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November 8, 2002
Breaking the Bank

Hopefully, they were on their way in to close their accounts.
After federal regulators closed the $2.3 billion Superior Bank in July 2001, investigations revealed that the suburban Chicago thrift was tainted with the hallmarks of a mini-Enron scandal. New legal developments are adding additional twists, including racketeering charges. And yet the bank’s owners, members if one of America’s wealthiest families, ultimately could end up profiting from the bank’s collapse, while many of Superior’s borrowers and depositors suffer financial losses.

The Superior story has a familiar ring. Using a variety of shell companies and complex financial gimmicks, Superior’s managers and owners exaggerated the profits and financial soundness of the bank. While the company actually lost money throughout most of the ’90s, publicly it appeared to be growing remarkably fast and making unusually large profits. Under that cover, the floundering enterprise paid its owners huge dividends and provided them favorable loans and other financial deals deemed illegal by federal investigators.

Superior’s outside auditor, which doubled as a financial consultant, engaged in dubious accounting practices that kept feckless regulators at bay. Many individuals—disproportionately low-income and minority borrowers with spotty credit records—had apparently been exploited through predatory-lending techniques, including exorbitant fees, inadequate disclosure and high interest rates. In the end, more than 1,000 uninsured depositors lost millions of dollars in savings in one of the biggest bank failures of the past decade.

Yet unlike Enron, the people behind Superior’s collapse were not nouveau-riche corporate hustlers, but members of Chicago’s Pritzker family. The Pritzkers, whose two current patriarchs—Robert and his nephew Thomas—tie for 22nd place on Forbes’ list of the richest Americans, own an empire valued at more than $15 billion, including the Hyatt hotel chain, casinos, manufacturers and real estate, and they are major contributors to both political parties. They were equal partners in the private ownership of Superior with New York real estate developer Alvin Dworman, a longtime associate of Thomas’ father, Jay Pritzker, who died in 1999.

And Superior’s accounting and consulting was not provided by the disgraced Arthur Andersen, but by Ernst & Young. When regulators shuttered the bank, the publicity-shy Pritzkers, who take pride in their philanthropy (such as the prestigious international architecture award in the family name) quickly negotiated what appeared to be a generous settlement to stay out of the newspapers and the courtrooms.

But now both the Pritzkers and Ernst & Young may face the legal and public relations uproar they were trying to avoid. On November 1, the Federal Deposit Insurance Corporation (FDIC) sued Ernst & Young for more than $2 billion. The FDIC alleges that the firm concealed its improper accounting practices at Superior to facilitate the sale of its consulting unit for $11 billion, leading to Superior’s insolvency and ultimately costing the FDIC $750 million. Ernst & Young denies responsibility, blaming the bank’s managers and board, failed regulation and changing economic conditions. Investigators from the FDIC, Treasury Department and the General Accounting Office (GAO) had cited all those causes for Superior’s failure, but also had criticized Ernst & Young’s flawed work and conflicts of interest.

Meanwhile, in a case that has received no public notice, uninsured depositors are bringing a charge of financial racketeering against one-time board chairwoman Penny Pritzker, her cousin Thomas Pritzker, Dworman, other bank principals and Ernst & Young. In this federal class-action suit filed under the RICO (Racketeering Influenced and Corrupt Organizations) statute, plaintiffs’ attorney Clint Krislov claims that those who controlled Superior induced depositors to put money in the bank, “corruptly” funneling money out of the bank to “fraudulently” profit the owners. Pritzker attorney Stephen Novack says that the defendants will ask to dismiss the case as having no merit. Such a RICO suit has rarely, if ever, been used to recover money lost in a bank failure, partly because the owners in such cases, in the words of bank consultant Bert Ely, “usually don’t have a pot to piss in.” But the Pritzkers have a gold-plated pot.

This may not be the last of legal battles stemming from the Superior failure. Published reports indicate that a federal grand jury has been investigating potential criminal wrongdoing and that the Internal Revenue Service could press claims against the owners for tax evasion.

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The problems at Superior Bank date back to at least 1988, when the Federal Home Loan Bank Board, in an effort to conceal the depths of the developing savings-and-loan crisis, hastily made generous arrangements for the takeover of several failed thrifts. The Pritzkers and Dworman bought the failed Lyons Federal for the relatively modest price of $42.5 million, with each using a shell corporation to control half of Coast-to-Coast Financial Corporation (CCFC), a holding company created to own Superior.

Superior opened for business with substantial federal assistance and guarantees, but the Pritzkers also reportedly received $645 million in tax credits as an inducement to buy Lyons. This was not the first Pritzker-Dworman joint venture into banking. In 1985, the partners had acquired New York-based River Bank America. But in 1991, federal and state regulators closed River Bank, which was engaged in large-scale real estate speculation, when they discovered that the bank had inadequate capital and was badly managed. Nelson Stephenson, the chief financial officer of River Bank, later became chairman of Superior.

In 1992, the Pritzkers and Dworman transferred ownership of Alliance Funding Company, a nationwide mortgage banking company the partners had founded in 1985, to Superior Bank, which began specializing in selling securities backed by subprime mortgages. Prospective homeowners with less-than-stellar credit ratings often must turn to such subprime lenders, which typically charge higher interest rates to compensate for the higher risk of default.

But a great many subprime lenders also unfairly exploit borrowers, seeking them out through aggressive television, direct mail and telemarketing techniques, then charging excessively high interest rates and exorbitant fees. Since many borrowers are in difficult situations and financially unsophisticated, they often are duped into agreeing to harsh conditions, such as stiff penalties for pre-paying their mortgages if their credit improves or interest rates drop, or improper costs, such as having the entire dividend for a 30-year-mortgage insurance policy included up-front in their mortgage.

Superior Bank accumulated mortgages that originated from its own branches or Alliance offices, as well as those bought from other brokers. They would then issue securities with high credit ratings but lower interest rates than what they charged borrowers. As collateral, these securities were backed by the stream of income from the mortgages. Superior Bank would retain “residual interests”—part of the collateral mortgages plus some of the excess mortgage interest—but they also retained responsibility for all of the potential losses, or what’s known in the business as “toxic waste.”

Because of the greater risks of subprime lending, it was difficult to project the future value of Superior’s residual interests. But aided by Fintek, another subsidiary of CCFC, and abetted by Ernst & Young, Superior made extremely rosy projections and—like Enron—booked those projected profits as immediate, or “imputed,” earnings. The extremely optimistic value of some residual interests was also counted as part of Superior’s capital, which banks must maintain at regulated levels—depending on their condition and type of business—to make sure that depositors can be repaid.

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Examiners from the Office of Thrift Supervision (OTS) expressed concern about aggressive subprime policy, the value of residuals, the level of capital and other bank practices early in the ’90s. But Superior’s managers and board filed erroneous reports and repeatedly failed to take any of the action that regulators recommended. Nevertheless, according to investigators, the OTS did not take any corrective action. They were persuaded that management was experienced (even though two top managers had been involved in large losses or failures at other thrifts); that Ernst & Young had given its approval in annual audits without any reservations (even though the firm had a long history of penalties and censure for its involvement in high-profile thrift failures); and that “because of their financial status, the OTS placed a great deal of reliance on the ability of the owners to inject capital if the institution encountered any financial difficulties,” as the FDIC inspector general’s report stated.

Meanwhile, Superior was growing rapidly: Loan volume rose from $200 million generated in 1993 to $2.2 billion in 1999, with the value of securities issued reaching $9.4 billion. The bank reported a return on assets that was 12 times the industry average. But its reliance on the risky residual interests from its mortgage securitization soared to levels far out of line with the rest of the industry, and by 2000 the bank’s residual interests were valued at more than four times its less fictional capital (such as stockholder equity). Superior expanded its business to subprime auto loans, then had to pull out because it was clearly failing.

All this should have looked like a sea of red flags to regulators, but they issued modest warnings and failed to follow up when management ignored their recommendations. Superior’s management actually revised its accounting methods in 1997 to further exaggerate its projected earnings, and it more than doubled the volume of the lowest quality loans in the following years. It was all a house of cards, but a very lucrative one for the owners. During the ’90s, the bank paid CCFC—and thus the Pritzkers and Dworman—more than $200 million in dividends.

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There was a small problem, however. From 1995 on, investigators concluded, Superior was actually losing money, except for the fictional “imputed” earnings. So the dividends effectively were being paid out of the growing deposits, a practice that Ely describes as having “Ponzi-like characteristics.” Furthermore, in 2000 Superior sold loans to CCFC, which the holding company immediately resold for a $20.2 million profit. Such a sale of assets at less than fair market value to insiders is a violation of federal law. There were other loans made to CCFC and its affiliates totalling $36.7 million—all in violation of the Federal Reserve Act—that were never repaid, the inspector general reported.

Superior also supposedly loaned the Dworman family’s shell company $70 million in 1996, but even though Dworman promised to pay it all back by the end of 1999, the inspector general found no evidence of any payments being made. (Dworman reportedly claimed that the money was a dividend payment concealed as a loan, which would raise questions about tax evasion.) All these transactions enriched the Pritzkers and Dworman at the expense of the bank—and ultimately the FDIC insurance fund and uninsured depositors.

In the spring of 1999, both the OTS and FDIC downgraded Superior’s rating. Over the course of nearly two years, Superior and Ernst & Young resisted the analysis and recommendations of the regulatory agencies, but by January 2001 Ernst & Young finally agreed that the accounting of the residual assets had been wrong. The bank was deeply troubled even in good times, but the vulnerabilities would only increase. As interest rates declined, borrowers would try to pay off high-interest loans and refinance; as unemployment rose, increasing numbers of subprime borrowers would default.

After downgrading the bank further, regulators concluded that it was “significantly undercapitalized” and needed an infusion of $270 million, which the Pritzkers—with some participation by Dworman—agreed in March to provide. Then in July regulators reported that, as a result of overly optimistic assumptions, the bank would need to write off an additional $150 million of of its residual interests. The Pritzkers pulled out of the agreed capital plan, and the feds closed the bank.

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Wanting to avoid a lawsuit, the secretive Pritzkers quickly agreed to what the FDIC hailed in December as the biggest settlement they had ever negotiated. The Pritzkers would pay $100 million immediately, then $360 million over 15 years. But there were lots of little provisions in the agreement that benefit the Pritzkers. First, as former bank consultant and longtime thrift watchdog Tim Anderson notes, the $100 million doesn’t even quite pay back all of the unpaid loans made to the owners. The Pritzkers also pay no interest on the $360 million, and since it is paid over many years, the real cost to the Pritzkers may be only around $250 million. As of September 2002, according to FDIC figures, the insurance fund was still out $440 million after this settlement.

But it gets even sweeter for the Pritzkers. The FDIC also agreed to pay the Pritzkers 25 percent of any claim won in a lawsuit against Ernst & Young. Since the FDIC is now suing for $548 million, the Pritzker share could be $137 million. On top of that, the agreement stated that the Pritzkers get half of any civil penalties from such a lawsuit (after certain agency expenses). The FDIC is asking for triple damages, or $1.64 billion; the Pritzker share could be over $800 million.

Even taking into account the “record” settlement they made with the FDIC, the Pritzkers could make more than $700 million in additional profit for running a financial institution into the ground. They had already profited handsomely, sharing in the more than $200 million in dividends to the owners in the ’90s. They accomplished all this with an investment of about $21 million for each partner—though the Pritzkers had also already benefited from $645 million in tax credits.

Meanwhile, roughly 1,000 depositors who had deposits above $100,000 in a Superior account—money above the FDIC-insured limit—lost about $65 million. Most of them were middle-class individuals, attracted by Superior’s high interest rates. In the three months just before the bank was closed, there was a surge of $9.6 million in uninsured deposits. Since about 54 percent of the uninsured money has since been repaid as Superior was sold off, the depositors have still collectively lost about $30 million. (That just happens to be the amount that the Pritzkers gave to the University of Chicago’s Pritzker School of Medicine earlier this year.)

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Some of that money could have paid back Fran Sweet for the roughly $138,000 that she has still not recovered from her deposits at Superior. After retiring as a manager at a telecommunications company, Sweet was seeking a secure place to put her entire retirement savings of about $500,000. “I knew the Pritzkers were owners of the bank,” she says, “and they were a reputable name in Chicago. I had no idea that the bank was in trouble.”

She even asked a bank manager if there was anything wrong with the bank. “She said, ‘No, nothing is wrong, We’re owned by the Pritzkers,’ ” Sweet recalls. “I want it all back. I worked 23 years for a company and got this money from them as a buyout, and the Pritzker family and Dworman stole it from me.”

People at the other end of the deal—who borrowed from Superior—are also still hurting as a result of the scam. The National Community Reinvestment Coalition, which monitors bank lending, last year accused Superior of participating in a variety of predatory practices, including overly aggressive telemarketing, targeting low-income minority borrowers, and disproportionately incorporating problematic “balloon payments” in the loans. One borrower in Philadelphia, represented by attorney Brian Mildenberg, ended up in bankruptcy partly because Superior didn’t properly credit him for payments he had made. In another case, Cleveland construction worker Dan Sutton claims that a broker for Superior falsified papers to inflate his mortgage and charged exorbitant fees.

The Pritzkers are likely to make out like bandits, which is exactly what customers like Sweet and Sutton think they are. All of the government studies of Superior’s failure agree that there’s plenty of blame to spread around. As the FDIC inspector general’s report concluded, the bank managers pursued an ultra-risky strategy based on unrealistic assumptions and unjustifiably pumped dividends and illegal, unpaid loans out of the bank and into the owners’ coffers.

Ernst & Young provided inaccurate audits, resisted regulators, and did not test or properly disclose crucial financial assumptions. The OTS didn’t investigate or follow up on problems adequately, ignored warning signs for years, and unduly relied on the expertise of managers, the auditor’s report, and the promise of the wealthy owners to put their money behind the bank’s strategy, which they ultimately refused to do. While the FDIC lawsuit against Ernst & Young correctly highlights the accounting firm’s sorry record of accounting malpractice, it ignores the dubious history of the Pritzkers and Dworman in cases ranging from tax evasion to bank mismanagement, instead praising the Pritzkers for their charity.

What looked like a good deal for the FDIC in resolving Superior’s failure is now looking like yet another opportunity for the wealthy Pritzkers to further profit from their misdeeds. Certainly, the record suggests that Ernst & Young bears responsibility, but so do the Pritzkers and Dworman. The question is not just who will extract money from whose pocket in the aftermath of the bank failure, but also whether the rich are simply above the law. The RICO lawsuit against bank managers, owners and auditors raises the issue of criminal conspiracy and at least attempts to recover damages for the uninsured depositors. But beyond that, argues thrift watchdog Anderson, “I think there ought to be a criminal investigation.”


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