event likely to occur prior to the takeover of Franklin. 84. Following the OTS’s February 20, 1990, directive concerning the hedge accounting and credit enhancement write-downs, Franklin nonetheless had the means to comply with all regulatory capital requirements through transactions already scheduled to occur. Exhibit 603 is a table showing Franklin’s ' available means to meet or exceed all regulatory capital requirements after the first wave of adjustments. 85. The Savers Life intangible asset indicated in the table on Exhibit 603 relates to the purchase by Franklin subsidiary Savers Life Insurance Company of a block of insurance policies from Sun Life Insurance Company. The court finds that this intangible asset may be properly included in Franklin’s capital because it meets the three requirements set out in 12 C.F.R. § 567.5(a)(2)(h). First, the intangible asset is capable of being sold apart from Franklin’s and Savers Life’s other business. Second, a market clearly is established annually through an identifiable cash flow stream for the assets acquired. The market value of the cash flow stream is not in any way dependent on the future prospects of Franklin, and indeed the cash flow stream from Savers Life intangible bears no relationship to Franklin’s other activities. Finally, a large market exists for blocks of insurance policies making this asset liquid. See Conclusion of Law No. 10. 86.Franklin properly included in its capital this amount of its investment in its Savers Life subsidiary, even though it was engaged in an activity not permitted for national banks. The amount of Franklin’s investment in its Franklin Financial Services (“FFS”) subsidiary in October of 1989, which was used to fund Savers Life’s purchase of the block of insurance policies, did not exceed Franklin’s investment in and extension of credit to FFS as of April 12, 1989. Based on applicable law, this asset was properly included in Franklin’s capital. See Conclusion of Law No. 11. 87. The “sale of assets” referred to in Exhibit 603 was a step which Franklin could take to meet capital requirements after the first wave of adjustments and was explained to OTS prior to the conserva-torship in attachments to Mr. Fleischer’s letters of December 19, 1989, and February 8, 1990. 88. On March 7,1990, the RTC recorded some of the accounting adjustments set forth in OTS’s February 20, 1990 directive. (Pretrial Order stipulation (af)). OTS learned that since RTC refused to make all the adjustments set forth in the,directive, Franklin would significantly fail only one of the three capital requirements imposed on Franklin by FIRREA and OTS regulations (tangible capital, core capital, and risk base capital). (Pretrial Order stipulation (ag), (ah), Exhibits 633, 686). 89. On or about March 8, 1990, OTS reviewed four alternative hedge accounting adjustments for Franklin. (Pretrial Order stipulations (ai)). 90. Prior to the imposition of the conservator, OTS had considered the four alternative hedge accounting adjustments which it reviewed again on March 8, 1990. (Pretrial Order stipulation (aj)). OTS Topeka apparently chose one of the four additional options prepared by Mr. Benson and considered it a “safety and soundness” concern to effect extra write-downs to its concern about historical asset sales. The option selected was basically a disallowance of the “six month grace period feature” of Franklin’s hedge, accounting policy. See, infra., Finding of Fact No. 116. 91. On March 8, 1990, OTS was informed by facsimile transmission that Franklin had available the means to meet regulatory capital requirements, even if the hedge accounting and credit enhancement write-downs were valid and that RTC was preparing to announce publicly that Franklin was a solvent institution. On the following day, March 9, 1990, OTS imposed a second wave of adjustments consisting of an additional $61.9 million (later corrected to $51.9 million) (Exhibit 132) “safety and soundness”, hedge accounting write-down and a write-down of $110 million relating to the tax agreements entered into between Franklin and FSC. The court finds that this second wave of adjustments imposed on March 9, 1990, was arbitrary and capricious and lacked any reasonable basis. 92. In view of the invalidity of OTS’s proposed write-downs, Franklin exceeded all three regulatory capital requirements on December 31, 1989. 93. In view of the invalidity of OTS’s proposed adjustments, Franklin exceeded all three regulatory capital requirements on March 31, 1990. 94. On June 1, 1990, OTS Director T. Timothy Ryan issued a “ratification and appointment order,” which attempted to ratify the initial conservator appointed on February 15, 1990, and to appoint a new conservator based on an expanded administrative record. This court has determined that the purported ratification and appointment of a new conservator was invalid. See Memorandum and Order of June 22, 1990. D. OTS’s Directed Write-downs for Deferred Hedging Losses. 95. At all times relevant to the October 1989 examination, Franklin was a liability hedger. On June 30, 1989, Franklin switched to operati