HG30.5 .

z5
1982

cop. 1

THE
OF 1980

SILVER CRISIS

A REPORT OF THE STAFF OF THE U.S. SECURITIES AND EXCHANGE COMMISSION OCTOBER 1982

THE ~ILVER CRISIS

OF 1980 I

TABLE OF CONTENTS
. INTRODUCTION AND SUMMARY

INTRODUCTION

..................
...............

3
3

I1 .

SUMMARY OF EVENTS A B

. Buildup in Hunt Silver Holdings . . . . . . . . Market Decline and Hunt Default . . . . . . . . 1 . Cash Drain on Brokers . . . . . . . . . . . 2 . Potential Financial Implications . . . . . 3. Liquidation . . . . . . . . . . . . . . . 4 . The Hunts Refinance . . . . . . . . . . . . 111 . SUMMARY OF PRINCIPAL FINDINGS . . . . . . . . . A . Excessive Exposure in Particular Customers' Accounts . . . . . . . . . . . . . B . Inappropriate Valuation of Customer Commodity Accounts . . . . . . . . . . . . . . C . Inadequate Credit Information . . . . . . . . D . Separately Capitalized Commodity Subsidiaries . . . . . . . . . . . . . . . . . E . Public Disclosure . . . . . . . . . . . . . . F . NYSE Surveillance . . . . . . . . . . . . . . IV . OTHER PUBLIC RESPONSE TO THE SILVER CRISIS . . .
PART ONE: AN OVERVIEW OF HUNT FAMILY ACTIVITY IN THE SILVER MARKET

4 7 9 10 12 14 15 15 15 16 17 17 17 18

........... I1 . THE HUNT FAMILY AND ITS BUSINESS . A . Individuals . . . . . . . . . . B . Corporations and Partnerships . C.Trusts . . . . . . . . . . . . . I11 . HUNT SILVER ACTIVITY .JULY 1979 THROUGH MARCH 1980 .
I

INTRODUCTION

. . . . .

. . . . .

. . . . .

.... .... .... .... ....

23 23 24 26 28 31 31

.......

A . Hunt Family Members and Related Entities Involved in Silver

.........

PAGES R. Developments i n t h e Hunt S i l v e r P o s i t i o n Through Mid-January 1980.

......

1. E a r l y I n t e r e s t i n S i l v e r 2. B u i l d u p i n t h e Hunt S i l v e r P o s i t i o n
C.

Hunt S i l v e r A c t i v i t i e s During t h e Market Decline.

. . . . . . . . . . . . . . . . . . .

1. T h e S i l v e r M a r k e t s , J a n u a r y T h r o u g h M a ~ c h1 3 8 0 2 . T h e Impact o n t h e H u n t s o f S i l v e r Market C o n d i t i o n s
a. Overview b. T h e E n g e l h a r d D e a l

3. Financing S i l v e r i n t h e Market Decline

A. R.

The H u n t s ~ e f a u l t The H u n t s R e f i n a n c e T h e i r S i l v e r Debt.

.............. ....

PART TWO: BACHE GROUP I N C .

I.

THE BACHE GROUP COMPLEX The B. T h e C. The

A.

.......... H o l d i n g Company. . . . . . . . . . . ........... Broker-Dealer. Metal Company a n d B a c h e L o n d o n . . .

. . . .

.. .. .. ..

1. B a c h e Metals 2. B a c h ~L o n d o n
11.

THE INCEPTION AND DEVELOPMENT OF THE HUNT RELATIONSHIP

.......

111. THE BUILDUP 1N.SILVER

- AUGUST 1, 1 9 7 9 THROUGH JANUARY 1 7 , 1 9 8 0

A.

......

B.

Introduction: Increasing Exposure i n t h e Hunt Accounts. I n c r e a s e s i n Hunt F u t u r e P o s i t i o n s

. . . . . . . . . . . . . . . .......

1. T h e H u d d l e s t o n A c c o u n t s 2. The San F r a n c i s c o Accounts 3 . T r a n s f e r s f r o m J. A r o n

PAGES C. Management Information Concerning The Hunts' Financial Condition and The Volatility of The Silver Market.

.....

59

1. Information About the Hunts 2. Information About the Silver Markets IV. THE MARKET BREAK - JANUARY 22 TO THE CRISIS AT BACHE COMPANY A. B,

....... Introduction . . . . . . . . . . . . . . . . . Increasing the !3ache Metals Loans. . . . . . .

a, The Hunt Requests and Executive

66

1. Background 2. The Major Line Increases Committee Action b. Funding the Increased Hunt Lines - Bache Metals' Borrowing in February 1980 C. Early Indications of Problems in the Hunt Accounts.

................

1. The Huddleston Margin Call 2. Bache Halsey's Knowledge of the Hunts' Efforts to Obtain Financing

D. The Hunt Accounts on the Eve of the Crisis. V.

..............

THE CRISIS AT BACHE GROUP - MARCH 17 THROUGH APRIL 8 , 1980 A. B.

C. Financial Implications of

....... Overview . . . . . . . . . . . . . . . . . . . Bache Accepts Silver Collateral in Lieu of Cash Margin . . . . . . . . . . . .

t h e c r i s i s . . . . . . . . . . . . . . .

. . .

1. Status of Hunt Accounts During the Crisis 2. Steps to Maintain Net Capital Compliance a. Reledgering the Huddleston Deficits b. The Approach to Comex c. Allocating Collateral from the Bache Metals Loans to Bache Halsey

D.

L i q u i d a t i o n , Loss and Recovery

. . . . . . . .

24

1. T h e L i q u i d a t i o n s 2 . The B a n k i n g P r o b l e m
a. b.

Subordinated Lenders The " S i l v e r Banks" c. B a c h e H a l s e y ' s " L i n e B a n k s "

VI.

AFTER THE C R I S I S .
A.

The A u d i t C o m m i t t e e R e p o r t

..........

106 107 107 107 108 108 109

1. 2. 3. 4. 5.

Concerning Bache H a l s e y ' s A c c e p t i n g S i l v e r C o n c e r n i n g t h e March 28 P r e s s R e l e a s e Concerning t h e C r e d i t Decision Concerning t h e Huddleston Accounts Concerning Whether t h e Hunts had Received P r e f e r e n t i a l Traatment A s a Result o f T h e i r Bache Group S t o c k Cwnership

VII.

... DISCLOSURE OF EVENTS . . . . . . . . . . . . . . A. C r i s i s P e r i o d P r e s s Announcement. . . . . . .

B.

C h a n q e s i n Commodity C r e d i t P r o c e d u r e s .

109

1. 2. 3. 4.
B.

The The The The

March March March April

27 A n n o u n c e m e n t 28 P r e s s Release 3 1 Releases 1 Release

D i s c l o s u r e i n Bache G r o u p ' s F i l i n g s w i t h t h e Commission and S h a r e h o l d e r Communications.

...............

114

1. D i s c l o s u r e B e f o r e t h e C r i s i s 2. Disclosure A f t e r t h e C r i s i s
a. b. c. d. The The The The C o h n , Dach & Howard S-16 A p r i l 2 5 Form 8-K A p r i l 3 0 Form 10-Q 1 9 8 0 Form 10-K 117

3. Other M a t e r i a l P u b l i c l y Disseminated

PAGES PART THREE: MERRILL LYNCH & CO.,

I.

INC.

THE MERRILL LYNCH COMPLEX

A. B.

The The

............ H o l d i n g Company. . . . . . . . . . . . . . Broker-Dealer. . . . . . . . . . . . . . . ......... ........ . ................ ........

JULY 1 9 7 9

11.

INCEPTION, DEVELOPMENT AND SCOPE OF THE HUNT RELATIONSHIP THROUGH JANUARY 1 9 8 0

A. B.

111. THE BUILDUP I N SILVER

Introduction I n c r e a s i n g S i l v e r E x p o s u r e - T h e IMIC Account and S i l v e r Financing f o r Hunt H o l d i n g s and H e r b e r t Hunt

1. T h e IMIC A c c o u n t

a. E s t a b l i s h i n g t h e Account
b. IMIC F u t u r e s P o s i t i o n s Silver Deliveries

c. Merrill L y n c h L e n d s t o IMIC t o F i n a n c e
2. Lending t o Hunt H o l d i n g s 3. L e n d i n g t o H e r b e r t H u n t
C. The C r e d i t D e c i s i o n s : I n f o r m a t i o n A v a i l a b l e t o M e r r i l l C o n c e r n i n g IMIC, t h e Hunts, and t h e S i l v e r Market.

......

1. I n t r o d u c t i o n a n d Summary 2 . I n f o r m a t i o n A b o u t IMIC 3. I n f o r m a t i o n a b o u t t h e H u n t s Other than IMIC 4. I n f o r m a t i o n A v a i l a b l e t o Management Concerning t h e S i l v e r Market

IV.

THE MARKET BREAK - JANUARY THROUGH MARCH 1 9 8 0 . A. B. C.

. . . . . . . . . . .

Introduction T h e H e r b e r t H u n t a n d IMIC L o a n s H u n t A c c o u n t s o n t h e Eve o f t h e C r i s i s

................. ....... ....

V.

THE C R I S I S PERIOD AT MERRILL LYNCH MARCH 1 4 THROUGH APRIL 1, 1 9 8 0

.......

PAGES A B

. Introduction and Overview . . . . . . . . . . . . Merrill's Attempt to Obtains Cash and Collateral . . . . . . . . . . . . . . C . Crisis Period Loans to Bunker and Herbert Hunt . . . . . . . . . . . . . . .
D

. The potential
1 2 3

of the Crisis

.................

Financial Implications

. Generally . The Net Capital Analysis . The ML & Co . Analysis

. Measures
1 2

Relating to Merrill's Net Capital Position

...............

. The

. Seeking

$200 Million Subordination the Hunts' Guarantee of the IMIC Account

F G

. Liquidations . . . . . . . . . . . . .
. Public
Disclosure Concerning the Crisis

....
.

PART FOUR: THE E.F. HUTTON GROUP INC

. The Holding Company . . . . . . . . . . . . ............ . The Rroker-Dealer . I1 . THE BUILDUP IN SILVER .JULY 31. 1979 .... THROUGH JANUARY 31. 1980 -. A . The Hunt Accounts Come to Hutton . . . . . B . Futures Trading in the Hunts' Accounts . . . Financing Physical Silver . . . . . . . . .
A B I11

.. ..

. . . . C D . Management Decisions Concerning the Hunt Accounts . . . . . . . . . . . . . E . Hunt Accounts at the Market Break . . . . . .

. . . . . .

. THE

...... A . Cancelling the Silver Loan . . . . . . . . . . B . Re-establishing the Silver Loan . . . . . . . .

MARKET BREAK .JANUARY 17 THROUGH THE CRISIS AT HUTTON

IV

.......... A . The Hunts Decline to Meet Margin Calls . . . . B . Liquidating the Accounts . . . . . . . . . . .

THE CRISIS PERIOD AT HUTTON . MARCH 26 THROUGH 28. 1980

PAGES PART -FIVE: PAINE WEBBER INCORPORATED

.
.

THE PAINE WEBBER COMPLEX

A B

. The . The

............ H o l d i n g Company . . . . . . . . . . . . . . Broker-Dealer . . . . . . . . . . . . . . .

...........

187 187 187

I1

INCEPTION AND DEVELOPMENT OF THE HUNT RELATIONSHIP

A B

188 188 189 191 191 191 193 194 194 195 197 197

C.HuntAccountsatJuly31.1979
I11

. E a ct ak b rl oi su h dn g. T r a.d i.n g. L i m i .s .i n t.h e. . . . . . . B g n . .. . . s i t HuntAccounts . . . . . . . . . . . . . . . . . ........

....... A . Management D e c i s i o n s C o n c e r n i n g Hunt Trading . . . . . . . . . . . . . . . . . . . . B. S t a t u s o f t h e H u n t A c c o u n t s I m m e d i a t e P r i o r to t h e S i l v e r C r i s i s . . . . . . . . . . I V . THE C R I S I S AT PAINE WEBBER . MARCH 27 ...... THROUGH APRIL 1 4 . 1 9 8 0 A . L i q u i d a t i o n o f t h e Hunt Accounts . . . . . . . B. The E r r o n e o u s March 27 " A l l Clear" Report . . . . . . . . . . . . . . C. F r e e z i n g t h e H u n t A c c o u n t s . . . . . . . . . . D . P a i n e Webber C o l l e c t s f r o m t h e H u n t s . . . . . E . T h e NYSE E x c u s e s P a i n e W e b b e r f r o m T a k i n g C a p i t a l Charges i n Connection with t h e Hunt D e f i c i t . . . . . . . . . . . . . . . . . . I. THE DEAN WITTER COMPLEX . . . . . . . . . . . . . A . T h e H o l d i n g Company ............. R . The B r o k e r - D e a l e r . . . . . . . . . . . . . . . I1 . DEVELOPMENT OF THE HUNT RELATIONSHIP . . . . . . . A . Background . . . . . . . . . . . . . . . . . . B. T r a d i n g L i m i t s i n Hunt A c c o u n t s . . . . . . . .
PART S I X : DEAN WITTER REYNOLDS ORGANIZATION INC I11

. THE

BUILDUP AND DECLINE I N SILVER . JULY 3 1 . 1 9 7 9 THROUGH MARCH 1 7 . 1 9 8 0

. HUNT

ACCOUNTS DURING T H E RISE AND DECLINE I N SILVER . . -

..........

.v i i .

PAGES . -

IV.

. .... ... ... ............. .. CRISIS PERIOD EVENTS . . . . . . . . . . . . . A. The Hunts Miss Margin Calls. . . . . . . . . B. Liquidation. . . . . . . . . . . . . . . . . C. Net Capital Position and Public Disclosures. . . . . . . . . . . . . . . . .
A. Futures Positions . . B. Dean Witter Rejects a Hunt Borrowing Request. C. Margin Calls in February and March 1980. PART SEVEN: A.G. EDWARDS
&

. . .

204

. . .
.

SONS, INC. 213 213 215 215 216 217 219 219

I. 11. 111.

THE FIRM.

....................

IV.

........ THE CRISIS AT EDWARDS . . . . . . . . . . . . . . A. Bunker Hunt Misses a Call on March 25, 1980. . B. Attempts to Collect. . . . . . . . . . . . . . C. Liquidations . . . . . . . . . . . . . . . . . D. Recovery from the Hunts. . . . . . . . . . . . REMEDIAL MEASURES FOLLOWING THE CRISIS . . . . .
PART EIGHT: THE NEW YORK STOCK EXCHANGE

INCEPTION AND DEVELOPMENT OF HUNT RELATIONSHIP

I.

BACKGROUND - ORGANIZATION AND RESPONSIBILITIES OF THE EXCHANGE UNITS RESPONSIBLE FOR SURVEILLANCE OF MEMBER FIRMS THE NYSE'S SURVEILLANCE OF ITS MEMBER FIRMS DEALING IN SILVER - SEPTEMBER 1979 THROUGH MARCH 26, 1980

..

223

11.

...

224 230

111. THE SILVER CRISIS - MARCH 26 THROUGH MARCH 31, 1980

.......

viii -

PAGES PART NINE: LEGAL AND POLICY-IMPLICATIONS OF THE SILVER CRISIS INTRODUCTION A

...................

241 241 242 243 244 244 244 245 245 247 247 250 251 252

. Excessive Exposure to Particular Customers or Markets . . . . . . . . . . . . . . . . B . Weaknesses in the Commodity Aspects of the Uniform Net Capital Rule . . . . . . . . C . Adequacy of Financial Information . . . . . . . D . Public Disclosure . . . . . . . . . . . . . . . E . Self-Regulatory Organization Oversight . . . . F . Segregation of Commodity and Securities Activities . . . . . . . . . . . . . EXPOSURE TO LOSS . . . . . . . . . . . . . . . . . A . Introduction . . . . . . . . . . . . . . . . . B . Regulatory Disincentives to Excessive Commodity Concentration . . . . . . . . . . . . 1 . Background: Regulation Prior to July 1979 2 . Remedial Measures Since the Crisis 3 . Reintroduction of Commodities Futures Concentration Haircuts C . Direct Limitation on Exposure to Loss . . . . . I11 . THE NET CAPITAL RULE . . . . . . . . . . . . . . . A . Introduction . . . . . . . . . . . . . . . . . B . Use of Futures Prices to Value CustomerAccounts . . . . . . . . . . . . . . C . Incorporation of Margin Requirements of Commodity Exchanges . . . . . . . . . . . .
IV

257 21 53 264 266 266 267 271

........ A . Introduction . . . . . . . . . . . . . . . B . Existing "Know Your Customer" Rules . . . . C . Requirements for Financial Information . . DISCLOSURE OBLIGATIONS . A . Introduction . . . . . . . . . . . . . . . 1 . The Significance of Disclosure 2 . Improvements for Disclosure of Adverse Effects of Customer Defaults 3 . Disclosure of Contingent Liabilities
ADEQUACY OF CREDIT INFORMATION

. . . .

. . . .

..

272 272 275 276

PACE VI. SELF-REGULATORY ORGANIZATION OVERSIGHT.

. . . . .

VII. SEGREGATION OF COMMODITIES AND SECURITIES ACTIVITIES APPENDIX I: BACKGROUND INFORMATION ON FUTURES MARKETS APPENDIX 11: GLOSSARY

..........

APPENDIX 111: SUMMARIES O F HUNT-RELATED ACCOUNTS WITH BROKER-DEALERS

INTRODUCTION AND SUMMARY

I.

INTRODUCTION

On March 2 7 , 1 9 8 0 , t h e S e c u r i t i e s and E x c h a n g e Commission ( " C o m m i s s i o n " ) a u t h o r i z e d a f o r m a l i n v e s t i gation i n t o events r e l a t i n g t o t h e so-called " s i l v e r c r i s i s " o f 1980. T h i s r e p o r t embodies t h e f i n d i n g s and c o n c l u s i o n s o f t h e Commission s t a f f w i t h p a r t i c u l a r emphasis on t h e r o l e o f c e r t a i n s i l v e r t r a d e r s and o f securities industry participants in the events leading t o t h e crisis o f 1980 and t h e impact o f t h o s e e v e n t s on t h e industry. The s t a f f a l s o i d e n t i f i e d a number o f a r e a s i n w h i c h i t recommends t h a t t h e Commission c o n s i d e r r e m e d i a l l e g i s l a t i o n o r rulemaking i n o r d e r t o p r e v e n t r e c u r r e n c e o f t h e f a c t o r s t h a t produced t h e s i l v e r crisis. In its investigation, t h e s t a f f has received extensive document p r o d u c t i o n and t e s t i m o n y o r o t h e r s t a t e m e n t s f r o m many w i t n e s s e s . The s t a f f h a s f o c u s e d i t s a t t e n t i o n on t h e a c t i v i t i e s of broker-dealers carrying s i l v e r posit i o n s f o r t h e Hunt f a m i l y a t t h e t i m e o f t h e crisis and on t h e a c t u a l and p o t e n t i a l impact o f t h o s e a c t i v i t i e s on t h e f i n a n c i a l c o n d i t i o n of t h o s e f i r m s . These a r e t h e a s p e c t s o f t h e crisis most d i r e c t l y r e l a t e d t o t h e Commission's regulatory responsibilities. Except as necessary f o r an understanding of t h e matters j u s t described, t h e s t a f f d o e s n o t r e p o r t upon t h e a c t i v i t i e s o f o t h e r s i l v e r t r a d e r s , w h e t h e r l o n g o r s h o r t , f u t u r e s commission m e r c h a n t s n o t r e g i s t e r e d w i t h t h e Commission a s b r o k e r - d e a l e r s o r b o a r d s Moreo f t r a d e d e s i g n a t e d as c o n t r a c t m a r k e t s i n s i l v e r . o v e r , t h e r e p o r t d o e s n o t a d d r e s s t h e q u e s t i o n as t o whether the individuals o r e n t i t i e s discussed i n the report o r o t h e r w i s e involved i n t h e s i l v e r crisis v i o l a t e d t h e f e d e r a l s e c u r i t i e s o r commodities laws o r o t h e r r e l e v a n t laws a s they apply t o such persons. The s t a f f t h a t have d e v e l o p e d t h i s r e p o r t a r e p r i n c i p a l l y p e r s o n n e l i n t h e D i v i s i o n o f Enforcement. We have, however, r e c e i v e d e x t e n s i v e a s s i s t a n c e from t h e O f f i c e of General Counsel, t h e Division of Corporation Finance, t h e O f f i c e of Chief Accountant, and, most n o t a b l y , t h e D i v i s i o n of Market Regulation. The l a t t e r d i v i s i o n , in addition t o providing valuable insights i n t o the financ i a l r e s p o n s i b i l i t y r e q u i r e m e n t s , was p r i n c i p a l l y r e s p o n s i b l e f o r t h e portion of t h i s r e p o r t concerning t h e r o l e o f t h e N e w York S t o c k E x c h a n g e .
11.

SUMMARY OF EVENTS

F o r s i x d a y s l a t e i n March 1 9 8 0 i t a p p e a r e d t o government o f f i c i a l s , Wall S t r e e t and t h e p u b l i c a t l a r g e t h a t a d e f a u l t by a s i n g l e f a m i l y o n i t s o b l i g a t i o n s i n t h e plummeting s i l v e r m a r k e t m i g h t s e r i o u s l y d i s r u p t t h e

U.S. financial system. Various broker-dealers carrying Hunt accounts, among the largest firms in the securities industry, faced the possibility of very substantial losses if this group of customers had failed to make good on its obligations. The potential failure of even one of these firms threatened a financial chain reaction that would have jeopardized commodity clearinghouses and their members, other broker-dealers and their customers and banks, public companies and their stockholders. Although financial catastrophe was ultimately averted, the silver crisis provides a valuable lesson in the fragility and interdependence of the financial structure, and challenges both the private sector and government to respond. A. Buildup in Hunt Silver Holdings Although the "silver crisis" first came to public attention on March 27, 1980, the conditions that produced it had been developing since the summer of 1979, when members of the family of the late Texas oilman H.L. Hunt, Jr. and related entities began buying silver in the cash and futures markets in a series of transactions that increased their already substantial position in the metal to more than 195 million ounces by the end of that year. Meanwhile, the price of silver, which was below $10 per ounce prior to August 1, 1979, rose to $34.45 per ounce by December 31, 1979. It peaked at more than $50 on January 17, 1980. The silver in the Hunts' and related entities' position at the end of 1979, therefore, had an apparent value--assuming such a large position could have been liquidated at or near quoted prices--of approximately $6.6 billion. The magnitude of this holding is noteworthy even apart from i-tsdollar value. Handy & Harman, the leading source of information on the silver market, stated in its 1979 market review that reported silver stocks in the United States, both government and private, totalled only 339.6 million ounces. The same report estimated that total world silver stocks--reported and "conjectural"-totalled 1.3 billion ounces. By either measure, the Hunts' physical silver holdings and futures positions represented an enormous amount of the metal. The more significant feature of the Hunts' silver position for the financial markets, however, was the degree to which it was leveraged. At the end of 1979, approximately 50% of their position was in the form of long

f u t u r e s c o n t r a c t s on t h e t w o p r i n c i p a l d o m e s t i c s i l v e r f u t u r e s e x c h a n g e s . 1/ L i k e a l l f u t u r e s t r a d e r s , t h e H u n t s were a b l e t o e s t a b l i s h a n d m a i n t a i n t h e i r p o s i t i o n by m a k i n g a m a r g i n d e p o s i t o n e a c h c o n t r a c t t h a t was s m a l l i n comparison w i t h t h e v a l u e o f t h e s i l v e r it c o n t r o l l e d . On December 3 0 , 1 9 7 9 , e v e n a t t h e h i g h e s t m a r g i n r a t e s p r e v a i l i n g o n e i t h e r market f o r s i l v e r f u t u r e s c o n t r a c t s , a $30,000 d e p o s i t margined a c o n t r a c t f o r s i l v e r worth more t h a n $ 1 7 0 , 0 0 0 . T h e H u n t s a l s o l e v e r a g e d t h e i r phys i c a l s i l v e r h o l d i n g s by b o r r o w i n g a g a i n s t t h e b u l l i o n t h e y owned. The H u n t s were n o t t h e o n l y s i l v e r m a r k e t p a r t i c i p a n t s to bear the r i s k s associated with t h e i r leveraged position. They c o n d u c t e d t h e i r s i l v e r f u t u r e s t r a d i n g a n d o b t a i n e d a s u b s t a n t i a l portion of t h e i r bullion financing through a p p r o x i m a t e l y 20 f u t u r e s c o m m i s s i o n m e r c h a n t s ( " F C M s " ) . A s c l e a r i n g members o f t h e e x c h a n g e s upon w h i c h t h e H u n t s c a r r i e d t h e i r n e t long s i l v e r f u t u r e s p o s i t i o n t h e s e firms guaranteed t h e Hunts' performance of t h e o b l i g a t i o n s associated with the contracts. They g u a r a n t e e d p a y m e n t (1) o f v a r i a t i o n m a r g i n o n a d o l l a r - f o r - d o l l a r b a s i s i f t h e p r i c e o f s i l v e r d e c l i n e d a n d (2) o f t h e amount n e c e s s a r y t o t a k e d e l i v e r y o f t h e u n d e r l y i n g s i l v e r i f t h e cont r a c t were a l l o w e d t o m a t u r e . F i n a l l y , t h e FCMs c a r r y i n g t h e H u n t s ' a c c o u n t s would a b s o r b a n y losses i n t h e f u t u r e s p o s i t i o n and b u l l i o n l o a n s i f l i q u i d a t e d w i t h o u t r e c o v e r y from t h e Hunts. Among t h e FCMs c a r r y i n g H u n t s i l v e r p o s i t i o n s a t t h e e n d o f March 1 9 8 0 were s i x b r o k e r - d e a l e r s r e g i s t e r e d w i t h t h e Commission a n d c e r t a i n o f t h e i r a f f i l i a t e s . These i n c l u d e d Bache H a l s e y S t u a r t S h i e l d s I n c . ("Bache H a l s e y " ) , Merrill L y n c h , P i e r c e , F e n n e r & S m i t h , I n c . ("Merrill"), Dean W i t t e r R e y n o l d s , I n c . ( "Dean Witter" ) , A.G. E d w a r d s & S o n s , I n c . ( " E d w a r d s " ) , E.F. H u t t o n & C o . I n c . ( " H u t t o n " ) , and P a i n e Webber J a c k s o n & C u r t i s I n c . ( " P a i n e W e b b e r " ) . A t year-end 1979, t h e s e f i r m s c a r r i e d f o r t h e Hunts a t o t a l o f 1 7 , 4 4 4 l o n g s i l v e r f u t u r e s and f o r w a r d c o n t r a c t s c o v e r i n g a p p r o x i m a t e l y 87.2 m i l l i o n ounces o f s i l v e r . Hunt a c c o u n t s w i t h t h e s e f i r m s o r t h e i r a f f i l i a t e s a l s o h e l d 14.9 m i l l i o n ounces o f s i l v e r b u l l i o n a s c o l l a t e r a l f o r $127 m i l l i o n i n l o a n s .

1/ -

Throughout t h i s r e p o r t , r e f e r e n c e s c o n t r a c t s are t o c o n t r a c t s f o r t h e o f 5,000 o u n c e s o f s i l v e r . Unless forward p o s i t i o n s have been s t a t e d units.

to s i l v e r futures purchase o r sale otherwise noted, i n 5,000 ounce

The silver in these positions had an apparent value of $3.35 billion at December 31, 1979, but the equity in the Hunt accounts, including securities holdings, physical silver and unrealized gain on silver and other commodities futures positions, was only $1.1 billion. Two of the firms, Bache and Merrill, accounted for 80% of the futures contracts and 87% of the physical silver held at year end by the six brokers. The $1.1 billion equity in the Hunts' accounts with the six broker-dealers provided a "cushion" against an $11 per ounce, or 31%, price decline in silver in the event of a Hunt default. The protection afforded by this cushion, however, was seriously eroded by the increasing volatility of the silver market and the increasing proportion of the open interest represented by the Hunt position. As the price of silver had risen during the fall of 1979, the volatility of the market had increased as well. In January 1980, the average daily swing in the price of the metal was 98, up from approximately 1.2% during August 1979. Trading volume and open interest on both principal exchanges had declined substantially. Both the market concentration indicated by the size of the Hunt position and the volatility of the market created a degree of exposure in certain of these firms that was significant in relation to their respective capital resources. This was particularly true at Bache Halsey, whose net capital at the end of February 1980 was approximately $38 million in excess of prescribed minimums. In the firms carrying the largest Hunt silver positions, the decision to assume the risks associated with such subtantial holdings was made at the executive committee level or higher. Certain of these decision makers had available extensive information of a general nature concerning the Hunts' reputation for enormous wealth and involvement in the silver markets. They were, however, without current or specific knowledge of the extent of the Hunts' silver trading activities with other firms, the extent and scheduled maturity of their liabilities, or the amount and availability to the Hunts of cash or other assets necessary to satisfy those obligations. Broker-dealers carrying Hunt positions did not insist on obtaining this data from the Hunts, nor did they seek such information from other firms. As a result, broker-dealers established and continued to carry Hunt positions with no clear idea of the extent of their potential exposure.

B.

Market D e c l i n e and Hunt D e f a u l t

A s l o n g a s s i l v e r prices c o n t i n u e d t o c l i m b , b r o k e r d e a l e r s ' e x p o s u r e t o t h e H u n t s was n o t c o n s i d e r e d a m a t t e r of s e r i o u s concern. A s d i s c u s s e d more f u l l y b e l o w , howe v e r , and as i l l u s t r a t e d i n t h e c h a r t on t h e following page, d u r i n g t h e week o f J a n u a r y 2 1 , 1 9 8 0 , t h e b u l l m a r k e t i n s i l v e r reversed. By t h e e n d o f J a n u a r y s p o t p r i c e s h a d f a l l e n f r o m a p p r o x i m a t e l y $ 4 4 t o a p p r o x i m a t e l y $ 3 4 per ounce. During F e b r u a r y and e a r l y March, s p o t p r i c e s ranged b e t w e e n $ 3 1 a n d $30.50, b u t o n March 1 0 t h e d e c l i n e r e s u m e d , w i t h s p o t prices f a l l i n g from $29.75 t o $10.80 i n t h e 1 4 b u s i n e s s d a y s e n d i n g T h u r s d a y , March 27. The r a p i d l y d e c l i n i n g p r i c e s g e n e r a t e d margin c a l l s on t h e Hunts' n e t long f u t u r e s p o s i t i o n as w e l l as c a l l s f o r a d d i t i o n a l bullion deposits to maintain required c o l l a t e r a l i z a t i o n r a t i o s o n t h e l o a n s t h e Hunts had o b t a i n e d . The H u n t s also purchased s u b s t a n t i a l amounts o f s i l v e r s t a n d i n g f o r delivery on maturing contracts i n t h e i r futures positions and i n t r a n s a c t i o n s w i t h b u l l i o n d e a l e r s m a i n t a i n i n g s h o r t hedges a g a i n s t physical s i l v e r inventories. A s t h e s e c a s h n e e d s d e v e l o p e d , t h e Hunts borrowed h e a v i l y from t h r e e o f t h e s i x b r o k e r - d e a l e r s c a r r y i n g t h e i r p o s i t i o n s , from b a n k s , commodity m e r c h a n t f i r m s and i n d i v i d u a l s a n d f r o m P l a c i d O i l Company ( " P l a c i d " ) , a p e t r o l e u m c o n c e r n owned b y H u n t f a m i l y t r u s t s . Bache H a l s e y ' s p a r e n t , Bache Group I n c . , t h r o u g h its Bache H a l s e y S t u a r t Metal Co. s u b s i d i a r y , l e n t t h e H u n t s $ 1 9 3 m i l l i o n i n F e b r u a r y , b r i n g i n g t o $233 m i l l i o n t h e unhedged b u l l i o n l o a n s it had o u t s t a n d i n g t o f a m i l y members and a r e l a t e d entity. I n March, Merrill Lynch l e n t $76 m i l l i o n t o H e r b e r t H u n t a n d , when a H u n t - r e l a t e d e n t i t y d i d n o t p a y $13 m i l l i o n f o r d e l i v e r y on maturing forward c o n t r a c t s , Merrill f i n a n c e d t h e d e l i v e r y f o r i t . By March 1 2 , M e r r i l l had $144 m i l l i o n i n s i l v e r l o a n s o u t s t a n d i n g t o t h e Hunts. On March 1 4 , H u t t o n r e n e w e d a l i n e o f c r e d i t t o t h e H u n t s it had c a n c e l l e d t w o months e a r l i e r and l e n t $87 m i l l i o n t o Bunker and $13 m i l l i o n to H e r b e r t Hunt. Despite t h e s e l o a n s , t h e H u n t s were e x p e r i e n c i n g d i f f i c u l t i e s o b t a i n i n g financing elsewhere.

On T h u r s d a y , M a r c h 1 3 , 1 9 8 0 , I n t e r n a t i o n a l M e t a l s I n v e s t m e n t Co., ("IMIC"), a H u n t - r e l a t e d e n t i t y w i t h a c c o u n t s a t Merrill, t o l d t h e f i r m t h a t i t would b e u n a b l e to m e e t a $45 m i l l i o n margin c a l l on its s i l v e r p o s i t i o n w i t h i n 24 h o u r s a s was i t s c u s t o m b e c a u s e o f w h a t i t a s s e r t e d were a d m i n i s t r a t i v e p r o b l e m s . T h e f o l l o w i n g Monday, March 1 7 , t h e H u n t s t o l d B a c h e t h a t t h e y d i d n o t h a v e t h e c a s h n e c e s s a r y t o meet $ 4 4 m i l l i o n i n m a r g i n c a l l s i n t h e i r accounts. IMIC a n d t h e H u n t s o f f e r e d t o M e r r i l l a n d Bache b u l l i o n and o t h e r f o r m s o f p h y s i c a l s i l v e r i n s t e a d . Those f i r m s accepted t h e Hunts' s i l v e r i n l i e u o f c a s h a s

SETTLEMENT PRICES, COMEX SILVER JANUARY 21 THROUGH APRIL 3, 1980

4bN=
MONTH SPOT MONTH

Date, 1980

m a r g i n c a l l s m o u n t e d d u r i n g t % e e n s u i n g two w e e k s . The Hunts c o n t i n u e d to pay c a s h to t h e o t h e r f o u r brokerd e a l e r s c a r r y i n g t h e i r a c c o u n t s u n t i l March 2 5 a n d 2 6 , when t h e y s t o p p e d a l l c a s h p a y m e n t s a n d b u l l i o n d e p o s i t s a n d t o l d t h e b r o k e r s t h a t t h e y were i l l i q u i d a n d t h u s u n a b l e t o pay. The H u n t s a l s o d e f a u l t e d o n o b l i g a t i o n s t o banks and p r e c i o u s m e t a l s d e a l e r s . The most n o t a b l e o f t h e s e w a s a $ 4 3 2 m i l l i o n i n s t a l l m e n t d u e o n March 3 1 toward t h e p u r c h a s e o f 28.5 m i l l i o n ounces o f s i l v e r from t h e Engelhard Minerals & Chemicals Corporation. A t the t i m e of t h e i r d e f a u l t , t h e Hunts' o v e r a l l s i l v e r - r e l a t e d o b l i g a t i o n s , e x c l u s i v e o f margin c a l l s on f u t u r e s p o s i t i o n s , were a p p r o x i m a t e l y $ 1 . 7 5 b i l l i o n .

1. C a s h D r a i n o n B r o k e r s
A s t h e market continued to d e c l i n e , t h e firms reqained o b l i g a t e d t o make d a i l y v a r i a t i o n m a r g i n p a y m e n t s t o t h e clearinghouses, on a dollar-for-dollar b a s i s , f o r market losses o n t h e H u n t s 1 s i l v e r f u t u r e s p o s i t i o n s . A t Bache, f o r example, Hunt f a m i l y a c c o u n t s , h e l d a p p r o x i m a t e l y 4500 s i l v e r f u t u r e s c o n t r a c t s g o i n g i n t o t h e crisis; i n t h e limit-down market c o n d i t i o n s p r e v a i l i n g d u r i n g t h e p e r i o d i n w h i c h t h e H u n t s were p a y i n g n o c a s h t o t h e f i r m , B a c h e e x p e r i e n c e d $ 2 2 . 5 m i l l i o n p e r d a y i n c h a r g e s to i t s c l e a r i n g a c c o u n t w i t h o u t r e c e i v i n g c a s h from t h e Hunts. Merrill also experienced unreimbursed c h a r g e s to its c l e a r i n g account i n connection with IMIC's 3808-contract n e t long futures position. Both f i r m s , i n a d d i t i o n , r e c e i v e d s p e c i a l m a r g i n c a l l s f r o m t h e CBT c l e a r i n g h o u s e o n March 27. A s long a s t h e Hunts represented t h a t a d d i t i o n a l b u l l i o n or c a s h would o n e d a y b e f o r t h c o m i n g , Bache and Merrill c h o s e n o t t o s e l l o u t t h e H u n t s 1 p o s i t i o n s , w h i c h w o u l d h a v e e l i m i n a t e d f u r t h e r e x p o s u r e to p r i c e d e c l i n e s in silver. On March 2 5 , h o w e v e r , B a c h e s o u g h t r e l i e f f r o m t h e Commodity E x c h a n g e , I n c . ("Comex" ) b y way o f r e d u c e d margin requirements i n s i l v e r . Comex a c t e d o n t h a t r e q u e s t o n March 2 6 , a n d r e d u c e d m a r g i n r e q u i r e m e n t s by o n e - t h i r d , t h e r e b y f r e e i n g a p p r o x i m a t e l y $80 m i l l i o n f o r Bache and smaller a m o u n t s f o r t h e o t h e r b r o k e r - d e a l e r s , t o u s e t o m e e t v a r i a t i o n margin c a l l s with t h e clearinghouse.

2. P o t e n t i a l F i n a n c i a l I m p l i c a t i o n s

The H u n t s ' illiquidity a n d t h e c o n t i n u i n g d e c l i n e i n s i l v e r p r i c e s t h r e a t e n e d m a j o r losses t o s e v e r a l o f t h e A t l e a s t a s e a r l y a s March 1 4 , t h e s p o t firms involved. p r i c e o f s i l v e r h a d f a l l e n t o a p o i n t t h a t l o s s e s i n cert a i n o f t h e Hunt a c c o u n t s e x c e e d e d t h e a s s e t s o n d e p o s i t with the firms. On March 1 4 , t h e H u n t s ' a c c o u n t s a s a g r o u p a t e a c h o f Bache, Edwards, H u t t d n and P a i n e Webber, had s i g n i f i c a n t u n s e c u r e d d e b i t b a l a n c e s computed a t s p o t prices. A t Merrill .Lynch, H u n t f a m i l y members a n d r e l a t e d entities' a c c o u n t s r e m a i n e d a p p r o x i m a t e l y $ 4 0 3 m i l l i o n i n e q u i t y o n March 1 4 . I n t h e IMIC a c c o u n t , however, l o a n s a n d o t h e r d e b i t b a l a n c e s o n t h a t d a t e e x c e e d e d by $ 3 4 m i l l i o n t h e remaining v a l u e o f I M I C ' s s i l v e r p o s i t i o n and Merrill Lynch o f f i c i a l s t e s t i f i e d t h a t other holdings. b a s e d o n s t a t e m e n t s by H e r b e r t H u n t , t h e y b e l i e v e d t h e Hunt f a m i l y had committed to s t a n d b e h i n d t h e I M I C a c c o u n t . U n t i l A p r i l 1, h o w e v e r , t h e f i r m h a d n o w r i t t e n g u a r a n t y t o that effect. On March 2 7 , when s i l v e r p r i c e s r e a c h e d t h e i r l o w p o i n t d u r i n g t h e c r i s i s , u n s e c u r e d d e b i t b a l a n c e s i n Hunt a c c o u n t s , which r e p r e s e n t e d p o t e n t i a l losses t o t h e s e f i r m s i f t h e a c c o u n t s were l i q u i d a t e d w i t h o u t r e c o v e r y , h a d increased s u b s t a n t i a l l y notwithstanding t h e Hunts' cash or c o l l a t e r a l d e p o s i t s i n t h e intervening period. Table I o n t h e f o l l o w i n g page i l l u s t r a t e s t h e s t a t u s o f Hunt a c c o u n t s h a d t h e y b e e n l i q u i d a t e d a s o f March 1 4 a n d March 27 a n d compares t h e c r e d i t or u n s e c u r e d d e b i t b a l a n c e s ' i n t h e accounts with each f i r m ' s regulatory c a p i t a l i n excess o f p r e s c r i b e d minimums a n d w i t h t h e L e p o r t e d p r e - t a x e a r n i n g s o f e a c h f i r m or its p u b l i c l y - h e l d p a r e n t f o r t h e then-current f i s c a l year. The p o t e n t i a l l o s s e s j u s t d e s c r i b e d were n o t i d e n t i i e d and a d d r e s s e d a t t h e t i m e t h e y f i r s t o c c u r r e d d u e to p r a c t i c e s p r e v a i l i n g i n t h e iridustry f o r valuing f u t u r e s p o s i t i o n s i n customers' accounts. I n d u s t r y practice h a s been to v a l u e t h e s e p o s i t i o n s a t t h e d a i l y s e t t l e m e n t p r i c e q u o t e d by t h e c o m m o d i t y e x c h a n g e f o r e a c h m a t u r i t y i n e a c h f u t u r e s c o n t r a c t i n the account. Such a v a l u a t i o n h a s been used both f o r p u r p o s e s o f d e t e r m i n i n g whether a margin c a l l is r e q u i r e d and whether a n a c c o u n t c o n t a i n s a n unsecured d e b i t balance r e q u i r e d to be charged to r e g u l a t o r y c a p i t a l . I n t h e "limit-down" t r a d i n g market p r e v a i l i n g i n s i l v e r a t t h e t i m e , u s e of t h e s e prices a s s i g n e d a n u n r e a l i s t i c a l l y high apparent value to t h e Hunts' accounts. This occurred because t h e d e c l i n e i n s i l v e r f u t u r e s p r i c e s f o r c o n t r a c t s i n b a c k m o n t h s h a d b e e n r e s t r a i n e d by e x c h a n g e - i m p o s e d p r i c e movement l i m i t a t i o n s , w h i l e t h e p r i c e o f t h e s p o t c o n t r a c t was p e r m i t t e d t o f a l l f r e e l y . May 1 9 8 0 Comex s i l v e r , f o r example, was p e r m i t t e d t o f a l l o n l y $ 1 p e r o u n c e e a c h d a y d u r i n g much o f M a r c h , w h e r e a s s p o t p r i c e

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-+DEALERS
~ g

a s s i g n e d d u r i n g t h e month t o March a n d , l a t e r , A p r i l m a t u r i t i e s f e l l without restraint. A s a consequence, on March 1 4 , 1 9 8 0 , t h e s p o t p r i c e o f s i l v e r o n Comex w a s $ 1 0 . 7 2 p e r o u n c e lower t h a n t h e a v e r a g e o f p r i c e s q u o t e d by t h e e x c h a n g e f o r f u t u r e s c o n t r a c t s i n b a c k m o n t h s . On March 271 t h i s d i f f e r e n t i a l r e a c h e d $13.26 p e r o u n c e . Under t h e s e c i r c u m s t a n c e s , t h e r e w a s n o m a r k e t a t q u o t e d p r i c e s f o r f u t u r e s c o n t r a c t s i n back months, a l t h o u g h Although t r a d e s could be accomplished a t t h e s p o t p r i c e . t h e s p o t price t h u s r e p r e s e n t e d t h e t r u e v a l u e o f t h e H u n t s ' s i l v e r f u t u r e s c o n t r a c t s , i n d u s t r y p r a c t i c e perm i t t e d broker-dealers to c o n t i n u e to use t h e u n r e a l i s t i c a l l y h i g h back month f u t u r e s p r i c e i n computing t h e m a r g i n and n e t c a p i t a l r u l e s t a t u s of t h e accounts. Commodity a n d s e c u r i t i e s e x c h a n g e s , as w e l l as t h e Commission and t h e CFTC, h a v e b e e n aware of t h i s p r a c t i c e a n d h a v e a c q u i e s c e d i n its c o n t i n u a t i o n . Valued as t h e y were a t back month f u t u r e s p r i c e s , 2/ t h e a g g r e g a t e H u n t a c c o u n t s a t e a c h f i r m a p p e a r e d to-be i n e q u i t y e v e n a t t h e low p o i n t i n s i l v e r prices d u r i n g t h e crisis, and o n l y f e l l i n t o d e f i c i t i n c e r t a i n cases when H u n t f u t u r e s a c c o u n t s w e r e l i q u i d a t e d o n March 27 a n d 28 a t o r n e a r t h e spot p r i c e .
3 . L i q u i d a t i o n -/ 3

On M a r c h 2 5 , t h e H u n t s t o l d B a c h e t h e y h a d n o more c a s h or s i l v e r t o d e p o s i t w i t h t h e f i r m . The n e x t d a y t h e y c o n v e y e d s i m i l a r a d v i c e t o Merrill a n d o n M a r c h 27 t h e remaining f o u r broker-dealers learned f o r t h e f i r s t t i m e t h a t t h e Hunts c o u l d n o t pay. Bache a n d Merrill, which had been a c c e p t i n g s i l v e r from t h e Hunts i n l i e u o f c a s h v a r i a t i o n m a r g i n , now d e t e r m i n e d t o l i q u i d a t e H u n t p o s i t i o n s . The o t h e r f o u r b r o k e r s , which had been r e c e i v i n g c a s h u n t i l March 2 5 o r 2 6 , made a n i m m e d i a t e d e c i s i o n t o sell o u t t h e accounts. By t h e close o f b u s i n e s s o n M a r c h 2 8 , B a c h e , Dean W i t t e r , E d w a r d s , H u t t o n a n d P a i n e W e b b e r had l i q u i d a t e d , a t or n e a r s p o t prices, s u b s t a n t i a l l y , a l l o f t h e Hunts n e t long f u t u r e s p o s i t i o n s . H u t t o n liq u i d a t e d t h e b u l l i o n collateral f o r its $100 m i l l i o n l o a n .

2/ -

Throughout t h e r e m a i n d e r o f t h i s report, prices f o r f u t u r e s c o n t r a c t s i n back months as opposed to t h e s p o t month w i l l f o r c o n v e n i e n c e , b e r e f e r r e d t o s i m p l y as " f u t u r e s prices", w h i l e p r i c e s f o r t h e s p o t month cont r a c t w i l l b e c a l l e d "spot prices". Unless t h e context indicates otherwise, t h e expressions " l i q u i d a t i o n " or " s a l e " as used i n t h i s r e p o r t i n c l u d e s o u t r i g h t sale or hedging o f a p o s i t i o n , or t h e c l o s i n g o u t o f a p o s i t i o n i n o n e o r more o f f s e t t i n g t r a n s a c t i o n s .

3/ -

Bathe, however, still held approximately 6.9 million

ounces of bullion and 116 long futures contracts. Merrill liquidated only 9.9 million ounces of the 24.4 million ounce IMIC position it had carried on March 25. Several firms liquidated Hunt positions other than silver and the Treasury bills the Hunts had posted as margin. Bache sold out gold, other non-silver futures positions and stock. Paine Webber liquidated cattle and currency futures. Merrill and Dean Witter liquidated substantial securities positions in Herbert and Bunker Hunt's accounts. As of the close of business on March 28, giving effect on an accrual basis to liquidation trades not yet settled, Hunt-related accounts with broker-dealers appeared approximately as follows:

TABLE I1
SUMMARY OF HUNT RELATED SILVER POSITIONS AND EQUITY ... AT BROKER-DEALERS, C O B MARCH 28, 1980 SILVER POSITION EQUITY (DEFICIT) (Million Ounces) (Spot Prices) ( $ Million) Bache
Dean Witter

EQUITY(DEFIC1T) (Futures Prices) ( $ Millions) (55) 46 . (4

75 . -0-0-

(55) 46 . (4)

Edwards

Merrill (IMIC Account) Merrill (Hunt Family and other related entities) Paine Webber (Hunt Family) Paine Webber (Placid Oil)

30 10.7

-0-0-

The Hunts repaid Bache, Hutton, Edwards and Paine Webber over the following month out of the proceeds of transactions that ultimately refinanced the Hunts' silver debts.

The u n c e r t a i n t i e s a s s o c i a t e d w i t h t h e crisis c o n t i n u e d A t Bache, o v e r t h e weekend a n d i n t o t h e week o f March 31. t h e b u l l i o n c o l l a t e r a l i z i n g t h e bank l o a n s t h a t Bache had o b t a i n e d t o fund i t s l e n d i n g t o t h e Hunts was i n s u f f i c i e n t to cover the outstanding balances. Bache had i n c o r r e c t l y a n n o u n c e d o n March 28 t h a t i t h a d l i q u i d a t e d t h e H u n t p o s i t i o n s w i t h o u t l o s s , a n d when i t i n f o r m e d i t s b a n k e r s o n S u n d a y , March 3 0 a n d Monday, M a r c h 3 1 , o f a $ 1 7 m i l l i o n collateral s h o r t f a l l , s e v e r a l i n s i s t e d o n repayment and had t o be bought o u t o f t h e c r e d i t by t h e o t h e r s . T h i s was n o t a c c o m p l i s h e d u n t i l t h e e a r l y m o r n i n g h o u r s o n A p r i l 1. Bache t h e r e a f t e r l i q u i d a t e d r e m a i n i n g b u l l i o n i n t h e Hunt a c c o u n t s and r e c e i v e d c a s h d e p o s i t s from P l a c i d to settle t h e Hunts' remaining o b l i g a t i o n s .
A t Merrill t h e I M I C a c c o u n t w a s $ 6 4 m i l l i o n i n e q u i t y o n March 2 8 v a l u i n g f u t u r e s c o n t r a c t s r e m a i n i n g i n t h e account a t futures p r i c e s i n accordance with recognized industry practices. A t s p o t p r i c e s , however, remaining l o a n s and d e b i t b a l a n c e s e x c e e d e d by $83 m i l l i o n a l l o f t h e c o l l a t e r a l i n t h e IMIC a c c o u n t . The Hunt f a m i l y and r e l a t e d e n t i t i e s , meanwhile, had approximately $295 m i l l i o n i n equity in other accounts with the firm. As previously n o t e d , Merrill L y n c h m a n a g e m e n t b e l i e v e d t h a t H u n t f a m i l y m e m b e r s s t o o d b e h i n d t h e IMIC a c c o u n t f r o m t h e t i m e o f i t s i n c e p t i o n , b u t i t w a s n o t u n t i l M a r c h 27 t h a t t h e y s o u g h t a w r i t t e n g u a r a n t y from t h e Hunts. Five days later, a f t e r i n i t i a l r e s i s t a n c e on t h e p a r t o f t h e Hunts' a t t o r n e y s , Bunker and H e r b e r t Hunt e x e c u t e d a p e r s o n a l g u a r a n t y t h a t e n a b l e d t h e f i r m t o u t i l i z e assets i n Hunt f a m i l y a c c o u n t s to avoid charging a g a i n s t n e t c a p i t a l unsecured d e b i t In b a l a n c e s a n d u n m e t m a r g i n c a l l s i n t h e IMIC a c c o u n t . r e l i a n c e o n t h i s d o c u m e n t , Merrill m a i n t a i n e d t h e IMIC a c c o u n t , w i t h o u t t a k i n g c h a r g e s to c a p i t a l , u n t i l Hunt i n t e r e s t s paid o f f t h e d e f i c i t i n connection with t h e Hunts' refinancing o f t h e i r s i l v e r debts.

4. The Hunts R e f i n a n c e
A s noted i n t h e foregoing s e c t i o n , t h e Hunts repaid t h e b r o k e r - d e a l e r s c a r r y i n g t h e i r p o s i t i o n s by r e f i n a n c i n g t h e i r s i l v e r debt. They accomplished t h i s by o b t a i n i n g bank c r e d i t and u l t i m a t e l y , a $ 1 . 1 b i l l i o n l o a n from a g r o u p o f b a n k s a n d t h r o u g h P l a c i d O i l Company. T h e y sat i s f i e d t h e i r a d d i t i o n a l $702 m i l l i o n o b l i g a t i o n o n t h e s i l v e r p u r c h a s e c o n t r a c t w i t h Engelhard by conveying t o t h a t firm i n t e r e s t s i n petroleum licenses i n t h e Beaufort S e a o f f s h o r e a r c t i c Canada and p e r m i t t i n g t h a t f i r m t o r e t a i n s i l v e r d e p o s i t e d as collateral and remaining to be d e l i v e r e d under t h e c o n t r a c t .

111. SUMMARY OF PRINCIPAL FINDINGS As evident in the foregoing discussion, a principal focus of the staff's investigation has been to establish and evaluate the role in the Hunts' silver activities of brokerdealers regulated by the Commission, the impact and potential impact of those activities on the firms involved, and the sufficiency of the current regulatory scheme. A summary of the staff's conclusions and recommendations follows. A. Excessive Exposure in Particular Customers' Accounts The magnitude of the potential losses confronting broker-dealers upon the Hunts' default is directly attributable to decisions by senior management in those firms (1) to permit the Hunts to establish very large commodity futures positions with respect to which the broker-dealers acted as guarantors, and ( 2 ) to lend amounts to the Hunts, secured by physical silver, that were very substantial in relation to the capital resources of the firms. These decisions created the potential that default by this single group of customers could jeopardize entire firms. The exposure associated with the extension of such large amounts of credit to, and role as a guarantor for, a single customer was compounded by the customer's concentration in silver. The size of the Hunt silver position, even at certain individual firms, was so substantial as to endanger liquidity given sufficiently large adverse market movement. The positions of any individual firm, moreover, were only a portion of the total. To address these problems the staff recommends that the Commission consider establishing a limitation on the extent of broker-dealers' exposure to any one customer or group of related customers, and that it reestablish in the net capital rule a full range of charges for excessive concentration in commodities like those removed from the rule in 1979. The two recommendations are non-duplicative and will, if put into place together, tend to prevent the recurrence of conditions which caused the crisis at the broker-dealers. B. Inappropriate Valuation of Customer Commodity Accounts As noted above, industry practice has been to value commodity futures positions in customer accounts at futures prices quoted by commodity exchanges, even when limit-down or up trading conditions have rendered the realizable market value of the position substantially less than that computed

at futures prices. Accordingly, industry practice permits broker-dealers to margin and evaluate customer accounts in limit-up or down markets at inflated values, thus permitting unsecured debit balances to develop in customer accounts without appropriate margin calls or net capital charges. The staff recommends that the Commission initiate discussions with the Commodity Futures Trading Commission ("CFTC") to rectify this situation. One possible solution, since adopted by the Comex in connection with its customer margin requirements, is to require a customer account to be marked to the spot market in price limited trading conditions when price movements occur adverse to the account's open trade positions. In addition, in certain specific respects, including determination of required levels of margin, the net capital rule expressly incorporates board of trade or clearing organization requirements. This leaves open the possibility that, as apparently occurred in Comex silver on March 26, 1980, commodity exchanges can manipulate margin requirements to benefit particular market participants in derogation of the protections of the net capital rule. The staff believes it is inappropriate for these entities to affect the net capital protections in a manner potentially adverse to the public interest or without appropriate Commission oversight. C. Inadequate Credit Information The staff has also observed that broker-dealers permitted the Hunts to establish and maintain large, concentrated positions based on a general belief concerning the extent of the Hunts' financial resources, but without detailed or current information concerning those resources, their availability to satisfy obligations of a particular Hunt account holder or the extent of the Hunts' silver position at other brokers, banks or metals dealers. The staff believes that current "know your customer" rules, while adequate as tools for ascertaining customer suitability, had not, in their development or present application, been directed to credit decision-making and thus cannot assure that brokers have enough information about customers to make credit judgments. Specifically, "know your customer" rules either do not specify the information to be obtained or are nonmandatory. In either case competitive considerations may result in less than vigorous application of the rule.

The staff believes that if the Commission effectively controls single-customer exposure as proposed above there is no need to strengthen or expand the "know your customer" rules. If, however, as at present, broker-dealers retain the discretion to take on excessively exposed or highly concentrated customer positions, then the Commission should consider establishing mandatory and specific requirements that brokers obtain, review and maintain current information as a basis for reasonable credit decisionmaking. D. Se~aratelvCawitalized Commoditv Subsidiaries One alternative to insulate public securities customers from the risk to broker-dealers associated with the guarantee of highly leveraged commodity positions is the establishment of separately capitalized subsidiaries, whose liabilities are not traceable to the broker-dealer, to handle firms' commodity activities. One broker-dealer involved in the silver crisis has already established such a subsidiary to act as the exchange clearing member for its customers' commodity trading. The staff recommends that the Commission study the advisability of mandating separation of these two functions. E. Public Disclosure Before March 27, 1980, there was no public disclosure of the existence or magnitude of the Hunt silver positions or the associated exposure notwithstanding that each of the broker-dealers carrying these positions was at the time a public company itself or the principal subsidiary of a publicly-held parent. The staff recommends that issuers be reminded of their obligations to timely disclose material corporate information. In addition, issuers should be reminded that material changes in items such as liquidity must be discussed annually and updated quarterly in management's discussion and analysis of financial conditions and results of operations, and that such discussion is subject to the anti-fraud provisions of Rules lob-5 and 12b-20. The staff also recommends one substantive amendment to Regulation S-K. Finally, the staff suggests that insufficient attention has been given to the proper accounting treatment of the contingent liabilities associated with customer commodity futures transactions. F. NYSE Surveillance The staff's inspection of the NYSE's surveillance of its member firms which dealt in silver commodities indicated that with respect to those firms with Hunt and Hunt related accounts, the Exchange failed to obtain sufficient information from its members, failed to verify the information it

did receive from its members, and failed to be alert to the potential of a crisis situation as it developed. The staff recommends that the Exchange adopt more formal procedures for the conduct of its member firm surveillance which would include, in cases of potentially serious import, submission to the Exchange of hard copy data from its members, attestation of the accuracy of such data by a senior officer of the member, and field verification of the data. The staff also recommends that the Exchange adopt procedures and supervisory controls to assure the closest possible interrelationship between the individuals performing surveillance and examination operations. IV. OTHER PUBLIC RESPONSE TO THE SILVER CRISIS

The silver crisis prompted the Congress and a number of other public agencies to inquire into various aspects of these events, particularly as they relate to the Hunts and other substantial longs trading in the silver market in their own names or through offshore financial institutions or other entities. These matters are only incidentally related to the Commission's regulatory responsibilities and accordingly we have not sought to duplicate the activities of other agencies. In the Congress, several committees have held hearings on the crisis and received testimony or statements from numerous witnesses. These include the Commerce, Consumer and Monetary Affairs Subcommittee of the House Committee on Goverment Operations, chaired by Representative Benjamin Rosenthal, (the "Rosenthal Subcommittee"); the Subcommittee on Agricultural Research and General Legislation of the Senate Committee on Agriculture, Nutrition and Forestry, chaired by Senator Donald W. Stewart, (the "Stewart Subcommittee"); the Senate committee on Banking, Housing and Urban Affairs, chaired by Senator William Proxmire, (the "Senate Banking Committee"); and the Subcommittee on Conservation, Credit, and Rural Development of the House Committee on Agriculture, chaired by Representative Edward Jones (the "Jones Subcommittee"). Each of these committees has published the volume of its hearings 4 / and the House Committee on Government Operations has pu6lished a report
4 -/

Silver Prices and the Adequacy of Federal Actions in The Marketplace, 1979-80, 96th Cong., 2d Sess. (Rosenthal Subcommittee, 1980); Price Volatility in the Silver Futures Markets, 96th Cong., 2d Sess. (Stewart Subcommittee, 1980); Margin Requirements for Transactions in Financial Instruments, 96th Cong., 2d Sess. (Senate Banking Committee, 1980); Joint Agency Reports on the Silver Markets, 97th Cong., 1st Sess. (Jones Subcommittee, 1981)r and earlier volumes.

of the Rosenthal Subcommittee inquiry. 5/ Former Chairman Harold M. Williams and Commissioner phirip A. Loomis testified at one or more of these hearings and the Commission has furnished information to various committees in response to requests. The Commodity Futures Trading Commission ("CFTC") has also been actively involved in inquiries concerning the silver crisis. In an investigation styled In the Matter of ACLI International Commodity Services, Inc., et al., the CFTC's Division of Enforcement is inquiring into possible violations of the Commodity Exchange Act by silver market participants. There has been no public dissemination of the results of that investigation. After the crisis, CFTC's Division of Trading and Markets prepared, with the assistance of Commission staff and staff of the Treasury and the Board of Governors of the Federal Reserve System ( "Fed' ) , a lengthy report concerning these matters pursuant to Section 21 of the Commodity Exchange Act (the "Section 21 Report"). 6/ The portion of the report dealing with silver market activities contains an extensive economic analysis of the behavior of the silver market during 1979 and early 1980, and a review, based largely on reports filed with the CFTC, of the activities of the Hunts and other major longs active in the market. The Section 21 Report does not make use of information gathered in the CFTC or the Commission's enforcement investigations. The Section 21 Report also recounted the responses of the principal domestic commodity exchanges and the CFTC to events in the market, and described the Commission's activity during the crisis period. The Section 21 Report briefly described the position of FCMs and broker-dealers carrying and financing Hunt positions, but did not examine in detail the circumstances leading up to the crisis in these firms nor identify, except by implication, the problems discussed in the foregoing section.

5/ - Silver Prices and the Adequacy of Federal Actions in The Marketplace, 1979-80, H.R. Rep. No. 395, 97th Cong., 1st Sess. (1981).
",

6/ -

CFTC, Report to the Congress in Response to Section 21 of the Commoditv Exchanqe Act, Pub. L. No. 96-276. 96th 7, Cong., 2d ~ e s s . ~ ~ e c t i o n -94'Stat. 542 (June 1, 1 9 8 0 ) ~ (May 29, 1981). The CFTC had earlier transmitted to Congress an abbreviated report on the silver situation recountinq many of the same events. Report of thecommodity-~utu;es Trading Commission ontRecent Developments in the Silver Futures Markets, (April 25, 1980).

The CFTC has also undertaken inquiries in connection with its enforcement investigation, the Section 21 Report and its periodic rule enforcement reviews of commodity exchanges relating to allegations by the Hunts and others that commodity exchange governors acted out of self-interest in voting to raise margin requirements, establish position limits and impose liquidation-only trading in silver during the 1979-80 bull market. These allegations are based on the observation that a number of exchange governors or their employers maintained substantial short positions in the silver futures market during its rapid rise and were thus subject to substantial margin calls to finance their short position as the price continued to climb. On February 8 , 1982, CFTC Chairman Philip McB. Johnson sent to Chairman Jack Brooks of the House Government Operations Committee a summary of the results of the CFTC's rule enforcement review. The Johnson letter concluded that the CFTC's inquiry had "failed to uncover evidence that would prove conflicts of interest on the part of any board member." The CFTC's enforcement investigation of these matters continues. In addition to the foregoing, the Fed recounted generally the makeup of the Hunts' overall silver-related borrowing in its Interim Report on Financial Aspects of the Silver Market Situation in Early 1980, published as a part of the Rosenthal Subcommittee hearings. While the foregoing summary is not a comprehensive review of the literature of the silver crisis, it does cover the major published material developed by government agencies with respect to these events. None of this material, however, has addressed in detail the aspect of the silver crisis of most concern to the Commission: the genesis and impact of the crisis in the securities industry. 7/ The remainder of this report seeks to address those issues.

7/ -

The staff in this report makes no findings nor draws any conclusions with respect to violations of the federal securities laws by any person.

PART ONE AN OVERVIEW OF HUNT FAMILY ACTIVITY IN THE SILVER MARKET

I.

INTRODUCTION

Many market participants contributed to the circumstances producing the silver crisis. The principal cause of the financial instability experienced by securities brokerdealers, however, was their relationship with the Hunt family and entities it controlled 8/ and the Hunts' failure to meet margin calls on silver futures positions and make cash or collateral deposits required to maintain loans they had obtained to finance their silver trading activities. It is, accordingly, important to an understanding of the circumstances leading to the crisis and the crisis itself to have some familiarity with the Hunts' overall activity in the silver market, the financial arrangements that accompanied it and the principal features of the Hunt family businesses. This section of the report will, therefore, describe in general terms: (1) The ownership, structure and business of principal Hunt family enterprises; and (2) The nature and extent of the Hunts' silver trading activities and the means by which they were financed. 11. THE HUNT FAMILY AND ITS BUSINESSES

Silver trading was one of a number of business activities conducted by Herbert, Bunker and Lamar Hunt (the "Hunt brothers") and members of their family. The nature and extent of the Hunts' other businesses, as well as the ownership arrangements characterizing them, were important to brokers extending commodity credit to the Hunts for silver trading and to the banks that ultimately funded the Hunts' refinancing of their obligations after the silver crisis. In this section of the report, we briefly describe the more important Hunt individual and family enterprises involved directly or indirectly in the silver situation It should be emphasized that the "Hunt family" described in this report is the so-called "first family1' of the late Haroldson Lafayette Hunt, Jr. (1889-1974) ("H.L. Hunt"), comprised of descendants of his first wife, Lyda Bunker. The first family includes H.L. Hunt's sons Hassie, William Herbert ("Herbert Hunt"), Nelson Bunker ("Bunker Hunt") and Lamar and their respective children and grandchildren, and H.L. Hunt's daughters Margaret Hunt Hill and Carolyn Hunt Schoellkopf and their children and grandchildren. For the sake of convenience and as the context so indicates, this report frequently refers to two or more Hunt family members and Hunt-related entities and their activities collectively, or describes their holdings in the aggregate.

a n d t h e t r u s t s a n d h o l d i n g c o m p a n i e s t h a t own t h e m . A s c h e m a t i c summary o f t h e r e l a t i o n s h i p s among f a m i l y m e m b e r s a n d r e l a t e d e n t i t i e s i n v o l v e d i n t h e s i l v e r m a r k e t is p r e s e n t e d a t p a g e 27 b e l o w .

A.

Individuals

1. N e l s o n B u n k e r H u n t ( " B u n k e r H u n t " o r " B u n k e r " 1 , 5 6 , is t h e f o u r t h c h i l d i n H.L. H u n t ' s f i r s t f a m i l y . In addition t o h i s and h i s w i f e ' s i n t e r e s t s i n s i l v e r d u r i n g e a r l y 1 9 8 0 , B u n k e r owned i n h i s own name a n d t h r o u g h v a r i o u s p a r t n e r s h i p s and c l o s e l y - h e l d c o r p o r a t i o n s , o i l , g a s , g e o t h e r m a l and coal p r o p e r t i e s , r e a l e s t a t e and r a n c h e s , c a t t l e , r a c e h o r s e s , rare c o i n s and a r t , s e c u r i t i e s and g o l d . H i s personal holdings i n A p r i l 1 9 8 0 were v a l u e d f o r p u r p o s e s o f t h e P l a c i d l o a n a t a p p r o x i m a t e l y $2.9 b i l l i o n . 9/ On A p r i l 3 0 , 1 9 8 0 , h e h a d d e b t s and o t h e r pending o b l i g a t i o n s o f a p p r o x i m a t e l y $679.3 million. A t $14.05 p e r ounce, Bunker's s i l v e r p o s i t i o n comprised $562 m i l l i o n , or 1 9 % , o f h i s assets. In addition, Bunker is t h e income b e n e f i c i a r y o f t h e N e l s o n Bunker Hunt T r u s t E s t a t e , s e t t l e d o n him b y h i s f a t h e r i n . 1 9 3 5 . The T r u s t E s t a t e h o l d s h i s i n t e r e s t i n , among o t h e r t h i n g s , P l a c i d and Penrod.

B u n k e r H u n t h a s f o u r c h i l d r e n , e a c h o f whom w a s t h e r e c o r d owner o f a c c o u n t s t r a d i n g s i l v e r f u t u r e s or p h y s i c a l s i l v e r . I n a d d i t i o n , B u n k e r ' s c h i l d r e n are t h e b e n e f i c i a r i e s o f t e s t a m e n t a r y t r u s t s ( t h e "Lyda Hunt-Bunker T r u s t s " ) s e t t l e d o n them by t h e i r g r a n d m o t h e r a t h e r d e a t h i n 1955. T h e s e t r u s t s owned a p o r t i o n o f t h e f a m i l y ' s i n t e r e s t i n I M I C t h r o u g h a h o l d i n g company c a l l e d P r o f i t I n v e s t m e n t C o . 9 -/ A p p r o x i m a t e l y $ 1 . 1 4 b i l l i o n , o r 5 0 % o f B u n k e r ' s e s t i m a t e d a s s e t s were a t t r i b u t e d t o h i s 5 0 % s h a r e o f t h e H u n t brothers' i n t e r e s t s through a general p a r t n e r s h i p c a l l e d H u n t I n t e r n a t i o n a l P e t r o l e u m Company o f C a n a d a ("HIPCO The (Can.)") i n petroleum l i c e n s e s i n t h e Beaufort Sea. v a l u a t i o n u s e d i n t h e t e x t was p r e p a r e d l a t e i n A p r i l 1980 i n c o n n e c t i o n w i t h t h e P l a c i d l o a n t o c o v e r t h e 80% remaining p o r t i o n of t h e Hunts' earlier Beaufort holdings a f t e r t h e s e t t l e m e n t w i t h Engelhard M i n e r a l s and Chemical Corp. d e s c r i b e d below a t p a g e 41. The t r u e v a l u e o f t h e p r o p e r t i e s , however, a p p e a r s s p e c u l a t i v e . On March 2 7 , 1980, a bank t o which t h e p r o p e r t i e s had been pledged v a l u e d t h e B e a u f o r t S e a p r o p e r t i e s a t a much lower f i g u r e , a s s i g n i n g $ 5 1 0 m i l l i o n a s t h e v a l u e o f t h e h o l d i n g s bef o r e t h e Engelhard s e t t l e m e n t . Based on t h i s v a l u a t i o n , Bunker's 50% s h a r e o f t h e 80% remaining a f t e r t h e Engelhard d e a l w o u l d a p p e a r t o b e w o r t h o n l y $ 2 0 8 m i l l i o n , 8 2 % less than t h e value assigned f o r purposes of t h e Placid loan. H i s t o t a l a s s e t s u s i n g t h i s v a l u a t i o n w o u l d b e 4 0 % less than described i n the text.

2. W i l l i a m H e r b e r t Hun& ( " H e r b e r t H u n t " o r " H e r b e r t " ) , 5 4 , i s t h e f i f t h c h i l d i n H.L. H u n t ' s f i r s t f a m i l y . In A p r i l 1980 h i s holdi;-igs, l i k e B u n k e r ' s , i n c l u d e d e n e r g y p r o p e r t i e s , r e a l e s t a t e , s e c u r i t i e s , r a r e c o i n s and a r t and s i l v e r and g o l d p o s i t i o n s . I n April 1980, h i s holdings were v a l u e d f o r p u r p o s e s o f t h e P l a c i d l o a n a t a p p r o x i m a t e l y $ 1 . 3 8 b i l l i o n , 1 0 / o f w h i c h $ 5 6 9 m i l l i o n , o r 4 1 % , was r e p r e At A p r i l 3 0 , 1980, he had s e n t e d by h i s s i l v e r p o s i t i o n . d e b t s o f $591.5 m i l l i o n . H e r b e r t is t h e income b e n e f i c i a r y o f t h e W i l l i a m H e r b e r t H u n t T r u s t E s t a t e , s e t t l e d o n him b y h i s f a t h e r i n 1 9 3 5 . The T r u s t E s t a t e h o l d s H e r b e r t ' s i n t e r e s t i n , among o t h e r t h i n g s , P l a c i d a n d P e n r o d . H e r b e r t H u n t h a s f i v e c h i l d r e n , f o u r o f whom a p p e a r t o have been t h e r e c o r d owner o f a c c o u n t s t r a d i n g or h o l d i n g silver. I n a d d i t i o n , H e r b e r t ' s c h i l d r e n are t h e s t o c k h o l d e r s o f P e n t a d R e s o u r c e s , I n c . ( f o r m e r l y H u n t H o l d i n g s ) , a corpora t i o n t h a t engaged i n s i l v e r t r a d i n g . Like t h e i r cousins i n Bunker's f a m i l y , H e r b e r t ' s c h i l d r e n a r e also t h e b e n e f i c i a r i e s o f t r u s t s s e t t l e d o n them b y t h e i r g r a n d m o t h e r i n 1955. T h e s e "Lyda H u n t - H e r b e r t T r u s t s " o w n e d , w i t h t h e Lyda HuntB u n k e r T r u s t s d e s c r i b e d a b o v e , t h e f a m i l y ' s i n t e r e s t i n IMIC. 3. Lamar Hunt ( " L a m a r Hunt*' o r " L a m a r " ) , 4 9 , i s t h e y o u n g e s t o f t h e s i x c h i l d r e n H.L. H u n t ' s f i r s t f a m i l y . A l t h o u g h Lamar i s b e s t known f o r h i s r o l e i n f o u n d i n g t h e American F o o t b a l l League and h i s o w n e r s h i p o f t h e Kansas C i t y C h i e f s p r o f e s s i o n a l f o o t b a l l t e a m a n d World Champions h i p T e n n i s , h i s p e r s o n a l h o l d i n g s also i n c l u d e e n e r g y , o i l and g a s p r o p e r t i e s , r e a l e s t a t e , a r t and s e c u r i t i e s . In A p r i l 1 9 8 0 , h i s a s s e t s were v a l u e d f o r p u r p o s e s o f t h e P l a c i d 11/ l o a n a t . $ 6 0 1 . 9 m i l l i o n , - and a t A p r i l 3 0 , 1 9 8 0 , h e had d e b t s o f $40.6 m i l l i o n . Lamar i s t h e i n c o m e b e n e f i c i a r y o f t h e Lamar H u n t T r u s t E s t a t e , s e t t l e d o n him b y h i s f a t h e r i n 1 9 3 5 . T h e T r u s t E s t a t e h o l d s L a m a r ' s i n t e r e s t i n , among o t h e r t h i n g s , P l a c i d and Penrod. 10 -/ A p p r o x i m a t e l y $ 5 6 8 m i l l i o n , o r 4 1 % , o f H e r b e r t ' s e s t i m a t e d a s s e t s were a t t r i b u t e d t o h i s 2 5 % s h a r e o f t h e B e a u f o r t Sea properties d e s c r i b e d a t n. 9 , above. As d e s c r i b e d i n t h e n o t e j u s t c i t e d , h o w e v e r , t h e March 27 b a n k e v a l u a t i o n a s s i g n e d a v a l u e t o t h e s e p r o p e r t i e s 8 2 % lower than t h a t estimated f o r t h e Placid loan. Adjusting the Beaufort p r o p e r t i e s to t r u s t v a l u a t i o n , H e r b e r t ' s estimated n e t w o r t h a p p e a r s to b e a p p r o x i m a t e l y $320 m i l l i o n r a t h e r t h a n t h e $790 m i l l i o n c a l c u l a t e d i n c o n n e c t i o n with the Placid loan. Using t h i s v a l u a t i o n , H e r b e r t ' s s i l v e r p o s i t i o n c o m p r i s e d 6 2 % of h i s a s s e t s .
11/ -

L a m a r ' s a s s e t s i n c l u d e d 2 5 % o f t h e Hunt b r o t h e r s ' i n terests i n t h e B e a u f o r t S e a . A d j u s t e d to t h e bank v a l u a t i o n d e s c r i b e d a t n. 9 , L a m a r ' s a s s e t s were $ 1 3 6 . 6 million.

B.

C o r p o r a t i o n s and P a r t n e r s h i p s

1. H u n t E n e r g y C o r p o r a t i o n ( " H u n t E n e r g y " o r "HEC") i s a D e l a w a r e c o r p o r a t i o n w h o l l y owned by H u n t I n d u s t r i e s , a g e n e r a l p r t n e ; s h i p o f t h e ~ y d a u n t - B u n k e r a n d Lyda HuntH H e r b e r t T r u s t s a n d g r o u p s o f s i m i l a r t r u s t s s e t t l e d by H . L . Hunt's f i r s t w i f e on h e r g r a n d c h i l d r e n . A s o f A p r i l 28, 1 9 8 0 , B u n k e r s e r v e d a s c h a i r m a n o f H E C a n d H e r b e r t a n d Lamar were v i c e p r e s i d e n t s a n d d i r e c t o r s . T h e i r c o u s i n , Tom H u n t , w a s p r e s i d e n t and a d i r e c t o r .

W h i l e HEC i s a c t i v e i n t h e o i l a n d g a s i n d u s t r y , i t i s i m p o r t a n t t o t h e p r e s e n t d i s c u s s i o n b e c a u s e i t p r o v i d e s bookk e e p i n g a n d a c c o u n t i n g s e r v i c e s f o r most o f t h e a p p r o x i m a t e l y 1 5 0 c o r p o r a t i o n s , p a r t n e r s h i p s , t r u s t s , j o i n t v e n t u r e s and f o u n d a t i o n s t h a t c o l l e c t i v e l y encompass t h e i n t e r e s t s of H.L. H u n t ' s f i r s t f a m i l y . With r e s p e c t t o t h e s i l v e r p c s l t l o n s o f H u n t f a m i l y members a n d r e l a t e d e n t i t i e s , H u n t E n e r g y p e r s o n n e l m a i n t a i n e d books r e f l e c t i n g p o s i t i o n s , margin c a l l s and s i l v e r f i n a n c i n g , h a n d l e d t h e r e c e i p t and d i s b u r s e m e n t s o f f u n d s i n t h e H u n t s ' bank a c c o u n t s , and c o n f i r m e d t r a d e s with the various brokers handling s i l v e r positions. MEC a p p e a r s n o t t o h a v e t r a d e d s i l v e r f o r i t s own a c c o u n t . 2. P l a c i d O i l Company ( " P l a c i d " ) i s a D e l a w a r e c o r p o r a t i o n owned by t h e N e l s o n B u n k e r ( 2 0 . 9 % ) , W i l l i a m H e r b e r t ( 2 1 . 3 % ) , ~ a m a r( 2 2 . 1 % ) , C a r o l i n e ( 1 8 . 9 % ) , M a r g a r e t ( 8 . 4 % ) a n d H a r o l d s o n L. ( 8 . 4 % ) H u n t T r u s t E s t a t e s . C a r r o l l Dan Brown ("Brown"), a non-family p e t r o l e u m g e o l o g i s t , is p r e s i d e n t of Placid. C a r o l i n e Hunt S c h o e l l k o p f and M a r g a r e t Hunt H i l l , e a c h a v i c e p r e s i d e n t and d i r e c t o r , a r e t h e o n l y f a m i l y members o n t h e b o a r d . 1 2 / A l t h o u g h Herbert a n d B u n k e r H u n t h o l d n o f o r m a l p o s i t i o n s w i t h t h e company, t h e y a p p e a r t o h a v e a c t i v e l y p a r t i c i p a t e d i n management. P l a c i d is p r i n c i p a l l y engaged i n t h e d o m e s t i c and i n t e r n a t i o n a l o i l and g a s b u s i n e s s a s a p r o d u c e r , r e f i n e r I t i n v e s t s i n s e c u r i t i e s a n d comnoand p i p e l i n e owner. d i t i e s through various s u b s i d i a r i e s . F o r t h e 11 m o n t h s e n d e d December 3 1 , 1 9 7 9 , P l a c i d r e a l i z e d n e t e a r n i n g s o f $153 m i l l i o n o n r e v e n u e s o f $756 m i l l l o n and p a i d $13.5 million i n dividends. S h a r e h o l d e r s ' e q u i t y a t t h e end o f 1978, a c c o u n t i n g f o r p e t r o l e u m r e s e r v e a s s e t $ a t c o s t , was $477 m i l l i o n . Recasting P l a c i d ' s balance sheet to r e f l e c t

12 -/

A s l a t e a s A p r i l 5 , 1 9 8 0 , Lamar H u n t w a s a d i r e c t o r o f

P l a c i d , b u t l e f t t h a t p o s i t i o n sometime p r i o r t o t h e closing of t h e Placid loan.

t h e c u r r e n t m a r k e t v a l u e o f its p e t r o l e u m r e s e r v e s , however, Morgan G u a r a n t y T r u s t C o . o f N e w Y o r k ( " M o r g a n G u a r a n t y " ) o n F e b r u a r y 8, 1 9 7 9 , e s t i m a t e d i t s s t o c k h o l d e r s ' e q u i t y a t $1.08 b i l l i o n . 3. H u n t M i n e r a l s I n t e r n a t i o n a l L i m i t e d ( " H u n t M i n e r a l s " ) is a D e l a w a r e c o r p o r a t i o n owned i n e q u a l p r o p o r t i o n s b y Bunker and Herbert. Hunt. Bunker and H e r b e r t a r e b o t h d i r e c t o r s and s e r v e r e s p e c t i v e l y a s p r e s i d e n t and v i c e p r e s i d e n t . T h e company o w n s r o y a l t i e s o n c o a l p r o p e r t i e s i n S o u t h A f r i c a . I n 1979 and 1980 Hunt M i n e r a l s m a i n t a i n e d p h y s i c a l and f u t u r e s i l v e r p o s i t i o n s w i t h Bache Group s u b s i d i a r i e s and borrowed from Bache a g a i n s t p h y s i c a l s i l v e r c o l l a t e r a l . 4 . H u n t H o l d i n g s , now d o i n g b u s i n e s s a s P e n t a d R e s o u r c e s , I n c . ( t h i s r e p o r t w i l l r e f e r t o t h i s e n t i t y a s "Hunt Holdi n g s " ) , i s a D e l a w a r e c o r p o r a t i o n w h o l l y owned b y H e r b e r t H u n t ' s f o u r c h i l d r e n . H e r b e r t ' s s o n Douglas H. Hunt is p r e s i d e n t and a d i r e c t o r o f t h e f i r m and h i s sisters B a r b a r a Hunt H u n t C r o w a n d Lyda B u n k e r H u n t a r e v i c e p r e s i d e n t s . H o l d i n g s c a r r i e d s i l v e r f u t u r e s c o n t r a c t s w i t h Merrill Lynch and o b t a i n e d l o a n s from t h a t f i r m c o l l a t e r a l i z e d by s i l v e r d u r i n g 1979 and 1980. I t a l s o owns o i l a n d g a s p r o p e r t i e s and r e a l e s t a t e . 5. I n t e r n a t i o n a l M e t a l s I n v e s t m e n t C o . , Ltd. ("IMIC") i s a Bermuda c o r p o r a t i o n . I t s common s t o c k , c a r r y i n g 5 0 % o f t h e v o t i n g p o w e r i n t h e c o r p o r a t i o n , i s owned b y P r o f i t I n v e s t m e n t Company ( " P r o f i t " ) , 1 3 / a D e l a w a r e c o r p o r a t i o n i n t u r n owned b y t h e Lyda ~ u n t - ~ u n k earn d Lyda H u n t - H e r b e r t Trusts. Two S a u d i s , A l i B i n M u s s a l a m a n d Mohammed Aboud Al-Amoudi, owned a l l o f a c l a s s o f p r e f e r r e d s t o c k c a r r y i n g t h e remaining 50% of t h e voting r i g h t s . H e r b e r t and Bunker s h a r e d a c l a s s o f n o n v o t i n g p r e f e r r e d s t o c k and s e r v e d a s v i c e p r e s i d e n t and d i r e c t o r , r e s p e c t i v e l y .
I M I C was c r e a t e d i n J u l y 1979. During August and S e p t e m b e r 1 9 7 9 , i t e s t a b l i s h e d a t M e r r i l l Lynch a l o n g s i l v e r f u t u r e s p o s i t i o n t o t a l l i n g a p p r o x i m a t e l y 50 m i l l i o n ounces. T h e r e a f t e r , i n "exchange f o r physicals" t r a n s a c t i o n s and by s t a n d i n g f o r d e l i v e r y o n its c o n t r a c t s , I M I C o b t a i n e d

13 -/ H e r b e r t , B u n k e r a n d Lamar H u n t c o m p r i s e a m a j o r i t y o f t h e boards of d i r e c t o r s o f P r o f i t and o f t h e P l a n e t Investment Lamar i s v i c e C o r p o r a t i o n d i s c u s s e d below a t p. 28. president of each. Lamar a n d H e r b e r t a r e c o - t r u s t e e s w i t h t h e i r sisters o f t h e t w o t e s t a m e n t a r y t r u s t s t h a t own P l a n e t a n d P r o f i t .

a p p r o x i m a t e l y 57.4 m i l l i o n o u n c e s o f p h y s i c a l s i l v e r and continued t o maintain a f u t u r e s p o s i t i o n of an a d d i t i o n a l 19 m i l l i o n ounces. I M I C ' s c a p i t a l i z a t i o n and i t s s i l v e r t r a d i n g a c t i v i t i e s a r e covered i n d e t a i l i n t h e s e c t i o n of t h i s r e p o r t d e s c r i b i n g t h e a c t i v i t i e s a t Merrill Lynch. 6. Hunt I n t e r n a t i o n a l R e s o u r c e s Corp. ("HIRCO") is a D e l a w a r e c o r p o r a t i o n owned by P l a n e t I n v e s t m e n t C o r p o r a t i o n ( " P l a n e t " ) , i t s e l f a D e l a w a r e c o r p o r a t i o n owned by t h e same t e s t a m e n t a r y t r u s t s t h a t own P r o f i t . HIRCO i s t h e s u c c e s s o r t o t h e G r e a t Western United C o r p o r a t i o n , i n which H e r b e r t and Bunker a c q u i r e d a m a j o r i t y i n t e r e s t i n a 1974 t e n d e r offer. I n 1979 t h e y s o l d t h e i r i n t e r e s t t o P l a n e t , which acquired t h e remaining p u b l i c i n t e r e s t i n the firm using a $ 3 7 m i l l i o n b a n k l o a n c o l l a t e r a l i z e d by t h r e e m i l l i o n o u n c e s of s i l v e r . B u n k e r a n d H e r b e r t H u n t n e v e r t h e l e s s c o n t i n u e a s chairman and v i c e chairman o f t h e board, r e s p e c t i v e l y . T h r o u g h v a r i o u s s u b s i d i a r i e s , HIRCO i s e n g a g e d i n t h e o i l and g a s , s u g a r , real estate a n d p i z z a p a r l o r b u s i n e s s e s . I t had e a r l i e r h e l d s u b s t a n t i a l i n t e r e s t s i n t h e s i l v e r m a r k e t , t h r o u g h s u b s i d i a r i e s W e s t e r n B u l l i o n Co. a n d W e s t e r n I n v e s t m e n t C o . , b u t h a d c e a s e d t h o s e a c t i v i t i e s by mid-1979. F o r t h e f i s c a l y e a r e n d e d S e p t e m b e r 3 0 , 1 9 7 9 , HIRCO r e a l i z e d Its n e t $821,000 i n n e t e a r n i n g s on $446 m i l l i o n i n sales. w o r t h a t t h a t d a t e was a p p r o x i m a t e l y $55.8 m i l l i o n .
C.

Trusts

As evident i n the foregoing discussion, a substantial p o r t i o n o f H e r b e r t , B u n k e r a n d Lamar H u n t ' s f a m i l y r e s o u r c e s --including Placid--is held i n t h e William Herbert, Nelson B u n k e r a n d Lamar H u n t T r u s t E s t a t e s ; H e r b e r t , B u n k e r a n d Lamar a r e i n c o m e b e n e f i c i a r i e s o f t h e T r u s t E s t a t e s w h i l e t h e i r d e s c e n d a n t s are remaindermen. The t e r m s o f t h e t r u s t i n s t r u m e n t s r e c i t e t h a t t h e b e n e f i c i a r i e s p l a y n o role i n d e t e r m i n i n g t h e amounts o f d i s t r i b u t i o n s from t h e t r u s t s , n o r have t h e y any r i g h t t o t h e corpus of t h e t r u s t s nor t o c a l l f o r partition, division or dissolution. According t o t h e t r u s t i n s t r u m e n t s , t h e s e d e c i s i o n s are r e s e r v e d t o a t r u s t e e w i t h t h e a d v i c e and c o n s e n t o f a n a d v i s o r y c o m m i t t e e .

The W i l l i a m H e r b e r t and Nelson Bunker Hunt T r u s t E s t a t e s , a t least through June 1979, d i s t r i b u t e d to t h e b e n e f i c i a r i e s p r a c t i c a l l y a l l o f t h e income a v a i l a b l e . Distributions in f i s c a l 1 9 7 8 a n d 1 9 7 9 were $ 4 1 . 6 5 m i l l i o n t o b o t h b r o t h e r s Combined t r u s t e q u i t y f o r a l l t h r e e over those two years. Hunt b r o t h e r s ' t r u s t s a t J u n e 3 0 , 1979, was $386 m i l l i o n u s i n g t h e e q u i t y method o f a c c o u n t i n g f o r t h e T r u s t s ' i n t e r e s t s I t s h o u l d be n o t e d , however, i n P l a c i d and o t h e r e n t i t i e s . t h a t t h i s amount s u b s t a n t i a l l y u n d e r s t a t e s t h e r e a l v a l u e o f

t h e t r u s t s ' e q u i t y because it is based on a v a l u a t i o n of P l a c i d and o t h e r p r o p e r t i e s t h a t u s e s h i s t o r i c a l cost i n v a l u i n g a s s e t s . A Morgan G u a r a n t y memorandum d a t e d March 1 7 , 1 9 8 0 , e s t i m a t e d t h e Hunt b r o t h e r s ' t r u s t e s t a t e s ' s h a r e of P l a c i d t o b e w o r t h $ 1 . 9 b i l l i o n .
111. HUNT SILVER ACTIVITY
A.

JULY 1 9 7 9 THROUGH MARCH 1 9 8 0

H u n t F a m i l y Members a n d R e l a t e d E n t i t i e s Involved i n S i l v e r

Information obtained i n t h e investigation indicates t h a t t h e f o l l o w i n g 2 1 H u n t f a m i l y members a n d r e l a t e d e n t i t i e s h e l d o r t r a d e d s i l v e r d u r i n g t h e f a l l a n d w i n t e r o f 1979-80: N e l s o n Bunker Hunt C a r o l y n Hunt Houston Hunt Mary H u n t H u d d l e s t o n E l l e n Hunt Flowers E l i z a b e t h Hunt Curnes A l b e r t Huddleston Thomas J . C u r n e s Lamar H u n t Related E n t i t i e s I n t e r n a t i o n a l Metals I n v e s t m e n t C o . L t d Hunt M i n e r a l s I n t e r n a t i o n a l L t d Hunt H o l d i n g s (now d o i n g b u s i n e s s a s Pentad Resources, Inc., a t r a d i n g vehicle f o r Herbert's children) P l a n e t I n v e s t m e n t C o r p . ( h o l d i n g company f o r HIRCO) Bunker and H e r b e r t Hunt, I M I C a n d , t o a lesser e x t e n t , L a m a r H u n t were t h e p r i n c i p a l H u n t f a m i l y s i l v e r m a r k e t A t December 3 1 , 1 9 7 9 , Bunker, H e r b e r t and participants. I M I C owned o r c o n t r o l l e d a p p r o x i m a t e l y 1 9 5 m i l l i o n o u n c e s o f silver. Members o f B u n k e r a n d H e r b e r t ' s i m m e d i a t e f a m i l i e s owned o r c o n t r o l l e d a n a d d i t i o n a l 8 . 9 m i l l i o n o u n c e s t h r o u g h b r o k e r - d e a l e r s r e g i s t e r e d w i t h t h e Commission. The Hunts c o n d u c t e d t h e i r s i l v e r t r a d i n g a c t i v i t i e s w i t h a number o f b r o k e r - d e a l e r s , FCMS, p r e c i o u s m e t a l s d e a l e r s , banks and i n d i v i d u a l s . The Hunt f a m i l y c a r r i e d 1 0 2 m i l l i o n ounces o f its o v e r a l l p o s i t i o n i n accounts maintained with b r o k e r - d e a l e r s r e g i s t e r e d w i t h t h e Commission.
A.G.

W i l l i a m H e r b e r t Hunt Nancy B. H u n t D o u g l a s H. Hunt B r u c e W. H u n t B a r b a r a Hunt C r o w Lyda B u n k e r H u n t

H i l l , Jr. ( M a r g a r e t Hunt H i l l ' s s o n )

B. Developments in the Hunt Silver Position through Mid-January 1980 1. Early Interest in Silver Bunker and Herbert Hunt's first activity in the silver market started in the early 1970's when they became convinced that silver, then selling for about $2 per ounce, was underpriced and an excellent investment. They determined to accumulate positions in silver futures contracts and silver bullion. In 1973-1974, the Hunts began to build up a substantial position in silver futures contracts on the Comex and CBT. Bunker's first major acquisition of silver bullion occurred in late 1973 when he bought an estimated 20 million ounces of silver in a price range from $2.80 to $3.10 per ounce. Early in 1974 the Hunts purchased approximately 23 million ounces and eventually accumulated a total of about 50 million ounces of silver. The price of silver had edged up past $6.00 to $6.70, but faltered and fell back when Mexico sold 55 million ounces of silver. In the spring and summer of 1976, Bunker and Herbert took delivery of substantial quantities of silver on the CBT. Most of the deliveries were accepted by corporations controlled by the Hunts. Thereafter the Hunts each changed their pattern of trading in silver futures. Although they maintained large, net long or spread positions in silver, the Hunts generally did not take delivery of silver. Rather, they periodically rolled their positions forward to more distant maturities, a pattern they were to maintain through approximately July 1979. The Hunts' purchasing patterns with respect to silver were not confined to the metal itself. From at least 1977 through the silver crisis in March 1980 the Hunts engaged in several efforts to acquire major silver producers. 2. Buildup in the Hunt Silver Position During the fall and early winter of 1979-1980, the amount of silver controlled by Bunker and Herbert Hunt and IMIC increased from approximately 123 million ounces at July 31, 1979, to 195 million ounces at January 1, 1980. Meanwhile, as the price of silver rose from approximately $9.00 per ounce to approximately $35.00 per ounce, the apparent value of the silver represented by the position increased

f r o m approximately $1.1 b i l l i o n t o $6.8 b i l l i o n . When s i l v e r r e a c h e d i t s h i s t o r i c a l h i g h o f $50.00 p e r ounce o n J a n u a r y 1 7 , 1 9 8 0 , t h e a p p a r e n t v a l u e o f t h e H u n t p o s i t i o n was more than $9.8 b i l l i o n .
The l a r g e s t s h a r e o f t h e i n c r e a s e i n Hunt s i l v e r p o s i t i o n s p r i o r t o J a n u a r y o c c u r r e d t h r o u g h IMIC, w h i c h a c q u i r e d c a s h and f u t u r e s p o s i t i o n s t o t a l l i n g 57 m i l l i o n o u n c e s from J u l y t h r o u g h December. The o t h e r 1 2 m i l l i o n - o u n c e p o r t i o n o f t h e increased position occurred i n the personal accounts of o t h e r Hunt f a m i l y members. Of t h e n e t i n c r e a s e o f a p p r o x i m a t e l y 69 m i l l i o n o u n c e s i n H e r b e r t , Bunker and IMIC's p o s i t i o n , a p p r o x i m a t e l y 4 6 m i l l i o n was i n t h e f o r m o f p h y s i c a l s i l v e r ; t h e r e m a i n d e r was a t t r i b u t a b l e t o t h e a c q u i s i t i o n of new f u t u r e s c o n t r a c t s and t h e e s t a b l i s h m e n t of forward posit i o n s i n London a n d Z u r i c h . Lamar c a r r i e d a n 8 . 1 m i l l i o n o u n c e f u t u r e s p o s i t i o n a t J a n u a r y 3 1 , 1980. The o t h e r f a m i l y m e m b e r s a n d r e l a t e d e n t i t i e s c o m b i n e d had a 5 . 8 m i l l i o n ounce n e t long p o s i t i o n i n f u t u r e , forward and p h y s i c a l s i l v e r a t t h a t date. T h e c o m b i n e d Hunt/IMIC n e t l o n g f u t u r e s p o s i t i o n a t t h e e n d o f 1979 - a p p r o x i m a t e l y 20,000 c o n t r a c t s - r e p r e s e n t e d 9 % o f t h e c o m b i n e d o p e n i n t e r e s t o n Comex a n d CBT a n d a p p r o x i m a t e l y 76% o f t h e c e r t i f i c a t e d s i l v e r s t o c k s o f t h o s e two e x c h a n g e s . T h e Hunt/IMIC n e t l o n g p o s i t i o n i n p h y s i c a l a n d f u t u r e s , m o r e o v e r , c o m p r i s e d a p p r o x i m a t e l y 1 5 % o f Handy a n d Harmon estimates o f w o r l d s i l v e r s t o c k s a n d 1 2 1 % o f domestic i n d u s t r i a l c o n s u m p t i o n i n 1 9 7 9 . Meanwhile, t h e H u n t ' s s i l v e r p o s i t i o n g e n e r a t e d a subThis s t a n t i a l c a s h f l o w a s t h e p r i c e o f t h e metal i n c r e a s e d . F i r s t , pursuant to customary p r a c t i c e o c c u r r e d i n t w o ways. i n t h e f u t u r e s i n d u s t r y , b r o k e r - d e a l e r s a n d FCMs c a r r y i n g Hunt f u t u r e s p o s i t i o n s w i r e d d a i l y t o t h e H u n t s ' c a s h r e p r e s e n t i n g t h e a p p r e c i a t i o n i n v a l u e of t h e i r open f u t u r e s contracts. The c a s h g e n e r a t i n g p o t e n t i a l o f t h i s p r a c t i c e is o b v i o u s . A t J a n u a r y 1, 1 9 8 0 , f o r e x a m p l e , H e r b e r t a n d B u n k e r H u n t a n d IMIC m a i n t a i n e d s i l v e r f u t u r e s p o s i t i o n s a g g r e g a t i n g approximately 19,350 c o n t r a c t s , or approximately 96.8 m i l l i o n ounces. Each $ 1 p e r o u n c e i n c r e a s e i n t h e p r i c e of s i l v e r , t h e r e f o r e , produced a cash flow of approxim a t e l y $96.8 m i l l i o n i n t o t h e Hunts' a c c o u n t . A t y e a r end 1979, t h e " d e f e r r e d c r e d i t " i t e m o n Bunker and H e r b e r t H u n t ' s b a l a n c e s h e e t s , which r e p r e s e n t e d c a s h r e c e i v e d i n t h i s manner, t o t a l e d a p p r o x i m a t e l y $1.4 b i l l i o n . The Hunts o b t a i n e d a n a d d i t i o n a l , b u t less s i g n i f i c a n t , amount o f c a s h by b o r r o w i n g a g a i n s t t h e i r s i l v e r p o s i t i o n . T a b l e I11 o n t h e f o l l o w i n g p a g e s u m m a r i z e s s i l v e r - r e l a t e d f i n a n c i n g t r a n s a c t i o n s e f f e c t e d by B u n k e r , H e r b e r t a n d / o r Lamar H u n t a n d / o r H u n t H o l d i n g s , H u n t M i n e r a l s a n d / o r IMIC f r o m A u g u s t 1, 1 9 7 9 t h r o u g h March 2 7 , 1 9 8 0 . A s t h e t a b l e i l l u s t r a t e s , by J a n u a r y 1 7 , 1 9 8 0 , when t h e s p o t p r i c e o f

s i l v e r reached i t s h i s t o r i c i n t r a d a y high of approximately $50, t h e Hunts ' o u t s t a n d i n g s i l v e r - r e l a t e d borrowing t o t a l e d $522 m i l l i o n .

C.

Hunt S i l v e r A c t i v i t i e s D u r i n g t h e Market D e c l i n e
1. The S i l v e r M a r k e t s , J a n u a r y Through March 1 9 8 0

D u r i n g t h e f a l l and w i n t e r o f 1979-1980, t h e p r i n c i p a l domestic s i l v e r f u t u r e s exchanges, i n c o n s u l t a t i o n with CFTC, r e a c t e d t o s u r g i n g s i l v e r p r i c e s w i t h a number o f m e a s u r e s . 1 4 / T h e s e i n c l u d e d , among o t h e r s , (1) d r a m a t i c i n c r e a s e s in o r i g i n a l m a r g i n r e q u i r e m e n t s , p a r t i c u l a r l y f o r l a r g e n e t p o s i t i o n s , ( 2 ) i m p o s i t i o n o f l i m i t s (some o f them r e t r o a c t i v e ) o n t h e s i z e o f t r a d e r s ' p o s i t i o n s , a n d ( 3 ) r u l e s l i m i t i n g t r a d i n g i n s i l v e r f u t u r e s to o r d e r s placed bona f i d e Meanwhile, a s f o r l i q u i d a t i o n o r --h e d g i n g o n l y . s i l v e r p r i c e s c l i m b e d , i n d u s t r i a l demand d e c l i n e d r a p i d l y a n d new s u p p l i e s came i n t o t h e m a r k e t a s h o l d e r s were l u r e d i n t o s e l l i n g by h i g h p r i c e s . A c t i o n by t h e e x c h a n g e s i n r e s p o n s e t o d e v e l o p m e n t s i n s i l v e r a p p e a r t o h a v e c u l m i n a t e d d u r i n g t h e l a s t f u l l week i n J a n u a r y 1 9 8 0 . On Monday, J a n u a r y 2 1 , Comex imposed a n "emergency" r u l e l i m i t i n g s i l v e r f u t u r e s t r a d i n g t o l i q u i dation only. The n e x t m o r n i n g , CBT f o l l o w e d s u i t , i m p o s i n g l i q u i d a t i o n o n l y t r a d i n g i n t h e J a n u a r y , F e b r u a r y and March c o n t r a c t s and o r d e r i n g t h a t a l l p o s i t i o n s i n t h e February 1 9 8 0 c o n t r a c t be r e d u c e d by 25% i n ' e a c h o f t h e e n s u i n g f o u r weeks. On Wednesday, J a n u a r y 2 3 , Comex i n s t r u c t e d b r o k e r d e a l e r s a n d FCMs w i t h whom t h e H u n t s m a i n t a i n e d a c c o u n t s t o a g g r e g a t e B u n k e r , H e r b e r t , Lamar and D o u g l a s A u n t ' s a c c o u n t s w i t h one a n o t h e r and w i t h I M I C ' s a c c o u n t f o r p u r p o s e s o f p o s i t i o n l i m i t s imposed by t h a t e x c h a n g e e a r l y i n t h e month. On F e b r u a r y 4 , Comex m a r g i n r e q u i r e m e n t s on p o s i t i o n s o f t h e magnitude o f t h e H u n t s ' a t c e r t a i n f i r m s i n c r e a s e d from $30,000 t o $60,000 p e r c o n t r a c t . M e a n w h i l e , o n J a n u a r y 22 t h e s p o t p r i c e o f s i l v e r f e l l a p p r o x i m a t e l y $ 1 0 . 0 0 p e r o u n c e t o s e t t l e a t $34.00 o n Comex. Over t h e e n s u i n g s i x weeks ( J a n u a r y 22 - March 7 , 1 9 8 0 ) , s p o t s i l v e r s e t t l e d b e t w e e n $ 3 1 . 0 0 a n d $38.50 p e r o u n c e u n t i l i t resumed i t s d e c l i n e o n March 1 0 , f a l l i n g f r o m $ 2 9 . 7 5 t o $10.80 i n t h e f o u r t e e n b u s i n e s s d a y s t h r o u g h T h u r s d a y , March 27. 14 -/ The e x c h a n g e s a n d t h e C F T C ' s r e s p o n s e t o c o n d i t i o n s i n t h e s i l v e r m a r k e t h a v e b e e n e x h a u s t i v e l y documented i n r e p o r t s i s s u e d by t h e s e a g e n c i e s and by c o n g r e s s i o n a l c o m m i t t e e s t h a t h a v e h e l d numerous h e a r i n g s c o n c e r n i n g t h e s i l v e r c r i s i s . W e make no a t t e m p t i n t h i s r e p o r t t o recount such matters i n d e t a i l , but d i r e c t t h e reader t o those sources f o r f u r t h e r information.

2. The Impact on the Hunts of Silver Market Conditions a. Overview As the price of silver declined after January 21, the positive cash flow the Hunts enjoyed in the fall and early winter was reversed. To maintain their futures positions, the Hunts were required to deposit variation margin with the brokers carrying their silver futures accounts. In addition, rather than closing out their futures positions as they matured by effecting offsetting transactions, the Hunts in January and thereafter stood for delivery of the silver represented by the contracts, a practice that required them to pay for physical silver at prices then prevailing. 15/ Finally, during this period the Hunts effected a numberof so-called "exchange for physicals" ("EFP") transactions with holders of physical silver, whereby they acquired silver at or near prevailing prices and transferred to the sellers a corresponding number of open long futures contracts. b The Engelhard Deal . Of the EFP transactions effected by the Hunts, that with the Philipp Brothers ("Phibro") subsidiary of Engelhard Minerals & Chemicals Co. is particularly significant to an understanding of the silver crisis because of the magnitude and timing of the Hunts' resulting obligation. Raymond Nessim, Phibro group vice president for precious metals trading, later described to one of Engelhard's banks that prior to January 1980, Phibro maintained a short position in the silver futures market of approximately 12,000 contracts, established to hedge its physical silver inventory. As silver prices increased during the fall and winter of 1979-80, Phibro was required to post significant variation margin that Nessim said had strained its resources. Nessim told the banks that the firm was concerned that a continued increase in the price of silver could require additional variation margin payments of as much as $3 billion, a figure beyond its means. To reduce the size of its inventory position, and the required hedge, to manageable levels, Phibro determined to approach those with a long interest in the market concerning sale of part of Phibro's inventory in off-exchange EFP transactions. The firm realized that the

15/ -

It will be recalled that the Hunts had already withdrawn from their accounts the unrealized appreciation on their futures positions; in effect, they had to remit this amount and the contract price to the carrying broker to pay for delivery of the physical metal.

H u n t s were t h e o n l y p o t e n t i a l c o u n t e r p a r t y w i t h a m e a n i n g f u l long position. It determined t o modify its p o l i c y a g a i n s t d o i n g b u s i n e s s w i t h i n d i v i d u a l s or s p e c u l a t o r s and approach t h e Hunts w i t h a d e a l .

A s u l t i m a t e l y n e g o t i a t e d o n J a n u a r y 11 a n d d u r i n g t h e week o f J a n u a r y 1 4 , 1 9 8 0 , t h e H u n t s a g r e e d t o p u r c h a s e f r o m P h i b r o , i n a series o f t r a n s a c t i o n s , a p p r o x i m a t e l y 28.5 16 m i l l i o n o u n c e s o f s i l v e r a t a p p r o x i m a t e l y $ 3 6 p e r o u n c e , -/ for a t o t a l c o n s i d e r a t i o n o f a p p r o x i m a t e l y $1.04 b i l l i o n . The Hunts conveyed t o P h i b r o 5698 l o n g s i l v e r f u t u r e s cont r a c t s ( 1 5 0 0 F e b . 8 0 CBT; 3 3 9 8 Mar. 8 0 CMX; 8 0 0 May 8 0 CMX) which t h e f i r m used t o o f f s e t a n e q u i v a l e n t s h o r t p o s i t i o n , t h u s r e l i e v i n g it o f t h e o b l i g a t i o n t o pay v a r i a t i o n margin on those contracts. I n a d d i t i o n , t h e Hunts p o s t e d 8.5 m i l l i o n o u n c e s of s i l v e r a s c o l l a t e r a l f o r t h e i r p e r f o r m a n c e of the contractual obligation.

The d a t e s n e g o t i a t e d b y t h e p a r t i e s f o r p a y m e n t b y t h e Hunts and d e l i v e r y by P h i b r o are s i g n i f i c a n t : TABLE I V DATE J a n u a r y 1 6 , 1980 January 30, 1980 F e b r u a r y 1, 1 9 8 0 March 3 1 , 1 9 8 0 May 1, 1 9 8 0 J u l y 1, 1 9 8 0 16 -/ OUNCES TO BE DELIVERED (millions) 4.5 2.0 3.0 12.0 2.0 5.0 AMOUNT OF PAYMENT (millions) $157.0 74.0 105.0 434.0 76.0 192.0
-/ 17

D u r i n g t h a t w e e k , s p o t s i l v e r s e t t l e d o n Comex a t p r i c e s r a n g i n g f r o m $ 3 8 . 7 5 ( F r i d a y , J a n u a r y 11) t o $ 4 8 . 7 0 (Thursday, January 1 7 ) . P h i b r o ' s p r i c e to t h e Hunts t h u s r e p r e s e n t e d a s i g n i f i c a n t d i s c o u n t from t h e market.

17 -/ I t s h o u l d b e n o t e d t h a t t h e a g r e e m e n t s b e t w e e n P h i b r o a n d t h e H u n t s p r o v i d e d t h a t P h i b r o c o u l d , a t i t s o p t i o n , make d e l i v e r y o f a p o r t i o n o f t h e March d e l i v e r y a s e a r l y a s Monday, M a r c h 3 , 1 9 8 0 . When P h i b r o n o t i f i e d t h e H u n t s o f i t s i n t e n t i o n t o d e l i v e r 7 . 1 m i l l i o n o u n c e s o f t h e March d e l i v e r y o n March 3 , a n d r e q u e s t e d payment o f $ 2 5 3 m i l l i o n o n t h a t d a t e , however, H e r b e r t Hunt t o l d N e s s i m t h a t t h e Footnote continued on n e x t page.

Thus, i n J a n u a r y , j u s t b e f o r e s i l v e r began t h e p r i c e d e c l i n e t h a t c u l m i n a t e d o n March 2 7 , t h e H u n t s o b l i g a t e d t h e m s e l v e s t o a $ 4 3 4 m i l l i o n p a y m e n t o n M a r c h 3 1 . T h e H u n t s were u n a b l e t o meet t h a t p a y m e n t . 3. F i n a n c i n s S i l v e r i n t h e . M a r k e t D e c l i n e To f i n a n c e t h e m a r g i n c a l l s a n d d e l i v e r y payments d e s c r i b e d i n t h e foregoing s e c t i o n , t h e Hunts s u b s t a n t i a l l y i n c r e a s e d t h e i r borrowing from banks, b r o k e r - d e a l e r s , ind i v i d u a l s a n d f r o m a f f i l i a t e d Hunt e n t i t i e s s u c h as P l a c i d O i l Co. A l t h o u g h , a s i n d i c a t e d o n T a b l e I11 , d u r i n g t h i s p e r i o d , t h e H u n t s were a p p a r e n t l y a b l e t o a r r a n g e a n e t i n c r e a s e i n b o r r o w i n g o f a p p r o x i m a t e l y $896 m i l l i o n , t h e i r r e c o r d s and t h o s e o f v a r i o u s banks i n d i c a t e t h a t a s t i m e went on t h e y encountered an increasing l e v e l of r e s i s t a n c e to f u r t h e r borrowing requests. T h e y were t u r n e d down a t a number o f institutions. I n F e b r u a r y 1 9 8 0 , Morgan G u a r a n t y r e f u s e d H e r b e r t A u n t ' s r e q u e s t t o borrow $100 m i l l i o n t o be s e c u r e d by s i l v e r . On March 4 , B a r c l a y s Bank I n t e r n a t i o n a l L t d . ( " B a r c l a y s " ) , t o whom t h e H u n t s h a d b e e n i n t r o d u c e d by F i r s t N a t i o n a l Bank o f C h i c a g o ( " F i r s t C h i c a g o " ) , r e f u s e d a j o i n t r e q u e s t by H e r b e r t a n d B u n k e r t o b o r r o w $ 1 0 0 m i l l i o n s e c u r e d by s i l v e r . 1 8 / A c c o r d i n g t o B a r c l a y s 1 m e m o r a n d a , t h e b a n k r e j e c t e d tG r e q u e s t f o r s e v e r a l r e a s o n s : (1) i n t h e l i g h t o f t h e F e d ' s O c t o b e r 1 9 7 9 c r e d i t r e s t r a i n t p r o g r a m i t d i d n o t w i s h t o be s e e n a s s i s t i n g t h e Hunts to o b t a i n c r e d i t to c o n t i n u e t h e i r s i l v e r a c t i v i t i e s ; ( 2 ) t h e r e was a s t r o n g p o s s i b i l i t y t h a t t h e L o n d o n Metal E x c h a n g e w o u l d i m p o s e r e s t r i c t i o n s o n s i l v e r Footnote c o n t i n u e d from p r e v i o u s page. H u n t s ' f u n d s were i n v e s t e d u n t i l m o n t h e n d a n d t h a t i t w a s "not convenient" f o r t h e Hunts to s t a n d f o r d e l i v e r y on March 3. N e s s i m t o l d t h e Hunts t h a t t h e i r f a i l u r e to t e n d e r p a y m e n t u n t i l March 3 1 w o u l d c o s t P h i b r o $ 1 . 7 m i l l i o n i n i n t e r e s t and, as t h e p r i c e f o r d e l a y i n g del i v e r y u n t i l March 3 1 , i n s i s t e d o n a n upward m o d i f i c a t i o n o f t h e p r i c e t o compensate P h i b r o f o r t h e lost i n t e r e s t . 18 -/ I n presenting t h e Bunts' request, Parker t o l d Barclays' p e r s o n n e l t h a t a s CBT a n d Comex t i g h t e n e d t h e i r r e s t r i c t i o n s , t h e H u n t s had begun t o l o o k t o Europe as t h e s i t e f o r t h e i r s i l v e r a c t i v i t i e s and t h a t he ( P a r k e r ) w a s then v i s i t i n g b a n k s i n Z u r i c h , F r a n k f u r t a n d London t o a r r a n g e financing. P a r k e r t o l d t h e bank t h a t t h e Hunts wanted t o borrow $300 m i l l i o n o n a s h o r t t e r m b a s i s , o f which B a r c l a y s ' s h a r e would b e o n e - t h i r d .

s p e c u l a t i o n s i m i l a r t o t h o s e i m p l e m e n t e d by U.S. e x c h a n g e s ; ( 3 ) t h e amount o f s i l v e r c o l l a t e r a l r e q u i r e d t o c o l l a t e r a l i z e t h e H u n t s ' p r o p o s e d f i n a n c i n g w a s so e n o r m o u s t h a t a n y a t t e m p t t o l i q u i d a t e i n t h e e v e n t o f d e f a u l t would s o e r o d e t h e p r i c e o f s i l v e r t h a t c o l l a t e r a l c o v e r a g e c o u l d be i n s u f f i c i e n t ; and ( 4 ) t h e bank d i d n o t have t h e w h e r e w i t h a l , o n s h o r t n o t i c e , to adequately e v a l u a t e t h e Hunts' f i n a n c i a l capacity. On March 1 0 , D e u t s c h e Bank, l i k e B a r c l a y s , t u r n e d down a l o a n r e q u e s t from Bunker and H e r b e r t Hunt. On March 1 2 , Merrill Lynch r e f u s e d a $ 2 5 m i l l i o n r e q u e s t f r o m I M I C a n d o n March 1 8 , R o y a l Bank o f C a n a d a , T o r o n t o Dominion Bank a n d Bank o f Nova S c o t i a e a c h r e f u s e d a $100 m i l l i o n b o r r o w i n g r e q u e s t , 1 9 / a l t h o u g h T o r o n t o Dominion l a t e r a g r e e d t o l e n d $75 m i l l i o n t o I M I C a f t e r P l a c i d O i l t r e a s u r e r W a l t e r F r a k e r i n t e r v e n e d w i t h T o r o n t o D o m i n i o n ' s U.S. o f f i c e t o a r r a n g e a f u r t h e r meeting. In a d d i t i o n t o t h e foregoing i n s t i t u t i o n s , F i r s t Chicago, a major l e n d e r t o t h e Hunt f a m i l y , a l s o d e c l i n e d i n March t o make a n a d d i t i o n a l $ 1 3 5 m i l l i o n l o a n t o B u n k e r a n d H e r b e r t Hunt 20/ a b o v e t h e $90 m i l l i o n i t h a d l e n t them a n d Lamar i n ~ e b r u z ~ F i n a l l y , o n March 2 6 , t h e H u n t s s o u g h t t o r a i s e . money i n a n o f f e r i n g i n E u r o p e o f s i l v e r - b a c k e d b o n d s . 19 -/ L i k e B a r c l a y s ' , D e u t s c h e Bank, R o y a l Bank, T o r o n t o Dominion a n d Bank o f Nova S c o t i a e a c h c i t e d t h e F e d ' s c r e d i t r e s t r a i n t program i n d e c l i n i n g t o l e n d t o t h e Hunts. I n t e r e s t i n g l y e n o u g h , t h e Fed a n d a number o f b a n k e r s whose i n s t i t u t i o n s f i n a n c e d t h e H u n t s ' s i l v e r t r a d i n g s t a t e d a f t e r t h e crisis t h a t s u c h l e n d i n g d i d not contravene t h e Fed's c r e d i t r e s t r a i n t guidelines b e c a u s e t h e l o a n p r o c e e d s were u s e d t o m a i n t a i n t h e H u n t s ' e x i s t i n g p o s i t i o n s r a t h e r t h a n e s t a b l i s h new ones. 20/ F i r s t C h i c a g o e n t e r e d t h e p e r i o d o f s i l v e r p r i c e d e c l i n e s i n m i d - J a n u a r y w i t h $144 m i l l i o n i n l o a n s t o t h e On J a n u a r y 1, Hunts and r e l a t e d e n t i t i e s on its books. 1980, t h e bank had o u t s t a n d i n g t o H e r b e r t and Bunker Hunt $10 m i l l i o n o f a $35 m i l l i o n commitment a n d $ 1 3 4 m i l l i o n t o P l a c i d , Penrod and HIRCO o f $161 m i l l i o n i n c o m m i t ments. The H u n t s had i n v e s t e d $ 2 0 0 m i l l i o n t h r o u g h F i r s t C h i c a g o ' s money m a r k e t d e s k . By e a r l y F e b r u a r y , h o w e v e r , t h e H u n t s ' b o r r o w i n g a t F i r s t Chicago began t o i n c r e a s e . On F e b r u a r y 4 , Lamar Hunt b o r r o w e d $50 m i l l i o n t o h e l p him meet $ 1 0 1 m i l l i o n i n margin requirements on h i s s i l v e r f u t u r e s p o s i t i o n , a l o a n t h a t w a s s e c u r e d i n p a r t by s i l v e r b u l l i o n h e o b t a i n e d from Bunker. Bunker and H e r b e r t , meanwhile r e q u e s t e d t h a t t h e i r l i n e s o f c r e d i t b e i n c r e a s e d t o $80 Footnote c o n t i n u e d on n e x t page.

IV.

THE SILVER C R I S I S
A.

The Hunts'

D e f a u lt

On March 1 3 , I M I C t o l d M e r r i l l L y n c h i t w a s u n a b l e t o meet, w i t h i n t h e c u s t o m a r y 2 4 h o u r s , a $ 4 4 m i l l i o n v a r i a t i o n m a r g i n c a l l g e n e r a t e d M a r c h 11 o n i t s 3 8 0 8 - c o n t r a c t f u t u r e s I t also f a i l e d t o pay approximately position with the firm. $12 m i l l i o n f o r d e l i v e r y o f 600,000 ounces of s i l v e r p u r s u a n t t o m a t u r i n g f o r w a r d p u r c h a s e commitments i n t h e London market. On Monday, M a r c h 1 7 , t h e H u n t s t o l d B a c h e t h e y were u n a b l e t o s a t i s f y w i t h c a s h a margin c a l l f o r $44 m i l l i o n i n t h e family's accounts. T h e r e a f t e r , u n t i l w e l l i n t o t h e week o f March 3 1 , M e r r i l l a n d B a c h e f i n a n c e d t h e H u n t s ' v a r i a t i o n margin requirements a t t h e clearinghouse a g a i n s t p h y s i c a l s i l v e r h e l d i n t h e Hunts' a c c o u n t s or d e p o s i t e d by t h e Hunts i n l i e u of cash. They c o n t i n u e d , however, to p o s t m a r g i n w i t h t h e o t h e r f o u r f i r m s , which c a r r i e d approximately 33% o f t h e t o t a l Hunt p o s i t i o n . On M a r c h 2 6 , t h e H u n t s t o l d B a c h e , M e r r i l l a n d ACLI t h a t t h e y were s t o p p i n g m a r g i n p a y m e n t s . g/ Meanwhile, o n March 28 B u n k e r Hunt i n f o r m e d E n g e l h a r d chairman Milton Rosenthal ("Rosenthal") t h a t t h e b r o t h e r s w o u l d n o t make t h e r e q u i r e d p a y m e n t o f $ 4 3 4 m i l l i o n t o P h i b r o i n p a r t i a l s e t t l e m e n t o f t h e EFP t r a n s a c t i o n s d e s c r i b e d e a r l i e r . D u r i n g t h e same p e r i o d , t h e H u n t s f a i l e d t o meet $78.9 m i l l i o n i n m a r g i n c a l l s o n f o r w a r d p u r c h a s e commitments w i t h S w i s s Bank C o r p o r a t i o n i n Z u r i c h , commitments t h e y had t a k e n o v e r f r o m IMIC o n March 1 9 . A s s i l v e r p r i c e s f e l l , moreover, t h e H u n t s ' bank l o a n s became u n d e r c o l l a t e r a l i z e d and t h e Hunts e x p l a i n e d t o b a n k e r s t h a t t h e y had no f u r t h e r c a s h o r l i q u i d a s s e t s w i t h w h i c h t o p a y down o r f u r t h e r

Footnote continued from p r e v i o u s page. m i l l i o n a n d b y F e b r u a r y 22 r e q u e s t e d a f u r t h e r i n c r e a s e t o $185 m i l l i o n ($150 m i l l i o n above t h e e x i s t i n g $35 m i l l i o n l i n e ) . On F e b r u a r y 2 6 , t h e b a n k i n d e e d i n c r e a s e d t h e l i n e , b u t o n l y t o $50 m i l l i o n . A s t h e crisis d e v e l o p e d , t h e r e f ore, F i r s t Chicago had o u t s t a n d i n g t o i n d i v i d u a l Hunts $100 m i l l i o n i n l o a n s , t e n t i m e s t h e Its total outc r e d i t s on its books i n e a r l y January. s t a n d i n g t o a l l o f t h e Hunt i n t e r e s t s w a s $223.1 m i l l i o n , u p 55% f r o m J a n u a r y . 21/ T h e c i r c u m s t a n c e s s u r r o u n d i n g t h e H u n t s f a i l u r e t o meet margin calls and t h e b r o k e r s ' f i n a n c i n g of t h o s e calls a t t h e c l e a r i n g h o u s e s are d e s c r i b e d i n d e t a i l i n t h e p o r tions of t h i s report dealing with individual firms.

c o l l a t e r a l i z e the loans. A t March 28, 1 9 8 0 , H e r b e r t and Bunker Hunt and IMIC had o u t s t a n d i n g , e x c l u s i v e o f m a r g i n calls, approximately $1.75 b i l l i o n i n s i l v e r r e l a t e d o b l i gations. B. T h e H u n t s R e f i n a n c e T h e i r S i l v e r D e b t The m a g n i t u d e o f t h e H u n t s ' o b l i g a t i o n s became a p p a r e n t o v e r t h e w e e k e n d o f M a r c h 2 9 a n d 3 0 , 1 9 8 0 , when F e d C h a i r m a n Volcker and o t h e r s l e a r n e d o f t h e Hunts' impending d e f a u l t o n t h e E n g e l h a r d / P h i b r o EFP o b l i g a t i o n . During t h e weekend, t h e H u n t s s o u g h t , w i t h o u t s u c c e s s , b a n k l o a n s t o meet t h e $434 m i l l i o n payment. By S u n d a y n i g h t , March 3 0 , V o l c k e r and s e n i o r bank o f f i c i a l s a t t e n d i n g t h e Reserve C i t y Bankers A s s o c i a t i o n c o n v e n t i o n i n B o c a R a t o n were d i s c u s s i n g t h e p o t e n t i a l f o r a f i n a n c i a l d i s a s t e r t h e n e x t d a y when n e w s o f t h e i m p e n d i n g E n g e l h a r d d e f a u l t became p u b l i c . Engelhard h a d r e q u e s t e d t h a t t r a d i n g i n i t s s t o c k b e h a l t e d 22/ a n d i t s p e r s o n n e l were d i s c u s s i n g w h e t h e r t o f i l e a p e t i t i o n t o h a v e t h e Hunts d e c l a r e d bankrupt. The Hunts e x t r i c a t e d t h e m s e l v e s from t h i s s i t u a t i o n To s a t i s f y t h e b a l a n c e p r i m a r i l y through t w o t r a n s a c t i o n s . o f t h e i r t o t a l o b l i g a t i o n t o E n g e l h a r d , w h i c h was a p p r o x i m a t e l y $ 6 3 5 m i l l i o n , t h e H u n t s o n March 3 1 a g r e e d t o - f o r e g o d e l i v e r y o f t h e s i l v e r t h e y had c o n t r a c t e d t o p u r c h a s e , y i e l d e d t o Engelhard t h e 8.5 m i l l i o n ounces o f s i l v e r t h e y had d e p o s i t e d as s e c u r i t y f o r t h e performance o f t h e c o n t r a c t and conveyed t o t h e f i r m 20% o f t h e Hunt b r o t h e r s ' i n t e r e s t , t h r o u g h HIPCO ( C a n . ) , i n t h e B e a u f o r t Sea l i c e n s e s d e s cribed a t note 9 above. 23/ With r e s p e c t to t h e remaining o b l i g a t i o n s , t h e Hunts utilized Placid's resources t o satisfy their personal s i l v e r debts. A s e a r l y a s M a r c h 11, t h e H u n t b r o t h e r s h a d s o u g h t and o b t a i n e d from P l a c i d funds t o s u p p o r t t h e i r s i l v e r t r a d ing. On t h a t d a y , B u n k e r a n d H e r b e r t h a d e x e c u t e d i n f a v o r o f P l a c i d p r o m i s s o r y n o t e s f o r a n a g g r e g a t e o f $500 m i l l i o n a n d o n March 2 1 Lamar e x e c u t e d n o t e s f o r $ 4 0 m i l l i o n . Purs u a n t t o t h e s e n o t e s , Bunker and H e r b e r t drew $50 m i l l i o n and 22/ T r a d i n g i n E n g e l h a r d s t o c k was h a l t e d f o r p a r t o f Monday, March 31. 23/ T h e B e a u f o r t Sea p r o p e r t i e s , a s i t t u r n e d o u t , were a t t h e t i m e of t h e agreement w i t h Engelhard a l r e a d y pledged t o F i r s t Chicago a s a part of t h e collateral pool s u p p o r t i n g its $50 m i l l i o n l o a n t o Bunker and H e r b e r t . F i r s t Chicago r e f u s e d t o release t h o s e p r o p e r t i e s u n t i l t h e H u n t s h a d r e p a i d $100 m i l l i o n i n p e r s o n a l l o a n s from t h e bank. P l a c i d r e p a i d t h o s e l o a n s o n t h e Hunt b r o t h e r s ' b e h a l f o n A p r i l 8, 1980, o u t of t h e proceeds of t h e i n t e r i m l o a n s d e s c r i b e d below.

$55 m i l l i o n r e s p e c t i v e l y , a n d P l a c i d p u r c h a s e d f r o m t h e K a n s a s C i t y C h i e f s a $ 5 m i l l i o n n o t e Lamar h a d e a r l i e r e x e c u t e d i n its favor. I n a d d i t i o n , sometime b e f o r e A p r i l 3 , 1980, P l a c i d p u r c h a s e d f o r $132 m i l l i o n t h e Hunt b r o t h e r s ' 40% i n t e r e s t i n a North Sea petroleum license. T h e money P l a c i d p a s s e d t o t h e Hunt b r o t h e r s t h u s t o t a l e d a p p r o x i m a t e l y $242 million. P l a c i d funded t h e l o a n s to t h e b r o t h e r s and t h e N o r t h S e a p u r c h a s e i n p a r t by b o r r o w i n g $50 m i l l i o n f r o m B a n k e r s T r u s t o n March 1 4 a n d $ 6 5 m i l l i o n from C i t i b a n k o n M a r c h 3 1 a n d A p r i l 1. P l a c i d a l s o r e p a t r i a t e d $ 6 5 m i l l i o n i n g u i l d e r investments and r e l i e d t o an i n d e t e r m i n a t e d e g r e e o n i t s own f l o a t a n d w o r k i n g c a p i t a l . On S u n d a y , M a r c h 3 0 , h o w e v e r , t h e H u n t s t o l d R o s e n t h a l t h a t n o more f u n d s c o u l d b e o b t a i n e d from P l a c i d a n d Morgan G u a r a n t y r e c o r d s r e f l e c t t h a t on A p r i l 3 , P l a c i d had t o l d t h e Hunt b r o t h e r s t h a t t h e $242 m i l l i o n it had p a s s e d t o them as d e s c r i b e d above was t h e "end o f t h e l i n e . "

On Monday, A p r i l 7 , h o w e v e r , P l a c i d e n t e r e d a n i n t e r i m a g r e e m e n t w i t h a g r o u p o f b a n k s u n d e r w h i c h $ 3 0 0 m i l l i o n was a d v a n c e d t o P l a c i d t o meet c e r t a i n o f t h e H u n t s ' i m m e d i a t e obligations. The n e x t d a y , F i r s t i n Dallas d i s b u r s e d $230 m i l l i o n of t h i s a m o u n t t o v a r i o u s o f t h e H u n t s ' c r e d i t o r s . $ 1 0 1 . 5 m i l l i o n was p a i d t o F i r s t C h i c a g o t o r e p a y t h e H u n t b r o t h e r s ' p e r s o n a l l o a n s f r o m t h a t bank, t h e r e b y s e c u r i n g t h e release o f t h e B e a u f o r t and N o r t h S e a p e t r o l e u m i n t e r e s t s t h e Hunts had a l r e a d y c o n t r a c t e d to sell to Engelhard and P l a c i d , respectively. $ 7 8 m i l l i o n was p a i d t o S w i s s Bank C o r p o r a t i o n . $ 2 2 . 7 m i l l i o n was p a i d t o B a c h e G r o u p t o c o v e r Mary H u n t Huddleston and h e r husband A l b e r t ' s losses on a f o r w a r d s i l v e r p o s i t i o n i n London. Meanwhile, t h e H u n t s and v a r i o u s b a n k s , l e d by F i r s t i n D a l l a s a n d Morgan G u a r a n t y , d i s c u s s e d a t r a n s a c t i o n t h a t would r e f i n a n c e and c o n s o l i d a t e a l l o f t h e H u n t s ' s i l v e r A s u l t i m a t e l y arranged, Placid financed t h e Hunts' debts. r e p a y m e n t o f t h e i r s i l v e r d e b t by a d v a n c i n g t h e n e c e s s a r y amounts t h r o u g h a wholly-owned s u b s i d i a r y ( P l a c i d I n v e s t m e n t Co.), c r e a t e d f o r t h a t purpose, to a p a r t n e r s h i p comprised o f t h e Hunt b r o t h e r s a s l i m i t e d p a r t n e r s a n d P l a c i d I n v e s t m e n t Co. a s g e n e r a l p a r t n e r ( t h e " l i m i t e d p a r t n e r s h i p " ) . The Hunt b r o t h e r s , i n t u r n , c o n t r i b u t e d t o t h e p a r t n e r s h i p t h e i r and IMIC's remaining s i l v e r p o s i t i o n s ( v a l u e d a t $1.29 b i l l i o n u s i n g $14.05 p e r ounce as t h e p r i c e o f s i l v e r ) and c o a l p r o p e r t i e s i n Montana and N o r t h Dakota v a l u e d a t $294 million. The Hunts c o n t r i b u t e d t h e assets " s u b j e c t t o b u t w i t h o u t a n y a s s u m p t i o n by t h e [ p l a r t n e r s h i p o f " $ 1 . 1 3 billion i n debts. N o t w i t h s t a n d i n g t h e d i s c l a i m e r o f assumpt i o n j u s t q u o t e d , t h e l i m i t e d p a r t n e r s h i p undertook to discharge t h i s debt out of the proceeds of Placid's c a p i t a l contribution.

To r e p a y P l a c i d f o r t h e a m o u n t s e x p e n d e d t o s a t i s f y t h e i r s i l v e r d e b t , t h e H u n t B r o t h e r s c o m m i t t e d t o make p e r i o d i c a d d i t i o n a l " c a p i t a l contributions" to t h e l i m i t e d p a r t n e r s h i p t o t h e e x t e n t t h a t i t s o p e r a t i o n s and t h e sale, i f a n y , o f t h e Hunt b r o t h e r s ' s i l v e r p o s i t i o n s produced a n insufficient return. T h i s o b l i g a t i o n w a s s e c u r e d by a s e c o n d l i e n o n p e r s o n a l assets o f t h e Hunt b r o t h e r s v a l u e d a t $2.84 $2.3 b i l l i o n b i l l i o n , b u t s u b j e c t t o $93.8 m i l l i o n i n d e b t . o f t h i s c o l l a t e r a l w a s c o m p r i s e d o f t h e H u n t b r o t h e r s ' remaining i n t e r e s t i n t h e Beaufort Sea o i l l i c e n s e s , a p o r t i o n o f which had been conveyed t o Engelhard i n s e t t l e m e n t o f t h e H u n t / P h i b r o EFP t r a n s a c t i o n . A s n o t e d p r e v i o u s l y , h o w e v e r , t h e c o l l a t e r a l v a l u e o f t h e s e p r o p e r t i e s was q u e s t i o n a b l e a n d t h e v a l u e a s s i g n e d i n t h e P l a c i d l o a n d o c u m e n t a t i o n is a p p r o x i m a t e l y f o u r t i m e s g r e a t e r t h a n r e c e n t e a r l i e r estimates. To f u n d i t s r e p a y m e n t o f t h e H u n t b r o t h e r s ' o b l i g a t i o n s , P l a c i d borrowed $1.1 b i l l i o n from a consortium o f 1 3 banks s e c u r e d b y , among o t h e r t h i n g s , P l a c i d ' s i n t e r e s t s i n o i l and g a s p r o p e r t i e s , r e f i n e r i e s and p i p e l i n e systems. The H u n t b r o t h e r s g u a r a n t e e d t h e c r e d i t i n d i v i d u a l l y s e c u r e d by a f i r s t l i e n on t h e assets d e s c r i b e d i n t h e p r e c e d i n g p a r a graph. The l o a n c a r r i e d i n t e r e s t p a y a b l e q u a r t e r l y a t a premium o v e r p r i m e a n d was s u b j e c t t o c o v e n a n t s r e q u i r i n g P l a c i d t o m a i n t a i n c a s h f l o w from e n g i n e e r e d p r o p e r t i e s and o p e r a t i o n s o f 166% and 125% o f t h e d e b t s e r v i c e on t h e loan, respectively. By May 3 1 , a f t e r t h e t r a n s a c t i o n j u s t d e s c r i b e d h a d b e e n e f f e c t u a t e d , P l a c i d had p a i d t h e Hunt b r o t h e r s ' s i l v e r d e b t s and t h e crisis h a d p a s s e d .

PART TWO BACHE GROUP I N C .

I.

THE BACHE GROUP COMPLEX

A.

T h e H o l d i n g Company

Bache Group I n c . ("Bache G r o u p " ) , i n c o r p o r a t e d i n D e l a w a r e i n 1 9 7 4 , i s a h o l d i n g company e n g a g e d t h r o u g h 3 5 s u b s i d i a r i e s i n r e t a i l and i n s t i t u t i o n a l s e c u r i t i e s brok e r a g e , i n v e s t m e n t b a n k i n g , commodities f u t u r e s merchand i s i n g , p r e c i o u s metals t r a d i n g , i n s u r a n c e a n d r e a l e s t a t e . On J u l y 3 1 , 1 9 8 0 , B a c h e G r o u p w a s a p u b l i c l y - h e l d company; i t s 8 , 7 5 2 , 7 9 1 o u t s t a n d i n g common s h a r e s w e r e i n t h e h a n d s o f a p p r o x i m a t e l y 4 , 6 4 1 h o l d e r s o f r e c o r d . 24/ I t s common s t o c k was r e g i s t e r e d w i t h t h e C o m m i s s i o n p u r s u a n t t o S e c t i o n 1 2 ( b ) o f t h e E x c h a n g e A c t a n d l i s t e d o n t h e New Y o r k , P a c i f i c and Midwest S t o c k Exchanges. F o r t h e f i s c a l y e a r e n d i n g J u l y 31, 1980, Bache Group r e p o r t e d n e t p r e - t a x income o f $47.6 m i l l i o n o n r e v e n u e s o f $622 m i l l i o n . T h e company d e r i v e d i t s r e v e n u e s p r i n c i p a l l y from brokerage commissions on s e c u r i t i e s t r a n s a c t i o n s ($217 m i l l i o n ) , i n t e r e s t on customer margin accounts and financings ($163 m i l l i o n ) , spreads on t r a n s a c t i o n s as p r i n c i p a l ( $ 8 5 m i l l i o n ) a n d commissions o n commodity t r a n s I t s p r i n c i p a l e x p e n s e s were e m p l o y e e actions ($71 million). compensation and b e n e f i t s ($299 m i l l i o n ) and i n t e r e s t exp e n s e ($110 m i l l i o n ) . During its 1980 f i s c a l y e a r , Bache Group a s a b r o k e r h a n d l e d a p p r o x i m a t e l y 2.8 m i l l i o n s e c u rities t r a n s a c t i o n s and 900,000 commodity t r a n s a c t i o n s . T r a d e s t h a t i t e x e c u t e d i n s e c u r i t i e s l i s t e d o n t h e NYSE r e p r e s e n t e d a p p r o x i m a t e l y 2.7% o f t h e volume o n t h a t exA s o f J u l y 31, 1980, Bache Group r e p o r t e d a n e t change. worth o f $154 m i l l i o n .
B.

The Broker-Dealer

B a c h e G r o u p ' s p r i n c i p a l s u b s i d i a r y is Bache H a l s e y S t u a r t S h i e l d s Inc. ("Bache Halsey"), a broker-dealer r e g i s t e r e d w i t h t h e Commission p u r s u a n t t o s e c t i o n 1 5 ( b ) o f t h e Exchange A c t . On March 3 1 , 1 9 8 0 , B a c h e G r o u p ' s r e p o r t e d e q u i t y i n Bache H a l s e y r e p r e s e n t e d a p p r o x i m a t e l y 96% o f t h e r e p o r t e d e q u i t y o f Bache Group i t s e l f .

24/ - F o l l o w i n g a t e n d e r o f f e r f o r B a c h e G r o u p ' s common w a r r a n t s , Bache Group o n J u n e 1 2 , 1981 merged i n t o P r u H o l d i n g I n c . ( " P r u H o " ) , a n i n d i r e c t w h o l l y owned s u b s i d i a r y of P r u d e n t i a l I n s u r a n c e Company o f A m e r i c a ("Prudential"). PruHo c h a n g e d i t s name t h e r e a f t e r t o Bache Group I n c . A s a r e s u l t o f t h e merger, Bache G r o u p is a n i n d i r e c t wholly-owned s u b s i d i a r y o f P r u dential.

According to Bache Group, as of December 31, 1979, Bache Halsey "ranked among the top eight in terms of total capital among the 562 members of the NYSE." Bache Halsey is a member of all major securities and commodities exchanges in the United States, and it or its subsidiaries or affiliates hold memberships or associate memberships on several principal foreign securities and commodities exchanges. As a registered broker-dealer and as a member of the NYSE, Bache Halsey is subject to the financial responsibility requirements of the Uniform Net Capital Rule promulgated by the Commission as Rule 15c3-1 pursuant to the Exchange Act ("Rule 15c3-1") and adopted by the NYSE as its Rule 325 ("Rule 325"). Bache Halsey computes its net capital pursuant to the "alternative method" permitted by the Uniform Net Capital Rule, which required that it maintain minimum "net capital" (as defined in Rule 15c3-1, hereinafter "Rule 15c3-1 capital") equal to or greater than 4% of its debit items from customer transactions (as defined). 25/ At July 31, 1980, Bache Halsey reported its Rule 1 5 ~ 3 - 1 capital to be $112 million; $68.7 million more than that required by the Rule 15c3-1. $63 million of Bache Halsey's Rule 15c3-1 capital was comprised of subordinated debt to five banks; the remaining $49.0 million represented shareholders' equity in Bache Halsey less various capital charges. Bache Halsey is also subject to the so-called "early warning" provisions of NYSE Rule 325(b), which provides that it must notify the New York Stock Exchange if its Rule 15c3-1 capital falls below 7% of its aggregate debit items arising from customer transactions. Under NYSE Rule 326(c), Bache Halsey would, immediately upon falling below the 7% floor, be precluded from drawing, lending or advancing any funds to its stockholders without obtaining the Exchange's prior approval. 26/ If that condition persists for 15 consecutive business days after the Exchange is-notified, NYSE Rule 326(a) prohibits Bache Halsey from expanding its business. If the Rule 15c3-1 net capital falls below 6% of aggregate debit items arising from customer transactions

25/ -

The Commission has since reduced the minimum net capital requirement to 2% of aggregate debit items. - SecuSee rities Exchange Act Release No. 18417, (Jan. 25, 1982). The practical effect on Bache Group of Bache Halsey's net capital falling below the 7% level is to deprive it of upstream dividends or other advances that it could otherwise expect from its principal subsidiary.

26/ -

f o r 1 5 c o n s e c u t i v e b u s i n e s s d a y s a f t e r t h e Exchange is n o t i f i e d , Bache would be r e q u i r e d t o r e d u c e t h e volume o f its business s o long a s t h e condition p e r s i s t e d .

C . The M e t a l Company a n d B a c h e London

Two o f B a c h e G r o u p ' s o t h e r 3 4 s u b s i d i a r i e s h a n d l e d s i l v e r r e l a t e d Hunt b u s i n e s s a n d a r e r e l e v a n t t o a d i s c u s s i o n o f t h e s i l v e r crisis. T h e s e a r e Bache H a l s e y S t u a r t M e t a l Co., I n c . ("Bache M e t a l s " ) , Bache G r o u p ' s b u l l i o n t r a d i n g a r m , and Bache H a l s e y S t u a r t (London) L i m i t e d ( " B a c h e L o n d o n " ) , i t s London p r o d u c t i o n and s e r vice office.
1. B a c h e Metals

B a c h e M e t a l s is t h e s u b s i d i a r y t h r o u g h w h i c h B a c h e G r o u p a c t s a s b r o k e r f o r i n d i v i d u a l and c o r p o r a t e c l i e n t s i n t h e c a s h m a r k e t s i n m e t a l s , and a s a d e a l e r i n m e t a l s f o r s p o t o r forward d e l i v e r y . I n a d d i t i o n , Bache M e t . a l s f i n a n c e s c u s t o m e r s p o t commodity p o s i t i o n s r e c e i v e d i n d e l i v e r y o n f u t u r e s c o n t r a c t s a n d m a k e s l o a n s t o c u s t o m e r s s e c u r e d by warehouse r e c e i p t s evidencing ownership of p h y s i c a l commodities. A s d e s c r i b e d more f u l l y e l s e w h e r e i n t h i s r e p o r t , Bache Group c o n d u c t e d t h e s e a c t i v i t i e s i n Bache H a l s e y p r i o r t o 1 9 7 5 . 27/ The e x i s t e n c e of Bache M e t a l s as a n e n t i t y l e g a l l y d i s t i n c t from Bache H a l s e y is d i r e c t l y a t t r i b u t a b l e t o Bache G r o u p ' s d e s i r e t o l e n d t o t h e Hunts a g a i n s t s i l v e r c o l l a t e r a l w i t h o u t i n c u r r i n g c h a r g e s t o Bache H a l s e y ' s c a p i t a l , and t o a v o i d c e r t a i n o t h e r c a p i t a l c h a r g e s a s s o c i a t e d w i t h B a c h e H a l s e y ' s s p o t commodity a c t i v i t i e s . 28/ Bathe Metals i s n o t a r e g i s t e r e d b r o k e r - d e a l e r a n d i s n o t s u b j e c t t o t h e n e t c a p i t a l r e q u i r e m e n t s o f R u l e s 15c3-1, 325 a n d 3 2 6 . Bache M e t a l s is a bookkeeping v e h i c l e w i t h n o p a y r o l l o r o f f i c e s o f i t s own. Bache H a l s e y p e r s o n n e l a r e i t s o f f i c e r s ; B a c h e H a l s e y ' s money management d e p a r t m e n t a r r a n g e s i t s l o a n s ; Bache H a l s e y ' s a c c o u n t e x e c u t i v e s manage i t s c u s t o m e r s ' a c c o u n t s ; a n d B a c h e H a l s e y ' s s p o t commodity d e p a r t m e n t r e c e i v e s a n d a c c o u n t s f o r w a r e h o u s e r e c e i p t s c o l l a t e r a l i z i n g Bache M e t a l s ' l o a n s .

27/ -

S e e d i s c u s s i o n b e l o w a t p a g e s 67 t h r o u g h 6 8 . See d i s c u s s i o n below a t page 67.

28/

On D e c e m b e r 3 1 , 1 9 7 3 , B a c h e Metals r e p o r t e d a s s e t s o f $98.3 m i l l i o n o f which $53.9 m i l l i o n w a s r e c e i v a b l e from customers. I t r e p o r t e d l i a b i l i t i e s o f $97.5 m i l l i o n o f which $76.0 m i l l i o n r e p r e s e n t e d l o a n s from banks, t h e p r o c e e d s o f which it used t o l e n d t o c u s t o m e r s and t o f i n a n c e i t s own t r a d i n g i n v e n t o r y . Bache G r o u p ' s e q u i t y i n B a c h e Metals w a s $ 8 4 8 , 6 6 1 . 2 . B a c h e London B a c h e H a l s e y ' s London o p e r a t i o n s a r e a l s o c o n d u c t e d t h r o u g h a s e p a r a t e Bache Group s u b s i d i a r y n o t s u b j e c t t o the net capital rules. Bache London's a c t i v i t i e s h a v e t w o components. A s a p r o d u c t i o n o f f i c e , Bache London h a s account executives t h a t generate business f o r the firm f r o m c u s t o m e r s i n t h e U n i t e d Kingdom ("U.K.") a n d e l s e where o v e r s e a s i n c l u d i n g , i n c e r t a i n i n s t a n c e s , t h e United A s a s e r v i c i n g o f f i c e , B a c h e London e x e c u t e s States. t r a d e s i n U.K. m a r k e t s f o r c u s t o m e r s o f Bache H a l s e y ' s U.S. b r a n c h e s , w h o s e o r d e r s a r e f u n n e l e d i n t o a n o m n i b u s a c c o u n t m a i n t a i n e d by B a c h e H a l s e y w i t h B a c h e London. U.S. customers' p o s i t i o n s , t h e r e f o r e , continue to be c a r r i e d i n t h e i r a c c o u n t s w i t h B a c h e H a l s e y ' s U.S. b r a n c h e s , w h i c h a r e o r d i n a r i l y c h a r g e d i n t e r n a l l y w i t h a n y losses t o t h e f i r m a r i s i n g from customer d e f a u l t s i n connection w i t h U.K. m a r k e t t r a d i n g a c t i v i t i e s i n t h o s e a c c o u n t s . On F e b r u a r y 2 9 , 1 9 8 0 , B a c h e London h a d a s s e t s o f $22.7 m i l l i o n and l i a b i l i t i e s o f $22.1 m i l l i o n . Bache London's n e t worth w a s $576,680.
11.

THE INCEPTION AND DEVELOPMENT OF THE HUNT RELATIONSHIP

I n a b o u t June 1973, A l v i n Brodsky ("Brodsky"), t h e H u n t s ' f l o o r b r o k e r o n Comex, b e g a n t o d i r e c t some o f Bunker Hunt's s i l v e r b u s i n e s s t o C h a r l e s Mattey ("Mattey"), a 45 y e a r Bache H a l s e y employee. 29/ From 1 9 7 3 o n , M a t t e y was Bunker and H e r b e r t H u n t ' s p r i n c i p a l a c c o u n t e x e c u t i v e

29 -/ M a t t e y , 7 1 , h a s s e r v e d a s p r e s i d e n t a n d c h a i r m a n o f Comex a n d a s a member o f i t s b o a r d o f g o v e r n o r s . M a t t e y a t t r i b u t e s t h e o r d e r s Brodsky d i r e c t e d t o Bache Halsey beginning i n June 1973 t o an overflow o f busin e s s t h a t Brodsky would o t h e r w i s e h a v e d i r e c t e d t o B u n k e r ' s a c c o u n t w i t h L e s Ming, a f o r m e r Bache H a l s e y b r o k e r t h e n a t Reynolds S e c u r i t i e s I n c . ( "Reynolds" ) M a t t e y b e l i e v e s t h a t B u n k e r ' s t r a d i n g became too l a r g e f o r Reynolds to handle.

a t Bache. B u n k e r a n d H e r b e r t H u n t o p e n e d n u m b e r e d commod i t y t r a d i n g a c c o u n t s i n B a c h e H a l s e y ' s N e w York home o f f i c e o n J u n e 27 a n d J u l y 6 , 1 9 7 3 , r e s p e c t i v e l y . They i m m e d i a t e l y e s t a b l i s h e d l o n g p o s i t i o n s i n December 1 9 7 3 Comex s i l v e r . Although Bache H a l s e y c a r r i e d t h e s e a c c o u n t s , Bunker and H e r b e r t Hunt p l a c e d o r d e r s d i r e c t l y w i t h Brodsky o n t h e Comex f l o o r . B r o d s k y " g a v e up" H u n t b u s i n e s s t o B a c h e H a l s e y , which c o n f i r m e d t h e t r a d e s t o t h e H u n t s a n d became l i a b l e t o t h e Comex C l e a r i n g A s s o c i a t i o n , I n c . ("Comex C l e a r i n g " ) f o r m a r g i n d e p o s i t s and t h e costs o f d e l i v e r i e s Brodsky, as t h e i n t r o a t t r i b u t a b l e t o t h e Hunt a c c o u n t s . ducing broker, r e c e i v e d a p o r t i o n o f Mattey's commissions o n Hunt t r a n s a c t i o n s . This arrangement continued i n t h e Hunt s i l v e r a c c o u n t s a t Bache H a l s e y u n t i l t h e s i l v e r c r i s i s t e r m i n a t e d t h e r e l a t i o n s h i p . -/ 30 I n December 1 9 7 3 , t h e H u n t s ' f u t u r e s c o n t r a c t s m a t u r e d . R a t h e r t h a n c l o s i n g o u t t h e s e p o s i t i o n s or r o l l i n g them f o r w a r d , Bunker and H e r b e r t s t o o d f o r d e l i v e r y o n t h e f i v e m i l l i o n o u n c e s o f s i l v e r r e p r e s e n t e d by t h e c o n t r a c t s . B a c h e H a l s e y , w i t h t h e a p p r o v a l o f i t s e x e c u t i v e committee, a g r e e d to l e n d t o t h e Hunts $11.25 m i l l i o n , which r e p r e The Hunts s e n t e d 75% o f t h e cost o f t h e s e d e l i v e r i e s . s e c u r e d t h i s l o a n by m a i n t a i n i n g on d e p o s i t w i t h t h e f i r m t h e warehouse receipts e v i d e n c i n g t h e i r o w n e r s h i p o f t h e bullion collateral. From t h e i n c e p t i o n o f t h e r e l a t i o n s h i p , B a c h e H a l s e y s e t c r e d i t l i m i t s o n t h e H u n t s ' a c c o u n t s . -/ A f t e r s e v e r a l 31 30/ A f t e r Bunker and H e r b e r t opened t h e i r a c c o u n t s i n 1 9 7 3 , L a m a r H u n t o p e n e d a n a c c o u n t i n h i s own name o n Hunt M i n e r a l s I n t e r n a t i o n a l and February 7 , 1974. Great Western Sugar, both Hunt-controlled corporations, opened a c c o u n t s o n F e b r u a r y 7 , and A p r i l 24, 1975, respectively. Each o f t h e s e a c c o u n t s t r a d e d s i l v e r . Throughout t h i s r e p o r t t h e p h r a s e s " c r e d i t l i m i t s " , "position l i m i t s " , " c r e d i t l i n e " (or simply, " l i n e " ) a r e used i n t e r c h a n g e a b l y to i n d i c a t e t h e magnitude o f t h e commodity p o s i t i o n t h a t a broker-dealer/FCM, w i l l permit a customer to c a r r y . The p u r p o s e o f t h e s e l i m i t s is t o c o n t r o l t h e r i s k t o t h e f i r m o f a c u s t o m e r ' s f a i l u r e t o make g o o d o n l o s s e s i n h i s account. Some f i r m s e s t a b l i s h p o s i t i o n l i m i t s i n a d o l l a r amount a s a n u p p e r l i m i t o n t h e amount o f i n i t i a l margin required to c a r r y t h e customer's Footnote continued on n e x t page.

changes i n t h e Hunts' l i m i t s during t h e f i r s t t w o y e a r s of a c c o u n t a c t i v i t y , B a c h e H a l s e y ' s e x e c u t i v e committee i n October 1975 e s t a b l i s h e d t h e Hunts' a g g r e g a t e p o s i t i o n l i m i t w i t h t h e f i r m a t 4 , 2 0 0 c o n t r a c t s , a l e v e l Bache Halsey maintained, r e g a r d l e s s o f f l u c t u a t i o n s i n s i l v e r p r i c e s , u n t i l it s u b s t a n t i a l l y increased t h e l i n e i n September 1979. I n t h e e n s u i n g f o u r y e a r s , d u r i n g which s i l v e r p r i c e s remained r e l a t i v e l y s t a b l e i n t h e r a n g e o f $4 t o $ 6 p e r o u n c e , Bunker and H e r b e r t ' s p o s i t i o n s w i t h Bache H a l s e y remained c o m p a r a t i v e l y s t a b l e , as w e l l . The b r o t h e r s g e n e r a l l y r o l l e d forward t h e i r f u t u r e s p o s i t i o n s as they matured. To a v o i d r e g u l a t o r y c a p i t a l c h a r g e s , B a c h e G r o u p t r a n s f e r r e d its Hunt l o a n s and t h e a s s o c i a t e d b u l l i o n c o l l a t e r a l from Bache H a l s e y i n t o a p r e d e c e s s o r o f Bache Metals, where it r o l l e d o v e r t h e l o a n s a t 89 d a y i n t e r v a l s Commisi n amounts a v e r a g i n g a p p r o x i m a t e l y $40 m i l l i o n . s i o n s , i n t e r e s t s p r e a d s and o t h e r r e v e n u e s t o Bache Group a t t r i b u t a b l e to t h e Hunt r e l a t i o n s h i p t o t a l e d a p p r o x i m a t e l y $411,000 i n f i s c a l 1978 and a p p r o x i m a t e l y $520,000 by t h e , f i r s t s i x months o f f i s c a l 1980. Although t h e Hunts e f f e c t e d s e c u r i t i e s and o t h e r n o n - s i l v e r t r a n s a c t i o n s t h r o u g h Bache H a l s e y , t h e m o s t s i g n i f i c a n t a s p e c t o f t h e Hunt r e l a t i o n s h i p c o n t i n u e d t o

F o o t n o t e c o n t i n u e d from p r e v i o u s page. position. Thus, i f i n i t i a l margin requirements i n s i l v e r are, f o r example, $10,000 p e r c o n t r a c t , a $100,000 c r e d i t or p o s i t i o n l i m i t w i l l p e r m i t a customer t o c a r r y t e n c o n t r a c t s . I f m a r g i n s are t h e r e a f t e r r a i s e d to $20,000 p e r c o n t r a c t , on e x i s t i n g p o s i t i o n s , a $100,000 l i n e w i l l p e r m i t t h e customer to c a r r y o n l y f i v e c o n t r a c t s . O t h e r f i r m s e s t a b l i s h p o s i t i o n l i m i t s i n numbers o f contracts. I f margins a r e t h e r e a f t e r r a i s e d on e x i s t i n g p o s i t i o n s , and t h e customer p o s t s t h e a d d i t i o n a l requirements, he can maintain h i s ten contract position notwithstanding the increase.
A s d e s c r i b e d e l s e w h e r e i n t h i s r e p o r t , d u r i n g 1979 and

1980, Bache H a l s e y e s t a b l i s h e d c r e d i t l i m i t s f o r t h e Hunts i n numbers o f c o n t r a c t s , e x c e p t f o r a c c o u n t s maint a i n e d f o r B u n k e r H u n t ' s d a u g h t e r Mary a n d h e r h u s b a n d , w h i c h were s e t i n d o l l a r a m o u n t s .

be silver. 32/ On July 31, 1979, Hunt futures accounts were long 2,549 contracts of CBT and Comex silver, while the firm had lent Bunker, Herbert and Hunt Minerals approximately $33 million collateralized by 1,133 silver bullion warehouse receipts. These positions collectively represented l8,4lO,OOO ounces of silver with a market value (at spot prices) of approximately $167.2 million. 111. THE BUILDUP IN SILVER - AUGUST 1, 1979 THROUGH JANUARY 17, 1980 A. Introduction: Increasing Exposure in the Hunt Accounts During the five and one half months from August 1, 1979 through January 18, 1980, the price and volatility of silver and the size and value of the Hunt silver positions with Bache Group increased. The silver in the Hunt futures and physical positions continued to climb from 18.4 million ounces on August 1 to a high of 43.5 million ounces at October 31, declining only slightly to 42.2 million ounces by December 31, 1979. Assuming that a position of this magnitude could have been liquidated at or near the spot price, the value of the Hunts' combined physical and futures position with Bache Group rose from $165 million on July 31, 1979, to approximately $1.45 billion at December 31. The equity supporting this position, however, had only risen to $317 million, principally because the Hunts withdrew from their accounts substantially all of the unrealized appreciation on their futures positions. 33/ The equity in the Hunts' accounts with Bache Group on ~ecember31 could then have been eliminated in a drop in the price of silver of $7.47 per ounce. An additional decline of only $3.40 per ounce would have created deficits in Hunt accounts equal to the consolidated book value of Bache Group. 32/ - Bache Halsey handled other business for the Hunts.

Members of the family and aff iliated entities maintained securities accounts at the firm. The firm acted as dealer manager in connection with the Hunts' successful tender offer for Great Western United Corporation and their attempts, aborted in September 1975, to acquire Bates Manufacturing Company, Inc., a New York-based holding company with substantial coal reserves in Virginia, Pennsylvania and Kentucky.

33/ -

In an arrangement common in large commodity futures accounts, Bache Halsey wired to the Hunts daily amounts representing appreciation in the value of the positions. The Hunts, in turn, wired funds to Bache Halsey when the value of their positions declined.

The degree of Bache Group's exposure to the Hunts in silver was magnified by the volatility of the market. In August 1979, daily price movement in silver futures on the Comex was limited to $.20 per ounce, while the daily fluctuations in the freely trading spot price of the metal averaged only 1.5% of the prior day's closing price. By January 1980, daily price movement limits on futures contracts had been increased to $1.00 per ounce, while daily swings in the spot price averaged approximately 9% of the prior day's closing price. Daily movement of more than $4 per ounce was not uncommon. Meanwhile, average daily volume in silver on Comex declined by 56%, from 17,567 contracts in August to 7,717 contracts in January, and average open interest on that exchange dropped 31%, from 155,072 contracts in August to 106,300 contracts in January. It also became commonly known and widely publicized that the trading activities of the Hunts and other substantial holders had occasioned concern on the part of the Comex governors that market congestion and a possible squeeze were developing in silver. Both exchanges raised margin requirements and the CBT imposed position limits. Bache Halsey was among those opposing these limits on speculative traders. During this period, Bache Halsey's executive committee approved commodity credit lines for additional Hunt family members, accepted the transfer to Bache Halsey of 4,129 futures contracts that its existing Hunt customers had maintained with other firms, and permitted the Hunts to add 626 new silver futures contracts to their accounts. The executive committee made these decisions without specific or current information as to the Hunts' financial condition, the Hunts' continuing ability to satisfy obligations to Bache Group which would arise were a drop in the price of silver to occur or the extent of the Hunts' potential liabilities or exposure to loss in connection with silver positions maintained with other broker-dealers, FCMs or banks. Bache Group, because it and its counsel never considered it to be necessary, made no disclosure in its shareholder communications or its filings with either the Commission or the NYSE concerning the magnitude of the firm's exposure to one group of clients in a single commodity or the unavailability of reliable information concerning the client's financial condition.

B.

I n c r e a s e s i n Hunt F u t u r e P o s i t i o n s
1. T h e H u d d l e s t o n A c c o u n t s

I n J u l y 1 9 7 9 B u n k e r H u n t ' s d a u g h t e r , Mary, a n d h e r h u s b a n d A l b e r t D. H u d d l e s t o n o p e n e d c o m m o d i t i e s f u t u r e s a c c o u n t s w i t h Bache H a l s e y ' s Houston, Texas o f f i c e . 3 4 1 I n August 1979, t h e s e a c c o u n t s began t r a d i n g i n s i l v e r well a s o t h e r c o m m o d i t i e s a n d s t o c k s . By t h e e n d o f A u g u s t , t h e H u d d l e s t o n s ' a c c o u n t s c a r r i e d 7 5 s i l v e r f u t u r e s contracts. I n t h e n e x t f i v e months, t h e i r p o s i t i o n i n c r e a s e d u n t i l , on J a n u a r y 1 7 , 1980, t h e a c c o u n t s h e l d 387 c o n t r a c t s on d o m e s t i c exchanges and c o n t r a c t s f o r t h e forward d e l i v e r y o f 750,000 ounces o f s i l v e r ( t h e e q u i v a l e n t of 150 d o m e s t i c c o n t r a c t s ) o n t h e London Metal E x c h a n g e . The t o t a l p o s i t i o n r e p r e s e n t e d c o n t r o l o f 2.7 m i l l i o n ounces of s i l v e r .

as

An a c c o u n t e x e c u t i v e f r o m t h e H o u s t o n o f f i c e h a n d l e d t h e Huddleston a c c o u n t s d u r i n g t h e f i r s t f i v e months o f t h e i r existence. A t l e a s t u n t i l t h e end o f J a n u a r y 1980, t h e f i r m ' s c o m m o d i t y c r e d i t committee a p p e a r s t o h a v e considered r e q u e s t s f o r t r a d i n g l i m i t s f o r t h e Huddlestons independently o f its d e l i b e r a t i o n s concerning t r a d i n g l i m i t s f o r t h e o t h e r Hunts. I n t h e J u l y 9 , 1 9 7 9 commod i t y s u i t a b i l i t y letter executed i n opening t h e i r account, A l b e r t a n d Mary H u d d l e s t o n d i s c l o s e d a n e t w o r t h o f $125,000, a n n u a l income o f $50,000 t o $75,000 and t o t a l n e t l i q u i d assets o f $25,000 t o $50,000. By t h e e n d o f J u l y , A l b e r t a n d Mary f i l e d a new s u i t a b i l i t y l e t t e r w h i c h s t a t e d a n e t w o r t h o f $2 m i l l i o n , a n a n n u a l income o f $200,000 and t o t a l n e t l i q u i d assets o f $1.15 m i l l i o n . On A u g u s t 2 3 , 1 9 7 9 , a f t e r t h e H u d d l e s t o n s e s t a b l i s h e d a n i n i t i a l 7 5 c o n t r a c t p o s i t i o n , t h e commodity c r e d i t committee approved a margin l i n e o f $100,000 f o r t h e a c c o u n t s . One week l a t e r t h e committee i n c r e a s e d t h e l i n e t o $ 3 0 0 , 0 0 0 and 19 d a y s t h e r e a f t e r , on September 1 8 , set t h e Huddlestons' c r e d i t l i m i t a t $750,000. The committee d e n i e d f u r t h e r r e q u e s t s f o r i n c r e a s e s ( t o $ 1 m i l l i o n o n S e p t e m b e r 20 a n d t o $ 1 . 5 m i l l i o n o n November 1 a n d 2 9 ) u n t i l J a n u a r y 2 2 , 1 9 8 0 . Even so, B a c h e H a l s e y p e r m i t t e d t h e H u d d l e s t o n s t o m a i n t a i n p o s i t i o n s r e q u i r i n g s u b s t a n t i a l l y more i n i t i a l margin t h a n t h e $750,000 l i n e approved i n September. At I n a d d i t i o n t o t h e i r j o i n t commodity a c c o u n t , A l b e r t a n d Mary H u d d l e s t o n o p e n e d t w o s e c u r i t i e s a c c o u n t s a t t h e f i r m , a n d a c c o u n t s were o p e n e d i n t h e names o f Dale and Gordon H u d d l e s t o n a s w e l l . These accounts w i l l , f o r convenience, be t r e a t e d i n t h e aggregate.

month-end November 1979, the Huddleston accounts were net long 230 contracts with required margin of $1.32 million at exchange minimum rates. By December 31, 1979, the position was long 459 contracts, requiring $3.45 million in original margin. Finally, on January 16, 1980, Mattey, who by this time had taken over supervision of the Huddleston accounts, placed an order for the forward purchase, on July 16, 1980, of 750,000 ounces of silver on the London Metal Exchange at prices averaging $46.35 per ounce. On January 31, 1980, the net Huddleston silver position increased to approximately 1.3 million ounces long with a nominal market value well in excess of approximately $45.0 million. Six days later, noting that the Huddlestons' net worth and liquid assets now each exceeded $50 million, the commodity credit committee approved a $15 million trading limit in their account, provided that the Huddlestons maintained silver warehouse receipts with value of $25 million or more on deposit with Bache Halsey. The committee also agreed that the Huddlestons could satisfy any margin calls on their London positions with equity in an account with the Bache-related "MoneyMart Assets1' money market fund. The audit committee of Bache Group's board of directors later concluded that the trading pattern in the Huddleston accounts suggested that the Huddlestons were involved in a "classic pyramiding situation". In the rising market, they used the appreciation in existing positions to make original margin deposits on additional positions. Bache Halsey's executive committee acquiesced in this practice by extending additional commodity credit on the basis of this same appreciation. As audit committee chairman Stanley Shirk put it, "the customers' net worth, presumably, has not been enhanced except through the trading and the commodity transaction." 35/ Bache Halsey, without information 35/ The Dow Jones-Irwin Guide to Commodities Trading (Dow Jones-Irwin Inc., 1981) defines "pyramiding" as "the use of paper profits on established positions to buy or sell further future contracts." Pyramiding is a recognized trading strategy in the commodity markets. Harry Sarkisian, then chairman of Bache Halsey's commodity credit committee, described the dangers of pyramiding quite graphically: If you have an account who to begin with is not extremely credit worthy, who happens to go into a commodity at a point in time when that commodity is becoming extremely active and volatile and through luck or circumstances or whatever has the good fortune to be on the right side of it and suddenly finds itself making more money than he ever dreamed he could make and continues to plow that back into the same commodity without diversification, that can be dangerous.

concerning t h e Huddlestons' f i n a n c i a l position o t h e r t h a n t h e t w o J u l y 1979 s u i t a b i l i t y letters, t h e i r o t h e r h o l d i n g s a t Bache and knowledge o f t h e market g a i n s t h e y had o n t h e i r s i l v e r p o s i t i o n s i n c r e a s e d t h e i r commodity It required c r e d i t l i n e t o 150 t i m e s its o r i g i n a l value. only t h a t t h e Huddlestons d e p o s i t with t h e f i r m c o n t r a c t s o f p h y s i c a l s i l v e r , t h e f l u c t u a t i n g v a l u e o f w h i c h was also s u b j e c t to t h e r i s k s of t h e v o l a t i l e s i l v e r market. A s e v e n t s d e m o n s t r a t e d , t h e H u d d l e s t o n s were t h e f i r s t o f t h e Hunts w i t h a c c o u n t s a t Bache H a l s e y to e x p e r i e n c e d i f f i c u l t i e s meeting t h e i r f i n a n c i a l o b l i g a t i o n s a f t e r t h e market broke i n January. 2. The S a n F r a n c i s c o A c c o u n t s During August and S e p t e m b e r 1979, Bache H a l s e y h i r e d S c o t t Kevin McFarland as a n a c c o u n t e x e c u t i v e i n its San Francisco office. McFarland h a d been employed s i n c e t h e p r e v i o u s y e a r b y L o e b R h o a d e s , w h e r e h e had h a n d l e d s i l v e r f u t u r e s t r a n s a c t i o n s i n a c c o u n t s f o r B u n k e r Hunt a n d h i s c h i l d r e n Houston Hunt, E l i z a b e t h Hunt C u r n e s , E l l e n Hunt F l o w e r s a n d Mary H u n t H u d d l e s t o n . A f t e r L o e b R h o a d e s m e r g e d w i t h S h e a r s o n Hayden S t o n e , management o f t h e newly combined e n t i t y informed McFarland t h a t t h e Hunt p o s i t i o n s would b e margined a t $20,000 p e r c o n t r a c t r a t h e r t h a n t h e $ 5 , 0 0 0 (Comex) a n d $ 2 , 5 0 0 (CBT) minimum r a t e s p r e s c r i b e d b y t h e e x c h a n g e s f o r e x i s t i n g positions. M c F a r l a n d a n d B u n k e r H u n t d e c i d e d t o move 36/ t h e a c c o u n t s t o Bache H a l s e y . A t t h e t i m e McFarland j o i n e d Bache H a l s e y , t h e Hunt a c c o u n t s h e managed were l o n g 2 , 2 5 2 s i l v e r f u t u r e s c o n t r a c t s . A l t h o u g h t h e m a j o r i t y o f t h e s e p o s i t i o n s were c a r r i e d i n Bunker H u n t ' s a c c o u n t , h i s c h i l d r e n ' s a c c o u n t s c a r r i e d a n a g g r e g a t e o f 315 c o n t r a c t s r e q u i r i n g o r i g i n a l margin o f $1.58 m i l l i o n . According t o McFarland, Bunker Hunt d i d n o t g u a r a n t e e h i s c h i l d r e n ' s a c c o u n t s .

36/ -

D u r i n g t h e t i m e M c F a r l a n d h a n d l e d Hunt a c c o u n t s a t
Bathe H a l s e y , h e o b t a i n e d f i n a n c i n g f r o m B u n k e r H u n t

f o r h i s personal s i l v e r trading. Between August 1979 and A p r i l 1980, Bunker Hunt l e n t McFarland a p p r o x i m a t e l y $ 4 m i l l i o n t o f i n a n c e s i l v e r t h a t McFarland b o u g h t from Bunker under a n agreement t o resell i t t o Bunker. McFarland p u r c h a s e d from Bunker 250,000 o u n c e s o f s i l v e r a t t h e m a r k e t i n August 1979 and r e s o l d i t t o him a t a h i g h e r p r i c e i n t w o s e p a r a t e i n s t a l l m e n t s . Some o f t h e p u r c h a s e p r i c e o f t h e s i l v e r s t i l l r e m a i n s unpaid and McFarland h a s r e t a i n e d t h e p r o f i t o f a p p r o x i m a t e l y $630,000 o n t h e t r a n s a c t i o n . T h e r e is n o e v i d e n c e t h a t t h e f i r m was a w a r e o f t h e s e t r a n s a c t i o n s and Bache h a s d e n i e d t h a t i t was.

On A u g u s t 2 8 , 1 9 7 9 , w i t h o u t s e e k i n g o r r e v i e w i n g a n y a d d i t i o n a l f i n a n c i a l i n f o r m a t i o n from Bunker Hunt o r a n y i n f o r m a t i o n on t h e f i n a n c i a l c o n d i t i o n o f h i s c h i l d r e n , Bache H a l s e y ' s commodity c r e d i t c o m m i t t e e i n c r e a s e d t h e H u n t s ' a g g r e g a t e l i n e o f commodity c r e d i t i n s i l v e r t o 5000 c o n t r a c t s t o accommodate t h e San F r a n c i s c o p o s i t i o n s . B y t h e end o f September 1979, Hunt a c c o u n t s a t Bache H a l s e y were n e t l o n g 4 , 6 6 6 s i l v e r f u t u r e s c o n t r a c t s r e p r e s e n t i n g 2 3 . 3 m i l l i o n o u n c e s o f s i l v e r , more t h a n d o u b l e t h e p o s i t i o n a t t h e end o f August. 3. T r a n s f e r s f r o m J . A r o n I n e a r l y O c t o b e r 1 9 7 9 , l e s s t h a n a month a f t e r t h e S a n F r a n c i s c o a c c o u n t s came t o B a c h e H a l s e y , t h e H u n t s a s k e d M a t t e y i f Bache H a l s e y would a c c e p t t h e t r a n s f e r i n t o t h e i r accounts with t h e f i r m of 1,877 long s i l v e r f u t u r e s c o n t r a c t s t h e H u n t s were c a r r y i n g w i t h J. A r o n , a large precious metals dealer. The Hunts d i d n o t o f f e r a n y a d d i t i o n a l information concerning t h e i r f i n a n c i a l condition or l i q u i d i t y i n connection w i t h t h i s request. According t o M a t t e y , t h e H u n t s were " u n c o m f o r t a b l e " c a r r y i n g t h e i r p o s i t i o n a t J . Aron b e c a u s e i t , l i k e o t h e r p r e c i o u s m e t a l s d e a l e r s , was r e q u i r e d t o p o s t v a r i a t i o n margin t o m a i n t a i n t h e s h o r t s i l v e r f u t u r e s p o s i t i o n s w i t h which i t hedged i t s p h y s i c a l s i l v e r i n v e n t o r i e s . B e c a u s e o f t h e rise i n s i l v e r p r i c e s i n August and S e p t e m b e r , J. A r o n ' s o b l i g a t i o n t o p o s t v a r i a t i o n m a r g i n had i n c r e a s e d by m i l l i o n s o f 37/ dollars. 37/ A t a b o u t t h e same t i m e a s t h e t r a n s a c t i o n d e s c r i b e d i n t h e t e x t , Mattey s e r v e d as a n a d v i s e r to Bunker and H e r b e r t Hunt i n c o n n e c t i o n w i t h a n "exchange f o r p h y s i c a l s " t r a n s a c t i o n t h e y a r r a n g e d between I n t e r n a t i o n a l Metals I n v e s t m e n t C o . , L t d . ( " I M I C " ) , a Bermuda c o r p o r a t i o n owned j o i n t l y by t h e H u n t s a n d t w o S a u d i i n v e s t o r s , and Mocatta M e t a l s C o r p o r a t i o n , a New York-based p r e c i o u s m e t a l s d e a l e r . The H u n t s h a d e a r l i e r b o r r o w e d a p p r o x i m a t e l y $ 5 0 m i l l i o n f r o m Mocatta s e c u r e d by 1 0 . 7 m i l l i o n o u n c e s o f s i l v e r warehouse receipts. Mocatta had, i n t u r n , rehypothecated t h e s e r e c e i p t s t o b a n k s t o secure a much l a r g e r l o a n i t o b t a i n e d t o meet v a r i a t i o n m a r g i n c a l l s i s s u e d o n t h e s h o r t s i l v e r f u t u r e s p o s i t i o n s w i t h which i t hedged its b u l l i o n i n v e n t o r i e s . According to Mattey, t h i s t r a n s a c t i o n arose b e c a u s e t h e H u n t s were c o n c e r n e d t h a t i f M o c a t t a became i n s o l v e n t a s a r e s u l t o f i t s s i l v e r o b l i g a t i o n s t h e y would n o t b e a b l e t o r e c o v e r t h e s i l v e r t h e y had pledged a g a i n s t t h e l o a n . Footnote continued on n e x t page.

On October 2, 1979, the commodity credit committee, after a lengthy discussion, unanimously determined to increase the Hunts' commodity credit line to 7,500 contracts to accommodate the J. Aron position, provided the Hunts left on deposit with the firm the 1,133 silver warehouse receipts they had used to collateralize Bache Group's approximately $40 million loan to the Hunts through Bache Metals. 38/ The committee also determined that the line of credit extended by Bache Metals should remain at approximately $40 million. Bache Halsey's executive committee approved this arrangement on the same day. Neither the commodity credit committee nor the executive committee sought any additional information concerning the Hunts' financial condition or liquidity, or the size of their physical or futures silver positions and the related obligations elsewhere. C. Management Information Concerning the Hunts' Financial Condition and the Volatility of the Silver Market 1. Information About the Hunts As is evident in the foregoing discussion, Bache Halsey's commodity credit and executive committees, both senior level groups within Bache Group's home office Footnote continued from previous page. In the transaction between IMIC and Mocatta, IMIC purchased in cash 22.9 million ounces of silver from Mocatta and transferred to it 4,583 silver futures contracts. In a related transaction, Mocatta and Bunker and Herbert Hunt terminated the loan from Mocatta to the Hunts and Mocatta returned the Hunts' silver. Relieved of the need to hedge the silver it sold to IMIC, Mocatta was able to close out much of its short futures position by offsetting it with the long position it received from the Hunts, thereby substantially reducing the variation margin payments it had to make on its short hedge. 38/ - Bache Metals' loans to the Hunts are described more fully at pages 67 through 76, below. The market value of that collateral was, at September 30, 1979, approximately $93 million and the Hunts had paid down the earlier $40 million loan to only $2.4 million. The 1,133 silver warehouse receipts were, therefore, as of the October 2 meeting, substantially unencumbered. By October 31, however, the Hunts had drawn on the Bache Metals line for $40 million once again and the excess silver collateral was reduced to $54 million at October 31 prices.

management, made the decision to permit a threefold increase in the Hunts' silver futures positions in 1979. They had available to them, however, little specific or current information concerning the financial condition of Bache Halsey's Hunt clients, the size of the Hunts' overall position in the silver market, or the proportion of the physical or futures markets in silver represented by the Hunts' overall positions. Thus, they had no accurate information concerning the degree of the Hunts' concentration in silver and their concomitant exposure to loss. The audit committee of Bache Group's board of directors reported that: As part of this review, the Audit Committee inspected the credit files pertaining to the Hunt accounts and ascertained that they contained very little information of significance. Current financial statements of the Hunts, memorandums [sic] of discussions with them and other input data usually found in a credit file were absent. From the inception of the Hunt relationship, Bache Group was unable to secure meaningful information concerning the Hunts' financial condition. As early as 1973, according to Mattey, 39/ he sought to have Bunker Hunt provide Bache Halsey w s h financial inormat ion. Mattey test if ied that he asked Bunker:

39/ - It should be noted that Mattey was a member of the

commodity credit committee throughout the period of its deliberations on Hunt futures trading line and borrowing requests. Mattey derived approximately 70% of his compensation in 1979 from commissions and participation in interest spreads on Hunt accounts. Mattey testified that he did not participate in discussions concerning his clients' credit limits. Stevenson, however, testified that the commodity credit and executive committees relied heavily on Mattey's expertise and the assurances he gave concerning the liquidity of the silver market. Stevenson also testified that Mattey was enthusiastic in support of Bache Metals' loans to the Hunts, an enthusiasm that Stevenson believes was more pronounced as a result of Mattey's receiving as compensation 40% of the interest spread Bache Metals realized on the Hunt loans. (Mattey waived his participation in the spread on the final increase in Hunt loans late in February 1980.) Bache Group has since removed Mattey from the commodity credit committee.

Would he please ask the officer who was in charge of the Hunt account at the First National Bank in Dallas to take the wraps off and give our credit man who would call him a real good picture of Bunker Hunt's net worth, etc. credit worthiness

...

Sometime thereafter a Bache Group representative did discuss the Hunts' financial condition with a bank representative, but received no statements of financial condition from the Hunts. A year later, two Bache Group representatives went to Dallas to study the Hunts' financial condition. They came back with a favorable opinion, but 40/ without Hunt financials. From 1973 through 1980, Bache received no additional financial information. As recently as early 1980, after the executive committee determined to seek additional information in connection with increasing Bache Metals' loans to the Hunts, according to Mattey, he requested financials from Bunker Hunt and again was refused. Mattey 41/ did not persist. - Because Mattey was Bache's chief source 40/ - Bache's files showed that in 1973, First in Dallas 41/ -

confirmed the Hunts' net worth at more than $50 million.

At the time of Mattey's request, the most recent audited financial statements Herbert and Bunker Hunt had supplied to a bank showed significant concentration in silver as of December 31, 1978. Assets were valued at cost.
( $ million)

Bunker ASSETS : Current Assets: Investment in Silver Bullion (at cost) $112.9 Other 59.8 Total 172.7 Other Assets ( Including noncurrent notes receivable, investments in property and equipment at cost) Total Assets 143.1

Herbert

Staff Pro Forma Aggregation

$100.1 21.7 121.8 35.0

$213.0 81.5 294.5

315.8

156.8

Footnote continued on next page.

of financial information about the Hunts, no more detailed information reached the executive committee or the commod ity credit committee. Footnote continued from previous page.
($

million) Staff Pro Forma Aggregation

Bunker LIABILITIES Current Liabilities Bank notes - payable Other Total Other Liabilities Total 82.9 84.4 167.3 20.4 187.7

Herbert

75.9 66.8 142.7 1.8 144.5

Each financial statement carried in a footnote the following statement: (1) Summary of Significant Accounting Policies (b) Silver Bullion and Commodity Futures Trading

The Proprietorship has a substantial investment in silver bullion when compared to existing supplies. As a result, it is not possible to determine the effect of liquidation of the Proprietorship's investment on the spot price (whether positive or negative). Accordingly, investment in silver bullion carried at cost is not adjusted for changes in the spot price. At October 23, 1979, aggregate market based upon spot price was approximately $338,600,000 [$290,478,000 at September 24, 1979, for Herbert Hunt]. The investment in silver bullion is pledged to secure certain debt.

Peat Marwick, Mitchell & Co., auditors, reported on the financial statement as follows: Footnote continued on next page.

The most significant information unavailable to the commodity credit committee and the executive committee was the Hunts' overall exposure in silver, whether futures, forwards or physicals. Members of these committees uniformly testified that they never considered asking the Hunts the size of their overall position. Fred Horn, Bache Halsey's senior vice president for commodities, explained that "[ilt's not the type of thing you do with a customer." Nor did the committees consider asking other broker-dealers or FCMs about the extent of any positions they carried for the Hunts. Witnesses testified that broker-dealers and FCMs considered that information confidential and not to be divulged to'other firms. Nevertheless, senior Bache management was not without some idea of the size of the Hunt futures positions. Mattey told Jacobs late in 1979 that he believed that the Hunts' futures positions with Bache represented approximately one third of the Hunts' 42/ overall positions. The executive'committee relied on its general impression of the Hunts' financial condition. Bache Group president H. Virgil Sherrill ("Sherrill") testified that executive committee actions on Hunt credits were based on "the general opinion as to the credit worthiness of the Hunts".

Footnote Continued from previous page. In our report dated October 25, 1978 [Qctober 16, 1978, as to Herbert Hunt], our opinion on the 1977 financial statements was qualified subject to the effect of such adjustments, if any, as might have been required had we been able to satisfy ourselves as to the net realizable value of the Proprietorship's investment in silver bullion. As explained in note l(b), the market value of the silver bullion based on spot price has increased significantly in 1979. Accordingly, our present opinion on the 1977 financial statements, as presented herein, is different from that expressed in our previous report. It is not clear where Mattey got this information. Bache Group president H. Virgil Sherrill also heard figures from Mattey concerning the Hunts' total silver position, but viewed these figures as estimates* The CFTC later reported that Herbert, Bunker and Lamar'Hunt had futures positions on domestic exchanges that totaled 15,910 contracts at December 26, 1979- Hunt contracts at Bache Halsey comprised 42% of that number.

[ I ] t is n o t p r e d i c a t e d o n bank s t a t e m e n t s . I t is n o t p r e d i c a t e d o n Dun & B r a d s t r e e t . I t is n c t p r e d i c a t e d o n a n y t h i n g t h a t was i n w r i t i n g o r definitive. J a c o b s ' t e s t i m o n y was s u b s t a n t i a l l y s i m i l a r t o S h e r r i l l ' s i n t h i s regard, although Jacobs s t a t e d t h a t one b a s i s f o r h i s b e l i e f concerning t h e Hunts' f i n a n c i a l r e s p o n s i b i l i t y was a p e r s o n a l t o u r h e r e c e i v e d o f t h e Hunt o f f i c e s i n D a l l a s , i n c l u d i n g t o u r s o f t h e o f f i c e s o f P l a c i d a n d P e n r o d D r i l l i n g Company ( " P e n r o d " ) , a n d d i s c u s s i o n s with t h e Hunts o f t h e i r holdings. Jacobs t e s t i f i e d h o w e v e r , t h a t h e d i d n o t know w h e t h e r H e r b e r t a n d B u n k e r H u n t h a d access t o t h e r e s o u r c e s o f P l a c i d a n d Penrod t o s a t i s f y o b l i g a t i o n s t o Bache Group, In fact, e a c h o f t h o s e e n t i t i e s is owned i n p a r t by t h e W i l l i a m H e r b e r t H u n t , N e l s o n B u n k e r Hunt a n d Lamar H u n t T r u s t E s t a t e s a n d n o t by H e r b e r t , B u n k e r o r Lamar, o r o t h e r f a m i l y members as i n d i v i d u a l s . A f o o t n o t e i n e a c h o f t h e f i n a n c i a l s t a t e m e n t s d e s c r i b e d a t n o t e 4 1 s t a t e s as to t h e s e t r u s t s t h a t "the b e n e f i c i a r y has no r i g h t to t h e corpus of t h e T r u s t E s t a t e p r o p e r t y , n o r any r i g h t t o call f o r a p a r t i t i o n o r d i v i s i o n o f t h e same or d i s s o l u t i o n o f t h e T r u s t E s t a t e . " Notes o f a n a u d i t committee i n t e r v i e w w i t h J a c o b s r e f l e c t s t h a t h e t o l d t h e committee h e d i d n o t know P l a c i d O i l was h e l d " i n t r u s t " . I n summary, i t a p p e a r s t h a t Bache management r e l i e d o n t h e H u n t s ' r e p u t e d enormous w e a l t h and t h e f a c t t h a t t h e Hunts had a l w a y s p r o m p t l y m e t t h e i r o b l i g a t i o n s t o Bache by w i r e d f e d e r a l f u n d s , Management a l s o h a d c r e d i t r e p o r t s i t o b t a i n e d upon t h e o p e n i n g o f t h e v a r i o u s Hunt a c c o u n t s However, a s p r e t h a t c o n f i r m e d a good c r e d i t s t a n d i n g . v i o u s l y n o t e d , Bache n e v e r o b t a i n e d a q u a l i f i c a t i o n o f t h e Hunts' n e t worth which c o u l d j u s t i f y t h e c r e d i t l i n e s extended n o r d i d it r e c e i v e c u r r e n t i n f o r m a t i o n a b o u t t h e amounts or m a t u r i t i e s o f t h e Hunts' i n d e b t e d n e s s or t h e magnitude of t h e i r o v e r a l l exposure i n t h e s i l v e r market.
2.

I n f o r m a t i o n About t h e S i l v e r Markets

A s p r e v i o u s l y d e s c r i b e d , 43/ a d r a m a t i c i n c r e a s e i n b o t h t h e p r i c e l e v e l and v o l a t i l i t y o f t h e s i l v e r m a r k e t , a s w e l l a s t h e m a r k e t s i n g o l d a n d o t h e r p r e c i o u s metals, o c c u r r e d d u r i n g t h e p e r i o d i n which Bache H a l s e y ' s commod i t y c r e d i t a n d e x e c u t i v e committees were a u t h o r i z i n g i n c r e a s e s i n Hunt s i l v e r f u t u r e s p o s i t i o n s . Persistent rumors and p r e s s r e p o r t s c o n c e r n i n g c o n c e n t r a t i o n s o f s i l v e r i n t h e h a n d s o f t h e Hunts and o t h e r l a r g e i n v e s t o r s accompanied t h e p r i c e c l i m b i n s i l v e r . A s t h e a u d i t committee o f Bache G r o u p ' s board o f d i r e c t o r s c o n c l u d e d :

43/ -

S e e page 54, above.

64

The [executive committee] had available to it information contained in public prints which, from time to time, dealt with the silver situation. During the period from August 31, 1979 to March 30, 1980, the Wall Street Journal contained at least 40 articles on the subject, many of which expressed concerns long before the March 1980 silver crisis. Commodity credit and executive committee members uniformly testified that they read the financial press and were aware of the extraordinary market activity in silver, but they could not recall this information being discussed in connection with the extension of additional commodity 44/ credit to the Hunts. In addition, Bache Halsey's research department had generated extremely cautious assessments of the silver market during the period in question and reports were furnished to, among others, commodity credit or executive committee members Smith, Horn and Mattey. There is no evidence that either committee considered these reports in arriving at decisions on the Hunt credits. 45/ While Mattey, the Hunt account executive and a member of the commodity credit committee, was a governor of Comex throughout the fall and winter of 1979-1980, he apparently did not alert his colleagues deliberating on the Hunt credit to Comex' concerns regarding the silver market or to the steps it considered throughout the period to curb the buildup of substantial long positions such as the Hunts'. Mattey attributes his silence to a perception on his part that he had a duty not to disclose to his firm information he learned as an exchange governor which he believed to be non-public. Commodity credit and executive committee members acknowledged, however, that they were aware of such concerns through news reports and Comex releases.

44/ - The audit committee of Bache Group's board of directors came to similiar conclusions in a report it prepared following the silver crisis:

.The Audit Committee could not determine from [executive committeel minutes whether any of the foregoing data sources [e.g., press reports on silver] were used in arriving at credit decisions. Interviews with individual members of the [executive committeel did not disclose that such was the case. 45/ Again, the audit committee report concurs.

..

IV.

THE MARKET BREAK AT BACHE GROUP

A.

JANUARY 2 2 TO THE C R I S I S

Introduction

On J a n u a r y 7 , 1 9 8 0 , w i t h s p o t s i l v e r p r i c e s a t $ 3 5 . 8 0 p e r o u n c e , t h e Comex b o a r d o f g o v e r n o r s i m p o s e d r e t r o a c t i v e p o s i t i o n l i m i t s o n l a r g e l o n g s p e c u l a t o r s i n s i l v e r , req u i r i n g t h e Hunts and o t h e r s t o reduce t h e i r p o s i t i o n s s u b s t a n t i a l l y i n t h e e n s u i n g t h r e e months. The m a r k e t cont i n u e d to c l i m b r a p i d l y , however, reaching a n i n t r a d a y h i g h o f $50.36 o n F r i d a y , J a n u a r y 1 7 , 1980. On Monday, J a n u a r y 2 1 , Comex i m p o s e d a r u l e p r o h i b i t i n g new o r d e r s i n s i l v e r f u t u r e s except those placed f o r the purpose of liquidating a pre-existing position. The n e x t d a y t h e spot price o f s i l v e r , unhampered by exchange-imposed t r a d i n g l i m i t s , d r o p p e d $ 1 0 p e r o u n c e t o close a t $ 3 4 . 0 0 . This began a two-month p e r i o d o f d e c l i n e i n s i l v e r p r i c e s t h a t e n d e d w i t h s p o t s i l v e r s e t t l i n g a t $10.80 o n March 2 7 , a p r i c e l e v e l lower t h a n a t any t i m e s i n c e August 31, 1979. B a c h e H a l s e y , c a r r y i n g a major p o r t i o n o f t h e H u n t s 1 f u t u r e s p o s i t i o n s , w a s among t h o s e m a k i n g d a i l y m a r g i n calls on t h e Hunts. While t h e Hunts reduced t h e i r aggregate f u t u r e and f o r w a r d p o s i t i o n s by 1 , 7 5 1 c o n t r a c t s from J a n u a r y t h r o u g h F e b r u a r y 29, t h e m a j o r i t y o f t h i s r e d u c t i o n was a t t r i b u t a b l e t o d e l i v e r i e s o f 1 , 1 0 7 c o n t r a c t s , or 5 . 5 m i l l i o n H e used t h i s ounces o f s i l v e r , i n Bunker Hunt's account. s i l v e r , w i t h t h e 1133 warehouse r e c e i p t s t h e Hunts a l r e a d y h a d o n d e p o s i t w i t h B a c h e Metals, t o s e c u r e a p p r o x i m a t e l y $ 1 9 1 m i l l i o n i n new b o r r o w i n g f r o m t h e f i r m . The n e t reduction i n t h e Hunts1 aggregate physical, f u t u r e s and f o r w a r d p o s i t i o n s d u r i n g t h o s e two months was t h u s o n l y 644 c o n t r a c t s , or 7.6%. Meanwhile, t h e r a t i o o f e x c e s s c o l l a t e r a l v a l u e i n t h e B a c h e Metals l o a n a c c o u n t d e c l i n e d s h a r p l y ; f r o m 373% o n December 3 1 , 1980 t o 68% o n F e b r u a r y 29. The practical e f f e c t o f t h i s r e d u c t i o n i n t h e collateral r a t i o s w a s t o i n c r e a s e B a c h e Metals1 e x p o s u r e i n t h e H u n t l o a n s , r a i s i n g f r o m $ 7 . 1 5 t o $ 2 1 . 0 0 per o u n c e t h e s i l v e r p r i c e l e v e l a t w h i c h a c o l l a t e r a l d e f i c i e n c y would o c c u r . B a c h e G r o u p ' s p o s i t i o n w a s r e n d e r e d more p r e c a r i o u s b y a f u r t h e r increase i n t h e v o l a t i l i t y of t h e s i l v e r market. I n J a n u a r y , a v e r a g e d a i l y s w i n g s i n t h e spot price o f Comex s i l v e r a v e r a g e d 9 % o f t h e p r e v i o u s d a y ' s s e t t l e m e n t price; i n March t h e s e s w i n g s a v e r a g e d 1 2 % . The o p e n i n t e r e s t d e c l i n e d as w e l l , f a l l i n g from an average o f 1 0 6 , 3 0 0 c o n t r a c t s i n J a n u a r y t o 5 9 , 3 2 1 c o n t r a c t s i n March. Even a s t h e m a g n i t u d e o f t h e d a i l y price s w i n g s i n s i l v e r i n c r e a s e d , however, t h e p e r c e n t a g e price d e c l i n e t h a t would c a r r y t h e H u n t s ' a c c o u n t s w i t h Bache i n t o d e f i c i t g o t smaller.

By March 1 4 , 1 9 8 0 , a 27% d e c l i n e i n t h e p r i c e o f t h e m e t a l , a s s u m i n g t h e H u n t s d e p o s i t e d n o f u r t h e r a s s e t s , was s u f f i c i e n t t o p r o d u c e a d e f i c i t i n t h e a c c o u n t s . 46/ A t J a n u a r y 3 1 , a 44% d e c l i n e would h a v e b e e n r e q u i r e d t o p r o d u c e a deficit. The Bache H a l s e y e x e c u t i v e committee d u r i n g t h i s p e r i o d d e t e r m i n e d t o i n c r e a s e Bache M e t a l s ' l o a n s t o t h e I t d i d so d u r i n g a r a p i d d e c l i n e i n t h e m a r k e t Hunts. p r i c e o f s i l v e r and w i t h o u t d e t a i l e d i n f o r m a t i o n c o n c e r n i n g t h e Hunts' c u r r e n t f i n a n c i a l condition.
B.

I n c r e a s i n g t h e Bache M e t a l s Loans 1. B a c k s r o u n d

A s d e s c r i b e d e a r l i e r i n t h i s r e p o r t , s i n c e 1973, Bache Group had e x t e n d e d a l i n e o f c r e d i t t o B u n k e r and H e r b e r t H u n t , a n d l a t e r t o Hunt M i n e r a l s , s e c u r e d by s i l v e r b u l l i o n warehouse r e c e i p t s . U n t i l 1 9 7 5 , Bache H a l s e y , t h e broker-dealer, acted a s t h e lender i n these transactions. Bache H a l s e y l e n t f u n d s a g a i n s t 89-day n o t e s f r o m t h e Hunts and r o l l e d t h e l o a n o v e r a t t h e end o f t h a t p e r i o d . A c c o r d i n g t o Bache w i t n e s s e s , t h i s e n a b l e d t h e f i r m t o a v o i d a r e q u i r e m e n t t h a t i t c h a r g e t h e f u l l amount o f t h e To a v o i d t h i s p r o loan against its regulatory c a p i t a l . blem, i n J u n e 1 9 7 5 Bache Group e s t a b l i s h e d B a c o r , I n c . a s a wholly-owned s u b s i d i a r y o f Bache Group f o r t h e p u r p o s e o f f i n a n c i n g Hunt s i l v e r . 47/ S i n c e t h e new s u b s i d i a r y was not a registered broker-dealer, it w a s not subject t o t h e n e t c a p i t a l r e q u i r e m e n t s o f Commission R u l e 1 5 c 3 - 1 and By t h e e n d o f A u g u s t 1 9 7 5 , Bache NYSE R u l e s 325 and 3 2 6 . Group had Bache H a l s e y t r a n s f e r t h e Hunt r e c e i v a b l e , t h e n

T h i s c a l c u l a t i o n assumes t h a t s i l v e r f u t u r e s i n t h e a c c o u n t s a r e v a l u e d a t f u t u r e s p r i c e s , which on t h a t d a t e were a r t i f i c i a l l y i n f l a t e d by a p p r o x i m a t e l y $ 1 0 . 7 2 p e r o u n c e a s a r e s u l t o f e x c h a n g e - i m p o s e d p r i c e movement l i m i t a t i o n s . See d i s c u s s i o n above a t pages 10-12 and e l s e w h e r e i n t h i s r e p o r t . A t spot prices, which r e p r e s e n t e d t h e t r u e l i q u i d a t i n g v a l u e o f t h e f u t u r e s , Hunt a c c o u n t s were a l r e a d y $ 3 5 m i l l i o n i n deficit. 47/ Bache G r o u p , t h e p a r e n t , c h o s e n o t t o c a r r y t h e Hunt r e c e i v a b l e because of adverse s t a t e t a x consequences.

$32.5 million, into the new entity in return for all of its 100 shares of outstanding capital stock. 48/ In 1977, another NYSE policy respecting the capital treatment of Bache Halsey's metal trading activity caused the firm to rearrange its corporate structure again, moving the metals trading activities of the broker-dealer into another Bache Group subsidiary. 49/ As a result, Bache Stuart Metals Co., changed Bacor's name to Bache ~ a E e y Inc. and consolidated in it both the bookkeeping for Bache's bullion trading activities and the Hunt silver financings. The Hunt silver financings continued to be rolled forward in Bache Metals at 89 day intervals until February 1978, when the parties modified the loan agreement to provide that the loans would remain outstanding indefinitely unless cancelled upon 30 day notice by either party. This is the arrangement that continued, with relatively minor modifications, until the silver crisis. The terms of the loans to the Hunts through January 1980, were that Bache Metals would lend 75% of the market value of the silver represented by warehouse receipts deposited with the firm. 50/ If the amount of the loan exceeded 77 1/28 of the collateral, the Hunts had five (later three) days within which to deposit additional collateral, or pay down the loan, to restore the 75% loan/collateral ratio. Bache Metals charged the Hunts interest on the loans at a rate approximately 1 1/2%

48/ - Bacor was a bookkeeping entity.

Its personnel were all employed and paid by Bache and its obligations were guaranteed by Bache Group.

49/ - According to Bache Halsey, the NYSE reinterpreted its

net capital rules in a manner that would have required Bache to charge to capital any deficits in customer accounts carrying forward contracts and to charge an additional amount equivalent to 30% of the market value of the commodity underlying the forward contracts. Bache would have had to charge approximately $5 million against its net capital to continue metals trading in the broker-dealer. According to Bache witnesses, the firm informed NYSE of its intention to form Bache Metals because of the capital charges just described. The Exchange did not object to Bache Group's decision. The bullion collateral for the loan was unhedged.

50/ -

h i g h e r t h a n t h e r a t e a t w h i c h B a c h e Metals b o r r o w e d t h e A f t e r December 1 2 , 1 9 7 9 , B a c h e Metals' funds it l e n t . agreement with t h e Hunts included c r o s s - d e f a u l t p r o v i s i o n s b e t w e e n t h e B a c h e Metals l o a n a g r e e m e n t a n d t h e H u n t s ' c u s t o m e r a g r e e m e n t s w i t h Bache H a l s e y a s w e l l a s a p r o v i s i o n t h a t Bache Halsey c o u l d t r a n s f e r e x c e s s f u n d s or o t h e r assets from t h e H u n t s ' a c c o u n t s w i t h Bache H a l s e y t o s a t i s f y o b l i g a t i o n s u n d e r t h e Bache M e t a l s l o a n a g r e e m e n t . B a c h e Metals o b t a i n e d t h e f u n d s t o l e n d t o t h e H u n t s by b o r r o w i n g f r o m commercial b a n k s , p l e d g i n g a s c o l l a t e r a l t h e same s i l v e r w a r e h o u s e r e c e i p t s t h e H u n t s d e p o s i t e d Langdon w i t h Bache M e t a l s t o s e c u r e t h e l o a n s t o them. S t e v e n s o n , Bache H a l s e y ' s t r e a s u r e r and p r i n c i p a l l i a i s o n w i t h t h e b a n k i n g community a r r a n g e d t h e s e l o a n s , which t h e banks p e r m i t t e d i n amounts g e n e r a l l y r a n g i n g from 65% t o 9 0 % o f t h e v a l u e o f t h e w a r e h o u s e r e c e i p t s B a c h e Metals pledged as c o l l a t e r a l . 51/ 2. The Major L i n e I n c r e a s e s a . The Hunt R e q u e s t s and E x e c u t i v e Committee Action
A s noted e a r l i e r i n t h i s r e p o r t , t h e Hunts' borrowing f r o m B a c h e Metals r e m a i n e d c o m p a r a t i v e l y s t a b l e a t a p p r o x i m a t e l y $40 m i l l i o n d u r i n g t h e f a l l and e a r l y w i n t e r o f 1 9 7 9 a n d 1 9 8 0 . 52,' Late i n January, several days a f t e r Comex i m p o s e d its p o s i t i o n l i m i t s a n d l i q u i d a t i o n - o n l y t r a d i n g r u l e and s i l v e r p r i c e s had begun to d e c l i n e , Hunt E n e r g y a s s i s t a n t t r e a s u r e r C h a r l e s Mercer c a l l e d M a t t e y t o r e q u e s t t h a t t h e Hunts be granted a d d i t i o n a l l o a n s a g a i n s t t h e 1 , 1 3 3 warehouse r e c e i p t s t h e y had o n d e p o s i t w i t h Bache M e t a l s and a d d i t i o n a l r e c e i p t s t o be d e p o s i t e d with t h e firm. On J a n u a r y 3 1 , B a c h e H a l s e y ' s e x e c u t i v e committee v o t e d t o i n c r e a s e B a c h e M e t a l s ' l o a n s t o t h e H u n t s t o a p p r o x i m a t e l y $174 m i l l i o n c o l l a t e r a l i z e d by 1 , 4 9 0

51/ -

I t s h o u l d be n o t e d t h a t wholly a p a r t from t h e Hunt f i n a n c i n g s , Bache M e t a l s borrowed from b a n k s t o f i n a n c e its a c t i v i t i e s a s a p r e c i o u s m e t a l s d e a l e r . To c o l l a t e r a l i z e l o a n s t o B a c h e M e t a l s a g a i n s t t h e f u l l y h e d g e d s i l v e r w a r e h o u s e r e c e i p t s i n i t s own i n v e n t o r y , banks l e n d i n g t o Bache M e t a l s a g a i n s t t h i s i n v e n t o r y p e r m i t t e d t h e f i r m t o b o r r o w 9 0 % o r more o f the value of the inventory, reflecting the g r e a t e r s e c u r i t y o f hedged, a s opposed t o unhedged, c o l l a t e r a l .

52/ - T h e H u n t s p a i d down t h e l o a n t o a p p r o x i m a t e l y $ 2 . 4 m i l l i o n i n September 1979, b u t drew it back up t o $ 3 9 . 9 m i l l i o n by t h e e n d o f O c t o b e r 1 9 7 9 .

warehouse receipts. 53/ The new borrowing was to be no more than 65% of thevalue of the collateral with additional margin required if the market value of the collateral declined by 30%. The executive committee determined that a condition to the additional lending was a cross-collateralization agreement to permit the application of funds in the metals company against deficits in the Hunts' accounts with Bache Halsey. Although, according to Mattey, he did not ask, nor did the Hunts inform him, what the purpose of the new financing was, Mattey and at least two members of the executive committee apparently believed that the Hunts would need additional funds to satisfy Comex requirements which, as of February 4, 1980, would require them to increase from $40,000 to $60,000 per contract original margin on their silver futures positions. Within days of the January 31 executive committee meeting, Mercer again called Mattey to ask for further financing against an additional 750 warehouse receipts. Mattey relayed this request to Bache Halsey executive vice president, Elliot Smith ("Smith"). By the end of February, Bache Metals had extended an additional $74 million in silver loans to the Hunts for a total of $233 million, collateralized by 2,240 warehouse receipts. The executive committee discussed this second increase several times during February and obtained the informal approval of the 54/ audit committee of Bache Group's board of directors. 53/ At January 31, the market value of 1,490 warehouse receipts was approximately $258 million, enough to maintain the loan in equity at a silver price as low as $23 per ounce. This represented a substantial increase in Bache Metals' exposure, inasmuch as the earlier $42 million loan would have remained in equity at prices as low as $7.15 per ounce. 54/ The minutes do not reflect the exact date of approval. The executive committee discussed additional financings at its meeting on February 11, 1980. The executive committee proposed certain terms, and it was agreed that Mattey would discuss these terms with the Hunts. The executive committee also requested inside and outside auditors to review the Hunts' accounts to clarify the existence of the collateral, and asked the commodity credit committee to obtain an updated report of information on the Hunts' total assets and any other obligations. Footnote continued on next page.

Even after the additional funds were wired to the Hunts late in the month, the executive committee continued to discuss the terms of the loan. On March 10, 1980, the spot price of silver settled below $30.00 per ounce for the first time in 1980. At its meeting on March 11, 1980, the executive committee discussed various modification~to the loan agreements previously governing the credit, and discussed more stringent margin requirements for the silver loan. 55/ The terms were more favorable to Bache than the previousterms agreed upon, and were instituted mainly at the instance of Sherrill, who believed that Bache needed'more protection, given the

Footnote continued from previous page. The executive committee again discussed the loan increase at its meeting on February 26, 1980. The committee recommended lending 65% of the market value of 750 additional silver certificates ($82 million), and that additional collateral would be required if the value of the collateral declined by 30%. The committee stated that no decision would be made until after Mattey reviewed the matter with the Hunts, and af ter the commodity credit committee and audit committee reviewed the matter. 55/ The executive committee agreed that the Hunt loan would not be greater than 60% of the market value of the silver collateral; also, if at any time a decline in the market value of the collateral reduced its value to less than 149% of the loan amount (a loan to collateral ratio of 67%), the Hunts would deposit additional collateral or pay down a portion of the outstanding loan balance. Three modifications to the loan agreement were approved: (1) Bache would accept silver certificates as well as cash if additional collateral were required; (2) the Hunts could withdraw equity in the form of cash or silver certificates, above the levels indicated in the loan agreement; (3) as payments were received to reduce the loan, silver certificates could be withdrawn providing the proper ratios were maintained. The cross default provisions remained as provided in the earlier agreement.

magnitude o f t h e l o a n . 56/ Bache and t h e Hunts d i d n o t exe57 c u t e t h e new l o a n a g r e e m e n t s u n t i l March 2 0 , 1 9 8 0 . -/

b. F u n d i n g t h e I n c r e a s e d H u n t L i n e s B a c h e Metals' B o r r o w i n q i n F e b r u a r y 1 9 8 0
B a c h e Metals f u n d e d t h e i n c r e a s e d H u n t l o a n s b y b o r rowing $233.2 m i l l i o n from a g r o u p o f t e n banks as set f o r t h i n t h e following table. F i r s t Chicago, which a t t h a t t i m e had d i r e c t l o a n s o f a p p r o x i m a t e l y $223 m i l l i o n i n o t h e r l o a n s o u t s t a n d i n g t o Hunt i n t e r e s t s , p r o v i d e d $75 m i l l i o n , or 3 2 % , of the total. T h e o t h e r 6 8 % was c o m p r i s e d o f l o a n s f r o m n i n e o t h e r banks r a n g i n g i n amount from $ 5 m i l l i o n t o $36 million. TABLE V BANKS FINANCING HUNT WAREHOUSE RECEIPTS, FEBRUARY 2 9 , 1 9 8 0

1.
2. 3.

F i r s t Chicago Irving Trust

$75,000,000 36,025,000 30,000,000

Harris T r u s t

S e n i o r m a n a g e m e n t s t a t e d t h a t t h e l o a n s p r o v i d e d more s e c u r i t y a n d less r i s k t h a n c a r r y i n g a n e q u i v a l e n t number o f f u t u r e s p o s i t i o n s . According to Jacobs, B a c h e ' s p o s i t i o n w i t h t h e s e l o a n s was more c o n s e r v a t i v e , b e c a u s e Bache had 40% e q u i t y o n hand i n t h e I t is h i s p o s i t i o n t h a t form o f s i l v e r c e r t i f i c a t e s . w i t h f u t u r e s , B a c h e ' s c u s t o m e r s were more h i g h l y l e v e r a g e d b e c a u s e r e q u i r e d m a r g i n s were lower t h a n In addition, c o l l a t e r a l i z a t i o n ratios on t h e loans. a c c o r d i n g t o J a c o b s , B a c h e was i n a more l i q u i d p o s i t i o n with s i l v e r loans because t h e s p o t market could Jacobs' absorb sales b e t t e r than t h e f u t u r e s markets. r e a s o n i n g d o e s n o t n e c e s s a r i l y h o l d up, however, a t least as to t h e e f f e c t i v e c o l l a t e r a l i z a t i o n ratios o n f u t u r e s a s opposed t o b u l l i o n l o a n s . Given t h e $ 6 0 , 0 0 0 p e r c o n t r a c t Comex m a r g i n s t h e n i n e f f e c t , a t s i l v e r p r i c e s a b o v e $ 3 0 p e r o u n c e , t h e terms o f t h e s i l v e r loans provided f o r a b e t t e r c o l l a t e r a l i z a t i o n ratio. A t s i l v e r p r i c e s below $30, however, margin requirements on f u t u r e s c o n t r a c t s provided g r e a t e r security

57/ - Bunker and H e r b e r t e x e c u t e d l o a n agreements f o r $221.1 m i l l i o n and $12.0 m i l l i o n , r e s p e c t i v e l y .

TABLE V

continued

BANKS FINANCING HUNT WAREHOUSE RECEIPTS, FEBRUARY 2 9 , 1 9 8 0 4. 5. 6. 7. 8. 9. Northern Trust Bankers T r u s t U.S. T r u s t Co. 25,000,000 20,000,000 12,175,000 10,000,000 10,000,000 10,000,000 5,000,000

Marine Midland F i r s t N a t i o n a l Bank o f O k l a h o m a C i t y Citizens

&

S o u t h e r n N a t i o n a l Bank

1 0 . B a r c l a y s I n t e r n a t i o n a l Bank, N.Y.

B a c h e Metals' l o a n s f r o m t h e l i s t e d b a n k s were o n a demand b a s i s g u a r a n t e e d b y B a c h e G r o u p . While collateraliz a t i o n r a t i o s v a r i e d s l i g h t l y among t h e v a r i o u s b a n k s , t h e y a p p r o x i m a t e d a l o a n t o c o l l a t e r a l r a t i o o f 75%. A s t h e p r i c e o f s i l v e r f e l l , t h e b a n k s r e q u i r e d B a c h e Metals t o f o r w a r d a d d i t i o n a l w a r e h o u s e r e c e i p t s , o r p a y down p a r t o f t h e l o a n s , s u c h t h a t t h e l o a n amount n e v e r exceeded a p p r o x i m a t e l y 7 5 % o f t h e v a l u e of t h e c o l l a t e r a l . 5 8 / The b a n k s c h a r g e d B a c h e Metals' i n t e r e s t o n t h e l o a n s a t t h e b r o k e r s ' B a c h e Metals r e - l e n t t h e money t o l o a n rate or a t prime. t h e Hunts a t i t s cost p l u s o n e and one-half p e r c e n t . Bache H a l s e y ' s t r e a s u r e r , Langdon S t e v e n s o n , and i t s a s s i s t a n t t r e a s u r e r K e n n e t h Herr, t e s t i f i e d t h a t t h e y d i s c l o s e d t o e a c h b a n k f r o m whom B a c h e Metals b o r r o w e d

58 -/ A s p r e v i o u s l y n o t e d , B a c h e Metals' l o a n s t o t h e H u n t s r e q u i r e d t h a t t h e y m a i n t a i n collateral valued a t 167% o f t h e l o a n amount, i . e . , t h a t t h e v a l u e o f t h e l o a n n o t The l a r g e r exceed 60% of t h e v a l u e of t h e collateral. a m o u n t o f c o l l a t e r a l B a c h e Metals r e q u i r e d o f t h e H u n t s l e f t it from t i m e t o t i m e w i t h s u r p l u s r e c e i p t s a f t e r i t h a d p l e d g e d w h a t was r e q u i r e d b y t h e b a n k s . Bache Metals d i d n o t m o n i t o r t h e c o l l a t e r a l p o s i t i o n o n t h e bank l o a n s ; r a t h e r , i t r e l i e d upon e a c h bank t o m o n i t o r t h e c o l l a t e r a l a n d c a l l it f o r a d d i t i o n a l d e p o s i t s as required.

o n t h e H u n t s ' b e h a l f t h a t t h e p r o c e e d s o f i t s l o a n would b e used t o f i n a n c e a "customer long p o s i t i o n " i n s i l v e r , a p h r a s e t h a t S t e v e n s o n a n d Herr b o t h s t a t e d i s commonly u s e d unt o mean t h a t t h e c u s t o m e r ' s p o s i t i o n i s n e t l o n g - - i . e . , hedged. 59/ The c o l l a t e r a l r a t e ( 7 5 % ) t h a t t h e banks r e q u i r e d t Bache ~ e t a l s o m a i n t a i n i n c o n n e c t i o n w i t h t h e s e l o a n s is c o n s i s t e n t w i t h S t e v e n s o n and H e r r ' s p o s i t i o n . Banks o r d i n a r i l y p e r m i t borrowing up t o 90% o f c o l l a t e r a l v a l u e where t h e commodity c o l l a t e r a l i z i n g t h e l o a n i s f u l l y h e d g e d . N e i t h e r S t e v e n s o n n o r Herr, h o w e v e r , d i s c l o s e d t h e i d e n t i t y

59/ -

Two b a n k s , H a r r i s T r u s t & S a v i n g s Bank ( " H a r r i s " ) a n d F i r s t N a t i o n a l Bank o f C h i c a g o ( " F i r s t C h i c a g o " ) , c l a i m t h a t t h e y were unaware t h a t t h e c o l l a t e r a l s u p p o r t i n g t h e i r l o a n s t o B a c h e M e t a l s was unhedged. F r a n k Mignano, t h e H a r r i s o f f i c e r o n t h e c r e d i t , knew t h a t t h e l o a n p r o c e e d s w o u l d b e u s e d by B a c h e M e t a l s ' c u s t o m e r s t o meet Comex " s u p e r m a r g i n " r e q u i r e m e n t s i n s i l v e r . Harris a l s o a g r e e d t o l e n d o n l y 65% o f t h e v a l u e o f t h e c o l l a t e r a l , f a r below r a t e s c u s t o m a r y f o r hedged c o l l a t e r a l . N e v e r t h e l e s s , Mignano t e s t i f i e d t h a t S t e v e n s o n t o l d him o n F e b r u a r y 5 , 1 9 8 0 , t h a t t h e c u s t o m e r p o s i t i o n s were h e d g e d , t e s t i m o n y c o r r o b o r a t e d by n o t e s Mignano made a t t h e t i m e of t h e c a l l . F i r s t Chicago r e p r e s e n t a t i v e s t e s t i f i e d i n t h e i n v e s t i g a t i o n , a n d F i r s t C h i c a g o p r e s i d e n t R i c h a r d Thomas t e s t i f i e d b e f o r e C o n g r e s s , t h a t t h e bank b e l i e v e d t h e c o l l a t e r a l was h e d g e d a n d t h a t i t was u n a w a r e t h a t t h e warehouse r e c e i p t s p l e d g e d f o r t h e l o a n t o Bache M e t a l s represented a customer p o s i t i o n . F i r s t Chicago claims t h a t B a c h e M e t a l s s u r r e p t i t i o u s l y s u b s t i t u t e d unhedged c u s t o m e r warehouse r e c e i p t c o l l a t e r a l f o r t h e hedged f i r m i n v e n t o r y p o s i t i o n s F i r s t C h i c a g o had p r e v i o u s l y financed. The c i r c u m s t a n c e s o f t h e l o a n s a n d t h e testimony o f Bache H a l s e y p e r s o n n e l , however, s u g g e s t t h a t F i r s t C h i c a g o p e r s o n n e l knew (1) t h a t t h e l o a n t o B a c h e M e t a l s was a g a i n s t unhedged c u s t o m e r s i l v e r , ( 2 ) t h a t t h e p r o c e e d s o f t h e l o a n were b e i n g r e - l e n t t o c u s t o m e r s t o meet m a r g i n r e q u i r e m e n t s and ( 3 ) t h a t t h e H u n t s were t h e Bache M e t a l s c u s t o m e r s i n v o l v e d .

o f B a c h e Metals' c u s t o m e r , 60/ n o r d i d t h e y i n f o r m e a c h bank t h a t i t was p a r t o f a much l a r g e r , $ 2 3 3 m i l l i o n c r e d i t package. 61/ N o t w i t h s t a n d i n g t h e c r e d i t r e s t r a i n t program i n i t i a t e d 62 by t h e Fed -/ i n O c t o b e r 1 9 7 9 , m o s t o f Bache Metals' l e n d e r s

60/ -

It appears t h a t s e v e r a l banks i n a d d i t i o n t o F i r s t C h i c a g o knew o r s u s p e c t e d t h e i d e n t i t y o f Bache Metals' customers. I r v i n g T r u s t w a s t h e c o n c e n t r a t i o n bank f o r t h e loans. Bache c o n c e n t r a t e d i t s bank l o a n s a t I r v i n g and i n s t r u c t e d I r v i n g t o w i r e f u n d s f o r t h e a c c o u n t o f Herr a l s o t h i n k s M a r i n e B u n k e r Hunt o r H e r b e r t Hunt. " I remember cerM i d l a n d knew who t h e " c u s t o m e r " was: t a i n c o n v e r s a t i o n s w i t h M a r i n e M i d l a n d a n d we b o t h k i d d i n g l y j o k e d a b o u t t h e l a r g e h o l d i n g o f s i l v e r by c e r t a i n i n d i v i d u a l s o u t of Texas." H e r r claims, howe v e r , t h a t t h e t h e H u n t s ' names were n e v e r m e n t i o n e d , so h e c a n n o t b e s u r e t h a t M a r i n e M i d l a n d knew i t w a s t h e Hunts. A c c o r d i n g t o Herr, C i t i z e n s a n d S o u t h e r n ' s r e p r e s e n t a t i v e , Rodney Knowles, a l s o knew t h e H u n t s ' i d e n t i t y a s Bache M e t a l s ' c u s t o m e r . In the course of c o n v e r s a t i o n w i t h Herr, Knowles i n d i c a t e d t h a t i t was o b v i o u s t o him who c o u l d b o r r o w t h i s amount o f money a g a i n s t t h a t much s i l v e r a n d t h a t h e a l s o w e n t t o s c h o o l Herr t e s t i f i e d t h a t h e n e v e r conw i t h a Hunt i n - l a w . f i r m e d or d e n i e d t h a t t h e customers were t h e Hunts.

61 -/ When a s k e d why B a c h e H a l s e y had n o t f i n a n c e d t h e H u n t l o a n s t h r o u g h a s y n d i c a t e d c r e d i t t o Bache M e t a l s , Herr t e s t i f i e d t h a t h e and Stevenson r e j e c t e d t h e i d e a because a s y n d i c a t i o n w a s e x p e n s i v e a n d t i m e - c o n s u m i n g , a n d unnec e s s a r y i n v i e w o f t h e e x t e n s i v e n e s s o f Bache H a l s e y ' s e x i s t i n g bank c o n t a c t s . 62/ - I n a n a n n o u n c e m e n t d a t e d O c t o b e r 6 , 1 9 7 9 , t h e Fed " s t r e s s e d t h a t banks should avoid l o a n a c t i v i t y i n g o l d , commodity a n d f o r e i g n e x c h a n g e m a r k e t s . " Board o f Governors o f t h e F e d e r a l Reserve System, B u l l e t i n (November 1 9 7 9 ) a t 8 3 0 .

w e n t f o r w a r d w i t h u n h e d g e d c o m m o d i t y l o a n s t o B a c h e Metals. 6 3 / S t e v e n s o n a n d Herr e n c o u n t e r e d r e s i s t a n c e t o t h e l o a n , howe v e r , f r o m C o n t i n e n t a l I l l i n o i s N a t i o n a l Bank & T r u s t Co. o f Chicago ( " C o n t i n e n t a l " ) . I n November 1 3 7 9 , a n d a g a i n o n J a n u a r y 3 1 , 1 9 8 0 , C o n t i n e n t a l r e f u s e d t o l e n d t o B a c h e Metals s e c u r e d by unhedged s i l v e r warehouse r e c e i p t s , b e c a u s e o f t h e F e d ' s c r e d i t r e s t r a i n t program. Continental agreed, h o w e v e r , t o l e n d t o B a c h e Metals t o f u n d i t s a d v a n c e s t o smelters a n d r e f i n e r s , l o a n s c o l l a t e r a l i z e d b y f u l l y h e d g e d physical silver. T h i s l o a n e n a b l e d B a c h e Metals t o f i n a n c e t h e Hunt p o s i t i o n by f r e e i n g borrowing c a p a c i t y w i t h F i r s t Chicago previously devoted to funding producer loans. C. E a r l y I n d i c a t i o n s o f P r o b l e m s i n t h e Hunt Accounts M e a n w h i l e , a s B a c h e Metals w e n t f o r w a r d w i t h a d d i t i o n a l c r e d i t t o t h e H u n t s , t w o m a t t e r s came t o t h e a t t e n t i o n o f c e r t a i n members o f management t h a t s u g g e s t e d t h a t c e r t a i n Hunt f a m i l y members m i g h t h a v e less a b i l i t y t o m a i n t a i n t h e i r s u b s t a n t i a l s i l v e r p o s i t i o n s t h a n management b e l i e v e d . The f i r s t o f t h e s e was A l b e r t a n d M a r y H u d d l e s t o n ' s f a i l u r e t o meet a m a r g i n c a l l i s s u e d i n t h e i r a c c o u n t o n J a n u a r y 2 4 , 1 9 8 0 . T h e s e c o n d was B u n k e r a n d H e r b e r t H u n t ' s i n t e n s i v e e f f o r t s i n e a r l y March t o o b t a i n f i n a n c i n g from E u r o p e a n banks to maintain t h e i r s i l v e r p o s i t i o n i n t h e f a c e of a r a p i d l y d e c l i n i n g market. 1. T h e H u d d l e s t o n M a r s i n C a l l On T h u r s d a y , J a n u a r y 2 4 , 1 9 8 0 , a f t e r t h r e e d a y s o f l i m i t down p r i c e m o v e m e n t i n t h e s i l v e r f u t u r e s m a r k e t s , B a c h e H a l s e y i s s u e d a margin c a l l f o r $19 m i l l i o n i n t h e A l b e r t and Mary H u d d l e s t o n s i l v e r a c c o u n t . The Huddlestons d i d n o t meet t h e c a l l a n d d i d n o t g i v e B a c h e H a l s e y a n o r d e r t o s e l l any of t h e s i l v e r f u t u r e s contracts i n t h e i r account. Accord i n g l y , Horn p l a n n e d t o l i q u i d a t e t h e H u d d l e s t o n s ' s i l v e r On S u n d a y , p o s i t i o n s t o meet t h e c a l l o n Monday m o r n i n g .

B a n k s t h a t made l o a n s t o B a c h e Metals, c o l l a t e r a l i z e d b y s i l v e r c e r t i f i c a t e s , claim t h a t t h e y conformed w i t h t h e Fed's guidelines. For example, I r v i n g T r u s t and Northern T r u s t o f f e r similar explanations: t h a t t h e b a n k ' s money was b e i n g u s e d t o meet m a r g i n r e q u i r e m e n t s o n p o s i t i o n s a l r e a d y i n e x i s t e n c e , n o t t o a c q u i r e new p o s i t i o n s . F i r s t Chicago t a k e s t h e p o s i t i o n t h a t they thought t h e c o l l a t e r a l was h e d g e d . According to Stevenson, Marine Midland a g r e e d t o l e n d up t o t h e amount o f t h e l i n e already i n existence. The bank i n d i c a t e d t h a t a l o a n i n e x c e s s o f t h e e x i s t i n g l i n e c o u l d b e c o n t r a r y t o Fed guidelines.

J a n u a r y 26, Mattey s p o k e w i t h A l b e r t Huddleston and h i s f a t h e r in-law, Bunker Hunt. According t o Bache H a l s e y w i t n e s s e s , Bunker Hunt t o l d M a t t e y t h a t t h e m a r g i n c a l l would b e m e t and, a t Mattey's r e q u e s t , o r a l l y guaranteed t h e Huddlestons' further obligations. Bunker Hunt d e c l i n e d t o g u a r a n t e e t h e Huddleston account i n w r i t i n g because he d i d n o t want t h e Huddleston s i l v e r p o s i t i o n s aggregated with h i s f o r p o s i t i o n l i m i t purposes. On Monday, J a n u a r y 2 7 , H u n t E n e r g y Corporation wired funds to m e e t t h e Huddleston margin c a l l . 2. B a c h e H a l s e y ' s K n o w l e d g e o f t h e H u n t s ' Efforts to Obtain Financins I n mid-March 1 9 8 0 , d u r i n g a p e r i o d o f r a p i d l y d e c l i n i n g s i l v e r p r i c e s and j u s t p r i o r to t h e crisis p e r i o d a t Bache, S t e v e n s o n s p o k e w i t h D a v i d Mann, a n o f f i c i a l o f B a r c l a y s Bank i n L o n d o n . Mann t o l d S t e v e n s o n t h a t t h e H u n t s were i n London s e e k i n g l o a n s a g a i n s t t h e i r s i l v e r p o s i t i o n , b u t were b e i n g t u r n e d down. Mann s a i d t h a t t h e H u n t s h a d b e e n r e f u s e d a loan a t Barclays. Mann t o l d S t e v e n s o n t h a t t h e r e a s o n t h a t B a r c l a y s a n d o t h e r b a n k s were r e f u s i n g t o l e n d t o t h e Hunts a g a i n s t t h e i r s i l v e r p o s i t i o n s w a s because t h e s i l v e r m a r k e t s were i l l i q u i d a n d c o u l d n o t a b s o r b t h e c o l l a t e r a l o f f e r e d by t h e H u n t s i f i t h a d t o b e s o l d , a l t h o u g h Mann b e l i e v e d t h a t t h e H u n t s would p r o b a b l y o b t a i n f i n a n c i n g i n Switzerland. S t e v e n s o n d i d n o t c a l l N e w York w i t h t h i s 64/ information. D.

T h e H u n t A c c o u n t s o n t h e Eve o f t h e C r i s i s

By F r i d a y , March 1 4 , 1 9 8 0 , t h e m a r k e t v a l u e o f t h e H u n t s ' s i l v e r f u t u r e s c o n t r a c t s i n a c c o u n t s a t B a c h e H a l s e y , comp u t e d a t t h e s p o t p r i c e , 65/ s t o o d a t $ 4 8 1 m i l l i o n a n d t h e The Hunts had a c c o u n t had u n r e a l i z e d losses o f $429 m i l l i o n . b o r r o w e d $ 2 3 3 m i l l i o n f r o m B a c h e Metals a n d p o s t e d 2 , 9 9 2 A t spot prices, the warehouse r e c e i p t s t o s e c u r e t h e loan. H u n t s ' a c c o u n t s w i t h B a c h e H a l s e y were a l r e a d y $ 1 0 8 m i l l i o n i n d e f i c i t , a l t h o u g h t h e B a c h e Metals l o a n a c c o u n t h e l d $ 8 1 million i n excess collateral. 64 -/ S t e v e n s o n t e s t i f i e d t h a t t h e c o n v e r s a t i o n w i t h Mann w a s " t h e f i r s t t i m e i t r e a l l y sunk i n " t h a t t h e r e was a l i q u i d i t y problem i n t h e s i l v e r market. 65/ - F u t u r e s p r i c e s o n March 1 4 s h o u l d n o t b e c o n s i d e r e d a s an a c c u r a t e measure of t h e value o f t h e Hunts' s i l v e r futures positions. The e x c h a n g e imposed $1.00 p e r ounce d a i l y p r i c e l i m i t a t i o n s i n f u t u r e s c o n t r a c t s , b u t t h e s p o t p r i c e o f s i l v e r lacked any such r e s t r i c t i o n s . T h e s p o t p r i c e o f s i l v e r o n Comex h a d f a l l e n t o $ 2 1 . 0 0 p e r ounce, $10.72 below a v e r a g e f u t u r e s p r i c e s .

V.

THE C R I S I S AT BACHE GROUP--MARCH THROUGH APRIL 8 I 1 9 8 0

A.

17

Overview

I n mid-March, f u t u r e s p r i c e s i n Comex a n d CBT s i l v e r f e l l d a i l y t h e a m o u n t o f t h e p r i c e movement l i m i t s e s t a b l i s h e d by t h o s e exchanges. On March 1 7 , 1 9 8 0 , B a c h e H a l s e y i s s u e d $ 4 4 m i l l i o n i n " h o u s e " m a r g i n c a l l s i n t h e H u n t a c c o u n t s . 66/ T h e H u n t s d i d n o t meet t h e B a c h e H a l s e y c a l l s . T h e y i n f o r m e d t h e f i r m t h a t t h e y e x p e c t e d t o meet t h e c a l l s a t some t i m e i n t h e f u t u r e b u t t h a t t h e y d i d n o t know when o r how. R a t h e r t h a n l i q u i d a t e t h e Hunt a c c o u n t s , Bache H a l s e y d u r i n g t h e week o f March 1 7 a n d o n March 24 a n d 2 5 a c c e p t e d from t h e Hunts, i n l i e u o f c a s h margin, warehouse r e c e i p t s f o r s i l v e r s t o r e d w i t h v a r i o u s b u l l i o n d e a l e r s i n London. N o t w i t h s t a n d i n g t h a t i t c o u l d n o t post t h i s b u l l i o n as v a r i a t i o n m a r g i n w i t h exchange c l e a r i n g c o r p o r a t i o n s , Bache Halsey d i d n o t l i q u i d a t e t h e b u l l i o n to cash because o f m a n a g e m e n t ' s v i e w t h a t , among o t h e r t h i n g s , t h e m a r k e t w o u l d Thereafter, on t h e not absorb a substantial liquidation. e v e n i n g o f March 2 5 , H e r b e r t H u n t t o l d H a r r y J a c o b s , B a c h e Group's chairman, t h a t t h e Hunts n o t o n l y remained w i t h o u t c a s h , b u t h a d n o more c o l l a t e r a l t o d e p o s i t w i t h t h e f i r m .

T h e v a r i a t i o n m a r g i n c a l l s o n March 1 7 were s o - c a l l e d " h o u s e c a l l s " g e n e r a t e d i n H u n t a c c o u n t s when a m a r k e t d e c l i n e caused a n u n r e a l i z e d loss i n t h e a c c o u n t s t h a t caused e q u i t y i n t h e a c c o u n t t o f a l l below 90% o f r e q u i r e d o r i g i n a l margin o f $60,000 p e r c o n t r a c t . Comex a n d CBT r u l e s r e l a t i n g t o v a r i a t i o n m a r g i n a r e more l e n i e n t , r e q u i r i n g an account to be c a l l e d f o r v a r i a t i o n margin o n l y when a m a r k e t d e c l i n e c a u s e s a n u n r e a l i z e d l o s s t h a t r e d u c e s e q u i t y i n t h e a c c o u n t below 75% o f t h e o r i g i n a l margin requirements. The f i r s t o f t h e s e " r u l e c a l l s " were g e n e r a t e d i n t h e H u n t s ' a c c o u n t s w i t h B a c h e o n W e d n e s d a y , March 1 9 , a n d t o t a l l e d $ 4 4 . 5 m i l l i o n . It s h o u l d b e n o t e d t h a t , i n a c c o r d a n c e w i t h i n d u s t r y pract i c e , Bache H a l s e y computed t h e s e c a l l s based o n f u t u r e s p r i c e s r a t h e r t h a n o n s p o t p r i c e s , w h i c h o n March 1 7 I n a limit-down market a v e r a g e d $ 1 4 . 2 0 p e r o u n c e lower. s u c h as e x i s t e d a t t h e t i m e , s p o t prices r e p r e s e n t e d t h e t r u e market value o f t h e Hunts' f u t u r e s c o n t r a c t s . Using s p o t p r i c e s t o compute m a r g i n c a l l s would h a v e g e n e r a t e d much l a r g e r c a l l s f a r e a r l i e r t h a n a c t u a l l y occurred.

Meanwhile, the spot price of silver, which had fallen from $35.30 to $17.40 during the first two weeks of the month, stabilized in the $20 range through Tuesday, March 25. Futures prices, however, were limit-down every day during the same period, falling from an average $31.60 on March 17 to $25.78 on March 25. 67/ Losses in the Hunt futures accounts increased by approximately $22.3 million daily. Bache Halsey continued to pay in cash to Comex and CBT clearinghouses, as a part of the daily variation margin deposit attributable to all of its customer positions, $22.3 million in margin to support the Hunt positions. This continuing requirement that Bache Halsey make variation margin deposits placed a severe cash drain on the firm. By the morning of March 26, Bache Halsey had paid approximately $156 million to clearinghouses to support the Hunt accounts without receiving any cash from the Hunts. This situation continued until Bache Halsey liquidated the Hunt futures positions on March 27 and 28. On March 26 and 27, the spot price of silver fell from $20.20 to $10.80. At spot prices at the close on March 27, notwithstanding Bache Halsey's liquidation of some of the Hunt futures and spot positions, the unsecured debit balance in the Hunt accounts, on a firm-wide basis, was $122 million. This deficit, had it been realized and charged against Bache Group's assets, would have reduced Bache Group's net worth by 84%, from approximately $146 million to approximately $24 million. Bache Group's principal concern was with the continued viability of the Bache Halsey subsidiary. As described earlier in this report, Bache Halsey was required to remain in continuous compliance with the financial responsibility requirements embodied in Commission Rule 15c3-1 and NYSE Rule 325. These rules provide that unmet margin calls on customers must be charged to capital if outstanding for five days or more and the amount of any liquidating deficits in these accounts must be charged immediately. On March 24, 1980, after borrowing $10.5 million in subordinated capital on the 21st and 24th, Bache Halsey had approximately $51.8 million in net capital in excess of the 4% level and $17.3 million in excess of the 7% "early warning" level. As the Hunt margin calls remained unmet, and as the

67/ Futures prices cited here are an unweighted average of Comex prices in the May, July, September and December 1980, and March 1981, contracts.

falling price of silver threatened to carry the Hunt accounts into deficit, management became concerned that it would have to charge these amounts to capital. Largely because Bache Halsey, in accordance with accepted industry practice, computed margin calls and liquidating deficits in commodity futures accounts using futures prices in silver rather than the spot prices, this result did not occur. In addition, by requesting Comex to reduce silver margins by 33%, allocating collateral to Bache Halsey from among the warehouse receipts the Hunts had deposited as collateral for their Bache Metals loans and reledgering the Huddlestons' forward positions from Bache Halsey into Bache Group's London subsidiary, Bache Group was able to further reduce the Hunt-related deficits potentially chargeable to Bache Halsey. As a result, on a liquidating basis Bache Halsey had capital deficiencies below the required minimum capital in the amount of approximately $69 million on March 14 and $12 million on March 27. By operation of industry practice in valuing futures accounts in limit-down markets, however, Bache Halsey remained in continuous compliance with the financial responsibility requirements as the industry and the exchanges had always applied them. At the same time, Bache Metals' creditors, the banks lending to it against the Hunts' silver warehouse receipts, began on March 27 to request that Bache Metals post additional warehouse receipts to maintain required collateralization ratios. Bache Metals informed the banks that it had no more collateral to supply. On March 27 and March 28, the loans exceeded by $33 million and $23 million, respectively, the value of the collateral. This information touched off a second crisis, as Bache Metals' banks with excess collateral ("long banks") threatened to call their loans and sell silver to recoup their loans, thus creating the potential for further decline in the market. Bache Group did not resolve this problem until the early morning hours of April 1, when the banks with inadequate collateral ("short banks") agreed to buy out the long banks and establish a repayment schedule to work out the loan. B. Bache Accepts Silver Collateral in Lieu of Cash Margin On or about March 17, shortly after Mercer told Mattey the Hunts would make no remittance on the margin call just issued in their accounts, Sherrill telephoned Herbert Hunt. 68/ Sherrill told Herbert Hunt that it was essentia1,that the call be met, and asked Hunt what he planned to do about the call. Hunt said he understood and would do anything he could to remedy the situation. According to Sherrill, at no 68/ Sherrill cannot recall whether he spoke with Herbert Hunt on Monday, March 17, or Tuesday, March 18.
\

80 -

time i n t h a t c o n v e r s a t i o n , o r d u r i n g any o t h e r c o n v e r s a t i o n w i t h t h e H u n t s u n t i l t h e e n d o f t h e n e x t week, d i d t h e H u n t s make a r e p r e s e n t a t i o n t h a t c a s h was f o r t h c o m i n g o n a s p e c i f i c day. Hunt t o l d S h e r r i l l t h a t t h e n a t u r e o f t h e p r o b l e m was " a s h o r t a g e o f c a s h . " 69/ Over t h e n e x t s e v e r a l d a y s , t h e Hunks d e s c r i b e d v a r i o u s i d e a s t h e y had t o r a i s e c a s h . Sherrill a r r a n g e d a m e e t i n g w i t h t h e H u n t s f o r Wednesday, March 1 9 , t o d i s c u s s what s t e p s t h e Hunts c o u l d t a k e t o meet t h e i r o b l i g a t i o n s a t Bache. On Wednesday a f t e r n o o n , Bache G r o u p g e n e r a l c o u n s e l John C u r r a n ( " C u r r a n " ) and S h e r r i l l m e t w i t h Bunker Hunt, H e r b e r t Hunt and Hunt E n e r g y v i c e p r e s i d e n t J i m P a r k e r . The H u n t s s a i d t h e y were g o i n g t o be b u s y i n t h e n e x t f e w . days trying to r a i s e funds. Bunker was g o i n g t o E u r o p e a n d had c o n t a c t s t h e r e . The H u n t s t o l d S h e r r i l l a n d C u r r a n t h a t t h e y had n o c a s h a v a i l a b l e o n t h a t d a y and t h a t t h e y d i d n o t f o r e s e e h a v i n g c a s h a v a i l a b l e f o r t h e r e s t o f t h a t week. The Bache Group r e p r e s e n t a t i v e s t o l d t h e H u n t s t h a t w i t h s i l v e r b e t w e e n $20-$22 a n o u n c e , t h e H u n t s would owe Bache a p p r o x i m a t e l y $20 m i l l i o n a d a y f o r t h e n e x t two t o t h r e e days. The H u n t s t o l d Bache Group r e p r e s e n t a t i v e s t h e y had n i n e m i l l i o n o u n c e s o f unencumbered b u l l i o n s t o r e d i n London a n d o f f e r e d t h r e e m i l l i o n o u n c e s t o Bache Group i n l i e u o f m a r g i n , w h i c h Bache Group a c c e p t e d . S h e r r i l l requested a l l nine m i l l i o n ounces of s i l v e r . Between March 1 9 and March 2 5 , Bache d i d r e c e i v e a n a d d i t i o n a l 3 . 6 m i l l i o n ounces of s i l v e r b u l l i o n , b r i n g i n g t h e t o t a l b u l l i o n d e p o s i t s

z /

69/ - S h e r r i l l had n o s p e c i f i c i n f o r m a t i o n f r o m Hunt a s t o w h a t had c a u s e d t h e " l i q u i d i t y p r o b l e m . " "My good s e n s e s t o l d m e i t was c a u s e d by t h e v e r y s h a r p d e c l i n e i n t h e p r i c e of s i l v e r . " 70/ - During t h e c o u r s e o f t h e hour-long m e e t i n g w i t h t h e Hunts, S h e r r i l l i n f e r r e d t h e impression t h a t t h e Hunts had p r o b l e m s e l s e w h e r e , b u t d o e s n o t remember t h e i r s a y i n g s p e c i f i c a l l y t h a t t h e y were m e e t i n g w i t h o t h e r financial institutions. B u n k e r s a i d h e was g o i n g t o S w i t z e r l a n d , and a l l u d e d t o t h e l a t e r p u b l i c i z e d p r o p o s a l t o s e l l s i l v e r - b a c k e d bonds. The H u n t s t o l d Bache t h a t t h e y had s u b s t a n t i a l a s s e t s . S h e r r i l l was a l w a y s u n d e r t h e i m p r e s s i o n t h a t t h e H u n t s would p a y Bache. I n S h e r r i l l ' s opinion, he thought t h a t Bunker Hunt g a v e a d e q u a t e a s s u r a n c e t h a t h e would be s u c c e s s f u l r a i s i n g c a s h i n E u r o p e .

t o 6.6 m i l l i o n ounces. Bache G r o u p d i d n o t l i q u i d a t e t h e s i l v e r u n t i l a f t e r i t l e a r n e d , l a t e o n March 2 5 , t h a t n o more b u l l i o n was f o r t h c o m i n g .

S h e r r i l l d e s c r i b e d Bache G r o u p ' s d e c i s i o n t o a c c e p t s i l v e r bullion instead of cash a s c o l l a t e r a l f o r the v a r i a t i o n margin c a l l : The a t t i t u d e J o h n C u r r a n a n d I had was w e b e l i e v e d them; t h a t o n t h a t p a r t i c u l a r d a y t h e r e was n o more c a s h . We b e l i e v e d t h e r e was a s t r o n g p o s s i b i l i t y a t a f u t u r e d a t e t h a t t h e r e would b e c a s h a v a i l a b l e , b u t i n t h e m e a n t i m e w e were g o i n g t o l a t c h o n t o w h a t e v e r was t h e m o s t l i q u i d a s s e t t h a t t h e y had t h a t w e c o u l d g e t o u r h a n d s on. S h e r r i l l w a n t e d t o c o o p e r a t e f u l l y w i t h t h e H u n t s so t h a t w h a t e v e r a d d i t i o n a l o b l i g a t i o n s became d u e , Bache would b e paid:
W e w a n t e d t o d o w h a t e v e r w e c o u l d t o i n s u r e Bache h a v i n g t h e b e s t chance t o g e t complete recovery of whatever t h e o b l i g a t i o n s were d u e u s f r o m t h e H u n t s . A decision was made a t t h a t t i m e t h a t w e would g o a l o n g w i t h t h e H u n t s b e c a u s e t h e y had p r e s e n t e d u s w i t h v e r y s u b s t a n t i a l a n d a d e q u a t e c o l l a t e r a l f o r t h e o b l i g a t i o n t h e y owed u s on t h a t p a r t i c u l a r d a y .

M e a n w h i l e , C u r r a n was a n x i o u s t o h a v e t h e H u n t s s i g n t h e l o a n a g r e e m e n t s embodying t h e terms o f Bache M e t a l s ' F e b r u a r y N o t w i t h s t a n d i n g t h a t t h e money h a d 1980 l o a n s t o t h e Hunts. b e e n a d v a n c e d b e f o r e t h e e n d o f F e b r u a r y , Bache H a l s e y ' s e x e c u t i v e c o m m i t t e e h a d n o t c o m p l e t e d i t s d e l i b e r a t i o n s on t h e terms o f t h e l o a n s a n d now, o n March 2 0 , d i d n o t h a v e executed agreements with t h e a d d i t i o n a l s a f e t y provisions s o u g h t by t h e e x e c u t i v e committee. S h e r r i l l obtained Bunker's s i g n a t u r e on t h e a g r e e m e n t a t a m e e t i n g on T h u r s d a y , March 20. L a t e r t h a t d a y , M a t t e y and C u r r a n m e t a t t h e Drake Hotel w i t h s e v e r a l Hunt l a w y e r s . H e r b e r t Hunt j o i n e d t h e m e e t i n g and s i g n e d t h e l o a n a g r e e m e n t . Sherrill talked a g a i n w i t h H e r b e r t Hunt o n F r i d a y , March 2 1 , s t r e s s i n g B a c h e ' s n e e d f o r more c o l l a t e r a l . Hunt s a i d t h e y were s t i l l w o r k i n g o n g e t t i n g c a s h o r c o l l a t e r a l , a l t h o u g h h e d i d n o t s a y when h e would know w h e t h e r t h e H u n t s were s u c c e s s f u l . Bache G r o u p ' s n e x t c o m m u n i c a t i o n w i t h t h e H u n t s o c c u r r e d o n T u e s d a y , March 25. The s p o t p r i c e o f s i l v e r had resumed i t s d e c l i n e , f a l l i n g by more t h a n $ 1 p e r o u n c e on Monday t o c l o s e o n Comex a t $ 2 1 . 2 5 . During t h e day on Tuesday, J a c o b s , Horn a n d o t h e r B a c h e G r o u p p e r s o n n e l s p o k e w i t h H e r b e r t Hunt. J a c o b s a s k e d Hunt f o r a n o t h e r 2 m i l l i o n o u n c e s o f b u l l i o n and f o r c a s h t o meet m a r g i n c a l l s . J a c o b s i n q u i r e d o f Hunt w h e t h e r Hunt w a n t e d t h e f i r m t o l i q u i d a t e f u t u r e s p o s i t i o n s . Hunt r e p l i e d t o e a c h q u e s t i o n t h a t h e would t a l k t o B u n k e r

and c a l l back. T h a t e v e n i n g , H e r b e r t Hunt c a l l e d J a c o b s a t home a n d t o l d him t h a t t h e H u n t s had n o c a s h a n d n o more c o l l a t e r a l , a temporary l i q u i d i t y bind. J a c o b s t o l d Hunt t h a t w a s "an e x t r e m e l y g r a v e and u n s a t i s f a c t o r y r e s p o n s e . " On Wednesday m o r n i n g , J a c o b s a g a i n s p o k e w i t h H e r b e r t Hunt. H e t o l d Hunt t h a t t h e y ( t h e H u n t s ) h a d n o t m e t t h e i r m a r g i n r e q u i r e m e n t s a n d t h a t B a c h e had n o c h o i c e b u t t o s e l l out the s i l v e r positions. A c c o r d i n g t o Bache w i t n e s s e s , J a c o b s asked Hunt whether o t h e r f i r m s had been r e c e i v i n g c a s h i n s t e a d o f b u l l i o n , t o w h i c h Hunt r e p l i e d , " a b s o l u t e l y n o t " , a n d t o l d J a c o b s t h a t Merrill Lynch h a d b e e n r e c e i v i n g Bache w a r e h o u s e r e c e i p t s a s m a r g i n b e f o r e March 20. 71/ a d v i s e d Hunt t o come t o N e w York f r o m D a l l a s a s s o o n a s possible. An a r r a n g e m e n t was worked o u t w h e r e b y Merrill Lynch a n d o t h e r b r o k e r s were a d v i s e d t o a t t e n d a m e e t i n g w i t h Hunt. A f t e r t h e Wednesday m o r n i n g t e l e p h o n e c a l l w i t h H e r b e r t H u n t , B a c h e p r e p a r e d t e l e g r a m s f o r e a c h Hunt a c c o u n t a n n o u n c i n g B a c h e ' s i n t e n t i o n o f l i q u i d a t i n g H u n t s i l v e r p o s i t i o n s . 72/ The f i r m b e g a n l i q u i d a t i n g t h e p h y s i c a l s i l v e r c o l l a t e r a l t h e H u n t s ' had d e p o s i t e d . T h a t e v e n i n g , v a r i o u s members o f B a c h e management w e n t t o t h e D r a k e Hotel t o meet w i t h H e r b e r t Hunt and r e p r e s e n t a t i v e s o f s e v e r a l o t h e r f i r m s .

71/ -

A s d e s c r i b e d elsewhere i n t h i s r e p o r t , t h e Hunts p a i d

cash to broker-dealers March 25.

o t h e r t h a n Bache H a l s e y t h r o u g h

72/ B a c h e H a l s e y p r e p a r e d t e l e g r a m s f o r W i l l i a m H e r b e r t H u n t ( A c c o u n t N o . 8 0 - 4 7 0 9 4 ) ; H o u s t o n B. Hunt ( A c c o u n t N o . SF3 1 2 0 4 ) ; N e l s o n B u n k e r H u n t ( A c c o u n t N o s . SF-31200 a n d 8 0 - 4 7 0 9 3 ) ; Lamar H u n t ( A c c o u n t N o . 8 0 - 4 7 1 4 7 ) ; a n d H u n t M i n e r a l s I n t e r n a t i o n a l Ltd. (Account No. 80-95886). Bache s e n t t h e same t e l e g r a m t o e a c h a c c o u n t : C o n f i r m i n g o u r a d v i c e t o you t o d a y , w e r e q u i r e 1 3 5 m i l l i o n immediately. I n view o f your telephone r e p l y t o d a y t h a t y o u were u n a b l e t o f u r n i s h i t a n d t h a t y o u have no o b j e c t i o n of o u r t r y i n g t o sell s i l v e r , w e a r e commencing e f f o r t s i m m e d i a t e l y t o l i q u i d a t e s i l v e r and, i n our d i s c r e t i o n f u t u r e s p o s i t i o n s t o meet t h i s c a l l . ( S i g n e d ) Bache H a l s e y S t u a r t S h i e l d s , I n c .

At the meeting, according to Bache witnesses, Herbert Hunt said that the Hunts had no resources immediately available and that the firms had to do whatever was necessary to take care of the problems. In addition, Hunt told the group the amount of the Hunts' outstanding margin calls at various other firms. Herbert stated that, although Bunker was still trying to arrange financing, as of that moment, they had no resources immediately available. C. Financial Implications of the Crisis 1. Status of Hunt Accounts During the Crisis As the price of silver declined during the crisis period the Hunts' accounts with Bache Halsey, Bache Metals and Bache London developed substantial unsecured debit balances. 73/ In Bache London, the unsecured debit balance in the ~ u d d l e z o n s ' 750,000 ounce long forward position increased from $19.6 million on March 25 to $21.2 million on March 26 and was locked in at $22.8 million when Bache effectively hedged it with an offsetting short position on March 27. Meanwhile, the declining value of the silver collateral the Hunts had posted rendered Bache Metals' loans to them undercollateralized, thus generating an unsecured debit balance in the Hunts' accounts with that subsidiary. The following table illustrates the status of the Bache Metals loans accounts during the six business days from March 25 through April 1, 1980:

73/ - The existence of an "unsecured debit balance" or "def$itu

in a customer account means that following an actual or hypothetical liquidation of the holdings in the account at prevailing prices, a balance, not secured by other assets, would be payable to the broker from the customer. Under rules prevailing at the time of the crisis an unsecured debit balance was required to be charged to a brokerdealer's capital if not collected from the customer by the close of business on the third business day after being generated in an account.

TABLE V I BACHE METALS LOANS O u t s t a n d i n g Amounts a n d C o l l a t e r a l V a l u e ($ Millions) Date

Mar. 2 5 75/ Mar. 2 6

Loans Outs t a n d i n g -/ 74 233 233 155 106 97 41.9

Collateral Value

Liquidating Value Equity (Deficit) 139

372 271 122 82.3 90.2 32.2

Mar. 2 7
Mar. 28 Mar. 3 1 76/

(33) (23 (6.8) (9.7)

Apr.

A s s e s s i n g t h e s t a t u s o f t h e Hunts' a c c o u n t s w i t h Bache H a l s e y i s r e n d e r e d more d i f f i c u l t b e c a u s e o f t h e a c c o u n t v a l u ation practice prevailing i n the industry. Silver futures c o n t r a c t s c o n s t i t u t e d t h e most s i g n i f i c a n t h o l d i n g s i n t h e Eiunts' a c c o u n t s w i t h t h e b r o k e r - d e a l e r . A s noted elsewhere throughout t h i s r e p o r t , i n valuing a customer's f u t u r e s a c c o u n t , b o t h f o r customer a c c o u n t i n g and n e t c a p i t a l purposes, i n d u s t r y p r a c t i c e h a s b e e n t o u s e t h e s e t t l e m e n t p r i c e q u o t e d d a i l y by c o m m o d i t y e x c h a n g e s f o r e a c h f u t u r e s c o n t r a c t i n the account. T h i s p r a c t i c e h a s been followed e v e n i n l i m i t - d o w n m a r k e t s , i n w h i c h , w i t h respect t o n e t l o n g p o s i t i o n s , such a practice produces a n u n r e a l i s t i c a l l y h i g h "market" v a l u e f o r t h e account. The s e l f - r e g u l a t o r y o r g a n i z a t i o n s and t h e t w o f e d e r a l r e g u l a t o r y a g e n c i e s i n v o l v e d have b e e n aware o f t h i s p r a c t i c e a n d h a v e a c q u i e s c e d i n i t s continuation. Bache and t h e o t h e r f i v e f i r m s d e s c r i b e d i n t h i s report t h u s v a l u e d Hunt a c c o u n t s d u r i n g t h e crisis a t f u t u r e s prices f o r a c c o u n t i n g and n e t c a p i t a l purposes. However, t o assess t h e f i r m ' s e x p o s u r e d u r i n g t h e p e r i o d , Bache p e r s o n n e l i n f o r m a l l y c a l c u l a t e d t h e v a l u e o f t h e Hunt a c c o u n t s u s i n g s p o t p r i c e s , w h i c h r e p r e s e n t e d much more c l o s e l y t h e realizable value of the accounts i n liquidation. 74 -/ C r e d i t a g a i n s t l o a n a m o u n t s f o r t h e v a l u e o f s i l v e r l i q u i dated h a s been g i v e n as o f t h e t r a d e date. 75/ 76/ Includes v a l u e o f 1.25 m i l l i o n ounces of b u l l i o n subseq u e n t l y a l l o c a t e d t o Bache H a l s e y . I n c l u d e s $ 7 m i l l i o n a l l o c a t e d t o Bache Metals f r o m a $ 1 7 m i l l i o n d e p o s i t b y P l a c i d O i l o n March 3 1 .

Although Hunt a c c o u n t s a t Bache H a l s e y remained i n e q u i t y t h r o u g h March 27 when v a l u e d a t f u t u r e s p r i c e s , a t t h e s p o t p r i c e s more l i k e l y t o b e r e a l i z e d i n l i q u i d a t i o n H u n t a c c o u n t s h e l d u n s e c u r e d d e b i t b a l a n c e s a t l e a s t a s e a r l y a s March 1 4 . The f o l l o w i n g t a b l e i l l u s t r a t e s t h e a p p r o x i m a t e s t a t u s o f t h e H u n t s ' a c c o u n t s w i t h Bache H a l s e y on s e l e c t e d d a y s d u r i n g t h e crisis p e r i o d : TABLE V I I HUNT ACCOUNTS WITH BACHE HALSEY L i q u i d a t i n s Value Durinq t h e C r i s i s - ~ ~ u Ti ~ te f i c i t )( $ M i l l i o n s ) ~ Date March 1 4 77/ March 2 5 Spot Prices (107) Futures Prices

z x/ /
(64.7) (10 - 0 177 (10) - 0 -

March 26 -/ 80 March 27 March 28 March 3 1 81/ 77/ -

I n c l u d e s t h e H u d d l e s t o n s ' 7 5 0 , 0 0 0 o u n c e LME f o r w a r d p o s i t i o n , w h i c h w a s removed f r o m B a c h e H a l s e y ' s b o o k s o n March 24. - d i s c u s s i o n b e l o w a t p a g e s 89-90. See

78/ - On a n d a f t e r March 2 0 , e q u i t y i n c l u d e s v a l u e a t s p o t o f .3.0 m i l l i o n o u n c e s o f b u l l i o n d e p o s i t e d b y t h e H u n t s o n March 1 9 . 79/ On a n d a f t e r March 2 5 , e q u i t y i n c l u d e s v a l u e a t s p o t o f a d d i t i o n a l 3.6 m i l l i o n ounces o f b u l l i o n d e p o s i t e d on March 24.

80/ - On a n d a f t e r March 2 6 , e q u i t y i n c l u d e s 1 . 2 5 m i l l i o n o u n c e s o f b u l l i o n o b t a i n e d f r o m B a c h e Metals. See discussion below a t page 94. 81/ I n c l u d e s $10 m i l l i o n of a $17 m i l l i o n d e p o s i t t o t h e Hunts' a c c o u n t s o n March 31.

86

t h e t a b l e makes a p p a r e n t , u n s e c u r e d d e b i t b a l a n c e s i n t h e Hunt a c c o u n t s o n a l i q u i d a t i n g b a s i s , computed a t s p o t p r i c e s , exceeded Bache H a l s e y ' s e x c e s s n e t c a p i t a l a t l e a s t a s e a r l y a s March 1 4 a n d a g a i n o n M a r c h 2 7 . A t f u t u r e s prices, however, no unsecured d e b i t balances developed i n t h e accounts u n t i l March 2 8 , when t h e l i q u i d a t i o n o f m o s t o f t h e H u n t f u t u r e s p o s i t i o n s a t o r n e a r spot prices produced a d e f i c i t , a c c o r d i n g t o B a c h e ' s contemporaneous c a l c u l a t i o n s , o f $10 m i l l i o n . A c c o r d i n g l y , u n d e r p r e v a i l i n g p r a c t i c e , Bache H a l s e y w a s r e q u i r e d to t a k e no charges to r e g u l a t o r y c a p i t a l prior to March 28 b e c a u s e n o u n s e c u r e d d e b i t b a l a n c e s were p r o d u c e d a t f u t u r e s p r i c e s . T h e u n s e c u r e d d e b i t b a l a n c e o n March 28 w a s r e p a i d by P l a c i d O i l , as d e s c r i b e d e l s e w h e r e i n t h i s r e p o r t , o n March 3 1 .
AS

A s t h e foregoing d i s c u s s i o n i n d i c a t e s , t h e magnitude o f t h e unsecured d e b i t balances t h a t developed i n t h e Hunts' a c c o u n t s as t h e price o f s i l v e r d e c l i n e d c a r r i e d t h e p o t e n t i a l f o r l o s s e s t o B a c h e G r o u p t h a t were v e r y s u b s t a n t i a l i n rel a t i o n to its o v e r a l l f i n a n c i a l resources. A s noted e a r l i e r o n March 2 7 , a t t h e l o w p o i n t i n s i l v e r p r i c e s d u r i n g t h e crisis, a n i m m e d i a t e l i q u i d a t i o n o f Hunt a c c o u n t s would h a v e produced u n s e c u r e d d e b i t b a l a n c e s i n Bache H a l s e y , Bache Metals a n d B a c h e London o f $ 1 2 2 m i l l i o n . I f not recovered from t h e H u n t s , s u c h a l o s s w o u l d h a v e a m o u n t e d t o a p p r o x i m a t e l y 2 . 5 times t h e p r e t a x i n c o m e i t r e p o r t e d f o r f i s c a l 1980. T h e s e p o t e n t i a l l o s s e s were u l t i m a t e l y a v e r t e d b e c a u s e (1) s i l v e r p r i c e s s t a b i l i z e d a f t e r March 2 7 ; ( 2 ) t h e H u n t s o b t a i n e d c r e d i t f r o m P l a c i d t o e n a b l e them t o r e p a y t h e March 28 d e f i c i t o n March 3 1 ; a n d ( 3 ) b a n k s were w i l l i n g t o ref i n a n c e t h e Hunts' o b l i g a t i o n s t o a l l o f t h e i r c r e d i t o r s 82/ through c r e d i t s to Placid O i l . -

The c r i s i s c a r r i e d a n e q u a l l y s e r i o u s p o t e n t i a l f o r i m p a i r m e n t o f t h e r e g u l a t o r y c a p i t a l r e q u i r e d t o b e maint a i n e d by Bache G r o u p ' s b r o k e r - d e a l e r s u b s i d i a r y . Bache H a l s e y ' s i n t e r n a l pro f o r m a c a p i t a l c o m p u t a t i o n a s o f F r i d a y , March 1 4 , 1 9 8 0 , s h o w e d i t t o h a v e $ 3 7 . 7 m i l l i o n of R u l e 1 5 c 3 - 1 c a p i t a l i n e x c e s s o f i t s minimum r e q u i r e m e n t s a n d $ 5 0 0 , 0 0 0 o f R u l e 3 2 6 c a p i t a l a b o v e t h e NYSE's " e a r l y w a r n i n g " level. On March 2 1 a n d M a r c h 2 4 , B a c h e H a l s e y b o r r o w e d a total o f $10.5 m i l l i o n i n subordinated l o a n s pursuant to a l i n e of c r e d i t i t m a i n t a i n e d w i t h a g r o u p o f f i v e b a n k s .

/ From B a c h e G r o u p ' s p e r s p e c t i v e , e v e n t s d e s c r i b e d i n t h e
F o r t h a t r e a s o n i t is a c c o m p a n y i n g t e x t were f o r t u i t o u s . i m p o r t a n t t o a n u n d e r s t a n d i n g o f t h e crisis t o a s s e s s t h e p o t e n t i a l i m p a c t o n Bache and t h e o t h e r f i r m s i n v o l v e d i f , a s w a s e n t i r e l y p o s s i b l e , n o p r i c e s t a b i l i z a t i o n o r ref i n a n c i n g o f Hunt o b l i g a t i o n s had o c c u r r e d .

Bache's Rule 15c3-1 capital at March 24 was thus $51.8 million in excess of minimum requirements and Rule 326 capital was $41.6 million above the "early warning" level. This continued to be the firm's approximate regulatory capitalization for the remainder of the crisis period. As Table VII makes apparent, unsecured debit balances in the Hunt accounts computed at spot prices exceeded Bache Halsey's excess net capital at least as early as March 14, for the two business days thereafter, and again on March 27. Under prevailing industry and regulatory practice, Bache Halsey was not required to recognize and charge to capital the debit balances so computed. The computation of these deficits at spot prices however, represents far more closely than a computation at 83/ futures prices, the actual liquidating value of the accounts. The magnitude of the unsecured debit balances computed at spot prices thus suggests a significant potantial for capital impairment had Bache Halsey been required to charge to capital on the basis of such a computation. 84/ Apart from the unsecured debit balances that developed in Hunt accounts, two other aspects of the silver crisis carried the potential for net capital impairment in the broker-dealer or for significant adverse financial impact on Bache Group. First, by March 26, the time approached at which Bache Halsey would have been required to charge to net capital "rule" variation margin calls that had remained unmet after March 19. Second, the limit-down daily decline in silver prices created a negative cash flow in Bache Halsey of approximately $22 million per day. Exchange clearinghouses charged Bache Halsey's clearing balance daily the full amount of the price decline in the Hunt positions, but Bache Halsey received no cash from the Hunts. Because clearinghouses will

83/ - In limit-down trading markets it is, as a practical matter, impossible to dispose of a futures position at the futures price. A liquidation under these circumstances requires a complex transaction sometimes referred to as a "switch", the net effect of which is to permit the disposition of the long futures contract at the much lower spot price, less a premium benefitting the "switch broker" on the other side of the transaction. Accordingly, the true market value of long futures positions in limit-down markets is the spot price, rather than the artificially restrained futures price.

84/ - In addition, the deficits illustrated on Table VII after March 26 take into account three other events, described more fully in the following section, that reduced the potential for capital impairment in the broker-dealer. See discussion below at pages 89 through 94.

not accept bullion or warehouse receipts in satisfaction of variation margin calls on clearing members, the Hunts' two bullion deposits with the firm did nothing to alleviate the cash drain associated with their failure to meet calls. 2. Steps to Maintain Net Capital Compliance As previously described, the possibility that Bache Halsey would suffer regulatory capital impairment as a result of the Hunts' default was substantially reduced because of the industry practices of computing margin requirements and liquidating deficits in commodity futures accounts using futures prices rather than spot prices. Nevertheless, Bache Halsey took several other steps that reduced the potential for capital impairment. These included (1) reledgering to Bache London the $22.8 million deficit in the Huddlestons' forward position, (2) allocating to Bache Halsey silver bar warehouse receipts held as collateral for the Bache Metals loans but not yet pledged to banks, and (3) successfully requesting that Comex reduce margin requirements in silver, thereby freeing, for application to clearinghouse variation calls, cash which under CFTC regulations Bache Halsey was otherwise obligated to maintain in customer segregation accounts. a. Reledgering the Huddleston Deficits As described earlier in this report, on January 16, 1980, Albert and Mary Huddleston entered through their account with Bache Halsey's Houston office, 85/ contracts for the forward purchase of 750,000 ounces of silver on the London Metal Exchange. Bache Halsey carried the position in an omnibus account it maintained with Bache London. The Huddlestons purchased the forward positions at an average price of $46.35 per ounce for a total obligation, due on July 16, 1980, of $34.8 million. By the close of business on Friday, March 21, the Huddlestons had unrealized losses of $18.4 million on these positions. From March 20 through 25, Mattey sold out all of the non-silver assets in the Huddlestons' account. Meanwhile, in order to eliminate the possibility that losses on the London position would have to be charged to Bache Halsey's capital, Frank Geremia ("Geremia"), head of Bache Halsey's

85/ -

Mattey, who by this time had assumed account responsibility for the Huddlestons, placed the order.

- 89

c o m m o d i t y o p e r a t i o n s , o n M a r c h 24 h a d t h e H u d d l e s t o n s ' London forward p o s i t i o n , and t h e a s s o c i a t e d losses, r e l e d g e r e d from Bache H a l s e y ' s omnibus a c c o u n t i n t o a n i n d i v i d u a l a c c o u n t w i t h B a c h e L o n d o n . -/ 86 On M a r c h 2 7 , B a c h e G r o u p h a d B a c h e London l i q u i d a t e t h e Huddleston p o s i t i o n i n o f f s e t t i n g t r a n s a c t i o n s to settle a t $ 1 5 . 1 5 per o u n c e , a l o s s o f a p p r o x i m a t e l y $ 2 2 . 8 m i l l i o n . b . T h e A p p r o a c h t o Comex Bache Group c h a i r m a n H a r r y J a c o b s r e t u r n e d from a n A u s t r i a n v a c a t i o n o n Monday, M a r c h 2 4 . On r e v i e w i n g t h e s i t u a t i o n , h e formed t h e o p i n i o n t h a t t h e s i l v e r crisis was s e r i o u s enough to w a r r a n t t h a t t h e commodity e x c h a n g e s d e c l a r e t h e e x i s t e n c e o f what J a c o b s d e s c r i b e d as a " f o r c e m a j e u r e " which would t h e r e b y j u s t i f y c l o s i n g t h e s i l v e r markets. J a c o b s c o n t e m p l a t e d t h a t t h e Comex w o u l d s h u t down t r a d i n g i n s i l v e r a n d s e t t l e a l l t h e c o n t r a c t s a t a s t i p u l a t e d p r i c e . -/ 87

86/ -

T h e r e i s c o n f l i c t i n g t e s t i m o n y f r o m w i t n e s s e s a s t o (1) w h e t h e r Bache H a l s e y would h a v e been charged w i t h def i c i t s f r o m t h e H u d d l e s t o n s ' London p o s i t i o n i f t h a t p o s i t i o n had remained i n Bache H a l s e y ' s omnibus a c c o u n t w i t h Bache London a n d ( 2 ) w h e t h e r i n f a c t t h e r e l e d g e r i n g was m o t i v a t e d b y n e t c a p i t a l c o n c e r n s . T h e a n s w e r t o t h e f i r s t q u e s t i o n appears t o d e p e n d o n w h e t h e r , i n t h e e v e n t o f a d e f a u l t b y B a c h e L o n d o n , t h e LME d e a l e r o n t h e o t h e r s i d e o f t h e s e c o n t r a c t s would have had r e c o u r s e to Bache H a l s e y a s t h e owner o f t h e omnibus a c c o u n t . A r t Regel, manager o f t h e Bache H a l s e y d e p a r t m e n t t h a t manages t h e omnibus a c c o u n t w i t h Bache London, t e s t i f i e d t h a t c a r r y i n g t h e p o s i t i o n i n t h e Houston a c c o u n t would h a v e a u t o m a t i c a l l y t r i g g e r e d a c a p i t a l c h a r g e by o p e r a t i o n o f Bache Halsey's automated accounting system. Both G e r e m i a and B a c h e H a l s e y c o n t r o l l e r , A l a n Hogan t e s t i f i e d t h a t t h e LME p o s i t i o n h a d b e e n c a r r i e d i n t h e H u d d l e s t o n s ' H o u s t o n a c c o u n t "by m i s t a k e " and t h a t its removal from t h e omnibus a c c o u n t m e r e l y c o r r e c t e d t h e " e r r o r " . S h e r r i l l , however, t e s t i f i e d , a n d t h e a u d i t committee o f B a c h e G r o u p ' s b o a r d o f d i r e c t o r s c o n c l u d e d , t h a t B a c h e H a l s e y e f f e c t e d t h e reledgering to avoid c a p i t a l charges.

87 -/ J a c o b s t e s t i f i e d h e f o r m e d h i s o p i n i o n c o n c e r n i n g t h e e x i s t e n c e o f a market emergency because h e b e l i e v e d t h a t t h e s i l v e r market w a s i l l i q u i d .

On T u e s d a y m o r ~ i n g , J a c o b s , S h e r r i l l and o t h e r members o f Bache Group management m e t w i t h L e e B e r e n d t , P r e s i d e n t o f t h e Comex, and Mark B u c k s t e i n , Comex c o u n s e l . Bache Group p e r s o n n e l e x p l a i n e d Bache G r o u p ' s s i t u a t i o n v i s - a - v i s t h e Hunt a c c o u n t s , i n c l u d i n g t h e f a c t t h a t Bache H a l s e y had r e c e i v e d b u l l i o n i n s t e a d o f c a s h f o r v a r i a t i o n margin c a l l s . The Bache Group r e p r e s e n t a t i v e s p r o p o s e d c l o s i n g t h e m a r k e t o r l o w e r i n g t h e m a r g i n r e q u i r e m e n t s . Berendt and B u c k s t e i n e x p r e s s e d o p . p o s i t i o n t o t h e p r o p o s a l t h a t t h e m a r k e t be c l o s e d , b u t t o l d t h e Bache Group p e r s o n n e l t h a t a Comex m a r g i n committee m e e t i n g was s c h e d u l e d f o r t h e n e x t d a y . B e r e n d t a n d B u c k s t e i n s a i d t h a t i f Bache Group f e l t i t was n e c e s s a r y , t h e y would c o n f e r c o n c e r n i n g Bache G r o u p ' s p r o b l e m s w i t h Comex' b o a r d o f g o v e r n o r s . On Wednesday m o r n i n g , some h o u r s a f t e r H e r b e r t H u n t ' s l a t e e v e n i n g c a l l t o J a c o b s e x p l a i n i n g t h a t t h e H u n t s had n o more c a s h o r b u l l i o n , B e r e n d t a n d B u c k s t e i n came t o Bache G r o u p ' s o f f i c e s . ~ e r e n d t n d B u c k s t e i n t o l d Bache t h a t t r a d i n g a i n t h e m a r k e t would n o t b e . s u s p e n d e d , b e c a u s e t h e Comex had c a l l e d a number o f o t h e r f i r m s where t h e y knew t h e H u n t s had p o s i t i o n s and t h o s e f i r m s were s t i l l r e c e i v i n g c a s h f r o m t h e H u n t s . 88/ The Cqmex o f f i c i a l s a l s o s a i d t h e y t h o u g h t t h e m a r k e t d i d h a v e l i q u i d i t y , a n d t o l d t h e Bache Group r e p r e J s e n t a t i v e s t h a t , ~ e n r y a r e c k i , chairman of Mocatta Metals, would buy a s u b s t a n t i a l amount o f s i l v e r from Bache. 89/ F i n a l l y , B e r e n d t a n d B u c k s t e i n t o l d t h e Bache o f f i c i a l s t h a t t h e m o r n i n g m a r g i n committee m e e t i n g had b e e n c a n c e l l e d . Bache Group o f f i c i a l s were, a c c o r d i n g t o J a c o b s , i r a t e a t t h e l a t t e r piece of information.
A t a b o u t 1 2 : 1 5 t h a t a f t e r n o o n , J a c o b s t e l e p h o n e d Fed chairman, Paul Volcker, because, a s he s t a t e d :

88/ - B e r e n d t and B u c k s t e i n s a i d t h a t based on t h e f a c t t h a t o t h e r h o u s e s were r e c e i v i n g w i r e t r a n s f e r s , i t was n o t B e r e n d t and B u c k s t e i n d i d n e c e s s a r y t o close t r a d i n g . n o t r e v e a l t o Bache w h i c h o t h e r h o u s e s Comex had contacted. 89/ J a c o b s c o n s i d e r e d i t " a s t o n i s h i n g and u n u s u a l " t h a t B e r e n d t a n d B u c k s t e i n t o l d him t h a t i f Bache w a n t e d t o s e l l o u t s i l v e r , t h o s e s a l e s would meet w i t h b r o a d " I n my l i q u i d i t y i n t h e market. According t o Jacobs: d e a l i n g s w i t h s t o c k exchange o f f i c i a l s over t h e y e a r s when w e h a v e b l o c k s o f s e c u r i t i e s t o buy o r s e l l , I h a v e n e v e r b e e n a d v i s e d by s t o c k e x c h a n g e o f f i c i a l s w h e r e t o g o . I t h o u g h t t h a t t h e y w e r e , you know, s t r u c t u r i n g a market place."

F i r s t , I t h o u g h t t h a t t h e r e was a n e x t r e m e l y i l l i q u i d s i t u a t i o n d e v e l o p i n g t h e r e and i t was i n t h e N a t i o n a l ( s i c ) i n t e r e s t t h a t I c a l l him a s t h e s e n i o r , c e n t r a l banker of t h e world.

S e c o n d l y , I g u e s s f r o m a more p a r o c h i a l p o i n t o f v l e w w e t h o u g h t i t would h e l p p u t p r e s s u r e o n t h e C o m e x . I n J a c o b s ' words,

I t o l d him t h a t t h e r e was a m a t t e r t h a t I t h o u g h t was e x t r e m e l y g r a v e a n d t h a t t h e r e was a g r e a t i l l i q u i d i t y i n t h e s i l v e r m a r k e t a n d t h a t w e had p r o p o s e d a t w i n a p p r o a c h t o t h e Comex o f e i t h e r a f o r c e m a j e u r e , w h i c h t h e y d i d n ' t seem i n t e r e s t e d i n , a n d / o r r e d u c i n g m a r g i n requirements.

Approximately a n hour a f t e r J a c o b ' s c a l l t o Volcker, Volcker returned the c a l l . V o l c k e r w a n t e d t o know t h e i d e n t i t y o f t h e b a n k s l e n d i n g t o Bache M e t a l s a g a i n s t , s i l v e r c o l l a t e r a l . J a c o b s i d e n t i f i e d t h e banks. According t o Jacobs, Volcker was " n o t p l e a s e d " t o l e a r n o f t h e s i l v e r l o a n s a n d e x p r e s s e d s u r p r i s e a t t h e t o t a l amount o f t h e l o a n s .
N o t long a f t e r Jacobs' second conversation w i t h Volcker, B e r e n d t phoned J a c o b s . A c c o r d i n g t o J a c o b s , B e r e n d t was " v e r y a n n o y e d " a n d w a n t e d t o know, "Why t h e h e l l d i d I c a l l was u p s e t t h a t Paul Volcker." Jacobs t e s t i f i e d t h a t ~ e r e n d t " I was p u t t i n g p r e s s u r e o n him t o e i t h e r h a v e a f o r c e m a j e u r e or g e t m a r g i n s r e d u c e d . "

T h a t a f t e r n o o n t h e Comex b o a r d o f g o v e r n o r s m e t o n a n e m e r g e n c y b a s i s w h i l e Bache o f f i c i a l s , i n c l u d i n g S h e r r i l l , and o t h e r s , w a i t e d o u t s i d e t h e meeting. According t o Mattey, he a t t e n d e d t h e meeting i n h i s c a p a c i t y a s a governor of t h e e x c h a n g e a f t e r B e r e n d t a n d L o w e l l A. M i n t z ( " M i n t z " ) , b o a r d c h a i r m a n , p e r m i t t e d him t o d o so. M a t t e y t e s t i f i e d , h o w e v e r , t h a t Mintz d i r e c t e d t h a t he n o t p a r t i c i p a t e i n t h e d i s c u s s i o n or v o t e . M a t t e y r e c a l l e d t h a t B e r e n d t t o l d t h e g o v e r n o r s t h a t Bache Group had r e q u e s t e d t h e m a r k e t be c l o s e d a n d t h a t t h e r e q u e s t had b e e n d e n i e d . T h e r e was n o f u r t h e r d i s c u s s i o n 90/ o f t h e Bache Group r e q u e s t , n o r a n y v o t i n g . The g o v e r n o r s d i d v o t e o n B a c h e ' s r e q u e s t t o r e d u c e margin requirements. The b o a r d l e a r n e d t h a t Bache H a l s e y was s e e k i n g r e l i e f f r o m a c a s h f l o w p r o b l e m c a u s e d by B a c h e ' s Mocatta o b l i g a t i o n t o d e p o s i t l a r g e sums o f v a r i a t i o n m a r g i n .

90/ -

M a t t e y s a y s t h a t no r e a s o n was g i v e n f o r d e n y i n g B a c h e ' s r e q u e s t , a n d no g o v e r n o r r a i s e d a n y o b j e c t i o n s t o t h e p r o c e d u r e f o l l o w e d f o r a c t i n g on it.

Metals chairman Henry Jarecki moved to reduce the margin requirements, and the Board voted to reduce original margin from $60,000 to $40,000 per contract. As noted in Comex' chronology of its activities before and during the crisis, 91/ the reduction in original margins had the effect of "[freeing] up" approximately $80 million in original margin deposits for Bache Halsey to apply to variation margin calls issued by the clearinghouses. The reduction of original margin requirements, moreover, reduced maintenance margins, which exchange rules set at 75% of original margin, from $45,000 to $30,000 per contract, thereby substantially reducing the degree of undermargining in the Hunt accounts. The Comex action had a two-fold beneficial effect on Bache Halsey's financial condition: (1) By freeing $80 million from the segregation account, the original margin reduction obtained for Bache Halsey cash needed to meet variation margin calls at the exchange clearinghouse, 92/ and (2) The concomitant reduction of maintenance m a r g i n levels eliminated the oldest outstanding margin calls, thereby avoiding the requirement that these aged calls be charged to capital.

9L/ - Commodity Exchange, Inc., Chronology of Activities Re-

lating to the Silver Market from September 1979 through March 1980 (April 14, 1980) at 43.

92/ - "Under the segregation provisions of the Commodity

Exchange Act, an FCM is prohibited from using the equity in one customer's account to offset a deficit in another customer's account. The Commodity Exchange Act requires that funds received by an FCM for margining customer trades must be accounted for separately and must be segregated from the operating funds of the FCM. Under Commission regulations, if an individual customer's account has a deficit balance, the carrying FCM must deposit its own funds to compensate for the deficiency, thus, any customer's losses that exceed the level of deposits or equity in the customer's account and result in a deficit balance must be paid to the clearinghouse by the FCM from its own funds." CFTC Study, Part Two at page 11 (Footnote omitted).

c. Allocating Collateral from the Bache Metals Loans to Bache Halsey On March 26, the spot price of silver fell $4.40 per ounce to close at $15.80. That morning Bache Halsey had begun to liquidate the bullion that the Hunts had deposited earlier in lieu of margin in the Hunts' futures accounts. Among other positions, Bache Halsey sold short in Bunker Hunt's account 250 contracts of March silver and credited Hunt's account with the $19.5 million in proceeds. To cover this position, Frank Geremia went to the office of Art Regel, the assistant vice president in charge of Bache Halsey's spot commodity department, and inquired as to the number of warehouse receipts in the Hunt loan accounts with Bache Metals that had not been transmitted to banks to collateralize Bache Metals' borrowings. Regel told him there were approximately 263 receipts in the account. Geremia told Regel to prepare the receipts for delivery against the short position in Bunker Hunt's account. Regel did so and that evening the firm tendered delivery notices on 250 contracts of Comex silver. When bankers the next day began requesting additional collateral for the Bache Metals loans, Stevenson and Herr informed them that none was available.
D. Liquidation, Loss and Recovery

1. The Liquidations On Wednesday morning, March 26, Jacobs and other Bache Group personnel called Herbert Hunt. They told him that the Hunts' inability to meet margin calls or deposit bullion left Bache with no choice but to liquidate the Hunts' silver positions. They asked his permission to do so. Hunt told them that Bache could proceed. After the call Horn began liquidating physical silver, beginning with the 6.5 million ounces Bache Halsey had received from the Hunts in lieu of margin and the 1.25 million ounces it had received from the Hunts' account with Bache Metals. On March 27, Horn began liquidating domestic silver futures positions, silver bullion deposited as collateral for the Bache Metals loans and the Huddlestons' London forward position. By the close of business on Friday, March 28, Bache Group had executed transactions liquidating all of the Hunts' silver positions, except, according to Bache, approximately 7.5 million ounces of bullion pledged to Bache Metals to secure its loan to the Hunts and 118 93/ futures contracts. - At the price prevailing at the close on March 28, on a liquidating basis, the Hunts' futures accounts with Bache Halsey had, according to later 93/ An on of to audit by Commission staff of available documentation these transactions suggests that 6.9'million ounces bullion remained unsold on March 28. We are attempting reconcile the differences in these numbers.

Bache r e p o r t s , a p p r o x i m a t e l y $10 m i l l i o n i n u n s e c u r e d d e b i t balances. T h e a m o u n t o f B a c h e Metals' r e m a i n i n g o b l i g a t i o n s o n demand n o t e s h e l d b y t h e b a n k s f r o m whom i t h a d b o r r o w e d t o f i n a n c e H u n t s i l v e r was a p p r o x i m a t e l y $ 1 0 5 m i l l i o n , w h i c h e x c e e d e d by a p p r o x i m a t e l y $ 2 2 m i l l i o n t h e v a l u e o f t h e unl i q u i d a t e d s i l v e r collateral. The Huddleston f o r w a r d p o s i t i o n t h a t had been r e l e d g e r e d i n t o Bache London h a d b e e n o f f s e t by a s h o r t f o r w a r d t r a n s a c t i o n l e a v i n g a d e f i c i t o f a p p r o x i m a t e l y $ 2 2 . 8 m i l l i o n . -/ 94 The $10 m i l l i o n d e f i c i t i n t h e Hunt a c c o u n t s a t Bache H a l s e y w a s p o t e n t i a l l y t h e most s e r i o u s p r o b l e m f o r t h e f i r m . With s i l v e r f u t u r e s c o n t r a c t s f o r 590,000 o u n c e s r e m a i n i n g o n its books, Bache H a l s e y had o n l y $10.6 m i l l i o n i n R u l e 326 c a p i t a l a b o v e t h e 7 % " e a r l y warning1' l e v e l . Charging t h e Hunt d e f i c i t s a g a i n s t t h a t amount would h a v e r e d u c e d Bache H a l s e y ' s R u l e 326 c a p i t a l to w i t h i n $500,000 o f t h e 95/ 7% t h r e s h o l d . - Although Bache H a l s e y h e l d i n Hunt a c c o u n t s

94 -/ B a c h e s o l d 8 3 4 , 3 9 9 o u n c e s o f s i l v e r t o r e t a i l c u s t o m e r s b e g i n n i n g F r i d a y , March 2 8 . U s i n g t h e B a c h e H a l s e y ret a i l n e t w o r k , Bache s e n i o r v i c e p r e s i d e n t E l l i o t S m i t h ( " S m i t h " ) and Bache H a l s e y ' s s y n d i c a t e d e p a r t m e n t conducted what Smith d e s c r i b e d as a "spot secondary d i s t r i bution" of silver. S m i t h h a d B a c h e Metals b u y a b l o c k He drafted a "spot o f s i l v e r from t h e Hunts' account. s e c o n d a r y " announcement w h i c h was d i s s e m i n a t e d o v e r t h e According t o S m i t h , Bache B a c h e H a l s e y b r a n c h wires. f i l l e d approximately 1,000 o r d e r s f o r retail s i l v e r on F r i d a y , March 2 8 c o m p a r e d w i t h o r d i n a r y r e t a i l v o l u m e o f 30-40 o r d e r s p e r d a y . According to S m i t h , Bache H a l s e y account e x e c u t i v e s were n o t requested to solicit o r d e r s from t h e i r customers f o r s i l v e r b a r s , and t h e second v e r s i o n o f t h e wire, d i s s e m i n a t e d t h e f o l l o w i n g w e e k , d i r e c t e d Bache p e r s o n n e l n o t to s o l i c i t r e t a i l o r d e r s . 95/ I t s h o u l d b e n o t e d t h a t i n a h o l d i n g company s u c h a s Bache Group i n which t h e b r o k e r - d e a l e r s u b s i d i a r y is t h e p r i n c i p a l asset, impairment o f b r o k e r - d e a l e r c a p i t a l below t h e R u l e 326 l e v e l c a n i n t r o d u c e a n e l e m e n t o f f i n a n c i a l i n stability. I f broker-dealer c a p i t a l f a l l s below t h e e a r l y warning l e v e l t h e p a r e n t can no l o n g e r upstream assets to c o v e r t h e o b l i g a t i o n s o f o t h e r s u b s i d i a r i e s t h a t may b e , a s i n t h e case o f B a c h e Metals a n d B a c h e L o n d o n , g u a r a n t e e d by t h e p a r e n t .

576,600 s h a r e s o f Bache Group s t o c k , t r a d i n g i n t h o s e s e c u r i t i e s h a d b e e n s u s p e n d e d b y t h e NYSE a n d t h e C o m m i s s i o n t h e d a y b e f o r e 96/ a n d c o u n s e l had a d v i s e d , i n a n y e v e n t , t h a t t h e s t o c k Kt b e s o l d . 96/ - S e c u r i t i e s E x c h a n g e A c t Release N o . 1 6 7 0 3 ( M a r c h 2 7 , 1 9 8 0 ) . A s d i s c u s s e d more f u l l y a t p a g e s 1 1 0 t h r o u g h 111, Bache Group i s s u e d a p r e s s r e l e a s e a t a b o u t 4:00 on F r i d a y a f t e r n o o n , March 2 8 , r e p o r t i n g t h a t "Bache1I h a d l i q u i d a t e d Hunt s i l v e r w i t h o u t a loss. T h a t r e l e a s e was o b v i o u s l y i n c o n s i s t e n t w i t h t h e f a c t s a s l a t e r acknowl e d g e d by Bache. Bache Group p e r s o n n e l i n v o l v e d i n t h e p r e p a r a t i o n o f t h e p r e s s release, however, have u n i f o r m l y t e s t i f i e d t h a t t h e y d i d n o t l e a r n o f t h e p o t e n t i a l losses d e s c r i b e d i n t h e t e x t u n t i l s o m e t i m e o v e r t h e weekend o f March 29-30. There are c i r c u m s t a n c e s t h a t s u g g e s t t h a t o t h e r B a c h e G r o u p p e r s o n n e l knew o r s h o u l d h a v e known o f t h e s e l o s s e s a t o r b e f o r e t h e t i m e o f t h e March 28 r e l e a s e .

(1) T h e b r o k e r - d e a l e r losses: ( a ) B a c h e l a t e r a t t r i b u t e d $ 5 m i l l i o n o f t h e b r o k e r - d e a l e r d e f i c i t s t o l i q-u i d a t i n g d e f i c i t s i n t h e Huddlestons' domestic account. Bache p e r s o n n e l have t e s t i f i e d t h a t t h e H u d d l e s t o n a c c o u n t s were o v e r l o o k e d i n c o m p u t i n g t h e s t a t u s o f t h e a c c o u n t s o n F r i d a y , e v e n t h o u g h (1) a s r e c e n t l y as March 1 9 , B u n k e r H u n t h a d r e n e w e d h i s o r a l g u a r a n t e e o f t h e a c c o u n t , ( 2 ) members o f m a n a g e m e n t t e s t i f i e d t h a t t h e r e were d i s c u s s i o n s o f t h e a c c o u n t a s l a t e a s March 26 among B a c h e G r o u p p e r s o n n e l r e s p o n s i b l e f o r t h e s i t u a t i o n and ( 3 ) t h e l i q u i d a t i o n s o f t h e H u d d l e s t o n d o m e s t i c ( b ) Bache a t t r i s i l v e r p o s i t i o n s b e g a n o n March 2 6 . b u t e d t h e o t h e r $ 5 m i l l i o n o f b r o k e r - d e a l e r losses t o t r a n s a c t i o n s c o s t s t h a t had t h e e f f e c t of r e d u c i n g t h e e f f e c t i v e p r i c e Bache H a l s e y r e c e i v e d on t h e l i q u i d a tions. According t o Geremia, he l e a r n e d on Saturday t h a t t h e s w i t c h e s Bache H a l s e y used t o e f f e c t l i q u i d a t i o n s o f t h e f u t u r e s a c c o u n t s were d o n e a t s p r e a d s o f cost $.675 p e r ounce below s p o t r a t h e r t h a n t h e $.275 B a c h e H a l s e y h a d e s t i m a t e d when c o m p u t i n g t h e r e s u l t s of t h e l i q u i d a t i o n on Friday. While Geremia c l a i m s it was n e c e s s a r y t o a w a i t p a p e r w o r k c o n f i r m i n g t h e t r a d e s t o l e a r n t h i s i n f o r m a t i o n , t r a d e r s from o t h e r f i r m s t e s t i f i e d t h a t t r a n s a c t i o n c o s t s a r e known i m m e d i a t e l y because t h e y are p a r t o f t h e s p r e a d on t h e s w i t c h .
Footnote continued on n e x t page.

On S u n d a y , March 3 0 , J a c o b s u r g e n t l y t e l e p h o n e d H e r b e r t Hunt a n d i n f o r m e d him o f t h e p r o b l e m , s a y i n g t h a t Bache Group needed f u n d s immediately. The n e x t d a y , P l a c i d w i r e d $17 m i l l i o n t o Bache Group f o r t h e H u n t s ' a c c o u n t s . Bache.Group a p p l i e d $10 m i l l i o n o f t h a t amount t o e l i m i n a t e t h e d e f i c i t s i n t h e Hunts' a c c o u n t s w i t h Bache Halsey and $7 m i l l i o n t o r e d u c e t h e amounts o u t s t a n d i n g on t h e s i l v e r l o a n s . Bache Halsey also l i q u i d a t e d t h e 118 c o n t r a c t s remaining i n t h e Hunt a c c o u n t s w i t h n o f u r t h e r loss. A t t h e end o f t h e d a y o n Monday, March 3 1 , t h e B a c h e Metals l o a n s r e m a i n e d u n d e r c o l l a t e r a l i z e d by a p p r o x i m a t e l y $7 m i l l i o n a n d Bache London continued t o c a r r y a n unsecured r e c e i v a b l e from A l b e r t and Mary H u d d l e s t o n t o t a l l i n g $ 2 2 . 8 m i l l i o n . B a c h e Metals s o l d t h e r e m a i n i n g s i l v e r b u l l i o n o v e r t h e n e x t month a n d o n A p r i l 8 a n d 24 r e c e i v e d a d d i t i o n a l c a s h f r o m t h e H u n t s t o t a l i n g $27.7 m i l l i o n . By A p r i l 2 9 , 1 9 8 0 , e x c e p t f o r m i n o r amounts f o r i n t e r e s t , s t o r a g e c h a r g e s and l e g a l e x p e n s e s , t h e Hunt losses had b e e n r e c o v e r e d . 2. T h e B a n k i n g P r o b l e m On March 2 7 , n e w s c o n c e r n i n g B a c h e G r o u p ' s d i f f i c u l t i e s w i t h t h e Hunts r e a c h e d t h e f i n a n c i a l community a t l a r g e . Bache H a l s e y t r e a s u r e r Langdon S t e v e n s o n and a s s i s t a n t treas u r e r Kenneth H e r r began r e c e i v i n g c a l l s from Bache H a l s e y a n d B a c h e Metals' l e n d e r s r e q u e s t i n g i n f o r m a t i o n c o n c e r n i n g t h e f i r m s ' f i n a n c i a l c o n d i t i o n o r , i n t h e case o f B a c h e Metals' b a n k s , a s k i n g f o r more s i l v e r c o l l a t e r a l t o s u p p o r t loans. T h r e e g r o u p s o f b a n k l e n d e r s were i m p o r t a n t t o t h e f i r m o n March 27 a n d t h e r e a f t e r . T h e s e were ( 1 ) B a c h e H a l s e y ' s s u b o r d i n a t e d l e n d e r s , whose l i n e s o f c r e d i t t h e b r o k e r - d e a l e r d e p e n d e d upon f o r a v a i l a b i l i t y o f s u b o r d i n a t e d d e b t should it r e q u i r e a d d i t i o n a l r e g u l a t o r y c a p i t a l ; ( 2 ) t h e

Footnote c o n t i n u e d from p r e v i o u s page. ( 2 ) The H u d d l e s t o n London losses: A g a i n , B a c h e G r o u p witnesses t e s t i f i e d t h a t they forgot about t h e Huddleston London p o s i t i o n w h i l e r e v i e w i n g t h e F i r m ' s p o s i t i o n o n Friday. ( 3 ) T h e B a c h e Metals d e f i c i t : Bache Group p e r s o n n e l t e s t i f i e d t h e y h a d n o i d e a u n t i l S u n d a y , March 3 0 , t h a t l t h e B a c h e ~ e t a l s o a n s were, a s a g r o u p , u n d e r c o l l a t e r a lized. One b a n k e r , h o w e v e r , t e s t i f i e d t h a t h e h a d b e e n s o informed by a Bache r e p r e s e n t a t i v e d u r i n g t h e d a y o n March 28. G e r e m i a , m o r e o v e r , h a d p e r s o n a l l y o r d e r e d 250 w a r e h o u s e r e c e i p t s t o b e removed from t h e c o l l a t e r a l p o o l and s o l d t h r o u g h t h e b r o k e r - d e a l e r o n March 26.

l e n d e r s t h a t p r o v i d e d Bache M e t a l s w i t h f u n d s t o a d v a n c e t o t h e Hunts a g a i n s t s i l v e r warehouse r e c e i p t s ; and ( 3 ) l e n d e r s p r o v i d i n g b r o k e r l o a n s to Bache H a l s e y s e c u r e d by c u s t o m e r marginable s e c u r i t i e s . A c t i o n s o r p o s i t i o n s t a k e n by b a n k s w i t h i n e a c h g r o u p of l e n d e r s deepened t h e crisis a t t h e f i r m o n a n d a f t e r March 27. a. Subordinated Lenders
A s o f March 2 7 , B a c h e H a l s e y h a d o u t s t a n d i n g a t o t a l o f $ 3 9 m i l l i o n i n s u b o r d i n a t e d l o a n s f r o m t h e R o y a l Bank o f Canada ("RBC") a n d f r o m a g r o u p c o m p r i s e d o f C h e m i c a l B a n k , B a n k e r s T r u s t , S e c u r i t y P a c i f i c N a t i o n a l Bank a n d T r u s t ( " S e c u r i t y P a c i f i c " ) , N o r t h e r n T r u s t Company o f C h i c a g o a n d C o n t i n e n t a l I l l i n o i s N a t i o n a l Bank a n d T r u s t Co. ( t h e "Continental Group"). C o n t i n e n t a l s e r v e d as a g e n t f o r t h e C o n t i n e n t a l Group o n t h e Bache H a l s e y s u b o r d i n a t e d c r e d i t . The b a n k s h a d made t h e s u b o r d i n a t e d l o a n s p u r s u a n t t o t e r m l o a n and r e v o l v i n g c r e d i t a g r e e m e n t s . $24 m i l l i o n remained committed b u t n o t y e t o u t s t a n d i n g under t h e t w o r e v o l v i n g l o a n a g r e e m e n t s , a s s u m i n g B a c h e H a l s e y c o u l d c e r t i f y comp l i a n c e w i t h t h e terms o f t h e c r e d i t a g r e e m e n t .

On March 2 7 , S t e v e n s o n c a l l e d F o r d P e a r s o n ( " P e a r s o n " ) , t h e C o n t i n e n t a l I l l i n o i s o f f i c e r a s s i g n e d t o Bache H a l s e y ' s a c c o u n t , a n d t o l d him o f t h e p r o b l e m i n t h e H u n t a c c o u n t s and t h e l i q u i d a t i o n s t h e n underway. Stevenson asked whether t h e s u b o r d i n a t e d l e n d e r s were w i l l i n g t o e x t e n d a d d i t i o n a l l o a n s u n d e r t h e s u b o r d i n a t e d c r e d i t . 97/ Pearson advised Stevenson n o t t o r e q u e s t a draw u n d e r t h e s u b o r d i n a t e d l o a n , but r a t h e r to hold a meeting of a l l t h e subordinated l e n d e r s t h e n e x t morning i n N e w York. 98/ On T h u r s d a y a f t e r n o o n , 97/ U n d e r t h e terms a n d c o n d i t i o n s o f t h e s u b o r d i n a t e d l o a n s , p r o v i d e d t h a t Bache m e t a l l t h e r e q u i r e m e n t s , t h e b a n k s were o b l i g a t e d t o e x t e n d t h e c r e d i t . Pearson polled t h e o t h e r s u b o r d i n a t e d l e n d e r s b e c a u s e , u n d e r t h e terms o f t h e s u b o r d i n a t e d l o a n a g r e e m e n t , t h e r e w a s room f o r d e b a t e a s t o w h e t h e r B a c h e m e t a l l t h e terms a n d c o n d i t i o n s . In p a r t i c u l a r , c e r t a i n b a n k s were c o n c e r n e d a b o u t t h e " m a t e r i a l adverse change" c l a u s e . Under t h i s c l a u s e , Bache had to w a r r a n t t h a t t h e r e w a s no m a t e r i a l a d v e r s e c h a n g e i n i t s f i n a n c i a l c o n d i t i o n b e f o r e a draw-down. G i v e n B a c h e ' s s i t u a t i o n w i t h t h e H u n t s , t h e r e was t h e p o s s i b i l i t y t h a t Bache c o u l d n o t w a r r a n t t h a t no material a d v e r s e change had o c c u r r e d , or t h a t t h e banks c o u l d challenge such a warranty i f given.

98/ P e a r s o n a d v i s e d S t e v e n s o n n o t t o r e q u e s t a d r a w b e c a u s e Nobody knew how t h e s i t u a t i o n w a s i n a state of flux. s e r i o u s t h e problem w a s , and c e r t a i n banks d i d n o t f u l l y Pearson thought Stevenson understand t h e s i t u a t i o n . h a d t o q u a n t i f y more s p e c i f i c a l l y t h e i m p a c t o f t h e problem on Bache's f i n a n c i a l c o n d i t i o n .

Stevenson told the subordinated lenders and certain of its operating banks that Bache Halsey would hold a meeting with its subordinated lenders and other key banks the next morning, Friday morning, March 28, representatives of Bache Halsey's subordinated lenders and several other banks met at Bache Group headquarters. 99/ Various Bache Group personnel made presentations concerning Bache's financial condition, 100/ the Hunt silver positions and the liquidations. - The meeting continued into the afternoon as Bache Group officials brought the bankers periodic updates on the progress of the firm's liquidation of the Hunt positions. Finally, sometime in mid-afternoon, Bache Group reported (erroneously, as it turned out) that it had completed its liquidation of the accounts with no loss to the firm. Meanwhile, Bache Group officers were quite concerned about the impact on the firm's operations of a trading suspension in Bache Group common stock entered by the Commission on March 27. The suspension by its terms was to continue until midnight on April 5, 1980, although the Commission left open the possibility that it would lift the suspension earlier

99/ -

The banks represented at the meeting were: Continental, Chemical, Security Pacific, Northern Trust, Bankers Trust, and Royal Bank of Canada, all subordinated lenders; and First Chicago, Morgan Guaranty, and Irving Trust. In addition, Morgan Guaranty officer, Tony Cutler remembers that a representative from Citizens and Southern Bank was present, although that bank is not listed as attending in the handout from the meeting. in testimony. Jacobs, Sherrill, Hogan and Geremia were the key Bache people making presentations at the meeting. Steve West, of Sullivan and Cromwell, Stevenson and others also made comments and responded to questions. Each person testifying about the meeting had a slightly different recollection as to what specifically was said and by whom. The bankers were informed about the total number of ounces of Hunt silver held by Bache; the history of the Hunt Pelationship; the fact that unmet margin calls occurred; Bache's approach to the Comex to close the market; the financial impact of the liquidation on the broker-dealer's net capital at 7% and 4%; the break-even-price for the silver liquidations; Bache's compliance with the terms of its loan agreements and the regulatory requirements of the SEC, CFTC and NYSE; Bache's difficulty in financing its daily operations; and the upsurge in retail demand for silver.

100/ - The substance of the meeting was described extensively

i f appropriate. Bache Group management p e r c e i v e d t h e s u s p e n s i o n a s h a v i n g a material a d v e r s e impact o n Bache G r o u p ' s c u s t o m e r s , i t s b a n k s and t h e f i n a n c i a l community g e n e r a l l y , a n d w a s a c c o r d i n g l y u n d e r i n t e n s e p r e s s u r e t o release i n f o r m a t i o n s u f f i c i e n t t o i n d u c e t h e Commission t o l i f t t h e s u s p e n s i o n t o p e r m i t t h e r e s u m p t i o n o f t r a d i n g o n Monday m o r n i n g . Bache G r o u p ' s g e n e r a l c o u n s e l , J o h n C u r r a n , its o u t s i d e c o u n s e l , S u l l i v a n & C r o m w e l l , and t h e f i r m ' s p u b l i c r e l a t i o n s p e r s o n n e l d r a f t e d a p r e s s release F r i d a y a f t e r n o o n t h a t "Bache" ( t h e release d i d n o t s p e c i f y w h e t h e r i t c o v e r e d a l l o f t h e Bache Group s u b s i d i a r i e s w i t h Hunt a c c o u n t s o r o n l y Bache H a l s e y ) had l i q u i d a t e d t h e Hunt p o s i t i o n s w i t h n o loss t o t h e f i r m . T h e release a l s o r e p o r t e d t h a t t h e f i r m was i n compliance w i t h a p p l i c a b l e r e g u l a t o r y r e q u i r e m e n t s and t h a t its s u b o r d i n a t e d l e n d e r s had c o n f i r m e d t h a t t h e $ 2 4 m i l l i o n committed, b u t n o t y e t o u t s t a n d i n g from its s u b o r d i n a t e d l e n d e r s , remained a v a i l a b l e . Bache Group r e g a r d e d t h e l a t t e r s t a t e m e n t as a n import a n t e x p r e s s i o n o f c o n f i d e n c e from its b a n k e r s and o n F r i d a y a f ternoon requested t h a t t h e subordinated lenders, still assembled a t Bache, a c c e d e t o t h e l a n g u a g e . The s u b o r d i n a t e d l e n d e r s m e t by t h e m s e l v e s w i t h a d r a f t o f t h e release. After t h e o f f i c e r s present telephoned t h e i r r e s p e c t i v e s u p e r i o r s f o r c l e a r a n c e , t h e y a g r e e d t o permit Dache G r o u p to i s s u e t h e statment concerning t h e continued a v a i l a b i l i t y o f subordinated capital.
A s B a c h e G r o u p m a n a g e m e n t knew a t t h e t i m e , h o w e v e r , t h e continued a v a i l a b i l i t y o f subordinated capital w a s n o t I t was b a s e d o n B a c h e G r o u p ' s r e p r e s e n t a t i o n s unqualified. t h a t (1) t h e f i r m h a d l i q u i d a t e d t h e H u n t p o s i t i o n s w i t h o u t a loss; ( 2 ) Bache H a l s e y ' s r e g u l a t o r y c a p i t a l c o n t i n u e d i n e x c e s s o f t h e " e a r l y warning" l e v e l ; and ( 3 ) t h a t Bache The l a t t e r r e p r e s e n t a t i o n , H a l s e y would n o t r e q u e s t a draw. a s R o y a l Bank o f C a n a d a o f f i c e r G o r d o n M a c I v o r c o n f i r m e d , a p p e a r s to have been a key f a c t o r i n t h e banks' d e c i s i o n . Perry Pero, an o f f i c i a l o f Northern T r u s t , also noted t h a t h i s b a n k a g r e e d t o t h e p r e s s release b a s e d o n B a c h e ' s rep r e s e n t a t i o n s t h a t it d i d n o t need a draw. The g e n e r a l c o n s e n s u s o f t h e b a n k s a s o f F r i d a y was t h a t , b a s e d o n t h e i n f o r m a t i o n p r o v i d e d by B a c h e c o u n s e l , t h e s t a t u s o f t h e f i r m was a c c e p t a b l e , t h e f u t u r e s were unwound a n d B a c h e Halsey's c a p i t a l w a s unimpaired. These f a c t o r s , coupled w i t h Bache's d e s i r e f o r a n e x p r e s s i o n o f c o n f i d e n c e from t h e banking community, c o n t r i b u t e d t o t h e b a n k s ' w i l l i n g n e s s t o a p p r o v e a press r e l e a s e .

B a c h e G r o u p o f f i c i a l s d e p o s e d by t h e s t a f f d e n y knowl e d g e t h a t t h e b a n k s a c c e d e d t o t h e p r e s s r e l e a s e b a s e d upon B a c h e ' s r e p r e s e n t a t i o n s t h a t i t would n o t r e q u e s t a d r a w . However, a c c o r d i n g t o P e r o , f o r e x a m p l e , Bache c o u n s e l "was c e r t a i n l y aware o f t h e f a c t t h a t h i s comment t h a t t h e r e would b e n o n e e d f o r a d r a w h a d a m a t e r i a l i m p a c t o n u s . " I n a d d i t i o n , a s a r e s u l t o f s t a t i n g t h a t t h e r e would b e n o d r a w , B a c h e H a l s e y d i d n o t h a v e t o make a n y s p e c i f i c r e p r e s e n t a t i o n s under t h e covenant provisions of t h e subordinated loan agreement. B a c h e H a l s e y d i d make a g e n e r a l r e p r e s e n t a t i o n , h o w e v e r , t h a t i t was n o t i n v i o l a t i o n o f k e y f i n a n c i a l covenants. P e a r s o n s t a t e d t h a t C o n t i n e n t a l would h a v e a c c e p t e d a t f a c e v a l u e a n y r e p r e s e n t a t i o n s made by Bache a s t o i t s conformity with f i n a n c i a l covenants of t h e subordinated loan. However, o t h e r b a n k s would h a v e r e q u i r e d s p e c i a l v e r i f i c a t i o n before accepting Bache's warranties. B a c h e G r o u p n e v e r t h e l e s s i s s u e d t h e p r e s s release a s d r a f t e d o n March 28. A t t h e t i m e i t w a s i s s u e d , Bache H a l s e y ' s l i q u i d a t i o n o f t h e H u n t p o s i t i o n h a d l e f t $10 m i l l i o n i n d e f i c i t s i n t h e Hunt a c c o u n t s ; 6.9 m i l l i o n o u n c e s o f Hunt s i l v e r r e m a i n e d i n B a c h e Metals a n d was w o r t h $ 2 2 m i l l i o n l e s s t h a n t h e a m o u n t B a c h e Metals owed t h e b a n k s t h a t h a d done t h e f i n a n c i n g ; and t h e Huddleston forward p o s t i o n s t h a t B a c h e H a l s e y h a d r e l e d g e r e d t o B a c h e London had l i q u i d a t e d t o a n unsecured d e f i c i t o f $23 m i l l i o n . Bache Group d i s c l o s e d s u b s t a n t i a l l y t h e f o r e g o i n g i n f o r m a t i o n t o i t s l e n d e r s o n March 3 0 a n d 3 1 a n d t h e a n n o u n c e m e n t c a u s e d c o n s t e r n a t i o n i n t h e bank g r o u p . A t a lunch meeting o n T u e s d a y , A p r i l 1, S t e v e n s o n a g a i n a s k e d P e a r s o n w h e t h e r B a c h e H a l s e y h a d a v a i l a b l e t o i t t h e $24 m i l l i o n i n undrawn c r e d i t l i n e s under t h e subordinated c r e d i t agreements, P e a r s o n t o l d S t e v e n s o n t h a t losses, p a r t i c u l a r l y a f t e r t h e f i r m h a d s o u n d e d t h e " a l l c l e a r " o n March 2 8 , made i t i n a d v i s a b l e f o r Bache H a l s e y t o r e q u e s t a draw a t t h a t t i m e . Bache H a l s e y d e t e r m i n e d n o t t o r e q u e s t a draw. b. The " S i l v e r B a n k s "
A t t h e same t i m e B a c h e G r o u p s o u g h t t o r e a s s u r e i t s s u b o r d i n a t e d l e n d e r s , t h e b a n k s l e n d i n g t o B a c h e Metals a g a i n s t t h e Hunts' s i l v e r warehouse r e c e i p t s ( " s i l v e r banks") o n March 2 7 , b e g a n c a l l i n g S t e v e n s o n and Herr r e q u e s t i n g a d d i t i o n a l collateral to maintain required r a t i o s i n t h e wake o f t h e p r i c e d e c l i n e i n s i l v e r o n March 2 5 a n d 2 6 . S t e v e n s o n a n d H e r r t o l d t h e s i l v e r b a n k s t h a t t h e r e was n o Some o f t h e b a n k s b e g a n t o r a i s e t h e p o s s i more c o l l a t e r a l . b i l i t y t h a t t h e y would c a l l f o r r e p a y m e n t o n t h e demand n o t e s

evidencing the loans. To a d d r e s s t h e p r o b l e m s , S t e v e n s o n a n d Herr s c h e d u l e d a m e e t i n g f o r t h e s i l v e r b a n k s a s a g r o u p i n B a c h e G r o u p ' s h e a d q u a r t e r s o f f i c e s o n Monday m o r n i n g , March 3 1 . Meanwhile, Bache G r o u p ' s F r i d a y p r e s s release e a s e d t h e s i t u a t i o n s o m e w h a t ; a number o f s i l v e r b a n k e r s t e s t i f i e d t h a t t h e y w e n t home o n F r i d a y e v e n i n g b e l i e v i n g t h a t t h e c r i s i s was o v e r .
A t t h e Monday m o r n i n g m e e t i n g , h o w e v e r , B a c h e G r o u p t o l d t h e s i l v e r b a n k e r s o f t h e a p p r o x i m a t e l y $50 m i l l i o n i n p o t e n t i a l losses t h a t it had d i s c o v e r e d o v e r t h e weekend.

P e a r s o n t e r m e d t h e Monday m e e t i n g a " f i a s c o , " a n d t h e testimony of o t h e r bankers corroborates the disorganized, highly emotional c h a r a c t e r o f t h e meeting. Bache's o u t s i d e c o u n s e l c h a i r e d t h e m e e t i n g f o r Bache, and s e r v e d a s t h e p r i m a r y f u n n e l o f i n f o r m a t i o n f r o m Bache t o t h e b a n k e r s . P a r t o f t h e problem a r o s e b e c a u s e Bache Group had d i s s e m i nated o p t i m i s t i c information on Friday. On Monday, w i t h news o f t h e a p p r o x i m a t e l y $ 5 0 m i l l i o n i n u n s e c u r e d d e f i c i t s , B a c h e ' s c r e d i b i l i t y w i t h t h e b a n k e r s was s e v e r e l y i m p a i r e d . I n a d d i t i o n , some o f t h e b a n k s were m e e t i n g w i t h B a c h e f o r t h e f i r s t t i m e and had t o be p r o v i d e d w i t h i n i t i a l f i n a n c i a l and t e c h n i c a l i n f o r m a t i o n . Soon a f t e r t h e m e e t i n g began, t h e banks p o l a r i z e d i n t o t w o g r o u p s : t h e "long" banks and t h e " s h o r t " banks. The "long" banks ( C i t i z e n s and S o u t h e r n , B a r c l a y s , Bankers T r u s t and F i r s t o f Oklahoma) had e x c e s s c o l l a t e r a l a t t h e c u r r e n t m a r k e t p r i c e t o l i q u i d a t e a n d p a y down t h e i r l o a n s . The o t h e r s i x " s h o r t " b a n k s , ( F i r s t o f Chicago, I r v i n g T r u s t , H a r r i s , N o r t h e r n T r u s t , M a r i n e M i d l a n d , a n d U.S. T r u s t ) h a d i n s u f f i c i e n t s i l v e r c o l l a t e r a l a t c u r r e n t m a r k e t prices t o l i q u i d a t e a n d p a y down t h e i r l o a n s . Irving T r u s t ' s repres e n t a t i v e was adamant t h r o u g h o u t m o s t o f t h e d a y i n t h e p o s i t i o n t h a t a l l t h e c o l l a t e r a l f o r a l l t h e banks be pooled, a n d t h a t p r o r a t a p a y downs b e made t o e a c h b a n k a s t h e s i l v e r was s o l d . The C i t i z e n s and S o u t h e r n r e p r e s e n t a t i v e o n t h e o t h e r hand, w a s e q u a l l y adamant i n h i s p o s i t i o n t h a t h i s As bank would n o t f o r e g o i t s f u l l y c o l l a t e r a l i z e d p o s i t i o n . t h e m e e t i n g p r o g r e s s e d , t h e C i t i z e n s and S o u t h e r n r e p r e s e n t a t i v e , speaking f o r t h e f o u r long banks, took t h e p o s i t i o n t h a t u n l e s s t h e l o n g b a n k s were p a i d t h a t d a y , t h e y w o u l d s e l l t h e i r c o l l a t e r a l i n s a l e s a t below m a r k e t p r i c e s . In f a c t , C i t i z e n s and S o u t h e r n had a r r a n g e d a p r i v a t e s a l e o f t h e b a n k ' s c o l l a t e r a l which c o u l d have been e x e c u t e d t h e n e x t day. T h e p r o b l e m s were f u r t h e r compounded by t h e f a c t t h a t Bache Group had a l r e a d y s o l d a s u b s t a n t i a l amount o f t h e banks' s i l v e r c o l l a t e r a l . B e g i n n i n g Monday, B a c h e h a d t o make d e l i v e r y o f t h e s i l v e r i n o r d e r t o e f f e c t t h e s e s a l e s .

C e r t a i n b a n k s , s u c h a s I r v i n g T r u s t , were u n w i l l i n g t o r e l e a s e t h e warehouse r e c e i p t s i n t h e i r p o s s e s s i o n t o e n a b l e Bache H a l s e y t o make d e l i v e r y o n t h e s t r e e t . - Bache G r o u p a s 101/ d e t e r m i n a t i o n t o a p p l y $10 m i l l i o n o f P l a c i d O i l ' s payment t o Bache H a l s e y c r e a t e d f u r t h e r c o n f l i c t b e c a u s e some o f t h e b a n k e r s w a n t e d t h e e n t i r e $17 m i l l i o n t o r e d u c e t h e s i l v e r loans outstanding. According t o F i r s t Chicago r e p r e s e n t a t i v e R o b e r t Yohanan ( " Y o h a n a n " ) , h e s u g g e s t e d t h a t Bache H a l s e y d r a w down t h e r e m a i n i n g s u b o r d i n a t e d money a v a i l a b l e t o i t , t h e n l e n d t h e p r o c e e d s t o Bache M e t a l s , e n a b l i n g i t t o p a y down t h e s i l v e r b a n k s . Yohanan t e s t i f i e d t h a t Bache c o u n s e l t o l d him t h a t Bache H a l s e y was n o t c e r t a i n t h e s u b o r d i n a t e d money was a v a i l a b l e t o i t . The d i s p u t e s among t h e l o n g a n d s h o r t b a n k s c o n t i n u e d u n t i l s h o r t l y a f t e r m i d n i g h t o n A p r i l 1, when t h e s h o r t b a n k s a g r e e d t o buy o u t t h e l o n g b a n k s , p o o l t h e s i l v e r c o l l a t e r a l and r e f i n a n c e t h e l o a n . Bache Metals p l e d g e d additional c o l l a t e r a l i n connection with the refinancing c o m p r i s e d o f 6 , 0 0 0 o u n c e s o f g o l d , t h e e q u i t y i n Bache M e t a l s ' s h o r t h e d g e p o s i t i o n i n t h e f u t u r e s m a r k e t s maint a i n e d i n a c c o u n t s w i t h Bache H a l s e y , Bache G r o u p ' s s t o c k i n i t s A l b e r t B e n d e r i n s u r a n c e s u b s i d i a r y and t h e H u n t s ' h o l d i n g s o f Bache Group s t o c k . - The o u t l i n e s o f t h e a g r e e m e n t 102/ were embodied i n a h a n d w r i t t e n document e x e c u t e d d u r i n g t h e e a r l y m o r n i n g h o u r s o f A p r i l 1. Bache M e t a l s t h e r e a f t e r r e p a i d t h e r e f i n a n c e d o b l i g a t i o n s t h e n e x t month o u t o f t h e proceeds of t h e l i q u i d a t i o n of t h e remaining s i l v e r b u l l i o n .

c. Bache H a l s e v ' s " L i n e Banks"

The c r i s i s i n c o n f i d e n c e a r i s i n g from t h e e v e n t s o f t h e s i l v e r c r i s i s and Bache G r o u p ' s d i f f i c u l t i e s w i t h t h e s i l v e r bank and s u b o r d i n a t e d l e n d e r s had a n i m p a c t , a s w e l l , o n t h e b a n k i n g r e l a t i o n s h i p s which were i n t e g r a l t o Bache H a l s e y ' s ordinary operations. 1 0 1 / The p r o b l e m was s o l v e d i n t w o ways. S e v e r a l banks volunt e e r e d warehouse r e c e i p t s f o r t h e d e l i v e r y . In addition, S t a n l e y S h i r k , c h a i r m a n o f Bache G r o u p ' s a u d i t committee, phoned t h e p r e s i d e n t o f I r v i n g T r u s t and c o n v i n c e d him t o d i r e c t t h e bank t o r e l e a s e t h e w a r e h o u s e r e c e i p t s f o r delivery. 102/ - On March 3 1 , Bache M e t a l s ' e q u i t y i n i t s f u t u r e s a c c o u n t s w i t h Bache H a l s e y was $ 2 0 . 1 m i l l i o n . Bache a t t o r n e y s h a v e a d v i s e d t h e s t a f f t h a t C o n t i n e n t a l , which had l o a n s o u t s t a n d i n g t o Bache M e t a l s a g a i n s t i t s hedged s i l v e r i n v e n t o r y , u n d e r s t o o d t h a t Bache M e t a l s was p l e d g i n g t h e e q u i t y i n t h e s h o r t f u t u r e s p o s i t i o n h e d g i n g t h e i n v e n t o r y coll a t e r a l and d i d n o t o b j e c t .

B e g i n n i n g o n T h u r s d a y , March 2 7 , t h e b r o k e r - d e a l e r b e g a n t o e x p e r i e n c e o b s t a c l e s t o a r r a n g i n g f i n a n c i n g and c o n d u c t i n g i t s r o u t i n e o p e r a t i o n s . 103/ These problems c r e a t e d abnormally Accorh i g h borrowing needs which c o n t i n u e d w e l l i n t o A p r i l . d i n g to Herr, Bache H a l s e y borrowing i n c r e a s e d from a p p r o x i m a t e l y $100 m i l l i o n t o a p p r o x i m a t e l y $600 m i l l i o n i n t h r e e days. Rache B a l s e y ' s c a s h f l o w p r o b l e m s had s e v e r a l c a u s e s . F i r s t , B a c h e H a l s e y w a s r e q u i r e d t o w i r e f u n d s t o t h e commod i t y c l e a r i n g h o u s e s w i t h o u t r e c e i v i n g f u n d s from t h e Hunts. I t b o r r o w e d f r o m l i n e b a n k s t o d o so. Second, banks c u t o f f t h e " i n t e r e s t e q u i v a l e n t programs" n o r m a l l y a v a i l a b l e t o Bache H a l s e y . The " i n t e r e s t e q u i v a l e n t program" i s a c o m p l i c a t e d c a s h management t e c h n i q u e t h a t c e r t a i n broker-dealers use, a t a very l o w i n t e r e s t rate, to o b t a i n a n amount o f f u n d s e q u i v a l e n t t o t h a t i n t h e i r commod i t y c u s t o m e r s e g r e g a t e d f u n d s a c c o u n t s . Under CFTC r e g u l a t i o n s , a b r o k e r - d e a l e r must m a i n t a i n c u s t o m e r s ' commodity The b r o k e r h a s t w o c h o i c e s funds i n a segregated account. as t o t h e use o f t h e s e g r e g a t e d funds: e i t h e r i n v e s t i n T - b i l l s and e a r n i n t e r e s t on t h e f u n d s or l e a v e t h e f u n d s on d e p o s i t w i t h a bank i n a s e g r e g a t e d a c c o u n t p e r m i t t i n g t h e b r o k e r t o withdraw f e d e r a l f u n d s from a n o t h e r account o f In t h e bank i n a n amount e q u a l t o t h e s e g r e g a t e d a c c o u n t . t h e l a t t e r i n s t a n c e , t h e bank h a s n o r i g h t o f o f f s e t a g a i n s t t h e segregated account. T h i s system, also c a l l e d " i n t e r e s t o f f s e t 1 ' , or l ' u n c o l l e c t i n g " , p e r m i t s a b r o k e r - d e a l e r t o have a n o p e n i n g c a s h f l o w o f f e d e r a l f u n d s good i m m e d i a t e l y . The b r o k e r - d e a l e r t h e n c o v e r s t h e f e d e r a l f u n d w i t h d r a w a l w i t h a c l e a r i n g h o u s e c h e c k , good t h e n e x t d a y . The bank h a s a c r e d i t r i s k i n t h e i n t e r i m s i n c e it h a s no r i g h t t o o f f s e t a g a i n s t t h e segregated account. B o r r o w i n g money f o r d a i l y c a s h flow, as opposed t o u s i n g t h e i n t e r e s t e q u i v a l e n t program, is e x p e n s i v e ; Bache H a l s e y p a i d o n l y 1/4% o n a n annualized b a s i s f o r funds it used i n t h e i n t e r e s t e q u i v a l e n t program, whereas it p a i d t h e b r o k e r l o a n rate, a t t h a t t i m e approximately 15%, f o r o r d i n a r y borrowing. A s banks withdrew Bache H a l s e y ' s " i n t e r e s t e q u i v a l e n t program" p r i v i l e g e s , t h e f i r m had t o r e p l a c e t h e f u n d s it had p r e v i o u s l y o b t a i n e d w i t h new b o r r o w i n g i n a n a m o u n t e q u i v a l e n t t o i t s s e g r e g a t e d funds account. 104/ 103/ H e r r d e s c r i b e d t h e s i t u a t i o n a t Bache H a l s e y on T h u r s d a y

as h a v i n g t h e day-to-day o p e r a t i o n s o f t h e t r e a s u r e r ' s d e p a r t m e n t " s e v e r e l y impaired" d u e to t h e rumors s p r e a d i n g i n t h e f i n a n c i a l community.

Chemical Bank, Chase Manhattan and Bankers T r u s t canc e l l e d or c u r t a i l e d t h e i n t e r e s t e q u i v a l e n t program as o f March 2 7 . Morgan G u a r a n t y , C i t i b a n k a n d M a r i n e Midland p e r m i t t e d Bache t o c o n t i n u e t h e i n t e r e s t e q u i v a l e n t program.

104/ -

I n a d d i t i o n , commodities exchanges' c l e a r i n g organizations requested additional cash deposits. The C h i c a g o Board o f T r a d e C l e a r i n g C o r p o r a t i o n r e q u e s t e d a $40 m i l l i o n " s p e c i a l m a r g i n " d e p o s i t o n March 2 6 , w h i c h i t r e d u c e d t o $ 2 0 m i l l i o n o n March 2 7 . B a c h e H a l s e y was r e q u i r e d t o m a i n t a i n t h e s p e c i a l m a r g i n o n d e p o s i t w i t h CBT a t l e a s t t h r o u g h A p r i l 3. Meanwhile, as Bache H a l s e y ' s borrowing n e e d s i n c r e a s e d , c e r t a i n of its r e g u l a r l e n d e r s suspended o r r e s t r i c t e d its borrowing p r i v i l e g e s . Two b a n k s , C r e d i t I t a l i a n o a n d C r e d i t L y o n n a i s , demanded r e p a y m e n t o f t h e i r l o a n s . Other banks r e q u i r e d Bache H a l s e y to s e c u r e l e t t e r s o f c r e d i t , c e r t i f i e d c h e c k s , f o r e i g n exchange l i n e s and agreement t o p l e d g e f a c i l i t i e s , requiring t h e physical deposit o f collateral ( i . e . , s t o c k c e r t i f i c a t e s ) w i t h t h e D e p o s i t o r y T r u s t Company or t h e bank i t s e l f . The n e e d t o s e c u r e a l l i t s b a n k l i n e s s t r a i n e d Bache's normal o p e r a t i n g procedures; and, i r o n i c a l l y , f u r t h e r increased its borrowing requirements. Bache H a l s e y f o u n d i t s e l f i n a " C a t c h - 2 2 " s i t u a t i o n . A s Herr e x p l a i n e d :
W e found o u r s e l v e s i n a s i t u a t i o n a s k i n g a bank to r e l e a s e c o l l a t e r a l t o u s so t h a t w e c o u l d i n t u r n make a d e l i v e r y on t h e s t r e e t and g e t p a i d and i n t u r n p a y t h e l o a n down. The b a n k s w e r e n o t r e l e a s i n g t h e c o l l a t e r a l t o u s u n l e s s t h e y g o t a l o a n p a y down p r i o r t o t h e i r r e l e a s i n g t h e collateral or t h e y g o t collateral t h a t they could r e a d i l y s u b s t i t u t e .

I n s h o r t , Bache H a l s e y c o u l d n o t g e t p a i d f o r s t o c k w i t h o u t presenting t h e stock; it could not present t h e stock without p a y i n g f o r i t s release. A s a s o l u t i o n , Bache g r e a t l y i n c r e a s e d its s t o c k loan a c t i v i t y . Herr c o n t i n u e d : So as a r e s u l t I was f o r c e d t o u s e e v e r y b i t o f c o l l a t e r a l t h a t B a c h e h a d -- t h e c o l l a t e r a l m a i n l y c u s t o m e r m a r g i n a b l e s e c u r i t i e s -- t o being b o r r o w e v e r y d o l l a r I c o u l d g e t my h a n d s o n t o meet o u r day to day c a s h f l o w s . 105/

...

Herr d e s c r i b e d t h a t h e h a d b o r r o w e d a g a i n s t a l l c o l l a t e r a l b l o c k s o f $ 1 0 0 , 0 0 0 o r more a n d h a d b e g u n t o p l e d g e s m a l l e r b l o c k s t h a t Bache o r d i n a r i l y would n o t u s e b e c a u s e o f depository charges. Bache a l s o had a l o g i s t i c a l problem i n moving l a r g e b l o c k s o f c o l l a t e r a l t o s e c u r e t h e v a r i o u s bank

105/ -

The Commission s t a f f t e s t e d Bache H a l s e y ' s c o n t r o l and possession of customers' fully-paid-for securities. The s t a f f c o n c l u d e d t h a t Bache H a l s e y d i d n o t p l e d g e c u s t o m e r s ' f u l l y - p a i d - f o r s e c u r i t i e s and a b i d e d by t h e r e q u i r e m e n t s c o n c e r n i n g t h e i r c o n t r o l and p o s s e s s i o n .

i n s t r u m e n t s . - A t t h e p e a k , Bache used $1.1 b i l l i o n i n 106/ Bache's borc o l l a t e r a l t o s u p p o r t $600 m i l l i o n i n l o a n s . rowings remained abnormally h i g h u n t i l t h e end o f A p r i l 1980. Another consequence of using customer marginable securities t o c o l l a t e r a l i z e bank f a c i l i t i e s , a c c o r d i n g t o H e r r , w a s t h a t it increased Bache's r e s e r v e s required pursuant t o SEC R u l e 1 5 c 3 - 3 , w h i c h e v e n t u a l l y r e a c h e d $ 1 2 0 m i l l i o n . Bache H a l s e y had t o borrow t h e f u n d s t o p u t i n t h e a c c o u n t , thereby f u r t h e r i n c r e a s i n g its c r e d i t requirements. Bache found i t s e l f i n a n o t h e r " C a t c h 22" i n r e l a t i o n t o its c u s tomer r e s e r v e f o r m u l a : o n c e i t b o r r o w e d money f o r i t s c u s tomer r e s e r v e , t h e s e b o r r o w i n g s became " c u s t o m e r l o a n s " a n d were c a l c u l a t e d i n t o t h e r e s e r v e f o r m u l a . 1 0 7 /
VI.

AFTER THE CRISIS

Following t h e l i q u i d a t i o n o f t h e Hunts' p o s i t i o n s , B a c h e G r o u p moved (1) t o e x a m i n e how t h e s i l v e r c r i s i s h a d a r i s e n t o determine what, i f any, p r o p h y l a c t i c measures it s h o u l d c o n s i d e r and ( 2 ) t o r e b u i l d t h e con i d e n c e o f t h e b a n k i n g community i n Bache Group. T h e s e m e a s u r e s f a l l i n three categories. F i r s t , Bache Group d i r e c t e d t h e a u d i t committee o f i t s b o a r d , c o n s i s t i n g o f t h r e e non-management d i r e c t o r s , t o review e v e n t s b e f o r e and d u r i n g t h e s i l v e r c r i s i s . C e r t a i n a u d i t committee f i n d i n g s h a v e b e e n n o t e d e l s e w h e r e i n t h i s report. S e c o n d , Bache G r o u p ' s e x e c u t i v e committee i m p l e m e n t e d c h a n g e s i n t h e f i r m ' s c o m m o d i t y cred i t p e r s o n n e l and procedures. F i n a l l y , Stevenson arranged m e e t i n g s w i t h Bache H a l s e y ' s s u b o r d i n a t e d l e n d e r s and o t h e r b a n k e r s t o report o n t h e crisis and t h e s t e p s t a k e n by Bache Group t o a v o i d a r e p e t i t i o n .
A.

The A u d i t C o m m i t t e e R e ~ o r t

On J u n e 1 2 , 1 9 8 0 , t h e a u d i t committee o f B a c h e G r o u p ' s board o f d i r e c t o r s completed its review o f Hunt-related a c t i v i t i e s a t t h e company f r o m A u g u s t 1, 1 9 7 9 , t h r o u g h A u g u s t 1 0 , 1 9 8 0 . The committee w a s c h a r g e d w i t h e v a l u a t i n g w h e t h e r

106/ - O f f i c i a l s i n B a c h e ' s c a s h management o f f i c e are informed d a i l y a s t o t h e amount o f c o l l a t e r a l , b o t h c u s t o m e r and f i r m , a n d w h a t t h e b o r r o w i n g c a p a c i t y is w i t h t h a t collateral. 107/ Whereas unsecured l o a n s are n o t c a l c u l a t e d i n t h e f o r m u l a , l o a n s s e c u r e d by c u s t o m e r m a r g i n a b l e s e c u r i t i e s a r e c o m puted i n t h e formula under "customer loans." Therefore, B a c h e i n c r e a s e d i t s r e s e r v e u n d e r t h e f o r m u l a t o correspond t o t h e i n c r e a s e d a m o u n t o f c u s t o m e r l o a n s .

Bache Group's "procedures and controls" were "adequate", whether "established procedures [had been] followed," and whether there were "evidences [sic] of conflicts of interest influencing the judgment of key personnel." The following are the principal findings of the committee. 1. Concerning Bache Halsey's Accepting Silver in Lieu of Margin The audit committee concluded that by accepting silver bullion in lieu of margin from March 17 through March 25, Bache Group management in the Hunt situation overrode Bache Halsey's established internal procedures regarding satisfaction of variation margin requirements and sellout procedures, but did so to "shore up" Bache Halsey's collateral position pursuant to a "business judgment" based on "its own prior experience, that the Hunts would obtain and remit cash or additional collateral, and its desire to be within legal bounds."
2. Concerning the March 28 Press Release

The Committee stated that the March 28 press release "served little purpose in its timing, was premature and erroneous as to its facts and therefore must be deemed ill-advised."
3. Concernina the Credit Decision

The Committee noted: (1) The Hunt credit files "contained very little information of significance" and such a situation "is not unusual in the case of a nonpublic client." (2) "The Audit Committee could find no evidence that the [executive committee] had real knowledge of the Hunt commodities silver activities worldwide so that it could assess total Hunt exposure."
(3) The basis for the executive committee's decisions to increase the Hunts' trading limits were (a) beliefs concerning the magnitude of the Hunts' resources, (b) that the Hunts had never missed a margin call, (c) that the silver market was very liquid, (dl that warehouse receipt financing was more secure than carrying futures positions, (el that Comex margin requirements were high enough to protect the firm, and (1 that all Hunt accounts activities were in fact "secured" financing~.

4. C o n c e r n i n g t h e H u d d l e s t o n A c c o u n-ts T h e H u d d l e s t o n s ' t r a d i n g , a c c o r d i n g t o t h e Committee, r e p r e s e n t e d a " c l a s s i c pyramiding s i t u a t i o n " c o n c e r n i n g which Bache Group had n o w r i t t e n p o l i c y . 5. Concerning Whether t h e Hunts had Received P r e f e r e n t i a l Treatment as a R e s u l t of T h e i r Bache Group S t o c k Ownership (1) "Although i t is n o t p r a c t i c a l to determine t h e s u b c o n s c i o u s b i a s o f p e o p l e ' s minds and t h e e f f e c t t h a t s u c h b i a s m i g h t h a v e had o n close d e c i s i o n s , i t is q u i t e c l e a r f r o m t h e r e c o r d s o f [ B a c h e G r o u p l t h a t t h e Hunts' ownership of a s i g n i f i c a n t block of t h e s t o c k o f [Bache Groupl d i d n o t r e s u l t i n t h e i r h a v i n g r e c e i v e d p r e f e r e n t i a l t r e a t m e n t i n s u c h t a n g i b l e areas a s c o m m i s s i o n s , h o u s e m a r g i n s ( b o t h i n i t i a l a n d wareh o u s e ) and i n t e r e s t rates." 108/

...

( 2 ) "With r e s p e c t t o i n t a n g i b l e aspects s u c h as management's a c c e p t a n c e o f s i l v e r pending r e c e i p t o f c a s h to m e e t house margin c a l l s and t h e t i m e o f t h e o v e r a l l l i q u i d a t i o n , t h e a u d i t committee h a s n o r e a s o n to b e l i e v e t h e s e a c t i o n s were i n f l u e n c e d by c o n f l i c t o f interest considerations. However, b e c a u s e t h e s u b t l e t y o f t h e matters d i s c u s s e d f a l l s i n t o t h e s u b c o n s c i o u s b i a s c a t e g o r y , which is d i f f i c u l t t o d e l i n e a t e a s t o o c c u r r e n c e , i n t h e a b s e n c e o f e v i d e n t i a r y matter t h e a u d i t committee i s u n a b l e t o r e a c h a f i n a l d e t e r m i nation." 1087 T h e a u d i t committee c i t e s a s e v i d e n c e f o r n o n - p r e f e r e n t i a l t r e a t m e n t t h a t ( 1 ) t h e H u n t s were r e q u i r e d t o p o s t " h o u s e " o r i g i n a l m a r g i n s , r a t h e r t h a n e x c h a n g e minimum m a r g i n , t o s u p p o r t t h e i r s i l v e r f u t u r e s p o s i t i o n s ; ( 2 ) t h e H u n t s were c a l l e d f o r v a r i a t i o n margin a f t e r a 10% impairment o f orig i n a l m a r g i n , r a t h e r t h a n t h e 25% p e r m i t t e d by e x c h a n g e s ; ( 3 ) t h e s i l v e r l o a n s were p r o f i t a b l e f o r B a c h e ; ( 4 ) B a c h e l i q u i d a t e d t h e Hunt a c c o u n t s i m m e d i a t e l y a f t e r l e a r n i n g , o n M a r c h 2 5 , t h a t t h e H u n t s h a d n o more c a s h o r b u l l i o n ; a n d ( 5 ) t h e e x e c u t i v e committee's d e c i s i o n c o n c e r n i n g t h e i n c r e a s e from 5,000 t o 7,500 c o n t r a c t s i n t h e Hunts' f u t u r e t r a d i n g l i n e occurred b e f o r e t h e Hunts began buying Bache Group s t o c k . T h e a u d i t committee d i d n o t , h o w e v e r , r e f e r t o t h e f a c t t h a t w i t h i n a week o f J a c o b s ' s u c c e s s f u l t r i p t o Dallas t o s o l i c i t t h e H u n t s ' " w h i t e k n i g h t " Bache G r o u p s t o c k p u r c h a s e s , t h e e x e c u t i v e committee a p p r o v e d d o u b l i n g t h e H u n t s ' B a c h e Metals l o a n s f r o m $ 4 0 m i l l i o n t o $80 m i l l i o n a g a i n s t $110 m i l l i o n i n warehouse r e c e i p t s . The a d d i t i o n a l l o a n was n o t advanced t h a t month b e c a u s e t h e Hunts a d v i s e d t h e y d i d n o t r e q u i r e t h e a d d i t i o n a l financing.

B. Changes in Commodity Credit Procedures Since the silver crisis, Bache Group has changed its commodity credit procedures. It has consolidated its credit analysis into a single department reporting to Stevenson as principal credit officer. The commodities and securities credit committees also report to Stevenson. The firm also expanded membership on the commodity credit committee to include additional non-commodities personnel. Mattey is no longer on the committee. The firm has established a pclicy which prohibits lending, to any one client or group of related clients, funds in excess of 15% of Bache Group's total equity capital in a commodities account, or 20% of equity capital in a securities account with a diversified portfolio. The new policy also limits to 15% of equity capital the amount of financing Bache will extend against a single commodity. Finally, the firm's aggregate customer overall margin positions in a single security may not exceed 10% of the outstanding shares of that security; and, in a single commodity, no more than 20% of the open interest. VII. DISCLOSURE OF EVENTS Prior to the silver crisis, Bache Group did not disclose or acknowledge in any annual, periodic or interim report filed with the Commission or disseminated to the public, or in any press release, the existence or magnitude of the Hunts' physical or future silver positions with its Bache Halsey and Bache Metals subsidiaries, nor did Bache Halsey make known to the Commission or the NYSE, in its annual, quarterly or monthly FOCUS reports or otherwise, the existence or magnitude of the Hunts' future and forward silver positions with the firm. The first public disclosure or acknowledgement of the existence of the Hunt positions occurred in an announcement on March 27, 1980. Bache Group later elaborated on the announcement in a series of press releases during and after the crisis period, a letter to customers late in April, a newspaper advertisement, in annual, periodic and interim reports pursuant to the Exchange Act and in Securities Act registration statements and the accompanying prospectuses filed pursuant to the Securities Act. A. Crisis Period Press Announcements 1. The March 27 Announcement On March 27, responding to widespread rumors concerning the Hunts' failure to meet Bache Halsey margin calls, Bache Group announced shortly after the Commission suspended trading in its stock that "the abrupt decline in the silver market has resulted in substantial margin calls to certain customers

o f i t s wholly-owned s u b s i d i a r y , [Bache H a l s e y ] , which t h e c u s t o m e r s h a v e f a i l e d t o meet a n d may b e u n a b l e t o meet. " T h e a n n o u n c e m e n t d i d n o t i d e n t i f y t h e H u n t s by name. Conc e r n i n g B a c h e ' s f i n a n c i a l c o n d i t i o n , t h e announcement s t a t e d :
A continuing d e c l i n e i n t h e s i l v e r markets could have

a n e g a t i v e impact on Bache's f i n a n c i a l p o s i t i o n .
In f a c t , a t the t i m e t h e release w a s issued, the s i l v e r m a r k e t d e c l i n e had a l r e a d y produced unsecured d e b i t b a l a n c e s i n t h e H u n t s ' a c c o u n t s w i t h B a c h e H a l s e y , B a c h e Metals a n d B a c h e London t h a t were q u i t e s u b s t a n t i a l i n r e l a t i o n t o b o t h Bache G r o u p ' s r e p o r t e d n e t w o r t h and what it u l t i m a t e l y r e p o r t e d as its e a r n i n g f o r t h e t h i r d q u a r t e r o f f i s c a l 1980. 2 . T h e March 2 8 P r e s s R e l e a s e
On t h e a f t e r n o o n o f March 2 8 , B a c h e G r o u p i s s u e d a p r e s s r e l e a s e r e p o r t i n g t h a t Bache H a l s e y t h a t d a y "completed l i q u i d a t i o n o n t h e Comex o f a l l o f t h e s i l v e r c o m m o d i t y f u t u r e s c o n t r a c t s it h e l d f o r t h e Hunt a c c o u n t s , and t h a t "Bache had p r e v i o u s l y completed l i q u i d a t i o n o f a l l o f t h e s i l v e r b u l l i o n it h e l d as collateral f o r t h e Hunt f u t u r e s i t now owned m o d e s t a m o u n t s o f b o u i l l o n a c c o u n t s and [sic]." T h e release w e n t o n t o s t a t e t h a t " [ t l h e l i q u i d a t i o n d i d n o t r e s u l t i n a n y l o s s t o Bathe," t h a t i t s " c a p i t a l p o s i t i o n r e m a i n s u n i m p a i r e d " a n d t h a t " i t c o m p l i e s i n a l l respects with the rules of the regulatory authorities." The F r i d a y release d i d n o t m e n t i o n , and Bache Group d i d n o t d i s c l o s e a t t h a t t i m e , B a c h e Metals' $ 2 3 3 m i l l i o n l o a n t o t h e H u n t s , o r t h a t B a c h e Metals a n d B a c h e G r o u p ' s c o r r e s p o n d i n g o b l i g a t i o n t o t h e s i l v e r b a n k s w a s u n d e r c o l l a t e r a l i z e d by what its c a l c u l a t i o n s i n d i c a t e d w a s a p p r o x i m a t e l y $17 m i l l i o n .

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The s t a t e m e n t i n t h e r e l e a s e t h a t t h e l i q u i d a t i o n had o c c u r r e d w i t h o u t loss t o Bache is e r r o n e o u s , e v e n assuming t h a t t h e "Bache" t o w h i c h t h e release r e f e r s is Bache H a l s e y a l o n e a n d d i d n o t i n c l u d e B a c h e Metals o r B a c h e London ( w h e r e t h e Huddleston a c c o u n t s had by t h i s t i m e been l i q u i d a t e d to a d e f i c i t o f approximately $23 m i l l i o n ) . I n f a c t , as o f t h e c l o s e o n March 2 8 , a c c o r d i n g t o B a c h e ' s l a t e r r e p o r t s , t h e r e were $ 1 0 m i l l i o n i n u n s e c u r e d d e b i t b a l a n c e s i n t h e b r o k e r dealer. A s d e s c r i b e d e a r l i e r i n t h i s r e p o r t , Bache H a l s e y o f f i c i a l s t e s t i f i e d t h a t t h e y o v e r l o o k e d $5 m i l l i o n i n d e f i c i t s i n t h e Huddlestons' domestic f u t u r e s account t h a t F r i d a y a n d were o t h e r w i s e u n a w a r e o f $ 5 m i l l i o n i n d e f i c i t s i n t h e o t h e r Hunt a c c o u n t s .

T h e March 28 r e l e a s e a l s o s t a t e d t h a t B a c h e H a l s e y ' s s u b o r d i n a t e d l e n d e r s had " c o n f i r m e d t h a t $24 m i l l i o n o f p r e e x i s t i n g subordinated stand-by loan arrangements remain a v a i l a b l e t o b e d r a w n b y B a c h e o n demand." The r e l e a s e d i d n o t d i s c l o s e t h a t t h e s u b o r d i n a t e d l e n d i n g banks had acquiesced i n t h e appearance of t h e foregoing statement i n March 28 r e l e a s e o n l y a f t e r B a c h e H a l s e y o f f i c i a l s t o l d them t h e f i r m d i d n o t i n t e n d t o s e e k a draw o n t h e s u b o r d i nated line. 3 . T h e March 3 1 R e l e a s e s
A s d e s c r i b e d i n n o t e 9 6 , o v e r t h e weekend o f March 29-30 B a c h e G r o u p d i s c o v e r e d $ 1 0 m i l l i o n i n u n s e c u r e d d e f i c i t s i n t h e Hunt a c c o u n t s w i t h Bache H a l s e y , $ 2 3 m i l l i o n i n t h e H u d d l e s t o n s ' a c c o u n t w i t h B a c h e London a n d w h a t i t computed t o be $17 m i l l i o n i n d e b t s t o t h e s i l v e r banks i n e x c e s s o f t h e r e m a i n i n g c o l l a t e r a l . - On Monday m o r n i n g , 109/ March 3 1 , B a c h e G r o u p i s s u e d a n o t h e r p r e s s r e l e a s e c o n c e r n i n g t h e Hunt s i t u a t i o n . W i t h o u t a l l u d i n g t o t h e March 2 8 r e l e a s e , t h e March 3 1 d o c u m e n t b e g a n :

Bache Group I n c . s a i d t o d a y t h a t t h e capital p o s i t i o n o f i t s b r o k e r a g e s u b s i d i a r y , Bache H a l s e y S t u a r t S h i e l d s Incorporated, remains i n complete compliance with t h e r u l e s of a l l regulatory a g e n c i e s d e s p i t e a p o t e n t i a l loss o f $10 m i l l i o n i n t h e Hunt a c c o u n t s . Bache s a i d t h a t t h i s p o t e n t i a l l o s s is p a r t i a l l y s e c u r e d by 5 6 0 , 0 0 0 s h a r e s o f B a c h e G r o u p I n c . s t o c k , t h a t t h e f i r m is c o n d u c t i n g b u s i n e s s i n t h e u s u a l manner, and t h a t i t h a s e x c e s s c a p i t a l o v e r a n d a b o v e t h e N e w York S t o c k Exchange 7% formula. The r e l e a s e a l s o r e c o u n t e d t h a t " B a c h e is i n t h e p r o c e s s o f [Bache M e t a l s ] verifying figures particularly those of a n d [ B a c h e Londonl ," a n d s t a t e d t h a t " [ t l h e r e now a p p e a r s t o b e a p p r o x i m a t e l y $ 4 0 m i l l i o n i n p o t e n t i a l losses i n H u n t family accounts maintained i n these subsidiaries." Bache Group s t a t e d i n its r e l e a s e t h a t its p r e - t a x e a r n i n g s f o r t h e s e v e n m o n t h s e n d e d F e b r u a r y 2 9 , 1 9 8 0 , were $ 3 5 . 4 m i l l i o n . T h e r e l e a s e a l s o s t a t e d t h a t " a n y l o s s s u s t a i n e d by [ B a c h e Metals] o r [ B a c h e Londonl w i l l n o t i n a n y way a f f e c t [ B a c h e H a l s e y ' s ] a b i l i t y t o c o n t i n u e to conduct b u s i n e s s and s e r v i c e t o its c l i e n t s . "

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109/ - I n l e t t e r s t o t h e C o m m i s s i o n s t a f f d a t e d March 3 0 a n d 3 1 , 1 9 8 0 , Bache Group d e s c r i b e d t h e c i r c u m s t a n c e s s u r r o u n d i n g discovery of these losses. The s t a f f ' s c o n t a c t w i t h Bache and o t h e r b r o k e r - d e a l e r s d u r i n g t h e crisis h a s been amply d i s c u s s e d i n i t s c o n t r i b u t i o n t o t h e CFTC r e p o r t a n d n e e d n o t be repeated here.

L a t e r t h a t d a y , a f t e r P l a c i d O i l p a i d Bache Group $17 m i l l i o n toward s a t i s f a c t i o n o f t h e H u n t s ' o b l i g a t i o n s , Bache Group announced r e c e i p t o f "$17 m i l l i o n from t h e Hunts f o r c r e d i t t o t h e i r a c c o u n t s , " and s t a t e d t h a t $10 m i l l i o n o f t h e s e f u n d s would b e a p p l i e d t o t h e H u n t s ' a c c o u n t s w i t h B a c h e H a l s e y w h i l e t h e r e m a i n i n g $ 7 m i l l i o n were t o h e a p p l i e d "to accounts of o t h e r non-broker-dealer s u b s i d i a r i e s . " N e i t h e r o f t h e March 3 1 r e l e a s e s d i s c l o s e d t h e e x i s t e n c e o r e x t e n t o f B a c h e Metals' l o a n t o t h e H u n t s o r t h a t B a c h e Metals h a d b o r r o w e d a n e q u i v a l e n t a m o u n t f r o m b a n k s t o f u n d t h e Hunt l o a n . The r e l e a s e s d i d n o t d i s c l o s e t h a t B a c h e M e t a l s ' b o r r o w i n g f r o m b a n k s w a s o n a demand b a s i s , t h a t c e r t a i n b a n k s had s o u g h t a d d i t i o n a l s i l v e r c o l l a t e r a l o r r e p a y m e n t and had b e e n a d v i s e d t h a t Bache Group w a s u n a b l e t o supply i t , or t h a t c e r t a i n banks proposed t o s e l l t h e i r s i l v e r collateral i n t o t h e market. S i m i l a r l y , t h e March 3 1 releases f a i l e d t o d e s c r i b e Bache G r o u p ' s g u a r a n t e e o f Bache London o b l i g a t i o n s a n d t h e i n s u f f i c i e n c y o f t h e a s s e t s o f b o t h B a c h e London a n d B a c h e G r o u p t o c o v e r t h e p o t e n t i a l l o s s e s i n t h e H u d d l e s t o n s ' London f o r w a r d p o s i t i o n . The March 3 1 r e l e a s e a l s o o m i t t e d m e n t i o n o f t h e d i f f i c u l t i e s , d e s c r i b e d a t p a g e s 103 t h r o u g h 106 o f t h i s r e p o r t , t h a t B a c h e H a l s e y was e n c o u n t e r i n g i n f i n a n c i n g i t s d a y - t o - d a y s e c u r i t i e s business a s a r e s u l t of bankers' lack of confidence i n t h e f i r m ' s f i n a n c i a l i n t e g r i t y . In l i g h t of t h e s e c i r c u m s t a n c e s and t h o s e d e s c r i b e d i n t h e p r e c e d i n g p a r a g r a p h , B a c h e G r o u p ' s s t a t e m e n t i n t h e f i r s t March 3 1 r e l e a s e t h a t B a c h e M e t a l s a n d B a c h e L o n d o n ' s losses " w i l l n o t i n a n y way" a f f e c t Bache H a l s e y ' s a b i l i t y t o c o n d u c t b u s i n e s s a p p e a r s t o c r e a t e a m i s l e a d i n g i m p r e s s i o n : (1) t h a t B a c h e H a l s e y ' s f i n a n c i a l c o n d i t i o n was t o t a l l y i n d e p e n d e n t o f B a c h e G r o u p ' s o t h e r s u b s i d i a r i e s ; and ( 2 ) t h a t concealed t h e f r a g i l i t y o f t h e broker-dealers' heavily credit-dependent finances.
4 . The A p r i l 1 R e l e a s e

Meanwhile, t h e t r a d i n g s u s p e n s i o n i n Bache Group s t o c k remained i n e f f e c t . A f t e r r e c e i v i n g $17 m i l l i o n from P l a c i d O i l o n March 3 1 , h o w e v e r , B a c h e G r o u p a g a i n r e q u e s t e d t h a t t h e s u s p e n s i o n be l i f t e d . The C o m m i s s i o n s t a f f a d v i s e d B a c h e Group t h a t d i s s e m i n a t i o n o f t h e f a c t s c o n c e r n i n g t h e company's f i n a n c i a l c o n d i t i o n a n d t h e r e c e n t e v e n t s i n t h e m a r k e t were a p r e r e q u i s i t e to a l i f t i n g of the suspension. On A p r i l 1, 1 9 8 0 , a f t e r showing i t t o t h e Commission s t a f f , Bache Group i s s u e d a p r e s s r e l e a s e summarizing " r e c e n t e v e n t s p a r t i c u l a r l y t h o s e i n t h e s i l v e r m a r k e t , w h i c h may a f f e c t [ B a c h e G r o u p ' s ] f i n a n c i a l c o n d i t i o n and t h a t o f [Bache H a l s e y ] .

The release opened w i t h Bache Group "emphasiz [ i n g l t h a ; , w i t h o u t q u a l i f i c a t i o n , t h e c a p i t a l p o s i t i o n o f [Bache Halseyl remains i n complete compliance with t h e r u l e s of a l l regu1atr)ry agencies There followed a one-paragraph d e s c r i p t i o n o f t h e H u n t s ' f a i l u r e t o meet m a r g i n c a l l s , i n w h i c h B a c h e Halsey a s s e r t e d t h a t t h e Hunts f a i l e d t o m e e t calls " f o r t h e The release " e l a b o r a t e d upon" f i r s t t i m e , o n March 2 5 t h . " t h e March 28 r e l e a s e by d e s c r i b i n g i t s u s e o f s w i t c h e s t o e f f e c t l i q u i d a t i o n s , b u t it d i d n o t a t t r i b u t e c a u s e t o or a c k n o w l e d g e i t s e r r o r i n r e p o r t i n g o n March 28 t h a t t h e l i q u i d a t i o n h a d p r o d u c e d n o loss t o t h e b r o k e r - d e a l e r .

. . ."

The A p r i l 1 release a l s o acknowledged, f o r t h e f i r s t t i m e , t h a t t h e H u n t s had borrowed from Bache M e t a l s a g a i n s t s i l v e r b u l l i o n and t h a t Bache M e t a l s had i n t u r n borrowed from banks. The release c o n t i n u e d , h o w e v e r , t o o m i t d i s c l o s u c c 3 o f t h e m a g n i t u d e o f Bache M e t a l s ' l o a n s to t h e Hunts and from t h e b a n k s a n d t h e f a c t t h a t t h e l o a n s were, a t t h e t i m e o f t h e r e l e a s e , u n d e r c o l l a t e r a l i z e d by a p p r o x i m a t e l y $10 m i l l i o n * The release d i d , h o w e v e r , a l l u d e c o l l e c t i v e l y t o "$33 m i l l i o n i n p o t e n t i a l losses i n H u n t f a m i l y a c c o u n t s " w i t h B a c h e M e t a l s and Bache London. C o n c e r n i n g t h e bank l o a n s , t h e A p r i l 1 release a l s o stated that: T h e b a n k s w h i c h h o l d s i l v e r b u l l i o n s u p p l i e d by t h e Hunts a s c o l l a t e r a l f o r l o a n s t o [Bache M e t a l s ] h a v e n o t demanded payment o f t h e i r l o a n s a n d h a v e a g r e e d , upon B a c h e ' s p l e d g e o f a d d i t i o n a l c o l l a t e r a l , t o w o r k w i t h B a c h e t o accomp l i s h t h e o r d e r l y l i q u i d a t i o n of t h e i r s i l v e r collateral. On March 3 1 , u p o n b e i n g t o l d o f t h e losses d i s c o v e r e d o v e r t h e weekend, t h e s i l v e r banks t h a t had e x c e s s c o l l a t e r a l i n s i s t e d t h a t u n l e s s t h e y were p a i d o u t t h e y w o u l d s e l l t h e i r c o l l a t e r a l i n t o t h e market. I n t h e e a r l y morning h o u r s of T u e s d a y m o r n i n g , A p r i l 1, t h e s o - c a l l e d " s h o r t b a n k s " a g r e e d t o buy o u t t h e " l o n g b a n k s " and implement what o n e o f t h e s h o r t bankers d e s c r i b e d a s a "workout" o f t h e l o a n . The a c c u r a t e s t a t e m e n t would have been t h a t w h i l e f o u r o u t o f t h e t e n b a n k s h a d demanded p a y m e n t , t h e r e m a i n i n g s i x b a n k s had a g r e e d to i n c r e a s e t h e i r l o a n s t o Bache M e t a l s , p e n d i n g l i q u i d a t i o n of t h e c o l l a t e r a l , to e n a b l e i t to pay t h e f o u r banks. Jacobs, moreover, a p p a r e n t l y believed on A p r i l 1 t h a t s i l v e r b a n k s had demanded payment o n t h e l o a n s . In J a c o b ' s c o n v e r s a t i o n w i t h H e r b e r t Hunt i n which J a c o b s o u g h t a d d i t i o n a l f u n d s J a c o b s s a i d t h a t " t h e b a n k s h a v e c a l l e d tht. loan." This apparent inconsistency is perhaps b e s t explained a s a m a t t e r o f s e m a n t i c s , or a s a m a n i f e s t a t i o n o f J a c o b s ' d e s i r e t o i m p r e s s o n Hunt t h e u r g e n c y o f Bache G r o u p ' s situation.

The April 1 release omitted another important piece of information concerning Bache Group's finances. On Monday or early Tuesday, Stevenson had explored with Pearson the possibility of Bache Halsey's drawing funds against its $24 million line of subordinated credit. By noon on April 1, Pearson had advised Stevenson that, in view of the adverse information discovered over the weekend, Bache Halsey should not risk a request for a draw that might be refused. This information rendered inaccurate the statement in the March 28 release that Bache Halsey's subordinated lending banks "have confirmed that $24 million or subordinated loan arrangements remain available to be drawn by Bache on demand1'.

...

...

B. Disclosure in Bache Group's Filings with the Commission and Shareholder Communications 1. Disclosure Before the Crisis Bache Group made no disclosure concerning the Hunt silver positions in any of its annual, quarterly or interim reports, or in shareholder communications, prior to the silver crisis. During the buildup in silver prices in the fall and early winter of 1979-80, the Hunts' silver positions at Bache Group ranged from 2,549 to 7,304 futures contracts in accounts with Bache Halsey and approximately $40 million in loans from Bache Metals. Bache Group did not report the Hunt activity as being significant to the "commodity commission" or commodity customer financing segments of its business in its annual report for the year ended July 31, 1979, filed in October. It did not footnote the accounts receivable from customers item on its balance sheet at July 31 or October 31, 1979, to reflect the proportion of accounts receivable represented by the single Hunt loan nor did it note the nature of the collateral for the loan. It did not footnote the bank loans payable item on its balance sheet to reflect the proportion of its bank borrowing devoted to funding the Hunt loan. As described elsewhere in this report, the Hunt loans increased from approximately $42 million to approximately $233 million during February 1980, an amount representing 160% of Bache Group's net worth. This new credit increased Bache Group's customer receivables from $1.172 billion at January 31, 1980, to approximately $1.46 billion (pro forma) at February 29, 1980, of which 17% was represented by the Hunt loan. The firm's bank loans payable also increased, as a result of Bache Metals' new borrowing to fund the Hunt loan, from $366 million to approximately $559 million, respectively. At February 29 borrowing to fund the Hunt loan represented approximately 42% of Bache Group's bank loans payable.

On March 17, 1980, after the loan increases in February, Bache Group filed its quarterly report on Form 10-Q for the period ending January 31, 1980. Bache Group did not report the $197 million increase in Bache Metals' lending to the Hunts and in its bank borrowings as material subsequent events. It did not footnote balance sheet items on accounts receivable from customers or bank loans payable to reflect the increases in the loans and borrowings or the reduction in the ratio of collateralization.
2. Disclosure After the Crisis

a. The Cohn, Dach

&

Howard S-16

Bache Group's first disclosure concerning the Hunt silver situation in filings with the Commission occurred in amendments to a registration statement on Form S-16 that Bache Group had filed in connection with the resale of its securities by persons from whom it had acquired the Cohn, Dach & Howard insurance agency in a stock-for-stock exchange in January 1980 (the "Cohn, Dach & Howard S-16"). Bache Group filed Amendment No. 1 to the Form S-16 ("Amendment No. 1") on April 10, 1980. That amendment incorporated by reference disclosures in Bache Group's annual report on Form 10-K for the year ending July 31, 1979, its quarterly report on Form 10-Q for the periods ending October 31, 1979, and January 31, 1980, and its interim report on Form 8-K reporting Bache Group's results for the three months ending February 29, 1980. As to events during the silver crisis, Bache Group stated: "On March 27, 1980, the Securities and Exchange Commission ("SEC") ordered a suspension of trading in Bache's common stock because of material corporate events relating to the abrupt decline in the silver markets and resulting margin calls on commodity accounts maintained by certain members of the Hunt family which could have resulted in a material loss to Bache. As a result of the liquidation of the Hunts' positions and collateral and payments by the Hunts, such loss did not occur. On April 1 , 1980, the SEC lifted the suspension of trading of Bache's Common Stock. " Bunker and Herbert Hunt's beneficial ownership, as of January 16, 1980, of more than 5% of Bache Group's common stock brought Bache Metals' loans to them within the category of "transactions with managementN for purposes of

H o w e v e r , Amendment N o . 1 t o t h e I t e m 4 ( f ) o f R e g u l a t i o n S-K. C o h n , Dach & Howard Form S-16 d i d n o t c o n t a i n i n f o r m a t i o n a m e n d i n q t h e a n n u a l r e p o r t o n Form 10-K i n c o r p o r a t e d t h e r e i n by r e f e i e n c e , t o d i s c l o s e t h e H u n t s ' s t o c k ownership i n Bache Group or t h e e x i s t e n c e or e x t e n t o f t h e l o a n s . 110/ Amendment N o . 1 d i s c l o s e d t h e a c q u i s i t i o n s o f B a c h e G r o u p s t o c k b y e n t i t i e s c o n t r o l l e d b y Messrs. S a m u e l a n d Hyman B e l z b e r g , a n d t h e r e l a t e d f i l i n g s w i t h t h e C o m m i s s i o n o n S c h e d u l e 13D. I t also disclosed t h e "shark r e p e l l a n t " amendments t o its c e r t i f i c a t i o n o f i n c o r p o r a t i o n a d o p t e d a t its 1979 a n n u a l meeting o f s h a r e h o l d e r s . I t d i d n o t , howe v e r , d i s c l o s e t h a t t h e Hunts had p u r c h a s e d 6 . 6 % o f Bache G r o u p ' s s t o c k o r t h a t t h e y h a d made t h e i r p u r c h a s e s a t Jacobs' r e q u e s t as a d e f e n s i v e measure a g a i n s t t h e Belzbergs. Amendment N o . 1 a l s o d i s c l o s e d B a c h e H a l s e y ' s s u b o r d i n a t e d b o r r o w i n g , t h e l i n e s o f c r e d i t i t m a i n t a i n e d w i t h RBC and t h e C o n t i n e n t a l g r o u p o f banks, and t h e draws on t h e l a t t e r l i n e i t made o n M a r c h 2 1 a n d M a r c h 2 4 , 1 9 8 0 . It did n o t , however, d i s c l o s e t h a t a s a r e s u l t o f t h e s i l v e r crisis, it had been a d v i s e d by s u b o r d i n a t e d l e n d e r s n o t t o r e q u e s t a d d i t i o n a l draws on t h e s e l i n e s . On A p r i l 2 2 , 1 9 8 0 , B a c h e G r o u p f i l e d Amendment N o . 2 t o t h e C o h n , Dach & Howard S-16 ( " A m e n d m e n t N o . 2 " ) . Amendment N o . 2 was i d e n t i c a l t o Amendment N o . 1 e x c e p t t h a t i t d i s c l o s e d t h a t Bache Group had e s t a b l i s h e d a r e s e r v e a g a i n s t d e b i t b a l a n c e s i n non-Hunt r e l a t e d s e c u r i t i e s and commodity f u t u r e s trading accounts. b . T h e A p r i l 2 5 Form 8-K On A p r i l 2 5 , 1 9 8 0 , B a c h e G r o u p f i l e d a n i n t e r i m r e p o r t o n Form 8-K r e p o r t i n g p u r s u a n t t o " I t e m 5 . O t h e r M a t e r i a l Events" which included t h e following: On M a r c h 2 7 , 1 9 8 0 , t h e S e c u r i t i e s a n d E x c h a n g e Commisson ( " S E C " ) o r d e r e d a s u s p e n s i o n o f t r a d i n g i n [ B a c h e ] G r o u p ' s Common S t o c k b e c a u s e o f m a t e r i a l corporate events relating to the abrupt decline i n the s i l v e r markets and r e s u l t i n g i n s u b s t a n t i a l margin calls o n commodity a c c o u n t s m a i n t a i n e d by c e r t a i n members o f

110/ The Commission a l l e g e d i n its c o m p l a i n t i n - v . Nelson SEC Bunker Hunt and W i l l i a m H e r b e r t Hunt, Civ. A c t i o n N o . 82-1931 (D.D.C.) t h a t Bunker a n d H e r b e r t Hunt a c t e d a s a g r o u p i n a c q u i r i n g Bache Group s t o c k . The Hunts c o n s e n t e d t o t h e e n t r y o f a f i n a l judgment o f permanent i n j u n c t i o n i n t h a t a c t i o n without admitting o r denying t h e Commission's a l l e g a t i o n s .

the Hunt family which could have resulted in a material operating loss to [Bachel Group. As a result of the liquidation of the Hunt's positions and collateral and payments by the Hunts, such loss did not occur. On April 1, 1980, the SEC lifted the suspension of [Bache] Group's common stock. There was no other disclosure concerning the Hunt relationship or the silver crisis. c. The April 30 Form 10-Q On June 16, 1980, Bache Group filed a quarterly report on Form 10-Q for the period ended April 30, 1980 ("April 30 Form 10-Q" ) The April 30 Form 10-Q incorporated by reference the disclosures concerning the silver crisis contained in the April 25 Form 8-K. There was no other disclosure concerning those events.

d. The 1980 Form 10-K On October 29, 1980, Bache Group filed with the Commission its annual report on Form 10-K for the fiscal year ended July 31, 1980. Bache Group disclosed the existence and subject matter of investigations by the Commission, the CFTC and the NYSE into matters relating to the silver crisis and reiterated earlier disclosure concerning the suspension of trading. The 1980 Form 10-K contained no further disclosure concerning the Hunt silver accounts, the silver crisis or related matters. In particular, there was no disclosure of the existence or extent of Bache Metals' loans to the Hunts which, coming as they did while Bunker and Herbert Hunt owned more than 5% of Bache Group's stock, constituted "transactions with management" required to be disclosed pursuant to Item 11 of Regulation S-K. Moreover, notwithstanding that Bache Metals' loans to the Hunts represented virtually the only customer financing undertaken by Bache Metals during the period, the 1980 Form 10-K did not disclose the Hunt loan activity as being significant to the customer commodity financing segment of its business. 3. Other Material Publicly Disseminated In addition to the press releases and public filings just described, Bache Group commented publicly on the events of the silver crisis in a two page letter to clients dated April 21, 1980, and in a large newspaper advertisement appearing late in April 1980. Each document purported to "set the record straight" concerning the silver crisis at Bache Halsey and each contains assertions that raise questions concerning the candor with which Bache Halsey reported

to its clients and to the public the nature and extent of Hunt-related difficulties at the firm. These two documents made the following representations in substantially identical terms : "1. At no time was our day-to-day service to any Bache client affected in any way. 2. At no time did Bache fail to meet all capital requirements of the New York Stock Exchange or the Securities and Exchange Commission.
3. At all times Bache met all its financial obligations, both to clients and to the various exchange clearing facilities.

4. At no time did these events require Bache to seek additional capital by borrowing or any other means. Not one penny.
5. At no time did Bache give preferential treatment to any client because he was a shareholder, nor did any shareholder ask for preferential treatment."

Neither of these documents contains any additional information that would inform Bache Halsey's customers or the public of the precariousness of Bache Group's overall financial situation as described elsewhere in this report. Indeed, the newspaper advertisement was headed "A Test of Strength" and stated that "in an important way, this series of unique events proved the strength of this 100-year-old company. The strength of Bache." Bachets forceful assertions that it remained in compliance with net capital requirements and was not required to seek additional capital are of particular concern, inasmuchas the advertisement and the client letter did not disclose the steps taken by the firm that contributed to maintaining its capital compliance: reledgering the Huddleston accounts in Bache London, reallocating collateral from the Bache Metals' loans to Bache Halsey and seeking and obtaining margin reductions from Comex. With regard to the timing of the liquidations, the April 21 letter to clients states that it was on March 25th, that "a group of very substantial related accounts" were unable to meet a margin call. The letter goes on to say that on March 26, Bache began to liquidate the customers' accounts. These statements create the impression that a prompt sellout followed the Hunts' failure to meet margin calls without disclosing that for a period of eight days Bache management accepted additional silver deposits in lieu of cash margin.

PART THREE MERRILL LYNCH

&

CO., INC.

THE MERRILL LYNCH COMPLEX

A. The Holding Company

Merrill Lynch & Co., Inc. ("ML & Co."), incorporated in Delaware in 1973, is a holding company engaged through approximately 109 subsidiaries in retail and institutional securities brokerage, investment banking, investment management, commodities futures brokerage, mortgage insurance, real estate, equipment leasing, financial consulting, real estate management and employee relocation. ML & Co. is a publicly-held company whose common stock is registered with the Commission pursuant to Section 12(b) of the Exchange Act and listed on the New York, Midwest, Pacific and London Stock Exchanges. On December 28, 1979, its 36.3 million outstanding common shares were in the hands of 20,107 holders of record. For the fiscal year ended December 28, 1979, ML & Co. reported pre-tax income of $196.3 million on revenues of $2.05 billion (1980 pre-tax income was $366 million). The company derived its revenues principally from interest on customer margin accounts and financings ($763.2 million), commissions on securities transactions ($421.9 million), spreads on transactions as principal ($290.5 million), investment banking ($155.3 million) and commodity transactions commissions ($103.5 million) Its principal expenses were employee compensation and benefits ($733.1 million), interest ($638.5 million) and occupancy expense and equipment rental ($100.7 million). ML & Co. Inc. reported a net worth of $784.2 million on December 28, 1979 and $969.5 million on December 26, 1980. B. The Broker-Dealer ML & Co.'s principal subsidiary is Merrill Lynch, Pierce, Fenner & Smith, Inc. ("Merrill Lynch" or "Merrill"), a broker-dealer registered with the Commission pursuant to Section 15(b) of the Exchange Act. On March 28, 1980, ML & Co.'s equity in Merrill Lynch represented approximately 71% of the equity of ML & Co. itself. ML & Co. reported that in fiscal 1979 Merrill Lynch's "share of total public listed equity volume" was 10.8% and that it was "the nation's largest futures broker." Merrill Lynch is a member of all major securities and commodities exchanges in the United States and it, its subsidiaries or affiliates hold memberships or associate memberships on several principal foreign securities and commodities exchanges.

As a registered broker-dealer and as a member of the NYSE, Merrill Lynch is subject to the Uniform Net Capital Rule. It computes its net capital requirements under the alternative method authorized by the Rule. On December 28, 1979, Merrill Lynch's net capital of $297.9 million was 9.3% of aggregate debit balances, $74.0 million above the 7% "early warning" level and $170.4 million above the 111/ 4% minimum requirement. - On that date, none of this amount was comprised of subordinated debt. ML & Co. conducted all of its Hunt-related commodity futures and 112/ financing business through Merrill Lynch. 11. INCEPTION, DEVELOPMENT AND SCOPE OF THE HUNT RELATIONSHIP

Bunker and Herbert Hunt opened commodity accounts with Merrill Lynch in 1974 ater Wilbur Marsh ( "Marsh") , an account executive in Merrill Lynch's Dallas office, solicited their business. In 1975, Lamar Hunt and Hunt Holdings Co. opened commodity accounts. By July 31, 1979, Bruce Hunt, Nancy Hunt, Lyda Hunt and Barbara Hunt Crow also had accounts at Merrill. Numerous Hunt related entities, including International Metals Invest113/ ment Company, Ltd. ("IMIC"), - Western Bullion Corp., Hunt Holdings, GWS International Trading Company, Penrod Drilling Company, and certain Placid Oil Co. subsidiaries also opened accounts by mid-1979. On July 31, 1979, various members of the Hunt family and related entities maintained 46 separate accounts with Merrill Lynch. Sixteen of the Hunts or their related entities owned twenty commodity trading accounts of which 18 had related U.S. Treasury bill accounts. Eight of the 46 accounts were securities accounts. Of these, one traded commercial paper, six traded conventional securities and one was used as a conduit for short term time deposits with other financial institutions.

111/ has recently been lowered to - The minimum net capit-a1

2% of aggregate debit items under the Net Capital Rule's alternative computation. See Securities Exchange Act of 1934 Release No. 18417 (Jan. 25, 1982). subsidiary, Merrill Lynch Commodities Inc. to carry its customers' commodities accounts.

112/ - On April 1, 1981, Merrill Lynch established a new

113/ -

As discussed on page 27 above, IMIC was owned 50% by Hunt interests and 50% by two Saudi Arabian investors.

The c o m m o d i t i e s a c c o u n t s t r a d e d i n p r e c i o u s metals, f o r e i g n c u r r e n c y f u t u r e s , U.S. T r e a s u r y o b l i g a t i o n f u t u r e s , l i v e s t o c k , s u g a r and v a r i o u s o t h e r a g r i c u l t u r a l products. T h e T r e a s u r y b i l l a c c o u n t s a n d t h e commercial p a p e r a c c o u n t h e l d i n s t r u m e n t s purchased w i t h c a s h dep o s i t e d as o r i g i n a l margin on commodities f u t u r e s posiThe t i o n s or s e r v e d as a r e p o s i t o r y f o r e x c e s s c a s h . stock accounts carried various large positions. F i v e o f t h e H u n t a c c o u n t s e n g a g e d i n t h e v a s t major i t y o f t h e s i l v e r t r a d i n g t h e Hunts and t h e i r r e l a t e d These accounts e n t i t i e s c o n d u c t e d a t Merrill L y n c h . were owned b y I M I C , H e r b e r t , B u n k e r a n d Lamar H u n t a n d A separate account associated with each Hunt H o l d i n g s . of t h e s e c o m m o d i t i e s a c c o u n t h e l d T r e a s u r y b i l l s p o s t e d as margin f o r commodities f u t u r e s p o s i t i o n s . On J u l y 31, 1 9 7 9 , o n t h e e v e o f f i v e a n d o n e - h a l f months o f s h a r p i n c r e a s e s i n t h e p r i c e and v o l a t i l i t y o f s i l v e r , H u n t - r e l a t e d a c c o u n t s a t Merrill L y n c h w e r e n e t l o n g 2506 s i l v e r f u t u r e s c o n t r a c t s r e p r e s e n t i n g 1 2 , 5 3 0 , 0 0 0 o u n c e s o f s i l v e r . - A t p r i c e s t h e n pre114/ v a i l i n g , t h e s i l v e r r e p r e s e n t e d by t h e s e c o n t r a c t s w a s v a l u e d a t $112 m i l l i o n . E q u i t y i n t h e combined Hunt f a m i l y a c c o u n t s s t o o d a t $6.4 m i l l i o n and P l a c i d had $43.3 m i l l i o n i n e q u i t y i n its s e c u r i t i e s accounts. 115/

114 -/ C e r t a i n o f t h e H u n t s ' a c c o u n t s h e l d s i l v e r s t r a d d l e s ,

t h a t i s , t h e a c c o u n t s were l o n g s i l v e r f u t u r e s c o n tracts w i t h o n e m a t u r i t y d a t e and s h o r t a n e q u i v a l e n t number o f s i l v e r f u t u r e s c o n t r a c t s w i t h a d i f f e r e n t m a t u r i t y d a t e . A s a p r a c t i c a l matter, t h e r i s k t o t h e t r a d e r and t h e f i r m from s u c h p o s i t i o n s are o r d i n a r i l y l i m i t e d t o t h e e x t e n t o f t h e price d i f f e r e n t i a l between c o n t r a c t s w i t h d i f f e r e n t m a t u r i t y dates. T h i s r i s k is g e n e r a l l y smaller t h a n t h e r i s k of a n e t l o n g or n e t s h o r t p o s i t i o n a n d t h e s t a f f h a s , a c c o r d i n g l y , c h o s e n t o assess t h e m a g n i t u d e o f t h e H u n t s ' p o s i t i o n w i t h Merrill L y n c h a n d o t h e r f i r m s n e t of any straddled positions i n t h e i r accounts.

1 1 5 / From 1 9 7 5 t h r o u g h 1 9 7 8 , s e v e n H u n t c o m m o d i t y a c c o u n t s a l o n e g e n e r a t e d almost $ 1 . 3 m i l l i o n i n c o m m i s s i o n s . Of t h i s , H u n t H o l d i n g ' s c o m m o d i t i e s a c c o u n t s g e n e r a t e d n e a r l y $98,000 and Bunker H u n t ' s two c o m m o d i t i e s a c c o u n t s g e n e r a t e d n e a r l y $190,000 i n commission r e v e n u e f o r Merrill.

111. THE BUILDUP IN SILVER - JULY 1979 THROUGH JANUARY 1980 A. Introduction As described elsewhere in this report, the price of silver and the volatility of the silver market increased significantly between August 1, 1979 and January 17, 1980. - Merrill Lynch, like Bache Group, permitted the 116/ Hunts to increase the size of their silver positions with the firm during this time, thereby increasing Merrill Lynch's exposure in the Hunt accounts. During the last five months of 1979, the Hunts, Hunt-related entities and IMIC's aggregate net long silver position (future, forward and physical) with the firm showed a net increase of 224%, from 12.5 million ounces with an apparent value of $112 million on July 31, 1980 to 40.7 million ounces 117/ on December 31, 1980. - This position aggregated 6281 net long futures contracts representing 31.4 million ounces, 1.95 million ounces of silver forward commitments, and 7.31 million ounces of silver bullion. The apparent value of this position was $1.4 billion and it was supported by equity which rose from $6.4 million to $535.4 million. At December 31, assuming no reduction in the position or additional cash or collateral deposits, a decline of approximately $13.00 per ounce in the price of the metal, from a price of $34.45 to $21.28, would have carried the combined Hunt/IMIC accounts into de118/ ficit. The increase in Merrill's Hunt-related exposure in the increasingly volatile silver markets during the fall and winter of 1979-1980 occurred as a result of management decisions to permit IMIC to open and maintain silver futures and forward positions that totaled 3,808 contracts 116/ For a more detailed description quantifying the increase in silver prices and volatility during this period, see page 54 above. The peak in Hunt silver positions with Merrill was reached in September 1979. At September 28, IMIC's future position stood at 10,309 contracts representing approximately 51.5 million ounces. It thereafter reduced its futures position with Merrill substantially in the EFP transaction with Mocatta described above at n. 37, and by standing for delivery on maturing contracts. Merrill financed certain of these deliveries as described below. 118/ During January 1980, the Hunt position had diminished somewhat. On January 31, 1980, the Hunts' positions at Merrill represented 35 million ounces in silver futures, forward contracts and bullion.

o n December 3 1 , 1 9 7 9 , a n d t o l e n d I M I C , Hunt H o l d i n g s a n d H e r b e r t Hunt a p p r o x i m a t e l y $ 5 6 m i l l i o n t o f i n a n c e d e l i v e r i e s of s i l v e r bullion i n t h e i r accounts.

A s w i t h B a c h e , M e r r i l l L y n c h ' s e x e c u t i v e committee made t h e s e d e c i s i o n s b a s e d o n t h e H u n t s ' r e p u t a t i o n f o r substantial financial resources, t h e i r past history of promptly meeting t h e i r o b l i g a t i o n s , and t h e magnitude I n a d d i t i o n , Merrill o f t h e i r e q u i t y w i t h Merrill. Lynch e x e c u t i v e s b e l i e v e d t h a t B u n k e r a n d H e r b e r t H u n t and t h e i r f a m i l y i n t e r e s t s s t o o d behind IMIC. They d i d n o t s e e k a w r i t t e n g u a r a n t e e or s i m i l a r w r i t t e n a s s u r a n c e t o t h a t e f f e c t u n t i l March 2 7 , 1 9 8 0 . They r e c e i v e d s u c h a d o c u m e n t o n A p r i l 1. W h i l e t h e f i r m had s u b s t a n t i a l i n f o r m a t i o n o f a g e n e r a l n a t u r e d e v e l o p e d o v e r t h e course o f its s i x - y e a r r e l a t i o n s h i p w i t h t h e f a m i l y , it had l i t t l e s p e c i f i c , c u r r e n t information a s t o t h e Hunts' f i n a n c i a l c o n d i t i o n i n 1979 and 1980 o r t h e a v a i l a b i l i t y o f Hunt f a m i l y r e s o u r c e s t o s a t i s f y I M I C or t h e i n d i v i d u a l Hunts' o b l i g a t i o n s to t h e firm.

The r e m a i n d e r o f t h i s s e c t i o n w i l l d i s c u s s t h e t r a n s a c t i o n s t h a t produced t h e i n c r e a s e i n Merrill's Hunt-related s i l v e r e x p o s u r e and t h e n i d e n t i f y t h e i n f o r m a t i o n t h a t was a v a i l a b l e t o Merrill Lynch d e c i s i o n - m a k e r s as t h e y d e t e r m i n e d w h e t h e r or n o t t o p e r m i t t h e Hunts and IMIC to e f f e c t t h e t r a n s a c t i o n s i n t h e i r accounts t h a t produced i n c r e a s e d exposure f o r t h e firm. B. I n c r e a s i n g S i l v e r Exposure - The I M I C Account and S i l v e r F i n a n c i n g f o r Hunt H o l d i n g s and H e r b e r t Hunt 1. T h e I M I C A c c o u n t

a. E s t a b l i s h i n g t h e A c c o u n t
I n J u l y 1 9 7 9 , t h e H u n t s a n d t w o S a u d i A r a b i a n assoc i a t e s f o r m e d I M I C , 1 1 9 / a n d H e r b e r t Hunt a p p r o a c h e d Marsh concerning t h e establishment of an account f o r IMIC with Merrill Lynch. Marsh c o n v e y e d t h e r e q u e s t t o t h e f i r m ' s c o r p o r a t e c r e d i t d e p a r t m e n t , which r e q u e s t e d a meeting with Herbert to d i s c u s s t h e proposed account. The m e e t i n g w a s h e l d i n Dallas i n l a t e J u l y or e a r l y August 1979 b e t w e e n M a r s h , s e n i o r M e r r i l l Lynch o f f i c i a l s , H e r b e r t H u n t , h i s s o n D o u g l a s , a n d o n e o r t w o Hunt e m p l o y e e s . A c c o r d i n g t o Merrill Lynch w i t n e s s e s , H e r b e r t H u n t t o l d t h e M e r r i l l p e r s o n n e l t h a t I M I C i n t e n d e d t o become a p r e c i o u s metals d e a l e r , t h a t i t wished t o e s t a b l i s h a 119/ B u n k e r a n d H e r b e r t H u n t ' s r e l a t i o n s h i p w i t h I M I C is d i s c u s s e d i n g r e a t e r d e t a i l a t p a g e 27.

125

position in silver futures and that it planned to stand for delivery of physical silver. Hunt requested a futures trading limit of 10,000 contracts. The Hunts also mentioned that IMIC might seek financing of silver deliveries but stated, according to Marsh, that Merrill's willingness to extend such financing was not a prerequisite to the firm doing business with IMIC. Merrill personnel sought assurance that if it accepted the account, IMIC would trade silver only through Merrill Lynch. Herbert Hunt gave them that assurance. Hunt did not disclose the identity of the Saudi coventurers in IMIC at this meeting, but he did describe IMIC's funding sources. An August 15, 1979 memorandum to Merrill's executive committee described IMIC's initial capitalization: Cash from Herbert and Bunker Hunt Cash from other principals Contributions of debentures and other securities from both sources Available "on demand", 50% from each group of principals Bank line of credit TOTAL
$ $ $ $ $

5 million 5 million 20 million 40 million 30 million

$100 million

It is apparent from this analysis that IMIC's initial capitalization was $30 million net of commitments for further contributions from the principals. Before the meeting discussed above, on July 25, 1979, Marsh opened a commodity account for IMIC in the firm's Dallas office. By August 3, after that meeting, IMIC's account was long 1,800 silver futures contracts with further orders pending. By August 15, this position had expanded to more than 4,600 contracts, well beyond the 2,000 contract level at which Merrill's internal procedures required executive committee approval for 120/ further trading. 120/ Marsh testified that IMIC acquired its initial position under the earlier trading limits of $10 million in margin, or 2,000 contracts-per-person established for several other Hunt commodities accounts at Merrill. He testified that he also received the approval of Merrill's corporate credit department for an interim limit of 3,000 contracts pending executive committee approval of the Hunts' 10,000-contract request. It is clear, however, that Marsh executed IMIC's orders beyond even this 3,000-contract limit before the executive committee formally acted on the larger line request.

b. IMIC Futures Positions Because of the expected magnitude of trading in the IMIC account, Merrill's corporate credit department presented to Merrill's executive committee for its approval IMIC's proposed trading plans as outlined to Marsh and in the Dallas meeting just described. The executive committee on August 20, 1979 approved futures trading limits for IMIC of either $30 million in initial margins or 15,000 contracts, whichever was less. If IMIC had utilized the full trading possibilities Merrill Lynch allowed it, it could have assumed a position of 75 million ounces. At margin rates then prevailing, the executive committee decision effectively permitted IMIC to commit the entire initial cash capitalization it had disclosed 121/ to the firm to a silver position at Merrill. - The executive committee decision to permit IMIC to engage in futures trading of this magnitude enabled IMIC to substantially increase Merrill's Hunt-related silver exposure in the fall of 1979. By the end of August 1979, the IMIC account held a 9,048 contract long position in silver futures. By the end of September, IMIC's long position totaled 10,309 contracts and its account held 7.1 million ounces of cash silver and forward contracts for delivery of an additional 400,000 ounces. In October 1979, IMIC reduced its long futures position with the firm to 3,808 contracts as a result of standing for delivery and effecting an "exchange for physicals" transaction with Mocatta Metals Corp. The IMIC long silver futures position remained at 3,808 contracts, or 19 million ounces, until March 27, 1980. c. Merrill Lynch Lends to IMIC to Finance Silver Deliveries In early September 1979, IMIC requested through Marsh that Merrill lend it 85% of the market value of 465 silver contracts on which it expected to stand for delivery that month. At prices then prevailing, the

121/ -

Were the account to have had a position equal to its futures trading limits of 75 million ounces, each one dollar movement in the price of silver would have produced unrealized gain or loss of $75 million. This should be compared to IMIC's initial cash capitalization of $30 million and the total capitalization of $100 million IMIC represented to the firm that it had available. The IMIC account never reached this 75 million ounce level.

l o a n IMIC r e q u e s t e d a g a i n s t t h e 2 . 3 m i l l i o n o u n c e s t o be d e l i v e r e d was $ 2 3 m i l l i o n . 122/ The terms o f t h e req u e s t e d f i n a n c i n g were: 1. An i n t e r e s t r a t e o f 1 / 2 % o v e r t h e N e w York brokers' call loan rate; 2 . IMIC w a s r e q u i r e d t o m a i n t a i n 1 5 % o f t h e v a l u e o f t h e d e l i v e r y a t a l l times; 3. C a l l s f o r a d d i t i o n a l c o l l a t e r a l or p a r t i a l paydown were t o b e m e t w i t h i n 24 h o u r s o f t h e d a y t h e y were i s s u e d ;

4 . T h e l o a n was e x t e n d e d f o r a 9 0 d a y t e r m , a l t h o u g h i t was c o n t e m p l a t e d t h a t t h e f i n a n c i n g c o u l d b e renewed e a c h 90 d a y s f o r a n i n d e f i n i t e t i m e .

Commodity d i v i s i o n h e a d J o h n J . C o n h e e n e y ( " C o n h e e n e y " ) and c o r p o r a t e c r e d i t department o f f i c i a l Michael E. L u r i e ( " L u r i e " ) recommended a p p r o v a l o f t h e IMIC f i n a n c i n g req u e s t t o M e r r i l l L y n c h ' s e x e c u t i v e committee i n a memorandum d a t e d September 7, 1979 t r a n s m i t t e d through e x e c u t i v e v i c e p r e s i d e n t f o r a d m i n i s t r a t i o n a n d f i n a n c e A l l a n L. S h e r ("Sher"). On S e p t e m b e r 1 0 , t h e committee a p p r o v e d $ 2 5 m i l l i o n i n f i n a n c i n g f o r t h e IMIC a c c o u n t . 123/ Seven d a y s l a t e r , o n September 1 7 , 1979, L u r i e i n f o r m e d S h e r , t h a t t h e n u m b e r o f c o n t r a c t s IMIC p l a n n e d t o a c c e p t i n d e l i v e r y d u r i n g September had i n c r e a s e d from 465 c o n t r a c t s to 9 4 1 c o n t r a c t s . IMIC w a s now r e q u e s t i n g a d d i t i o n a l f i n a n c i n g o f a p p r o x i m a t e l y $16 m i l l i o n .

122/ - IMIC a l s o r e q u e s t e d c o n s i d e r a t i o n o f a f u n d i n g p a c k a g e which would be a v a i l a b l e t o i t f o r f u t u r e p u r c h a s e s o f p r e c i o u s metals. T h e r e i s n o i n d i c a t i o n t h a t Merrill c o n s i d e r e d t h i s a s p e c t o f IMIC's f i n a n c i n g p r o p o s a l s . 123/ I n t h e same m e e t i n g , t h e e x e c u t i v e committee a l s o e l i minated t h e margin l i n e l i m i t a t i o n o f $30 m i l l i o n on I M I C ' s f u t u r e s t r a d i n g , s i n c e Comex a n d CBT's i n c r e a s e d i n i t i a l margin r e q u i r e m e n t s i n s i l v e r caused IMIC's p o s i t i o n t o e x c e e d t h e $ 3 0 m i l l i o n l i m i t . T o a l l o w IMIC t o t r a d e a t t h e volume i t d e s i r e d , Merrill's e x e c u t i v e committee o n S e p t e m b e r 1 0 c h a n g e d t h e s t r u c t u r e o f i t s t r a d i n g l i m i t o n IMIC. I n s t e a d o f l i m i t i n g t h e company t o a s p e c i f i e d a m o u n t o f m a r g i n , i t l i m i t e d IMIC t o a s p e c i f i e d number o f f u t u r e s c o n t r a c t s . T h a t number remained a t 15,000, s u b j e c t to c e r t a i n c o n d i t i o n s des c r i b e d a t page 129.

On September 21, 1979, the executive committee unanimously approved $50 million in financing for the IMIC account for 60 days incorporating the first IMIC financing into the company's second financing request. - In addi124/ tion, the executive committee reduced IMIC's futures trading limit to 10,000 contracts unless IMIC committed "certain funds" to the firm or an affiliate to establish 125/ a money management account. On November 12, 1979, the executive committee extended IMIC's $50 million line of credit for an additional 60 days. In early January, IMIC reduced its financing from Merrill Lynch to $25 million, collateralized by 450 warehouse receipts with an apparent value of approximately $80 million. On January 14, 1980, the executive committee approved extending this remaining portion of IMIC's financing for another 60-day period. On each occasion, the corporate credit department memoranda to the executive committee recommending the loan renewal reiterated the growth in IMIC's net worth due to price increases in silver.

124/ - This condition was apparently never met and the 10,000 contract trading limit remained in effect for the remainder of the IMIC-Merrill Lynch relationship.

125/ - Two problems seem to exist with the IMIC account on

October 31 as a result of errors in the firm's margin department. First, although the executive committee authorized only a $50 million loan to IMIC, Merrill in fact advanced a total of $60 million. Second, a shcrtfall existed in the non-silver margin deposits supporting IMIC's domestic futures positions. Physical silver held in the unregulated portion of the IMIC account was used for two purposes: to meet margin requirements on IMIC future positions and to collateralize loans IMIC received from Merrill to finance delivery of physical silver. Assuming that $75.6 million of IMIC's position in Comex cash silver is allocated to offset this shortfall, on October 31 IMIC maintained with Merrill only $40.8 million in unencumbered bullion to collateralize approximately $60 million in loans. IMIC had agreed to maintain physical silver equal to 118% of its loan amount; in fact, it maintained physical silver equal to only about 67% of the loan amount. Both problems were corrected during November.

2. Lendinq to Hunt Holdinas On October 2, 1979, Hunt Holdings stood for delivery of 128 CBT silver contracts at a cost of almost $10 million. Hunt Holdings sought 70% financing of that delivery at 1/2% over the New York brokers' call rate and, pending approval of its request by the executive committee, remitted slightly more than $3 million, or almost 30%, of the cost of the deliveries. Thus, between October 2, 1979, when delivery was taken by Hunt Holdings, until October 24, 1979, when the Executive Committee would approve the company's financing request, Merrill provided Hunt Holdings with over $7 million in financing prior to formal executive committee approval. Merrill's corporate credit department and commodity division recommended to the executive committee financing for Hunt Holdings on the following terms: 1. The 70% financing be provided for 89 days from the date of delivery; 2. The financing be reviewed after 60 days to determine whether it should be extended for an additional 89 day period;
3. The interest rate be greater than 1/28 over the New York brokers' call rate "[iln view of present bank interest rates and the tightness of credit.

...

'I

The corporate credit department also recommended that the executive committee acknowledge and ratify the delivery and partial payment that Hunt Holdings had made. On October 27, 1979, the executive committee approved a resolution authorizing financing to Hunt Holdings for 70% of the value of commodity futures contracts, "expected to approximate $10,500,000," for 89 days. The executive committee added that after 60 days the financing would be reviewed to determine whether it should be extended beyond 89 days. The executive committee also "confirmed, ratified and approved" prior actions taken by officers of the firm consistent with that action. This apparently ratified the pre-existing financing to the Hunts. In December, during the 60-day review mandated by the committee, the corporate credit department learned that Hunt Holdings would reduce to about $4 million its silver-collateralized borrowing from the firm. On January 21, 1980, the executive committee approved approximately $4.5 million of the loan for an additional 89 days, secured by 79 of the original 128 warehouse receipts on deposit with the firm.

3. Lending to Herbert Hunt Herbert Hunt was the third Hunt account to request loans against silver bullion. On January 3 and 4, 1980, he stood for delivery of 200 contracts of January 80 Comex silver with a value of approximately $38.2 million. Shortly thereafter, Herbert requested a loan for 85% of the value of the silver he received in delivery or approximately $32.5 million. He later reduced his request to 70% of the value of the silver, or approximately $26.7 million. On January 14, 1980, in the same meeting in which it authorized the extension of $25 million of the IMIC loan, the executive committee approved lending $27 million to Herbert Hunt for 89 days. C. The Credit Decisions: Information Available to Merrill Concerning IMIC, the Hunts and the Silver Market

I. Introduction and Summary

As noted in the preceding section of this report, Merrill's executive committee reviewed and approved each of IMIC's futures trading and borrowing requests, as well as Hunt Holdings and Herbert Hunt's borrowing requests. In each instance the basis for the committee's review was information and analysis supplied jointly by the firm's commodity division and its corporate credit department. In contrast with Bache, where written records of the bases for executive committee Hunt-related credit decision-making are virtually non-existent, joint commodity division/corporate credit department memoranda at Merrill furnish relatively detailed background as to what information and recommendations were available to the executive committee when it made its credit decisions concerning the Hunts. During the course of its six-year relationship with the Hunt family, Merrill Lynch credit analysts developed a file of approximately thirty pounds of material. This included, among other things, news clippings reporting on family business activities and resources during the entire period of the relationship, credit agency and bank credit reports obtained near the time the accounts were opened, public disciosure materials for HIRCO, memoranda of discussions between credit department personnel and the Dallas branch manager, and memoranda reflecting credit department analysis of the Hunt accounts. This material evidenced that the Hunts had enormous wealth and resources, although it revealed little concerning the extent or maturities of the Hunts' debts or other obligations.

A review of this material and the testimony of Merrill Lynch witnesses reveals that while the firm sought and received comparatively specific information concerning IMIC'S initial capitalization and subsequent financial condition during the fall and early winter of 1979-1980, it obtained little, if any, comparable material during this period relating to the Hunts themselves or to Hunt Holdings, even though testimony of witnesses and the circumstances of the firm's credit decisions suggest that Merrill considered the financial reputation of the Hunts important in its decision-making concerning IMIC. The information the firm had on the Hunts, moreover, dated primarily from the 19741975 period during which the Hunts had opened their principal accounts with the firm. During the critical 19?9 to 1980 period, apart from one event early in March 1980, the firm did not obtain additional financial information concerning the individual Hunts. Indeed, memoranda indicate that during 1974 and 1975 the ccrporate credit department was instructed not to conduct the credit inquiry on the Hunts it would normally accomplish for large accounts, although it is unclear whether that instruction was in effect in 1979 and 1980 at the time IMIC, Hunt Holdings and Herbert Hunt established the position discussed in this report. Law and custom in the commodity markets seek to assure anonymity for traders and the positions they hold. Merrill Lynch did not ask that the Hunts provide information about their silver activity through other firms. In accord with custom in the industry, Merrill did not seek such information from other brokers. As a result, the firm remained unaware of the extent of the Hunts' overall involvement in the silver market. The lack of this information continued at the firm until March 26, 1980, even though commodity division and credit department personnel were conscious of, and had alerted the executive committee to, the potential illiquidity of the bullion collateralizing Merrill's loans to the Hunts, a position that was comparatively small in relation to IMIC's net long futures position with the firm and the Hunts overall silver holdings. In reviewing joint commodity division/corporate credit department memoranda to the executive committee, corporate credit department files on the Hunts and the testimony of witnesses, it appears that Merrill's decisionmakers: (1) Were aware of the Hunts' history of fully meeting all large obligations to the firm until March 1980;
( 2 ) Had little specific financial information to

corroborate extensive press reports and generally held beliefs as to the extent of the Hunts' financial resources or the availability of those resources to meet the obligations of individual account holders;

( 3 ) Were aware of the Hunts' substantial holdings at

Merrill Lynch. Indeed, Perrill Lynch president, William Schreyer, indicated that the loans to IMIC would not have been made unless the executive committee was "satisfied that we were in effect having a relationship with the Hunts generally, so we looked upon them as a total entity as opposed to individual accounts";
( 4 ) Had comparatively detailed information, on an on-

going basis, concerning the initial capitalization and current financial condition of IMIC;

(5) Had assurances from IMIC that all of its futures trading activity was being conducted through Merrill;
( 6 ) Had no information concerning the nature or extent

of the Hunts' liabilities and obligations outside of Merrill Lynch;

(7) Were aware of the increasingly volatile condition of the silver market and the magnitude of Merrill's Hunt-related position in relation to it;
(8) Had no information, other than the general speculation within the industry, concerning the nature or extent of the Hunts' silver positions at other broker-dealers, FCMs or banks; and

(9) Believed that Hunt family resources stood behind IMIC notwithstanding the absence of a written guarantee to that effect.
The remainder of this section examines in more detail information available to management concerning IMIC, the Hunts and the silver market. 2. Information About IMIC After learning from Marsh of the IMIC account and the amount of trading it proposed to do, the corporate credit department arranged meetings with the Hunts in Dallas and New York for the purpose, according to Merrill Lynch witnesses, of enabling the firm to learn more about IMIC and its plans. In these meetings and in other discussions prior to the executive committee's August 20, 1979, decision to approve a 15,000 contract trading limit for IMIC, the firm obtained the following information:

( a ) I n i t s i n i t i a l c a p i t a l i z a t i o n , IMIC h a d a n e t w o r t h o f $30 m i l l i o n , a l i n e o f bank c r e d i t f o r a n a d d i t i o n a l $30 m i l l i o n and f u n d s "on c a l l " f r o m t h e H u n t s t o c k h o l d e r s i n IMIC a n d t h e i r S a u d i associates o f $40 m i l l i o n ;

( b ) IMIC r e p r e s e n t e d t o t h e f i r m t h a t a l l o f I M I C ' s f u t u r e s t r a d i n g w o u l d b e d o n e t h r o u g h Merrill Lynch; 126/

( c ) IMIC p l a n n e d

to e s t a b l i s h a long position of approximately 10,000 s i l v e r f u t u r e s c o n t r a c t s r e p r e s e n t i n g a p p r o x i m a t e l y 50 m i l l i o n o u n c e s o f silver.

T h e r e is n o i n d i c a t i o n i n t h e e v i d e n c e d e v e l o p e d by t h e Commission s t a f f t h a t a t t h e t i m e o f t h e e x e c u t i v e committee's f i r s t a c t i o n o n t h e IMIC t r a d i n g l i n e r e q u e s t i t knew t h e d e t a i l s o f I M I C ' s o w n e r s h i p s t r u c t u r e . For i n s t a n c e , c r e d i t d e p a r t m e n t memoranda c o n t e m p o r a n e o u s w i t h t h e D a l l a s m e e t i n g r e f l e c t t h a t t h e f i r m d i d n o t know t h e i d e n t i t i e s or f i n a n c i a l background o f t h e Hunts' S a u d i a s s o c i a t e s i n t h e IMIC v e n t u r e . - T h e f i r m a l s o w a s n o t 127/ aware t h a t t h e H u n t ' s i n t e r e s t i n IMIC w a s , i n f a c t , h e l d b y a c o r p o r a t i o n i n t u r n owned b y t r u s t s e s t a b l i s h e d f o r t h e b e n e f i t o f H e r b e r t and Bunker H u n t ' s c h i l d r e n , r a t h e r t h a n by H e r b e r t a n d Bunker Hunt t h e m s e l v e s . I n t h e e n s u i n g f i v e m o n t h s , a s t h e e x e c u t i v e comm i t t e e a d d r e s s e d IMIC's r e q u e s t f o r l o a n s a g a i n s t s i l v e r b u l l i o n and f o r e x t e n s i o n s o f t h o s e l o a n s , Merrill Lynch p e r s o n n e l o b t a i n e d f r o m IMIC r e p r e s e n t a t i o n s as t o t h e On November 8 , u p d a t e d f i n a n c i a l c o n d i t i o n of t h e f i r m . 1 9 7 9 , L u r i e r e c e i v e d a report f r o m Guinn, IMIC's managing d i r e c t o r , to t h e e f f e c t t h a t IMIC's assets a t t h a t t i m e w e r e $782 m i l l i o n and its n e t worth a p p r o x i m a t e l y $398 m i l l i o n , a n i n c r e a s e i n n e t w o r t h o f o v e r 1200% i n t h r e e months. On J a n u a r y 4 , 1 9 8 0 , M a r s h i n f o r m e d t h e corporate c r e d i t d e p a r t m e n t t h a t as o f December 3 1 , 1 9 7 9 , IMIC's assets w e r e $ 1 . 7 2 b i l l i o n a n d i t s n e t w o r t h $ 1 . 4 1 b i l l i o n , a n i n c r e a s e i n n e t w o r t h o f a b o u t a n a d d i t i o n a l 3400% i n t w o months. A l t h o u g h IMIC, b y y e a r e n d , h a d become o n

126/ T h i s r e p r e s e n t a t i o n was e f f e c t i v e l y f u l l f i l l o d , alt h o u g h IMIC d i d e x e c u t e a s m a l l t r a n s a c t i o n t h r o u g h another firm. Merrill l e a r n e d t h e i d e n t i t i e s o f I M I C ' s S a u d i i n v e s t o r s and its o w n e r s h i p s t r u c t u r e w i t h i n t h e Hunt f a m i l y h o l d i n g s when i t r e c e i v e d f r o m t h e H u n t s a c o p y o f a S e p t e m b e r 1 9 7 9 l e t t e r t o t h e CFTC d e t a i l i n g t h a t information.

127 -1

p a p e r , a $ 1 . 4 b i l l i o n company, s u b s t a n t i a l l y a l l o f i t s a s s e t s were c o n c e n t r a t e d i n s i l v e r b u l l i o n o r i n c a s h o r c a s h e q u i v a l e n t s a t t r i b u t a b l e t o money r e c e i v e d a s p o s i t i v e v a r i a t i o n on s i l v e r f u t u r e s p o s i t i o n s . A c c o r d i n g t o t h e t e s t i m o n y o f M e r r i l l Lynch w i t n e s s e s a n d t h e c o n t e n t s o f c o n t e m p o r a n e o u s memoranda, t h e f i r m was aware b o t h t h a t t h e r a p i d growth i n I M I C ' s r e p o r t e d n e t worth w a s a t t r i b u t a b l e p r i m a r i l y to t h e extreme apprec i a t i o n i n t h e v a l u e o f its s i l v e r h o l d i n g s and t h a t IMIC w a s withdrawing c e r t a i n of t h e a p p r e c i a t i o n from its s i l v e r f u t u r e s h o l d i n g s a n d u s i n g t h e s e f u n d s t o make down-payments o n l o a n s i t o b t a i n e d t o f i n a n c e p h y s i c a l s i l v e r purchases. I n a p o l i c y similar t o Bache H a l s e y ' s t r e a t m e n t o f t h e H u d d l e s t o n a c c o u n t , Merrill, n e v e r t h e l e s s , l o o k e d t o t h e i n c r e a s e s i n r e p o r t e d n e t w o r t h as s u p p o r t f o r its d e c i s i o n t o l e n d t o IMIC a g a i n s t warehouse r e c e i p t s . Although I M I C ' s f u t u r e s t r a d i n g w a s conducted through Merrill L y n c h , t h e f i r m w a s aware t h a t I M I C w a s b o r r o w i n g from o t h e r l e n d e r s a g a i n s t c e r t a i n o f t h e s i l v e r warehouse r e c e i p t s it acquired i n d e l i v e r i e s on f u t u r e s p o s i t i o n s a t the firm. A s e a r l y a s O c t o b e r 11, 1 9 7 9 , i n t e r n a l c o r p o r a t e c r e d i t d e p a r t m e n t memoranda r e f l e c t e d t r a n s f e r o f 1 , 3 4 4 w a r e h o u s e r e c e i p t s t o S w i s s Bank C o r p o r a t i o n i n N e w York C i t y a p p a r e n t l y t o c o l l a t e r a l i z e l o a n s . I n addit i o n , i n mid-November 1 9 7 9 , t h e A l - S a u d i Bank a p p r o a c h e d Merrill Lynch I n t e r n a t i o n a l ( " M L I " ) , a s u b s i d i a r y o f M & Co., r e q u e s t i n g its p a r t i c i p a t i o n i n a $50 m i l l i o n L s i l v e r - c o l l a t e r a l i z e d loan t o IMIC. MLI d e c l i n e d t o p a r t i c i p a t e i n t h e l o a n b e c a u s e o f Merrill L y n c h ' s 128/ p r e - e x i s t i n g $50 m i l l i o n i n l e n d i n g t o IMIC. Merrill Lynch w i t n e s s e s t e s t i f i e d t h a t t h e y r e m a i n e d "comfortable" with t h e IMIC account during t h i s period. They u n i f o r m l y t e s t i f i e d t h a t t h e y b e l i e v e d t h a t t h e l o a n w a s a d e q u a t e l y c o l l a t e r a l i z e d and t h a t H e r b e r t and Bunker Hunt s t o o d behind t h e IMIC a c c o u n t . C e r t a i n Merrill Lynch w i t n e s s e s s t a t e d t h a t H e r b e r t Hunt had o r a l l y r e p r e s e n t e d t h a t t o b e t h e case i n t h e A u g u s t 1 9 7 9 D a l l a s m e e t i n g b e t w e e n t h e H u n t s a n d s e n i o r M e r r i l l Lynch p e r s o n n e l . M e r r i l l Lynch p r e s i d e n t W i l l i a m S c h r e y e r t e s t i f i e d t h a t 128/ - T h e d e c i s i o n by MLI t o d e c l i n e p a r t i c i p a t i o n i n t h e l o a n p r o p o s a l d e s c r i b e d i n t h e t e x t w a s made i n c o n s u l t a t i o n w i t h t h e corporate c r e d i t d e p a r t m e n t a t M e r r i l l Lynch. L u r i e t e s t i f e d t h a t h e t o l d MLI t h a t i t w a s b e t t e r t o k e e p I M I C ' s f i n a n c i n g w i t h i n o n e Merrill Lynch o r g a n i z a t i o n r a t h e r t h a n h a v i n g " t w o e n t i t i e s w i t h i n t h e Merrill Lynch u m b r e l l a l e n d i n g t o t h e same c u s t o m e r . "

p e r s o n n e l a t Merrill L y n c h " l e t t h e H u n t s know t h a t w e c o n s i d e r e d IMIC t h e Hunts, t h a t was o u r u n d e r s t a n d i n g . " T h e r e were, h o w e v e r , n o w r i t t e n g u a r a n t e e s r u n n i n g f r o m Moreover, c o r p o r a t e c r e d i t H u n t f a m i l y members t o I M I C . d e p a r t m e n t memoranda r e q u e s t i n g t r a d i n g l i n e s a n d l e n d i n g ' i n d i c a t e d t h a t t h e I M I C a c c o u n t was t o b e t r e a t e d i n d e p e n d e n t l y o f t h o s e o f i n d i v i d u a l H u n t f a m i l y members and r e l a t e d e n t i t i e s . F u r t h e r , as d i s c u s s e d later i n t h i s r e p o r t , when t h e f i r m a s k e d H e r b e r t a n d B u n k e r H u n t to guarantee t h e IMIC account i n writing, t h e i r attorneys i n i t i a l l y r e s i s t e d M e r r i l l ' s e f f o r t s t o h a v e t h e m d o so.
3.

I n f o r m a t i o n About t h e Hunts O t h e r Than I M I C

Memoranda d a t e d J u l y 2 1 , 1 9 7 6 , a n d J u n e 2 0 , 1 9 7 7 , i n commodity c r e d i t d e p a r t m e n t f i l e s c o n c e r n i n g t h e Hunts i n d i c a t e t h a t t h e c o r p o r a t e c r e d i t d e p a r t m e n t had been asked n o t to perform its normal c r e d i t i n v e s t i g a t i o n i n t o t h e Hunt f a m i l y a c c o u n t s and t h a t t h e e f f o r t s t h e f i r m h a d made t o " i n d e p e n d e n t l y s u b s t a n t i a t e t h e f i n a n c i a l s t r u c t u r e o f t h e Hunt f a m i l y " had " c a u s e d c e r t a i n u n f a v o r 129/ The c r e d i t a b l e r e a c t i o n s on t h e p a r t o f t h e f a m i l y . " f i l e s c o n t a i n e d no f i n a n c i a l s t a t e m e n t s or o t h e r author i t a t i v e i n d i c a t i o n s , such as bank s t a t e m e n t s or sched u l e s o f i n d e b t e d n e s s , of t h e n e t w o r t h o r l i q u i d r e s o u r c e s o f t h e Hunts. While t h e r e is documentation r e f l e c t i n g Merrill Lynch i n q u i r i e s c o n c e r n i n g c e r t a i n o f t h e H u n t s a t F i r s t i n Dallas and F i r s t C h i c a g o e a r l y i n 1976, memoranda o f t h o s e c o n v e r s a t i o n s s t a t e o n l y t h a t b a n k e r s c o n f i r m e d t h a t H u n t - r e l a t e d a c c o u n t h o l d e r s had a n e t w o r t h i n e x c e s s o f $5 m i l l i o n . In other instances, c r e d i t d e p a r t m e n t memoranda r e c i t e t h a t b a n k i n g c o n t a c t s were u n w i l l i n g t o d i s c u s s n e t w o r t h f i g u r e s . Credit department r e c o r d s , however, d o r e f l e c t a g e n e r a l b e l i e f on t h e p a r t o f c r e d i t d e p a r t m e n t p e r s o n n e l t h a t t h e Further, H u n t s were p e r s o n s o f " u n q u e s t i o n a b l e " m e a n s . M e r r i l l Lynch w i t n e s s e s a n d a v a i l a b l e r e c o r d s i n d i c a t e t h a t t h e H u n t s had p r o m p t l y m e t s u b s t a n t i a l o b l i g a t i o n s to t h e f i r m i n t h e p a s t . During t h e build-up i n s i l v e r p r i c e s i n 1979 and e a r l y 1 9 8 0 , t h e f i r m r e c e i v e d n o new i n f o r m a t i o n c o n cerning t h e individual Hunts' f i n a n c i a l condition. This f a i l u r e to obtain financial information occurred even though t h e d i r e c t o r s o f t h e f i r m ' s commodity d i v i s i o n and i t s c o r p o r a t e c r e d i t d e p a r t m e n t wrote i n J u n e 1 9 7 9 t h a t "any proposed l i m i t f o r a n i n d i v i d u a l Hunt a c c o u n t s h o u l d 129/ - A s p r e v i o u s l y n o t e d , it is u n c l e a r w h e t h e r t h e i n s t r u c t i o n d e s c r i b e d i n t h e t e x t remained i n e f f e c t i n 1979 and 1980 d u r i n g t h e t i m e I M I C , Hunt H o l d i n g s and H e r b e r t Hunt e s t a b l i s h e d t h e p o s i t i o n s d e s c r i b e d i n t h i s r e p o r t .

b e s u p p o r t e d b y f i n a n c i a l d o c u m e n t a t i o n . " 1 3 0 / Memoranda t o t h e e x e c u t i v e committee c o n c e r n i n g I M I C f u t u r e s t r a d i n g r e q u e s t s and I M I C , Hunt H o l d i n g s and H e r b e r t H u n t ' s borrowing r e q u e s t r e c i t e t h a t t h e Hunts "were a b l e t o handle l a r g e p o s i t i o n s and to answer calls f o r s e v e r a l m i l l i o n d o l l a r s on a n immediate b a s i s , " b u t acknowledged t h a t " t h e e x a c t n e t worth and s p e c i f i c f i n a n c i a l f i g u r e s and l i q u i d i t y o f t h e i n d i v i d u a l s had never been c a l c u lated." I n accordance w i t h custom i n t h e i n d u s t r y , t h e f i r m a p p a r e n t l y d i d n o t c o n t a c t o t h e r b r o k e r - d e a l e r s to a s c e r t a i n w h e t h e r t h e y were a l s o e x t e n d i n g c r e d i t t o t h e Hunts. 131/

4.

I n f o r m a t i o n A v a i l a b l e t o Management Concernina t h e S i l v e r Market

T h e e v i d e n c e r e l a t i n g t o Merrill L y n c h ' s c r e d i t d e c i s i o n s c o n c e r n i n g t h e Hunt a c c o u n t s i n d i c a t e s t h a t t h e e x e c u t i v e committee c o n s i d e r e d t h e v o l a t i l i t y o f t h e s i l v e r m a r k e t , t h e m a g n i t u d e o f Hunt p o s i t i o n s i n r e l a t i o n to t h a t m a r k e t , and t h e p o s s i b i l i t y o f regul a t o r y i n t e r v e n t i o n i n making its d e c i s i o n s . T h i s 130 -/ J o h n Conheeney and Michael L u r i e noted i n t h e i r J u n e 2 7 , 1 9 7 9 , memorandum t o t h e Merrill e x e c u t i v e committee c o n c e r n i n g H e r b e r t H u n t ' s a c c o u n t t h a t f i n a n c i a l docum e n t a t i o n was i m p o r t a n t b e c a u s e , " [ a l s w i t h a n y s i g n i f i c a n t account, we must be a b l e to relate t h e p o s i t i o n l i m i t and t h e exposure i n p r o p o r t i o n to t h e a c c o u n t ' s f i n a n c i a l s t r u c t u r e and r i s k capital."" One r e a s o n f o r M e r r i l l L y n c h ' s r e l u c t a n c e t o i n q u i r e o f o t h e r f i r m s of t h e i r r e l a t i o n s h i p with t h e Hunts w a s b e c a u s e o f Merrill L y n c h ' s r e s p e c t f o r t h e i r c u s tomers' d e s i r e f o r c o n f i d e n t i a l i t y . W i t n e s s e s f o r Merrill Lynch, f o r e x a m p l e , n o t e d t h a t t h e y would n o t r e s p o n d t o i n q u i r i e s of t h i s n a t u r e by o t h e r f i r m s . According to S h e r , a t one meeting o f t h e executive committee d u r i n g l a t e 1 9 7 9 o r e a r l y 1 9 8 0 , ML & Co. c h a i r m a n Donald T. Regan ( " R e g a n " ) , s u g g e s t e d t h a t t h e f i r m " p u s h t h e c o m m o d i t y e x c h a n g e s , t h r o u g h t h e CFTC, to provide information on t h e o v e r a l l p o s i t i o n o f c u s t o m e r s so t h a t f i r m s c o u l d a s s e s s t h e i r c u s t o m e r s ' e x p o s u r e . " A f t e r March 1 9 8 0 S h e r , t h e n a s e n i o r v i c e p r e s i d e n t o f M & Co., d i s c u s s e d Regan's suggestion L w i t h CFTC C o m m i s s i o n e r s Dunn a n d M a r t i n . He described t h e CFTC r e s p o n s e a s " p o l i t e " b u t s t a t e d t h a t h e d i d n o t r e c e i v e much e n c o u r a g e m e n t f r o m t h e CFTC o n t h i s matter. A c c o r d i n g t o Merrill Lynch w i t n e s s e s , t h e n , e x c e p t a s t o I M I C , t h e f i r m was w i t h o u t i n f o r m a t i o n as to t h e magnitude of t h e Hunts' s i l v e r p o s i t i o n s w i t h o t h e r f i r m s u n t i l t h e e v e n i n g o f March 2 6 , 1 9 8 0 .

c o n c e r n is e v i d e n t from t h e o u t s e t w i t h r e g a r d t o t h e IMIC a c c o u n t . I n t h e i r j o i n t A u g u s t 1 5 , 1 9 7 9 , memorandum t o t h e e x e c u t i v e committee, t h e c o m m o d i t y d i v i s i o n a n d t h e corporate c r e d i t department included a d e s c r i p t i o n o f IMIC's t h e n c u r r e n t 4,641 c o n t r a c t s i l v e r p o s i t i o n , c o m p a r e d i t t o t h e o p e n i n t e r e s t o n Comex a n d CBT, a n d r e f l e c t sufconcluded t h a t "current s i l v e r markets f i c i e n t l i q u i d i t y a n d o p e n i n t e r e s t f i g u r e s t o accornmod a t e t h e requested trading l i m i t " of 15,000 contracts. The memorandum a l s o n o t e d t h a t t h e p o s i t i o n i n t h e IMIC a c c o u n t a t t h a t t i m e " h a s n o t made a n a p p r e c i a b l e i m p a c t on t h e Firm's c l e a r i n g p o s i t i o n

. . .

. . ."

A p p r o x i m a t e l y t h r e e w e e k s l a t e r , i n t h e i r memorandum recommending t h a t t h e f i r m l e n d a p p r o x i m a t e l y $ 5 0 m i l l i o n t o IMIC, t h e c o r p o r a t e c r e d i t d e p a r t m e n t a n d t h e commod i t y d i v i s i o n acknowledged t h a t " t h e S i l v e r [ s i c ] m a r k e t s are p r e s e n t l y e x p e r i e n c i n g v i o l e n t and d r a m a t i c p r i c e movements a n d t h e y a r e c u r r e n t l y a t a l l t i m e h i g h s . " The memorandum p o i n t e d o u t t h a t t h e s i l v e r w a r e h o u s e r e c e i p t c o l l a t e r a l f o r t h e IMIC l o a n was u n h e d g e d , b u t o p i n e d t h a t " t h e F i r m c o u l d f u r t h e r p r o t e c t i t s e l f by e s t a b l i s h ing a s h o r t p o s i t i o n i n t h e f u t u r e s market" i n t h e e v e n t of default. Ten d a y s l a t e r , L u r i e o b s e r v e d i n a memorandum t o S h e r d a t e d S e p t e m b e r 1 7 , 1 9 7 9 t h a t " t h e s i l v e r markets continue t o experience extreme p r i c e v o l a t i l i t y He a n d h a v e r e a c h e d new h i g h s o n a l m o s t a d a i l y b a s i s . " noted t h a t a " p r i c e correction" i n t h e s i l v e r market "cannot be p r e c i s e l y measured and c o u l d be extreme". He a l e r t e d Sher to t h e p o s s i b i l i t y t h a t "the v o l a t i l i t y of t h e markets coupled with t h e s i z e of t h e p o s i t i o n s could preclude immediate l i q u i d a t i o n or t h e establishment of hedges t o p r o t e c t t h e p o s i t i o n . " Finally, he noted that "there exists the possibility of regulatory intervention due to the continuing v o l a t i l i t y of t h e market place. "

...

Meanwhile, t h e c o r p o r a t e c r e d i t d e p a r t m e n t and t h e c o m m o d i t y d i v i s i o n m o n i t o r e d t h e p r o p o r t i o n o f Merrill Lynch a n d t h e e x c h a n g e s ' o p e n i n t e r e s t i n s i l v e r r e p r e A s o f September 18, 1979, s e n t e d by t h e Hunt a c c o u n t s . t h e y c a l c u l a t e d t h a t t h e f u t u r e s p o s i t i o n s i n t h e comb i n e d IMIC a n d H u n t f a m i l y a c c o u n t s r e p r e s e n t e d 7 9 . 7 % o f Merrill L y n c h ' s l o n g c u s t o m e r p o s i t i o n i n CBT s i l v e r a n d 6 7 . 1 % o f i t s l o n g c u s t o m e r p o s i t i o n s i n Comex s i l v e r . These p o s i t i o n s , i n t u r n , r e p r e s e n t e d 4.6% o f t h e open i n t e r e s t o n t h e CBT a n d 6 . 4 % o f t h e o p e n i n t e r e s t o n Comex. D u r i n g t h e same p e r i o d , a s e r i e s o f a l e r t n o t i c e s h a d b e e n i s s u e d b y t h e c o m m o d i t y d i v i s i o n a n d t h e corporate c r e d i t department concerning v o l a t i l e conditions i n t h e p r e c i o u s metal m a r k e t s . On O c t o b e r 2 , 1 9 7 9 ,

commodity division director John J. Conheeney and corporate credit department official Paul Carberry drafted a notice to Merrill's branch offices concerning conditions in the precious metals markets. The memorandum noted that "each day debits are incurred from good established accounts as well as from accounts that had realized or opened profits of substantial amounts." The memorandum pointed out that: the debits often have occurred because excess funds were withdrawn from Merrill Lynch or used to pyramid positions without sufficient money in reserve to cover the additional position commitment. Still other debits occurred when maintenance calls, on seemingly reasonable positions properly margined at one point, could not be met by the customer because of one or more additional accounts with other brokers which were also on call. Conheeney and Carberry urged that customers be encouraged to maintain unrealized profits on futures positions with Merrill Lynch and that they be discouraged from pyramid trading strategies. The firm's concern with conditions in the silver market as it related to the Hunt accounts was evident again two weeks after the Conheeney/Carberry memorandum when Lurie submitted to the executive committee the corporate credit department and commodity division's recommendation that the firm make loans to Hunt Holdings secured by silver warehouse receipts. Lurie noted as a factor weighing against the proposal that if both IMIC and Hunt Holdings defaulted on their loans at the same time, "the volatility of the markets, the potential lack of liquidity and the size of the combined positions could preclude immediate liquidation or establishment of hedges to protect the positions." The firm's corporate credit department and the commodity division raised similar concerns again early in January when Herbert Hunt requested a loan against 200 silver warehouse receipts. Lurie transmitted this request to the executive committee without a recommendation, but he did note that if Herbert Hunt, IMIC and Hunt Holdings were all to default on their loans at the same time, Merrill might not be able to liquidate or hedge the positions. He also noted for the committee that Hunt related accounts at the firm comprised 67% of the firm's open long customer silver positions at the

Comex a n d 7 3 % o f t h e f i r m ' s o p e n l o n g c u s t o m e r s i l v e r p o s i t i o n s o n CBT, a n d t h a t t h e p o s i t i o n s r e p r e s e n t e d 7 % and 5.6% r e s p e c t i v e l y , of t h e open i n t e r e s t on t h o s e He a l s o stressed t h a t t h e s i l v e r markets exchanges. were v o l a t i l e a n d t h a t a " p r i c e c o r r e c t i o n " c o u l d e x c e e d t h e p r o t e c t i o n f o r t h e f i r m a f f o r d e d b y t h e terms o f t h e financing.
IV.

THE MARKET BREAK

A.

JANUARY THROUGH MARCH 1 9 8 0

Introduction

A s described elsewhere i n t h i s report, following Comex' i m p o s i t i o n o f p o s i t i o n l i m i t s o n l a r g e t r a d e r s a n d the establishment of a liquidation-only trading r u l e i n s i l v e r on J a n u a r y 21, 1980, t h e m a r k e t p r i c e o f s i l v e r f e l l more t h a n $ 1 0 p e r o u n c e b e f o r e t e m p o r a r i l y s t a b i l i z i n g n e a r $34.60 p e r ounce, t h e p r i c e o f s p o t s i l v e r on J a n u a r y 31. I t resumed i t s s t e e p d e c l i n e i n March, c l o s i n g o n March 27 a t $10.80, $24.50 p e r o u n c e b e l o w t h e p r i c e o n F e b r u a r y 29. On M a r c h 1 3 , 1 9 8 0 , M e r r i l l l e a r n e d t h a t IMIC, f o r t h e f i r s t t i m e , would b e u n a b l e t o meet a m a r g i n c a l l i n i t s a c c o u n t o n t h e c u s t o m a r y 24-hour b a s i s .

M e a n w h i l e , Merrill L y n c h ' s e x p o s u r e t o t h e H u n t s i n 132/ s i l v e r c o n t i n u e d a n d i n c r e a s e d . - E a r l y i n March, t h e e x e c u t i v e committee a p p r o v e d $ 8 6 m i l l i o n i n a d d i t i o n a l f i n a n c i n g f o r H e r b e r t Hunt and e x t e n d e d f o r a n a d d i t i o n a l In 6 0 d a y s t h e o u t s t a n d i n g $ 2 5 m i l l i o n l o a n t o IMIC. a d d i t i o n , t h e f i r m o n March 1 2 , 1 9 8 0 , p a i d a p p r o x i m a t e l y $13 m i l l i o n f o r d e l i v e r y o f 600,000 ounces o f s i l v e r i n IMIC f a i l e d t o reimburse t h e f i r m f o r t h e IMIC a c c o u n t . t h a t e x p e n d i t u r e a s r e q u i r e d when i t b e g a n e x p e r i e n c i n g 132/ I t s h o u l d b e n o t e d t h a t Merrill e x p a n d e d i t s relat i o n s h i p with t h e Hunts d u r i n g t h i s period i n o t h e r a r e a s , as w e l l . P e n r o d D r i l l i n g Company, H u n t E n e r g y C o r p o r a t i o n and E i g h t h C r e s c e n t Investment Co. ( a P l a c i d O i l Co. g u a r a n t e e d s u b s i d i a r y ) e a c h opened new a c c o u n t s w i t h n e t l o n g p o s i t i o n s i n g o l d f u t u r e s . Marsh i n i t i a l l y e s t a b l i s h e d a 50 c o n t r a c t t r a d i n g l i m i t i n e a c h a c c o u n t , a t r a d i n g l e v e l t h a t contemp o r a n e o u s c o r p o r a t e c r e d i t d e p a r t m e n t memoranda i n d i c a t e would n o t n o r m a l l y b e c o n s i d e r e d i n t h e a b s e n c e o f a u d i t e d f i n a n c i a l s t a t e m e n t s , w h i c h were not available to the firm. On March 3 , 1 9 8 0 , w e l l a f t e r t h e t h r e e g o l d a c c o u n t s had e s t a b l i s h e d p o s i tions t h a t internal guidelines required t h a t the e x e c u t i v e committee a p p r o v e , t h e e x e c u t i v e committee r a t i f i e d a $5 m i l l i o n l i n e i n each account. These a c c o u n t s remained i n e q u i t y throughout t h i s p e r i o d .

d i f f i c u l t i e s meeting margin c a l l s on its f u t u r e s p o s i t i o n . By M a r c h 1 4 , t h e s p o t p r i c e o f s i l v e r b e l o w w h i c h I M I C ' s a c c o u n t w i t h t h e f i r m would h a v e l i q u i d a t e d t o a n unsec u r e d d e b i t b a l a n c e , had r i s e n t o $22.31 p e r ounce from its J a n u a r y 3 1 l e v e l o f $18.56. 133/ B. T h e H e r b e r t H u n t a n d IMIC L o a n s I n F e b r u a r y 1 9 8 0 , H e r b e r t H u n t a s k e d t h a t Merrill l e n d him f o r 8 9 d a y s 7 0 % o f t h e v a l u e o f 500 c o n t r a c t s o f Comex s i l v e r o n w h i c h h e i n t e n d e d t o s t a n d f o r d e l i v e r y A t F e b r u a r y 28 p r i c e s , t h e p r o p o s e d l o a n was i n March. for approximately $61 m i l l i o n . A t i t s March 3 m e e t i n g , Shortly t h e e x e c u t i v e committee a p p r o v e d t h e p r o p o s a l . t h e r e a f t e r , Herbert asked t h e firm f o r an additional l o a n o f $ 2 5 m i l l i o n t o b e s e c u r e d by t h e r e m a i n i n g 5 . 5 m i l l i o n o u n c e s o f unencumbered s i l v e r r e m a i n i n g i n h i s account. The c o r p o r a t e c r e d i t d e p a r t m e n t approved t h i s r e q u e s t o n M a r c h 1 2 a n d i t was r a t i f i e d b y t h e e x e c u t i v e committee o n M a r c h 1 7 . I n c o n s i d e r i n g t h e $ 6 1 m i l l i o n l o a n o n March 3 , t h e e x e c u t i v e committee r e c e i v e d a memorandum f r o m L u r i e c o n c e r n i n g b o t h t h e H e r b e r t Hunt l o a n and t h e e x t e n s i o n o f t h e I M I C l o a n t h a t r a i s e d a n u m b e r o f q u e s t i o n s res p e c t i n g t h e Hunts' f i n a n c i a l posture. L u r i e ' s memorandum n e i t h e r c o n t a i n e d n o r r e f e r e n c e d any statements of Herbert Hunt's financial condition. I n f a c t , Lurie described Herbert Hunt's f i n a n c i a l worth as " d i f f i c u l t t o p r e c i s e l y d e f i n e . " Lurie noted t h e p o s i t i o n s H e r b e r t m a i n t a i n e d a t Merrill i n c l u d e d a t l e a s t $73 m i l l i o n i n t r e a s u r y b i l l s and 1352 s i l v e r warehouse 134/ r e c e i p t s worth o v e r $223 m i l l i o n on February 28, 1979. L u r i e also n o t e d t h a t H e r b e r t Hunt "and s e v e r a l r e l a t e d c l i e n t s " had s e c u r i t i e s a c c o u n t s a t t h e f i r m w i t h a n 133/ I t s h o u l d b e r e c a l l e d t h a t r e c o g n i z e d commodity f u t u r e s i n d u s t r y p r a c t i c e is t o v a l u e c u s t o m e r s ' a c c o u n t s u s i n g f u t u r e s prices q u o t e d by e x c h a n g e s even though, i n limit-down t r a d i n g markets, such p r i c e s cannot be r e a l i z e d i n l i q u i d a t i o n . Valued a t f u t u r e s p r i c e s t h e IMIC a c c o u n t o n M a r c h 1 4 w a s $170 m i l l i o n i n e q u i t y .

134/ - L u r i e a d d e d t h a t 2 0 0 o f t h e s e c o n t r a c t s were a l r e a d y f i n a n c e d by t h e f i r m . By t h e t e r m s o f t h a t l o a n , H e r b e r t Hunt was r e q u i r e d to m a i n t a i n 30% m a r g i n , g i v i n g Merrill $ 1 1 . 4 5 p e r o u n c e p r o t e c t i o n f r o m t h e A t t h e t i m e of the meeting, d e l i v e r y price o f $38.17. s i l v e r was a t $ 3 5 . 2 0 .

a g g r e g a t e d e b i t b a l a n c e o f o v e r $162 m i l l i o n . L u r i e obs e r v e d t h a t , i f H e r b e r t ' s f i n a n c i n g r e q u e s t was a p p r o v e d , t h e Firm would b e e x t e n d i n g o v e r $280 m i l l i o n i n c r e d i t t o t h e H u n t s , t h r o u g h b o t h t h e i r s e c u r i t i e s a n d commod i t i e s accounts. E q u i t y i n t h e combined Hunt a c c o u n t s a t F e b r u a r y 29, 1980 was $956 m i l l i o n . L u r i e c a l c u l a t e d t h a t t h e 3 0 % r e q u i r e d b y t h e terms o f t h i s p r o p o s e d H e r b e r t Hunt f i n a n c i n g would p r o t e c t Merrill f r o m a $ 1 0 . 5 0 f a l l i n t h e d e l i v e r y p r i c e o f silver. H e also noted t h a t t h e open i n t e r e s t i n s i l v e r o n b o t h t h e Comex a n d CBT h a d d e c r e a s e d d r a m a t i c a l l y s i n c e l a t e 1979. Lurie observed t h a t i n the event of a d e f a u l t on t h e loan, t h e condition of t h e s i l v e r markets m i g h t n o t a l l o w t h e f i r m t o e s t a b l i s h a s h o r t hedge or t o l i q u i d a t e t h e c o l l a t e r a l i n a t i m e l y or e f f i c i e n t Lurie noted t h a t manner i n o r d e r t o p r o t e c t t h e f i r m . t h e Hunts were a "dominant f a c t o r " i n t h e s i l v e r markets a n d t h a t a d e f a u l t by them c o u l d p r e c i p i t a t e t h e c o l l a p s e i n t h e p r i c e s t r u c t u r e o f t h a t metal. Lurie cited several other negative considerations r e l a t i v e to Herbert's request f o r financing:
1. A s e v e r e " m a r k e t c o r r e c t i o n " c o u l d e x c e e d t h e f i r m ' s a v a i l a b l e margin p r o t e c t i o n ;

2. T h e c o l l a t e r a l s u p p o r t i n g t h e f i n a n c i n g w a s unhedged ; 3 . T h e CFTC a n d t h e e x c h a n g e s were c l o s e l y m o n i t o r i n g t h e H u n t s ' s i l v e r a c t i v i t i e s a n d t h e Wall S t r e e t J o u r n a l had r e p o r t e d a l l e g a t i o n s t h a t t h e Hunts were c o r n e r i n g o r s q u e e z i n g t h e s i l v e r m a r k e t ; 135/ and
4. Although t h i s f i n a n c i n g would h a v e a "minimal e f f e c t " o n t h e f i r m ' s R u l e 15c3-3 r e s e r v e r e q u i r e m e n t s , it would h a v e a g r e a t e r e f f e c t o n t h e

135/ I n c o n n e c t i o n w i t h t h e r e p o r t e d a l l e g a t i o n s d e s c r i b e d i n t h e t e x t , L u r i e e x p r e s s e d h i s v i e w i n t h i s memorandum, a s o t h e r s , t h a t " [ M e r r i l l ] h a s a c t e d i n a m a n n e r c o n s i s t e n t w i t h t h e h i g h e s t s t a n d a r d s w i t h reg a r d t o t h e [Hunt] a c c o u n t s . " H e also n o t e d , however, t h a t "[Merrill] could be s u b j e c t to r e g u l a t o r y r e v i e w and a d v e r s e p u b l i c i t y , i f t h e a l l e g a t i o n s a g a i n s t t h e Hunts are proven."

...

firm's net capital posture. 136/ Herbert Hunt's financing, therefore, "should be with the understanding that the loan may be called if capital requirements from [the firm's] regular securities and commodities operations require additional capital. " Lurie also outlined several positive considerations supporting Herbert's request for over $61 million in 137/ financing : 1. Hunt accounts had always met their obligations to the firm; 2. The financing to Herbert Hunt would produce interest income to the firm of about $1 million 138/ annually. - He also noted that the firm had already earned over $1.8 million in interest from its prior loans to IMIC, Hunt Holdings and Herbert Hunt. 3. Hunt would not withdraw appreciation in the collateral; 4. Hunt would meet maintenance margin calls within 24 hours of issuance; and 5. Commodities commission revenues from the Hunts had been approximately $721,000 in 1979 and had been over $142,000 in January 1980. cing. 136/ Lurie did not explicitly recommend the IMIC finanInstead, he suggested that: Lurie reported that the firm's excess Rule 1 5 ~ 3 - 3 reserve requirements on February 22, 1980 were about $120 million and he calculated that the proposed loan to Herbert Hunt would reduce that figure by less than $1.8 million. He also reported that, under the firm's conservative 8% internal guidelines, which required greater excess capital than SEC "early warning" provisions, the firm's excess net capital on February 22, 1980, was slightly over $33 million and that the proposed financing would reduce that, again pursuant to the firm's 8% guidelines, by about $4.8 million. Considerations similar to these also applied to IMIC's request to extend its $25 million financing. was subject to renewal.

1, 3' 7
-

138/ - Although the financing was to be for 89 days, it

The firm's senior management discuss the future relationship of the firm to the Hunt accounts, including whether to restructure the financing; The firm obtain permission from the Hunts to perform a "due diligence" review of their financial worth; [Elach financing be subject to cross collateralization and default provisions. If one account were to default, [the firm] could call all loans or secure itself with funds in other accounts. The Hunts provide the firm with information regarding the Hunts' commodities activities at other broker-dealer firms

In the March 3 executive committee meeting, Herbert's request for $61 million in financing and IMIC's request to extend its $25 million financing prompted significant discussion. One result of these requests, particularly Herbert's, was a decision by the executive committee to send a representative to Dallas in order to "determine that [the executive committee] was making a good businessman's decision" on the proposals. The executive committee instructed Schreyer, to obtain additional financial information about the Hunts, and specifically, Herbert Hunt. In the meantime however, the executive committee approved IMIC's $25 million request for renewal and Herbert's 139/ $61.6 million loan request. Schreyer selected ML & Co. treasurer, Robert Arnold "Arnold"), to meet with the Hunts and obtain the financial nformation requested by the executive committee. Arnold described his mission as an attempt to obtain audited financial statements for Herbert Hunt and to gather such additional information as could be supplied by the Hunts. Arnold and Schreyer called Herbert Hunt and scheduled a meeting between Arnold and Hunt Energy chief financial officer James Parker ("Parker1') for Friday, March 7, 1980. To prepare for this meeting, Arnold met with various individuals from the corporate credit, investment banking and the firm's finance organizations. In addition to 139/ Schreyer and ML & Co. treasurer Robert Arnold testified that the executive committee conditionally approved Herbert's request for $60 million in financing subject to the receipt by Arnold of this information. The minutes for that meeting do not indicate that any condition was placed on the executive committee's approval of Herbert Hunt's request.

b r i n g i n g A r n o l d u p t o d a t e "n t h e s t a t u s o f t h e H u n t s ' r e l a t i o n s h i p w i t h Merrill, t h e p a r t i c i p a n t s i n t h e s e meetings discussed t h e type o f infocrnation about t h e 3 u n t s t h a t Arnold might s e e k to o b t a i n . These sugcjestions included a n e x h a u s t i v e c h e c k l i s t o f " F i n a n c i a l Data Requirements" f o r a comprehensive f i n a n c i a l examination of t h e H u n t s t h e e x t e n t o f which w e n t w e l l beyond t h e i n s t r u c t i o n s h e h a d b e e n g i v e n by t h e committee. A r n o l d went t o t h e Hunt o f f i c e s i n D a l l a s on t h e Xe s p e n t a p p r o x i m a t e l y f o u r m o r n i n g o f March 7 , 1 9 8 0 . h o u r s t h e r e , s p e a k i n g m o s t l y t o P a r k e r and H e r b e r t H u n t , a l t h o u g h Bunker Hunt j o i n e d t h e g r o u p f o r l u n c h . Out o f t h e m e e t i n g , Arnold l e a r n e d , f o r t h e f i r s t

time s i n c e b e f o r e J u l y 1 9 7 9 , a d d i t i o n a l i n f o r m a t i o n
concerning Herbert's f i n a n c i a l p o s i t i o n o t h e r than a s r e f l e c t e d i n h i s s u b s t a n t i a l h o l d i n g s a t Merrill Lynch. He obtained Herbert's audited financial statement f o r 1978 and h i s unaudited i n t e r i m f i n a n c i a l statement f o r September 30, 1979. H e r b e r t and P a r k e r also g a v e Arnold o t h e r f i n a n c i a l information and explained i n general terms t h e s t r u c t u r e a n d n a t u r e o f t h e H u n t ' s b u s i n e s s operations. Arnold t e s t i f i e d t h a t t h e d i s c u s s i o n gave him "a b e t t e r f e e l f o r how H e r b e r t H u n t [ a n d B u n k e r a n d Lamar H u n t ] f i t i n t o t h e e n t i r e g r o u p o f H u n t c o m p a n i e s " . According to h i s testimony, Arnold focused on t h e Hunts' l i q u i d i t y . H e t e s t i f i e d t h a t H e r b e r t and P a r k e r . a s s u r e d h i m t h a t t h e H u n t ' s b a n k i n g r e l a t i o n s h i p s were a d e q u a t e a n d t h a t t h e i r e x i s t i n g l o a n f a c i l i t i e s were s u f f i c i e n t t o meet a n y l i q u i d i t y p r o b l e m s w h i c h m i g h t c o n f r o n t them. Although, according to Arnold, he asked f o r information concerning any contingencies not r e f l e c t e d on t h e b a l a n c e s h e e t , he remained unaware o f t h e $434 m i l l i o n i n s t a l l m e n t o n t h e E n g e l h a r d t r a n s a c t i o n coming d u e o n March 3 1 . A l t h o u g h Arnold t e s t i f i e d t h a t h e f e l t H e r b e r t was very s t r a i g h t f o r w a r d about t h e Hunts' banking r e l a t i o n s h i p a n d t h e i r l i q u i d i t y , h e a p p a r e n t l y d i d h a v e some c o n c e r n s . He t e s t i f i e d , f o r i n s t a n c e , t h a t he questioned t h e Hunts' method f o r f o r e c a s t i n g t h e i r f u t u r e l i q u i d i t y n e e d s and t h a t h e was c o n c e r n e d a b o u t t h e H u n t s ' u n d e r s t a n d i n g o f t h e development and m a i n t e n a n c e o f i n t e r n a t i o n a l b a n k i n g relationships. W h i l e A r n o l d knew t h a t Merrill was aware o f c e r t a i n Hunt b a n k i n g r e l a t i o n s h i p s , h e d i d n o t a s k f o r , nor d i d he r e c e i v e , a list of t h e s p e c i f i c banks or b r o k e r - d e a l e r s w i t h which t h e Hunts d i d b u s i n e s s . - H e 140/ d i d s a y h e was t o l d t h a t t h e l i q u i d i t y o f v a r i o u s H u n t 140/ Arnold had l e a r n e d o f t h e e x i s t e n c e o f l i n e s o f c r e d i t e x t e n d e d by S w i s s Bank C o r p o r a t i o n a n d F i r s t i n D a l l a s , a l t h o u g h h e d i d n o t l e a r n t o w h i c h Hunt i n d i v i d u a l o r e n t i t y t h e l i n e o f c r e d i t had b e e n e x t e n d e d .

family members could be enhanced by infusions of funds from Hunt trusts and the corporations those trust controlled. Arnold testified that Herbert explained this source of funds was limited by the estate and tax considerations guiding the trusts. He received no projections of funds available to individual Hunts from those trusts. Ultimately, according to his testimony, Arnold concluded that the Hunt's banking relationship problems, "if any", were manageable at that time and that the Hunts' liquidity situation did not threaten Nerrill Lynch's loans to Herbert Hunt. At lunch Bunker Hunt explained why he considered silver a good investment. Later, after Bunker had left, Herbert mentioned that although he expected to accept some additional silver deliveries on his domestic futures positions, he would not be accepting delivery on silver contracts in the same volume as he had done in the past. During the week of March 9 , 1980, Arnold discussed his Dallas meeting with various members of ML & Co. senior management, although apparently not at a formal meeting of the executive committee. C. Hunt Accounts on the Eve of Crisis During the first two weeks of March 1980, silver resumed its decline from January highs. - By March 14, 141/ 1980, Merrill Lynch's exposure in the Hunt accounts had increased significantly since January 31. On March 14, Hunt and IMIC accounts as a group held silver bullion and contracts for the future or forward receipt of silver aggregating 36 million ounces. Combined equity in these accounts at spot prices totaled $369 million. Of the assets in these accounts, $436 million, or 44%, was unrealized appreciation in future and forward silver positions and the market value of bullion positions. The firm's exposure was such that, assuming the value of the other assets in the accounts remained the same, that there was no reduction in the position and that the Hunts deposited no other assets, a decline in spot silver prices to $10.80 would have 142/ carried the accounts as a group into deficit. 141/ From February 29 through March 14, spot silver prices declined in value 41% from $35.30 per ounce to $21.00 per ounce.

142/ Interestingly, $10.80 is precisely the decline that in fact occurred from March 14 through March 27. As noted later in this report, however, additional assets deposited by the Hunts with the firm maintained the accounts, taken as a group, in equity.

The exposure to Merrill Lynch from the IMIC account alone on March 14 was substantial. The account carried silver positions aggregating 25 million ounces. Although the account remained $170 million in equity computed at futures prices (in accord with recognized industry practice), if computed at spot prices the account on March 14 would have liquidated to an unsecured debit balance of $34 million. Even at futures prices, then substantially higher than spot because of exchange-imposed price-movement limitations, the firm's exposure in the IMIC account was such that a $9.00 decline in futures prices, to approximately $23.00, would produce unsecured debit balances in the IMIC account. IMIC, meanwhile, had told Merrill it was having difficulty obtaining funds to meet margin calls. Moreover, the firm had also paid approximately $12 million for delivery in IMIC's account of 600,000 ounces of London silver. IMIC failed to deposit this amount with the firm. Merrill Lynch thus effectively lent an additional $12 million to IMIC.
V.

THE CRISIS PERIOD AT MERRILL LYNCH MARCH 14 THROUGH APRIL 1, 1980 A. Introduction and Overview

On March 11, 1980, Merrill issued a margin call to IMIC for $45 million as a result of market decline in the company's domestic silver futures positions on March 10. Bob Guinn, IMIC's managing director, told Marsh on March 12 that IMIC would not meet the call within its accustomed 24 hour period because it was having trouble 143/ transferring funds from a foreign bank. - On that day, the IMIC account generated an additional margin call of $44 million. Over the ensuing ten business days, according to Merrill Lynch witnesses, the firm continued to receive assurances from Guinn that cash would arrive in satisfaction of the calls. Merrill did not sell out the account as IMIC continued in its failure to meet the calls. On March 18, it began to treat excess bullion in IMIC's loan account as collateral for the calls. On March 21, IMIC offered as further collateral for its outstanding obligations options on bags of silver coins stored with various banks ("coin options") and, on March 27, leases covering silver bullion rented to industrial users ("leased silver" )

143/ - According to Arnold, he was told that IMIC's silver

had been mistakenly commingled with Bunker and Herbert Hunt's silver and thus IMIC's silver could not be used to collateralize a loan that would have enabled IMIC to meet the calls. The Hunts claimed that the banks had created the problem and Arnold contacted Swiss Bank Corporation which confirmed the Hunts' representation.

I n a d d i t i o n , $9.2 m i l l i o n o f a c a l l f o r $26.1 m l l l i o n g e n e r a t e d i n Bunker H u n t ' s a c c o u n t o n March 1 3 r e m a i n e d unanswered d u r i n g m o s t o f t h i s p e r i o d , a l t h o u g h Bunker had s u b s t a n t i a l e x c e s s e q u i t y w i t h t h e f i r m i n a s e c u r i t i e s a c c o u n t h e h e l d a s t e n a n t i n common w i t h H e r b e r t . Bunker f i n a l l y m e t t h e c a l l o n March 2 6 , 1 9 8 0 , u s i n g t h e p r o c e e d s o f a l o a n f r o m Merrill Lynch c o l l a t e r a l i z e d by s e c u r i t i e s o f f o r e i g n mining companies and o f Gulf Resources and C h e m i c a l Co. Meanwhile, i f v a l u e d a t spot prices t h e I M I C a c c o u n t would h a v e been r e c o g n i z e d t o h a v e d e v e l o p e d a n u n s e c u r e d d e b i t balance. On M a r c h 1 4 , 1 9 8 0 , s p o t s i l v e r c l o s e d a t $ 2 1 . 0 0 per o u n c e , a p p r o x i m a t e l y $ 1 . 4 0 p e r o u n c e b e l o w t h e p r i c e a t w h i c h d e b i t b a l a n c e s i n t h e IMIC a c c o u n t s The exceeded t h e assets it had d e p o s i t e d w i t h t h e f i r m . n e x t b u s i n e s s d a y , March 1 7 , s i l v e r c l o s e d a t $ 1 7 . 4 0 , a n d u n s e c u r e d d e b i t b a l a n c e i n t h e I M I C a c c o u n t i f computed a t s p o t p r i c e s r e a c h e d $ 1 5 5 m i l l i o n . - However, b e c a u s e 144/ t h e f i r m computed t h e v a l u e o f t h e a c c o u n t s , c o n s i s t e n t w i t h i n d u s t r y p r a c t i c e a c q u i e s c e d i n by r e g u l a t o r s , a t f u t u r e s p r i c e s , t h e n $13.29 p e r ounce above s p o t p r i c e s , Merrill L y n c h d i d n o t r e c o g n i z e t h e u n s e c u r e d d e b i t b a l a n c e s t h a t would h a v e been produced i n a l i q u i d a t i o n of the accounts. T h e s p o t m a r k e t moved u p s l i g h t l y f r o m t h e 1 8 t h through t h e 2 1 s t and reduced t h e unsecured d e b i t balance 145/ i n t h e a c c o u n t c o m p u t e d a t t h o s e p r i c e s . - On M a r c h 2 1 , Merrill r e c e i v e d t h e i n i t i a l d o c u m e n t a t i o n a s s e r t i n g t h a t IMIC a s s i g n e d t o M e r r i l l I M I C ' s i n t e r e s t i n t h e c o i n 146/ options. 144/ 145/ O t h e r Hunt r e l a t e d a c c o u n t s w i t h t h e f i r m c o n t i n u e d t o carry substantial equity. F u t u r e s p r i c e s , h o w e v e r , c o n t i n u e d m o v i n g l i m i t down.

146/ - I t was n o t u n t i l March 2 8 , a f t e r it had begun r e c e i v i n g confirmation from c u s t o d i a n banks o f t h e e f f e c t i v e n e s s o f t h e a s s i g n m e n t , t h a t Merrill g a v e v a l u e , f o r i n t e r n a l p u r p o s e s a n d i n d e t e r m i n i n g t h e e q u i t y or d e f i c i t p o s i t i o n o f t h e a c c o u n t s i n its n e t c a p i t a l c o m p u t a t i o n s , to 3.9 m i l l i o n of t h e seven m i l l i o n ounces of s i l v e r underlying the coin options. T h i s produced a d d i t i o n a l e q u i t y o f $46.8 m i l l i o n i n t h e a c c o u n t a t p r i c e s t h e n prevailing. I n view of t h e earlier d a t e of t h e assignment, i n a s s e s s i n g t h e f i r m ' s exposure t h e s t a f f has c r e d i t e d Merrill w i t h t h e e n t i r e s e v e n m i l l i o n o u n c e s o f c o i n o p t i o n c o l l a t e r a l a s o f March 21. A s noted below, however, f o r n e t c a p i t a l p u r p o s e s s u f f i c i e n t u n c e r t a i n t y remained a s t o Merrill's c o n t r o l o f t h e s e assets t h r o u g h M a r c h 2 7 , s u c h t h a t t h e s e v a l u e s were n o t a l l o w a b l e f o r n e t c a p i t a l p u r p o s e s a n d Merrill d i d n o t so t r e a t t h e m . N o a d j u s t m e n t h a s b e e n made f o r t h e $ 8 m i l l i o n r e q u i r e d to exercise the options.

On Monday, March 2 4 , t h e m a r k e t p r i c e o f s i l v e r resumed i t s d e c l i n e . A t t h e close on ilarch 2 5 , w i t h s p o t s i l v e r a t $20.20, t h e d e b i t balance i n t h e I M I C a c c o u n t s c o m p u t e d a t t h a t p r i c e was $ 6 5 . 4 m i l l i o n . The March 2 5 d e b i t b a l a n c e w a s , h o w e v e r , a p p a r e n t l y s e c u r e d by t h e s e v e n m i l l i o n o u n c e s o f c o i n o p t i o n c o l l a t e r a l which had a v a l u e o f $141 m i l l i o n a t s p o t p r i c e s . On March 2 6 , a f t e r a $ 4 . 4 0 d e c l i n e i n s p o t s i l v e r , t h e IMIC a c c o u n t v a l u e d a t s p o t p r i c e s c a r r i e d a d e b i t b a l a n c e o f $183 m i l l i o n . Again, h o w e v e r , t h i s a m o u n t w a s a p p a r e n t l y c o l l a t e r a l i z e d by t h e s e v e n m i l l i o n ounces o f c o i n o p t i o n c o l l a t e r a l and a n a d d i t i o n a l f i v e m i l l i o n ounces of bullion t h a t t h e f i r m o b t a i n e d f r o m IMIC t h a t d a y . A t t h e close o n March 2 6 , t h e r e f o r e , t h e IMIC account appeared to be approximately $7 m i l l i o n i n equity. T h a t n i g h t , a t t h e D r a k e Hotel i n N e w Y o r k C i t y , H e r b e r t Hunt t o l d Merrill, B a c h e a n d ACLI - t h a t t h e 147/ H u n t s h a d n o more c a s h or c o l l a t e r a l t o p o s t i n s a t i s f a c t i o n o f m a r g i n c a l l s . The n e x t d a y , March 2 7 , s i l v e r f e l l a n o t h e r $5 p e r o u n c e t o close a t $ 1 0 . 8 0 . At t h a t p r i c e , t h e I M I C a c c o u n t would h a v e l i q u i d a t e d a t t h e s p o t p r i c e of s i l v e r to a s u b s t a n t i a l unsecured d e b i t balance even a f t e r a p p l i c a t i o n of t h e value o f t h e c o i n o p t i o n a n d b u l l i o n IMIC h a d p l e d g e d o n March 2 1 a n d 2 6 a s w e l l a s t h r e e m i l l i o n o u n c e s o f l e a s e d s i l v e r t h a t IMIC p l e d g e d o n March 27. O t h e r H u n t f a m i l y a c c o u n t s a t Merrill, h o w e v e r , r e m a i n e d w i t h more t h a n s u f f i c i e n t e q u i t y t o o f f s e t t h e d e b i t b a l a n c e i n t h e IMIC a c c o u n t . Once a g a i n , Merrill Lynch d i d n o t r e c o g n i z e t h e d e b i t balance i n t h e IMIC account because, c o n s i s t e n t with r e c o g n i z e d i n d u s t r y p r a c t i c e , i t computed t h e v a l u e o f t h e f u t u r e s p o s i t i o n s i n IMIC's a c c o u n t on t h e b a s i s o f f u t u r e s p r i c e s r a t h e r t h a n t h e much lower s p o t p r i c e . A t futures prices, t h e n a v e r a g i n g more t h a n $ 1 3 h i g h e r t h a n s p o t p r i c e s , t h e I M I C a c c o u n t was a p p r o x i m a t e l y $ 7 6 m i l l i o n i n e q u i t y o n March 2 7 , g i v i n g v a l u e a t s p o t p r i c e s t o t h e c o i n o p t i o n , b u l l i o n and l e a s e d s i l v e r collateral. 148/ 147/ - ACLI I n t e r n a t i o n a l I n c . is a commodity m e r c h a n t f i r m d e a l i n g as p r i n c i p a l i n a wide range of commodities. On March 2 6 , 1 9 8 0 , ACLI h a d o u t s t a n d i n g t o t h e H u n t s a p p r o x i m a t e l y $ 1 1 0 m i l l i o n i n l o a n s s e c u r e d by s i l v e r bullion. 148/ A s d e s c r i b e d more f u l l y b e l o w , o n March 2 7 t h e c o i n

o p t i o n s a n d l e a s e d s i l v e r were n o t a l l o w a b l e a s c o l l a teral f o r n e t capital p u r p o s e s because o f u n c e r t a i n t i e s c o n c e r n i n g t h e d e g r e e o f Merrill's c o n t r o l o f t h o s e a s s e t s , a n d Merrill d i d n o t t r e a t them a s s u c h . A t f u t u r e s p r i c e s t h a t d a y , t h e r e f o r e , t h e f i r m had p o t e n t i a l n e t c a p i t a l exposure of approximately $32 m i l l i o n .

I n d i v i d u a l H u n t f a m i l y members a n d r e l a t e d e n t i t i e s , o t h e r t h a n B u n k e r Hunt a n d I M I C , c o n t i n u e d t o remit c a s h o r m a i n t a i n a d e q u a t e assets i n r e l a t e d a c c o u n t s to s a t i s f y margin c a l l s on r e l a t i v e l y modest n e t l o n g s i l v e r f u t u r e s positions. Herbert H u n t and H u n t H o l d i n g s c o n t i n u e d t o m a i n t a i n r e q u i r e d c o l l a t e r a l i z a t i o n r a t i o s on t h e i r l o a n s . T h e s e a c c o u n t s a s a g r o u p and i n d i v i d u a l l y r e m a i n e d i n e q u i t y , b o t h a t f u t u r e s and a t s p o t prices, t h o u g h o u t t h e crisis p e r i o d . On March 2 7 Hunt f a m i l y a c c o u n t s were $136 m i l l i o n i n e q u i t y , $14 m i l l i o n less t h a n n e c e s s a r y to f u l l y o f f s e t unsecured d e b i t balances i n t h e IMIC a c c o u n t computed a t t h e s p o t p r i c e s . P l a c i d O i l and o t h e r Hunt r e l a t e d e n t i t i e s ' a c c o u n t s h e l d a n a d d i t i o n a l $73 m i l l i o n i n equity.
I t w i l l b e r e c a l l e d , however, t h a t t h e Hunt f a m i l y had n o t g u a r a n t e e d i n w r i t i n g t h e I M I C a c c o u n t n o r a u t h o r i z e d t h e f i r m t o e x e c u t e o n f a m i l y assets to s a t i s f y IMIC's obligations. Merrill p e r s o n n e l s o u g h t s u c h a w r i t t e n guarantee o f t h e IMIC account hoping to use e x c e s s e q u i t y i n Hunt f a m i l y a c c o u n t s t o o f f s e t a n t i c i I n Merrillls f i r s t pated d e f i c i t s i n I M I C ' s positions. a t t e m p t o n t h e a f t e r n o o n o f March 2 7 , H ~ n t ~ a t t o r n e y s r e s i s t e d t h e s e e f f o r t s and t h e I M I C a c c o u n t s c o n t i n u e d t h r o u g h March 3 1 t o c a r r y u n s e c u r e d d e b i t b a l a n c e s i f liquidated a t spot prices. On T u e s d a y , A p r i l 1, 1 9 8 0 , h o w e v e r , S c h r e y e r a n d o t h e r s e n i o r Merrill Lynch o f f i cials met. w i t h t h e Hunts i n D a l l a s i n a n e f f o r t to o b t a i n a w r i t t e n cross-guarantee of , t h e IMIC account. Merrill s e c u r e d a n a g r e e m e n t , l a t e r acknowledged by H e r b e r t Hunt i n a n o t h e r agreement to be a p e r s o n a l g u a r a n t e e , t h a t it c o u l d " t r e a t [ t h e Bunker and H e r b e r t H u n t ' s 1 i n d i v i d u a l a c c o u n t s i n a -manner ( o t h e r t h a n by s a l e ) which [ p e r m i t t e d t h e f i r m ] to u s e a n y and a l l e q u i t i e s , s e c u r i t i e s o r other collateral as capital f o r r e g u l a t o r y p u r p o s e s . " [Emphasis added] Bunker and H e r b e r t Hunt also a g r e e d t o r e m i t c a s h t o Merrill to c o v e r a n y c a p i t a l c h a r g e s it w a s nevertheless required to take. A c c o r d i n g t o Merrill Lynch w i t n e s s e s , a f t e r o b t a i n i n g t h i s a g r e e m e n t a n d h a v i n g i t r e v i e w e d b y , t h e CFTC a n d t h e NYSE, t h e f i r m treated t h e IMIC account i n t h e aggregate with o t h e r H u n t a c c o u n t s a n d a c c o r d i n g l y made n o c h a r g e s t o i t s regulatory capitaL f o r d e f i c i t s i n t h e IMIC account.

. .

A s events unfolded i n connection with t h e IMIC a c c o u n t , Merrill c o n t i n u e d d o i n g b u s i n e s s w i t h t h e Hunts on other fronts. On March 2 6 , 1 9 8 0 , t h e f i r m l e n t a t o t a l o f $26 m i l l i o n t o Bunker a n d Herbert Hunt s e c u r e d by a v a r i e t y o f s t o c k s o f South A f r i c a n mining companies The w i t h m a r k e t v a l u e a t t h e t i m e o f o v e r $118 m i l l i o n . Hunts a p p a r e n t l y used t h i s l o a n t o s a t i s f y m a r g i n c a l l s i n t h e i r M e r r i l l Lynch a c c o u n t s . The e x c e s s m a r k e t v a l u e o f t h e s e s e c u r i t i e s o v e r t h e amount l o a n e d i n c r e a s e d t h e e q u i t y i n B u n k e r a n d Herbert H u n t ' s a c c o u n t s w i t h t h e f i r m b y n e a r l y $ 9 3 m i l l i o n . . Me.anwhile, h o w e v e r , t h e CBT

C l e a r i n g C o r p o r a t i o n a s s e s s e d Merrill f o r a $20 m i l l i o n s p e c i a l margin d e p o s i t a s s e c u r i t y f o r its c o n t i n u i n g f u l f i l l m e n t o f its o b l i g a t i o n s to t h e clearinghouse. T h e n e x t m o r n i n g , March 2 7 t h , Merrill b e g a n t o l i q u i d a t e b u l l i o n and f u t u r e s p o s i t i o n s i n t h e I M I C and Hunt a c c o u n t s . By t h e c l o s e o f b u s i n e s s o n F r i d a y , March 2 8 , t h e f i r m had l i q u i d a t e d 9 . 9 m i l l i o n o u n c e s o r 41%, o f I M I C ' s p o s i t i o n w i t h t h e firm. I t became a p p a r e n t o n t h e weekend, however, t h a t c o n t i n u e d l i q u i d a t i o n of positions i n the IMIC account with s i l v e r prices a t t h e l e v e l s t h e n p r e v a i l i n g would, to u s e Conheeney's words, "lock i n a l o s s " . According t o Conheeney, t h e f i r m was c o n c e r n e d a b o u t t h e p o s s i b i l i t y o f l i q u i d a t i n g t o a l o s s b e c a u s e i t was n o t s u r e t h e H u n t s would p a y w h a t t h e y owed. On M a r c h 3 1 , M e r r i l l s u s p e n d e d l i q u i d a t i o n s a t t h e H u n t s ' r e q u e s t p e n d i n g t h e outcome o f i t s e f f o r t s t o o b t a i n t h e c r o s s - g u a r a n t e e t h a t would enable it to a t t r i b u t e to t h e IMIC account excess e q u i t i e s i n t h e Hunts' i n d i v i d u a l accounts. After obtaining t h e Hunts' w r i t t e n consent f o r t h e f i r m to a t t r i b u t e t h e i r individual e q u i t i e s to t h e IMIC a c c o u n t u n d e r c e r t a i n c i r c u m s t a n c e s , Merrill began a program o f g r a d u a l l i q u i d a t i o n o f t h e remaining p o s i tions. On May 2 7 , 1 9 8 0 , P l a c i d I n v e s t m e n t s p u r c h a s e d t h e p h y s i c a l s i l v e r i n t h e I M I C a c c o u n t , and f u l l y p a i d t h e d e b i t balance remaining i n t h e account. B. M e r r i l l ' s A t t e m p t t o O b t a i n Cash and C o l l a t e r a l As e v i d e n t i n t h e f o r e g o i n g d i s c u s s i o n , o n l y t h e I M I C a c c o u n t had p o t e n t i a l losses o f s e r i o u s c o n c e r n t o Merrill. A c c o r d i n g l y , v i r t u a l l y a l l o f t h e f i r m ' s e f f o r t s a p p e a r t o have been d i r e c t e d to f o r e s t a l l i n g losses i n t h a t a c c o u n t . On M a r c h 11, 1 9 8 0 , M e r r i l l i s s u e d a margin c a l l t o I M I C f o r $44.6 m i l l i o n a s a r e s u l t o f m a r k e t d e c l i n e i n t h e company's d o m e s t i c s i l v e r f u t u r e s p o s i t i o n s o n March 1 0 . A f t e r l e a r n i n g from I M I C o n March 1 3 t h a t i t w a s u n a b l e t o meet M e r r i l l ' s March 11 m a r g i n c a l l , M a r s h r e m a i n e d i n c o n t a c t w i t h G u i n n t h r o u g h o u t t h e f o l l o w i n g week. Guinn c o n t i n u e d to t e l l Marsh t h a t c a s h would b e f o r t h c o m i n g a s s o o n a s I M I C r e s o l v e d t h e t e c h n i c a l d i f f i c u l t y w i t h bank collateral t h a t had c r e a t e d t h e problem. Based on t h i s r e p r e s e n t a t i o n , M e r r i l l d i d n o t s e l l o u t t h e I M I C a c c o u n t . Meanw h i l e , c a l l s i n t h e a c c o u n t mounted a s s i l v e r p r i c e s On M a r c h 1 4 a n o t h e r $ 4 4 . 1 m i l l i o n continued to decline. c a l l i s s u e d f o r m a r k e t a c t i o n o n t h e 1 3 t h . On March 1 8 , a d d i t i o n a l c a l l s went o u t f o r $32 m i l l i o n .

On March 18, with no funds having been forthcoming and the earliest outstanding calls aging to the point at which a charge to regulatory capital would have been required, commodity operations head Victor Silano ("Silano"), on advice of counsel, decided to treat the calls as adequately collateralized by allocating to them excess silver bullion in IMIC's "unregulated" commodities account (the account in which Merrill carried IMIC's physical silver positions and the loans they collateralized). On March 18, IMIC's excess bullion collateral was approximately four million ounces valued at approximately $72 million, an amount insufficient as of March 18 to collateralize 149/ all of IMIC's outstanding calls. While Silano was engaged in the effort just described, other Merrill personnel, including Arnold, Conheeney, and Lurie, met throughout the week of March 17 to discuss the IMIC situation. In a March 20 memorandum summarizing 149/ It should be noted that Comex rules acknowledge that exchange members may receive warehouse receipts from customers to satisfy calls, but permit only 75% of the value of the material at spot to be counted. Merrill, however, appears to have utilized 100% of the value of the excess IMIC bullion in determining whether the calls were satisfied. It did so in reliance on advice received from the NYSE, Merrill Lynch's designated regulatory authority, in a conversation on March 19 to the effect that no haircut need be taken for net capital purposes on bullion received in satisfaction of maintenance margin calls. It should also be noted that Merrill could not use this bullion to meet calls to it issued by the clearinghouses, which it had to meet with cash. Merrill thus found itself advancing cash to the clearinghouses, on IMIC's behalf, against IMIC's de silver bullion collateral. In effect, this was a facto loan to IMIC at no interest. By March 18, Merrill had lent IMIC over $37 million, not including the de facto loan described above. This $37 million i n l o a n s t o IMIC was $13 million more than the amount authorized by the executive committee. The additional $13 million came about because at about the time that IMIC missed the March 12 margin call it also failed to pay for delivery of 600,000 ounces of LME silver delivered in IMIC's account against maturing forward positions. Notwithstanding the executive committee's refusal to finance this additional delivery, the debit balance remained in IMIC's unregulated account and Merrill did not sell the silver received in the account when payment was not forthcoming.

Merrill's posture during this period, Arnold recorded that the firm expected to receive from IMIC $60 million in cash or 15 million ounces of silver collateral that day or the next, and an additional 10 million ounces on March 21. Arnold testified that Merrill had been "constantly pressuring" the Hunts for information about the status of the bank facilities that IMIC had told Merrill it would use to meet the calls. With Herbert Hunt's permission, Arnold contacted Swiss Bank Corporation to substantiate that the Hunts were working on obtaining funds. According to Arnold, that bank confirmed the Hunts' story that "technical problems" were preventing an immediate advance of funds. In the first of two meetings on March 20, Herbert Hunt, according to Arnold, assured him that the Hunts "would meet their requirements and that they had collateral and were going to get banking facilities that would be adequate to meet their commitments." Meanwhile, in a meeting on March 17, the executive committee had instructed Arnold to go to London to see what he could do to have Merrill Lynch International Bank ("MLIB") facilitate IMIC's attempts to put bank lines in place. In the second of his March 20 meetings with Herbert Hunt, also attended by Bunker, Lamar and Jim Parker, Arnold broached this subject. The next day, Friday, March 21, 1980, the Hunts agreed to have their employees meet with MLIB personnel in London. On Sunday, March 23, Arnold flew to London in anticipation of meetings between IMIC and MLIB. The next afternoon, Arnold and various MLIB personnel met with Guinn. According to Arnold, Guinn told the Merrill representatives that IMIC had short-term liabilities that did not match its long-term silver bullion holdings and had been requested to post additional silver collateral for bank lines as the price of the metal declined. Accordingly, it had remaining only 10 million ounces of unencumbered silver. Arnold testified that he sought to obtain that silver as collateral for IMIC's unmet margin calls at Merrill, but was not immediately successful. The next day, March 25, the Merrill personnel again met with IMIC representatives. This time Parker and IMIC co-director Mohammed Affara ("Affara") joined Guinn. Guinn told the Merrill officials that a $50 million line of credit from Dresdner Bank was finally in place but that IMIC now had remaining only seven million ounces of unencumbered silver bullion. During that evening and into the morning of the 26th, Arnold spoke with Parker, Guinn and Affara and tried to obtain additional collateral for Merrill Lynch from IMIC. The IMIC and Hunt Energy employees countered that the firm was fully collateralized

i n l i g h t o f t h e leases and o p t i o n s I M I C had a s s i g n e d t o i t o n M a r c h 2 1 , 1 9 8 0 , - a n d t h a t t h e y saw n o r e a s o n t o 150/ provide the firm with excess collateral. Arnold argued t h a t t h e p r i c e o f s i l v e r had f a l l e n s u b s t a n t i a l l y from F r i d a y a n d t h a t h e w a n t e d t o make c e r t a i n t h a t t h e f i r m remained f u l l y c o l l a t e r a l i z e d . P a r k e r , Guinn and A f f a r a r e p l i e d t h a t a l t h o u g h I M I C had f i v e m i l l i o n ounces o f u n p l e d g e d s i l v e r a v a i l a b l e i n London, t h e y had p l a n n e d t o u s e t h a t s i l v e r t o s e c u r e b a n k l i n e s a t London b a n k s . T h e y s a i d t h a t if t h e y were s u c c e s s f u l i n t h a t e n d e a v o r , t h e y would b e a b l e t o p r o v i d e Merrill Lynch w i t h c a s h . A r n o l d p e r s i s t e d , h o w e v e r , a n d b y March 2 6 , h e r e c e i v e d from IMIC t h e f i v e m i l l i o n ounces o f c o l l a t e r a l . Arnold a l s o r e c e i v e d f r o m I M I C a c o p y o f a wire f r o m A f f a r a a n d G u i n n t o D r e s d n e r Bank o r d e r i n g $ 4 5 m i l l i o n t o b e d e p o s i t e d i n M e r r i l l ' s a c c o u n t a t t h e Morgan G u a r a n t y b a n k . A r n o l d r e t u r n e d t o N e w Y o r k o n March 26 c a r r y i n g b o t h t h e wire t o D r e s d n e r a n d a wire a u t h o r i z i n g S h a r p s Pixley, b u l l i o n d e a l e r s , to t r a n s f e r f i v e m i l l i o n ounces o f s i l v e r b u l l i o n t o Merrillls a c c o u n t f r e e and clear o f e n c u m b r a n c e s . The f i r m n e v e r r e c e i v e d t h e $ 4 5 m i l l i o n f r o m D r e s d n e r Bank b e c a u s e , a c c o r d i n g t o o n e w i t n e s s , i n view o f t h e e v e n t s i n t h e s i l v e r market Dresdner d e c i d e d o n March 2 7 n o t t o p r o c e s s t h e I M I C r e q u e s t . Merrill Lynch d i d , h o w e v e r , r e t a i n t h e f i v e m i l l i o n ounces o f b u l l i o n collateral Arnold had o b t a i n e d n o t w i t h s t a n d i n g I M I C ' s l a t e r a s s e r t i o n , o n March 2 8 , t h a t A r n o l d h a d a g r e e d t h a t Merrill w o u l d r e r e l e a s e t h a t b u l l i o n i f IMIC needed it elsewhere. 151/ On M a r c h 2 1 , d u r i n g t h e c o u r s e o f t h e n e g o t i a t i o n s j u s t d e s c r i b e d , G u i n n a n d H e r b e r t H u n t g a v e Merrill Lynch counsel documentation a s s e r t i n g an assignment to t h e firm, on I M I C 1 s behalf, of o p t i o n s to purchase a t f a c e value bags of s i l v e r coins containing approximately seven m i l l i o n ounces of s i l v e r . Merrill t o o k n o steps t o 150/ T h e l e a s e s were n o t a c t u a l l y a s s i g n e d t o Merrill L y n c h u n t i l March 2 7 , 1 9 8 0 .

151/ - A r n o l d r e c e i v e d a t e l e g r a m f r o m G u i n n o n March 28 i n which Guinn, r e f e r r i n g t o a n earlier t e l e p h o n e c o n v e r s a t i o n between Arnold and A f f a r a , e x p l a i n e d I M I C 1 s need f o r t h e f i v e m i l l i o n o u n c e s a t S h a r p s P i x l e y . W i t h o u t d i r e c t l y a s k i n g M e r r i l l Lynch t o r e l e a s e t h e s i l v e r b u l l i o n , t h e wire a s s u m e d t h a t Merrill w o u l d r e l e a s e t h e b u l l i o n " a s a g r e e d i n London". Arnold r e p l i e d t o Guinn's telegram, w i t h the assistance of counsel, asserting t h a t "Merrill Lynch n e v e r h a d a n d n e v e r h a s h a d a n y o b l i g a t i o n s t o IMIC as s u g g e s t e d i n [ G u i n n ' s t e l e g r a m ] . " By t h e t i m e A r n o l d s e n t h i s r e s p o n s e t o G u i n n , Merrill Lynch had l i q u i d a t e d m o s t , i f n o t a l l , o f t h e s i l v e r b u l l i o n at issue.

c o n f i r m t h e c o i n o p t i o n a s s i g n m e n t u n t i l March 2 7 . In c o n t a c t i n g t h e v a r i o u s banks holding t h e s i l v e r c o i n s c o v e r e d by t h e o p t i o n s , c o u n s e l l e a r n e d t h a t M o c a t t a M e t a l s , f r o m whom I M I C h a d o b t a i n e d t h e o p t i o n s i n a n O c t o b e r 1 9 7 9 EFP t r a n s a c t i o n , a s s e r t e d t h e r i g h t t o s u b s t i t u t e b u l l i o n f o r c e r t a i n o f t h e c o i n s upon e x e r cise o f c e r t a i n o f t h e o p t i o n s . While t h i s s i t u a t i o n had n o material impact on t h e u l t i m a t e v a l u e o f t h e c o i n s t o Merrill L y n c h , i t d i d p o s e a n o b s t a c l e t o Merrill's immediate l i q u i d a t i o n o f c e r t a i n o f t h e c o i n s . A c c o r d i n g l y , o n March 2 8 , when t h e f i r m f i r s t a s s i g n e d v a l u e t o t h e c o i n o p t i o n collateral i n computing t h e s t a t u s o f t h e I M I C a c c o u n t f o r r e g u l a t o r y p u r p o s e s , it u t i l i z e d o n l y 3.9 m i l l i o n o u n c e s as c o l l a t e r a l . On March 2 7 , m e a n w h i l e G u i n n e x e c u t e d a d o c u m e n t s t a t i n g t h a t i t a s s i g n e d t o Merrill l e a s e s c o v e r i n g a n a d d i t i o n a l t h r e e m i l l i o n ounces of s i l v e r then on l o a n to various industrial users. On March 2 8 , H e r b e r t e x e c u t e d d o c u m e n t s w h i c h a s s e r t e d a g r a n t t o Merrill o f a s e c u r i t y i n t e r e s t i n t h i s same m a t e r i a l . S h o r t l y t h e r e a f t e r , when Merrill s o u g h t t o p e r f e c t i t s i n t e r e s t , C h a s e M a n h a t t a n b a n k a s e s c r o w a g e n t i n f o r m e d M e r r i l l t h a t Mocatta Metals, w h i c h h a d e a r l i e r a s s i g n e d t h e l e a s e s t o IMIC, h a d t o c o n s e n t t o I M I C ' s a s s i g n m e n t t o Merrill. N e g o t i a t i o n s c o n t i n u e d f o r w e e k s a f t e r t h e c r i s i s , o n l y r e a c h i n g res o l u t i o n a f t e r IMIC's d e f i c i t s were p a i d i n c o n n e c t i o n with t h e Placid loan. Merrill d i d n o t v a l u e t h e l e a s e d s i l v e r , w h i c h h a d a v a l u e o n March 2 8 , a t s p o t p r i c e s , o f a p p r o x i m a t e l y $36 m i l l i o n , i n d e t e r m i n i n g t h e s t a t u s o f t h e Hunt a c c o u n t s f o r r e g u l a t o r y c a p i t a l p u r p o s e s . T h e f i v e m i l l i o n o u n c e s o f s i l v e r b u l l i o n Merrill r e c e i v e d f r o m I M I C o n March 2 6 a n d t h e l e a s e a n d o p t i o n assignments j u s t d e s c r i b e d were t h e last d e p o s i t o f cash o r o t h e r a s s e t s Merrill r e c e i v e d f r o m IMIC u n t i l t h e Bunts purchased t h e IMIC account i n connection with t h e Placid loan.
C.

C r i s i s P e r i o d Loans to Bunker

a n d H e r b e r t Hunt Bunker and H e r b e r t Hunt s o u g h t t o o b t a i n f i n a n c i n g t o meet m a r g i n c a l l s o n t h e i r s i l v e r p o s i t i o n s f r o m v a r i o u s b r o k e r - d e a l e r s d u r i n g F e b r u a r y a n d March 1 9 8 0 . 1 5 2 / I n o n e of t h e M a r c h 20 m e e t i n g s w i t h A r n o l d , ~ e r b e r tHUT T h e H u n t s ' e f f o r t s i n F e b r u a r y a n d March t o b o r r o w money t o meet c a l l s i s d e s c r i b e d g e n e r a l l y a t p a g e s 38 t h r o u g h 39 o f t h i s r e p o r t . T h e i r borrowing from Bache and H u t t o n is r e c o u n t e d a t p a g e s 67 t h r o u g h 7 6 and 177 through 179, r e s p e c t i v e l y .

a s k e d t h a t M e r r i l l make l o a n s t o him a n d B u n k e r c o l l a t e r a l i z e d by American d e p o s i t o r y r e c e i p t s f o r s e c u r i t i e s o f v a r i o u s S o u t h A f r i c a n g o l d a n d p l a t i n u m m i n i n g companies. A r n o l d t o l d Hunt t h a t M e r r i l l Lynch management Merrill g o l d s t o c k a n a l y s t s would c o n s i d e r t h e r e q u e s t . r e v i e w e d t h e p r o f f e r e d c o l l a t e r a l a n d v a l u e d i t a t somet h i n g o v e r $100 m i l l i o n . M e r r i l l Lynch a g r e e d t o l e n d up t o 35% o f t h e v a l u e of t h e c o l l a t e r a l a l t h o u g h , as noted b e l o w , t h e l o a n a c t u a l l y made t o t a l l e d $ 2 6 m i l l i o n . On March 2 5 , 1 9 8 0 , t h e H u n t s d e p o s i t e d t h e p o r t f o l i o o f g o l d s t o c k s i n t o a new j o i n t s e c u r i t i e s a c c o u n t e s t a blished f o r t h a t purpose. On March 2 6 , Merrill Lynch Aladvanced t h e H u n t s $26 m i l l i o n o u t o f t h a t a c c o u n t . t h o u g h a c c o u n t d o c u m e n t a t i o n r e f l e c t s p a y m e n t by c h e c k , Bunker H u n t ' s commodities a c c o u n t w i t h t h e f i r m r e f l e c t s a t r a n s f e r of $13 m i l l i o n from a s e c u r i t i e s account i n It appears, s a t i s f a c t i o n of margin c a l l s then outstanding. t h e r e f o r e , t h a t B u n k e r u s e d t h e p r o c e e d s o f t h e March 26 g o l d s t o c k l o a n t o s a t i s f y m a r g i n c a l l s a t Merrill. Two M e r r i l l Lynch w i t n e s s e s , A r n o l d a n d S c h r e y e r , have s u g g e s t e d t h a t t h e f i r m ' s m o t i v a t i o n i n making t h e a d d i t i o n a l l o a n was t o o b t a i n f o r t h e f i r m a d d i t i o n a l c o l l a t e r a l t h e e x c e s s v a l u e o f w h i c h would p r o v i d e a d d e d e q u i t y f o r t h e Hunt a c c o u n t s as a g r o u p . Although t h e terms o f t h e l o a n s u g g e s t t h i s r e s u l t , a t t h a t t i m e M e r r i l l had n o w r i t t e n g u a r a n t e e o f t h e I M I C a c c o u n t . U n t i l A p r i l 1, 1 9 8 0 when B u n k e r a n d H e r b e r t H u n t s i g n e d the w r i t t e n guarantee discussed above, it w a s not c l e a r t o what e x t e n t , i f a t a l l , t h e f i r m c o u l d l o o k t o Bunker and Herbert Hunt's a s s e t s to s a t i s f y d e f i c i t s i n t h e IMIC account.
D.

The P o t e n t i a l F i n a n c i a l I m p l i c a t i o n s of the C r i s i s
1. G e n e r a l l v

A s previously described, t h e IMIC account w a s t h e p r i n c i p a l Hunt a c c o u n t t h a t w a s o f c o n c e r n t o Merrill d u r i n g t h e crisis p e r i o d . The a c c o u n t remained i n e q u i t y on a l l b u t o n e d a y o f t h e crisis p e r i o d i f i t s s i l v e r f u t u r e s p o s i t i o n s are valued a t f u t u r e s p r i c e s i n accord with industry practice. I f v a l u e d a t s p o t p r i c e s , however, t h e a c c o u n t would h a v e e x p e r i e n c e d s u b s t a n t i a l l o s s e s i f l i q u i d a t e d on any b u t one of t h e days during the period. The s t a f f h a s r e v i e w e d M e r r i l l ' s H u n t a c c o u n t s a s o f l a t e March 1 9 8 0 t o a s s e s s t h e i r p o t e n t i a l f i n a n c i a l i m p a c t o n t h e f i r m f r o m t h e s t a n d p o i n t o f b o t h (1) Merrill's c o n t i n u i n g c o m p l i a n c e w i t h t h e n e t c a p i t a l r u l e and ( 2 ) t h e f i n a n c i a l c o n d i t i o n o f M & Co. as a whole. L The s t a f f

r e v i e w n e c e s s a r i l y i n v o l v e s c e r t a i n a s s u m p t i o n s , inasmuch a s t h e s t a b i l i z a t i o n o f s i l v e r p r i c e s a f t e r March 2 7 , t h e Hunts' agreement t o t h e w r i t t e n g u a r a n t e e , and banks' w i l l i n g n e s s to refinance t h e Hunts' o b l i g a t i o n s through t h e P l a c i d l o a n e n a b l e d Merrill t o a v o i d a f o r c e d l i q u i d a t i o n o f t h e e n t i r e I M I C and Hunt f a m i l y p o s i t i o n .
2.

T h e N e t C a p i t -~l A n-y--i s a al- s

The n e t c a p i t a l r u l e r e q u i r e s t h a t b r o k e r - d e a l e r s m a i n t a i n minimum l e v e l s o f l i q u i d a s s e t s i n e x c e s s o f liabilities. These assets must be i n a form t h a t c a n be r e a l i z e d upon i m m e d i a t e l y , u n s e c u r e d c u s t o m e r o b l i g a t i o n s are n o t l i q u i d assets f o r t h e p u r p o s e s o f t h e n e t c a p i t a l r u l e n o r is t h e v a l u e o f a n y c o l l a t e r a l beyond t h a t w h i c h can be obtained i n a n immediate l i q u i d a t i o n . F o r t h e same r e a s o n , accounts must be valued " a t t h e market" to d e t e r mine i f , i n a n immediate l i q u i d a t i o n , a n unsecured customer o b l i g a t i o n would r e s u l t . On M a r c h 2 7 , when t h e s p o t p r i c e s of s i l v e r c l o s e d a t $10.80, t h e IMIC account i n a n immediate l i q u i d a t i o n , e x c l u s i v e o f assets i n o t h e r Hunt a c c o u n t s , would h a v e had a d e b i t b a l a n c e o f $150 m i l l i o n which included t h e v a l u e of c o i n o p t i o n and l e a s e d s i l v e r collateral. 153/
I t is i m p o r t a n t t o emphasize t h a t t h e u n s e c u r e d d e b i t b a l a n c e j u s t d e s c r i b e d is t h a t computed u s i n g t h e s p o t p r i c e of s i l v e r which i n limit-down markets such as t h a t e x i s t i n g d u r i n g t h e c r i s i s was t h e o n l y r e a l i z a b l e v a l u e of the futures position. I n m a r k i n g c u s t o m e r commodity a c c o u n t s t o " m a r k e t " a s r e q u i r e d by t h e n e t c a p i t a l r u l e , however, i n d u s t r y p r a c t i c e h a s been t o use t h e s e t t l e m e n t p r i c e f o r e a c h f u t u r e c o n t r a c t a s q u o t e d by e x c h a n g e s , even though i n a limit-down market such a p r a c t i c e produces a n u n r e a l i s t i c a l l y high "market" value f o r t h e account. Exchanges and t h e t w o r e g u l a t o r y a g e n c i e s concerned have been aware of t h i s p r a c t i c e and have acquiesced i n its continuation. Merrill a n d t h e o t h e r f i v e f i r m s d e s c r i b e d i n t h i s r e p o r t v a l u e d Hunt a c c o u n t s a t f u t u r e s p r i c e s i n accordance with such industry practice. Valued a t f u t u r e s prices, i n accord with the p r a c t i c e j u s t described, t h e I M I C a c c o u n t h e l d a d e b i t b a l a n c e of $32 m i l l i o n r a t h e r t h a n t h e more s u b s t a n t i a l d e b l t b a l a n c e t h a t would h a v e resulted in a liquidation at spot prices.

While Merrill had t h e c o i n o p t i o n and l e a s e d s i l v e r c o l l a t e r a l f o r t h e IMIC a c c o u n t , t h a t c o l l a t e r a l w a s n o t a l l o w a b l e f o r n e t c a p i t a l p u r p o s e s and M e r r i l l d i d n o t 1 5 3 / S e e d i s c u s s i o n a b o v e a t p a g e 1 2 1 , c o n c e r n i n g ML C o . ' s p r e - t a x e a r n i n g s f o r f i s c a l y e a r 1980.

&

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t r e a t i t a s s u c h o n March 2 7 . Merrill had r e c e i v e d documentation of an assignment o f t e n m i l l i o n ounces o f s i l v e r i n t h e form o f o p t i o n s on bags o f s i l v e r c o i n s and a g r e e m e n t s c o v e r i n g leases o f s i l v e r t o u s e r s . On M a r c h 2 7 , Merrill b e g a n t o c o n t a c t c e r t a i n o f t h e b a n k s h o l d i n g t h e c o i n s w h i c h were t h e s u b j e c t o f t h e o p t i o n s t o c o n f i r m t h e I t d i d n o t h a v e w r i t t e n conv a l i d i t y o f t h e assignment. f i r m a t i o n o f v a l i d i t y from t h e s e i n s t i t u t i o n s , however, and u n c e r t a i n t y remained as t o Merrill's c o n t r o l o f t h e s e assets s u c h t h a t none o f t h e i r v a l u e would have been a l l o w a b l e f o r n e t c a p i t a l p u r p o s e s o n March 27. By t h e c l o s e o f b u s i n e s s o n March 2 8 , h o w e v e r , Merrill h a d r e c e i v e d t e l e x or o t h e r confirmation o f t h e c o i n s i l v e r collateral, which it v a l u e d a t t h e s p o t p r i c e i n computing its n e t c a p i t a l as o f t h a t t i m e . I t d i d n o t , however, v a l u e f o r c a p i t a l p u r p o s e s t h e c o i n s i l v e r c o v e r e d by t h e r e m a i n i n g o p t i o n s , i n w h i c h Mocatta Metals C o r p . a s s e r t e d s u b s t i t u t i o n r i g h t s , or t h e s i l v e r t h e n l e a s e d to i n d u s t r i a l u s e r s . In addition, a l t h o u g h H u n t f a m i l y a c c o u n t s a t Merrill h e l d e q u i t y o f $136 m i l l i o n a t March 27, t h e r e w a s n o w r i t t e n g u a r a n t e e o f t h e IMIC a c c o u n t t h e n i n e f f e c t . A c c o r d i n g l y , t h i s amount w a s n o t a l l o w a b l e a s a n o f f s e t a g a i n s t t h e IMIC d e f i c i t f o r n e t c a p i t a l purposes.
V a l u i n g t h e IMIC a c c o u n t s a t f u t u r e s p r i c e s , i n accord a n c e w i t h a c c e p t e d p r a c t i c e s i n t h e i n d u s t r y , Merrill t h e r e f o r e , h a d a maximum n e t c a p i t a l e x p o s u r e o n M a r c h 2 7 a n d 2 8 o f a p p r o x i m a t e l y $ 3 2 m i l l i o n a n d $ 8 . 8 m i l l i o n respectively. Merrill's r e g u l a t o r y n e t c a p i t a l i n e x c e s s o f minimums t h e n p r e s c r i b e d a t t h e b e g i n n i n g o f t h e crisis p e r i o d was $175 m i l l i o n , and a f t e r a $200 m i l l i o n s u b o r d i n a t i o n o f c e r t a i n d e b t e f f e c t i v e March 2 6 , 1 9 8 0 was $360 m i l l i o n . In reliance on t h e provision of the n e t c a p i t a l r u l e as then i n e f f e c t t h a t d i d not r e q u i r e a c h a r g e f o r a l i q u i d a t i n g d e f i c i t u n t i l t h e close o f b u s i n e s s o n t h e second b u s i n e s s d a y a f t e r t h e d e f i c i t was g e n e r a t e d , - h o w e v e r , Merrill d i d n o t c h a r g e t h e $ 8 . 8 154/ 154/ T h e w a i t i n g p e r i o d p r o v i s i o n was i n t e n d e d t o a f f o r d b r o k e r s a n o p p o r t u n i t y to c a l l a customer t h e morning a f t e r a d e f i c i t appeared and g i v e t h e customer a f u l l d a y t o remit f u n d s b e f o r e r e q u i r i n g a c h a r g e t o c a p i t a l . Where a c u s t o m e r h a s a l r e a d y s t a t e d its i n a b i l i t y t o p a y , i t may b e a p p r o p r i a t e f o r a f i r m t o c o n s i d e r a n On M a r c h 2 6 , H e r b e r t immediate charge to c a p i t a l . H u n t h a d t o l d Merrill a n d o t h e r s t h a t n o f u r t h e r c a s h or c o l l a t e r a l would b e f o r t h c o m i n g t o c o v e r m a r g i n calls or d e f i c i t s . F u r t h e r , o n March 2 7 , Hunt a t t o r n e y s had r e s i s t e d Merrill's e f f o r t s t o have H e r b e r t a n d B u n k e r g u a r a n t e e t h e IMIC a c c o u n t i n w r i t i n g . T h u s i t w a s u n c l e a r d u r i n g t h i s p e r i o d w h e t h e r IMIC could cover its d e f i c i t immediately although f o u r days l a t e r Merrill d i d , i n f a c t , o b t a i n t h e a g r e e m e n t d e s c r i b e d a t p a g e s 162-164.

m i l l i o n d e f i c i t a s o f March 28 a g a i n s t t h e n e t c a p i t a l i t r e p o r t e d a g a i n s t i t s a p p r o x i m a t e l y $360 m i l l i o n i n e x c e s s n e t c a p i t a l i n i t s March 28 FOCUS r e p o r t .

I t s h o u l d a l s o b e n o t e d t h a t a c c o r d i n g t o Merrill Lynch p e r s o n n e l , M & C o . h a d a v a i l a b l e a t l e a s t a p p r o x i L mately $1 b i l l i o n i n resources i n the parent corporation and i n o t h e r s u b s i d i a r i e s t h a t i t c o u l d have i n f u s e d i n t o Merrill Lynch i f n e c e s s a r y . The f i r m d i d t a k e c e r t a i n s t e p s t h a t had a n i m p a c t o n i t s n e t c a p i t a l .

3 . The M L

&

Co.

Analysis

The p o t e n t i a l f i n a n c i a l i m p a c t o n M & C o . a s a w h o l e L o f t h e H u n t s ' p o s i t i o n s w i t h M e r r i l l i s more d i f f i c u l t t o assess. I f t h e H u n t s had b e e n u n a b l e t o r e f i n a n c e t h e i r s i l v e r r e l a t e d o b l i g a t i o n s , Merrill may h a v e o f f s e t a g a i n s t t h e I M I C a c c o u n t o t h e r Hunt assets i t h e l d i n t h e f i r m . Whether it would u l t i m a t e l y r e t a i n t h e s e amounts w o u l d , o f c o u r s e , h a v e d e p e n d e d o n w h e t h e r M e r r i l l Lynch obtained t h e Hunts' consent to u t i l i z e t h e i r i n d i v i d u a l h o l d i n g s w i t h t h e f i r m t o o f f s e t I M I C ' s o b l i g a t i o n s or t h e o u t c o m e o f w h a t e v e r l i t i g a t i o n t h e H u n t s may h a v e i n i t i a t e d to d e f e a t such an o f f s e t i n t h e absence of t h e i r consent. I n f a c t , o f c o u r s e , Merrill l a t e r o b tained t h e Hunts' guarantee. I f l i q u i d a t i o n h a d b e e n n e c e s s a r y o n March 2 7 , o n e a n a l y s i s o f Merrill's p o s i t i o n , a s s u m i n g ( 1 ) t h a t Merrill could have r e a l i z e d i n l i q u i d a t i o n t h e f u l l s p o t p r i c e of a l l 10 m i l l i o n ounces of s i l v e r underlying t h e c o i n o p t i o n s and l e a s e s as w e l l as a l l o f t h e p h y s i c a l and f u t u r e s p o s i t i o n s i n t h e a c c o u n t and ( 2 ) t h a t Merrill could have l i q u i d a t e d a l l of its o t h e r Hunt-related a c c o u n t s ( i n c l u d i n g among o t h e r s , i n d i v i d u a l f a m i l y m e m b e r s , H u n t H o l d i n g s , HIRCO, P l a c i d a n d s u b s i d i a r i e s and P e n r o d ) and a p p l i e d t h e p r o c e e d s a g a i n s t t h e I M I C d e f i c i t shows t h a t t h e H u n t s J a c c o u n t s i n c l u d i n g I M I C , would h a v e y i e l d e d a n e q u i t y o f a p p r o x i m a t e l y $ 7 3 million. 155/ 5 -/ t h e d e f i c i t s d i s c u s s e d are t h o s e computed u s i n g t h e s p o t p r i c e o f s i l v e r . As we have observed elsewhere throughout t h i s r e p o r t , i n a limit-down market such as e x i s t e d i n s i l v e r d u r i n g most o f March 1 9 8 0 , s p o t p r i c e s r e p r e s e n t more c l o s e l y t h a n f u t u r e s p r i c e s t h e l i q u i d a t i n g v a l u e o f a commod i t y futures position. I n d u s t r y practice, a c q u i e s c e d
A s noted i n t h e t e x t ,

Footnote continued on n e x t page.

A s d e s c r i b e d more f u l l y e l s e w h e r e i n t h i s r e p o r t , h o w e v e r , a s o f March 2 7 Merrill h a d n o w r i t t e n g u a r a n t e e o f t h e I M I C a c c o u n t by a n y o f t h e H u n t s o r r e l a t e d e n tities. An e s t i m a t e o f t h e s t a t u s o f t h e I M I C a c c o u n t i n a l i q u i d a t i o n a t s p o t p r i c e s o n March 27 t a k i n g i n t o c o n s i d e r a t i o n t h i s u n c e r t a i n t y a s s u m e s (1) t h a t Merrill u l t i m a t e l y could have r e a l i z e d on t h e p h y s i c a l and f u t u r e s s i l v e r p o s i t i o n s a l r e a d y i n I M I C ' s a c c o u n t and o n t h e t e n m i l l i o n ounces o f t h e c o i n o p t i o n and l e a s e d s i l v e r c o l l a t e r a l IMIC had a s s i g n e d , ( 2 ) t h a t t h e e q u i t i e s i n t h e i n d i v i d u a l H u n t s a n d r e l a t e d e n t i t i e s a c c o u n t s were n o t a v a i l a b l e to t h e firm except, perhaps, i n l a t e r n e g o t i a t i o n or l i t i g a t i o n , a n d ( 3 ) t h a t Merrill Lynch management would h a v e t a k e n n o e a r l i e r r e m e d i a l m e a s u r e s had t h e a c c o u n t s been v a l u e d a t s p o t p r i c e s . Based o n t h e s e a s s u m p t i o n s , a n o t h e r s c e n a r i o is t h a t a l i q u i d a t i o n o f t h e I M I C a c c o u n t o n March 27 w o u l d h a v e p r o d u c e d a n u n s e c u r e d d e b i t b a l a n c e o f a p p r o x i m a t e l y $150 m i l l i o n . The f o l l o w i n g t a b l e i l l u s t r a t e s t h e c o n d i t i o n o f t h e I M I C a c c o u n t d u r i n g t h e crisis p e r i o d had it been l i q u i d a t e d a t s p o t prices and compares it t o t h e v a l u e o f t h e a c c o u n t a s r e f l e c t e d i n Merrill's automated bookkeeping system, which valued t h e s i l v e r i n t h e a c c o u n t a t f u t u r e s p r i c e s i n accord with recognized industry p r a c t i c e . The t a b l e a l s o i l l u s t r a t e s t h e v a l u e o f i n d i v i d u a l Hunt and r e l a t e d e n t i t i e s ' accounts.

Footnote continued from p r e v i o u s page. i n by e x c h a n g e s and r e g u l a t o r y a g e n c i e s , is t o v a l u e accounts a t significantly higher futures prices Merrill L y n c h , c o n s i s t e n t under such circumstances. w i t h t h i s p r a c t i c e , v a l u e d t h e IMIC a c c o u n t i n its automated bookkeeping system u s i n g f u t u r e s p r i c e s and computed t h a t i t remained i n e q u i t y t h r o u g h a t l e a s t March 26. In special calculations presenting a r a n g e o f p o t e n t i a l e x p o s u r e p r e p a r e d f o r management h a n d l i n g t h e c r i s i s , h o w e v e r , M e r r i l l Lynch o p e r a t i o n s p e r s o n n e l marked t h e a c c o u n t s t o m a r k e t u s i n g b o t h s p o t and f u t u r e s p r i c e s . Thus, t h e f i r m w a s aware o f t h e p o t e n t i a l f o r s u b s t a n t i a l l y g r e a t e r losses t h a n those r e f l e c t e d i n computerized account documentation.

TABLE VII I - -. ..-- HUNT-RELATED ACCOUNTS W I T H MERRILL LYNCH STATUS DURING . - .SILVER CRISIS -. THE - --

Eauitv (Deficit)
IMIC IMIC

($

Millions) Placid and Subsidiaries

Date
M r 14 a.

-Spot

Futures -

Hunt Family & Directly Owned E n t i t i e s

HIRCO P e n -- --- r d

M r 25 a. 156/

M r 26 a. 157/
M r 27 158/ a. M r 28 a. M r 31 a.

E.

Measures R e l a t i n g t o Merrill's Net Capital Position

D u r i n g t h e c r i s i s p e r i o d Merrill t o o k c e r t a i n s t e p s T h e s e w e r e (1) t h a t had a n impact o n its n e t c a p i t a l . o b t a i n i n g e f f e c t i v e n e s s o f a $200 m i l l i o n s u b o r d i n a t i o n o f a n i n t r a c o r p o r a t e o b l i g a t i o n f r o m M e r r i l l t o M & Co. L and ( 2 ) s e e k i n g t o have Bunker and H e r b e r t Hunt i n d i v i d u a l l y g u a r a n t e e t h e IMIC a c c o u n t . The r e m a i n i n g two p o r t i o n s o f t h i s s e c t i o n o f t h e report w i l l d i s c u s s t h e s e measures.

1 5 6 / On a n d a f t e r M a r c h 2 5 , e q u i t y ( d e f i c i t ) h e r e d e s c r i b e d i n c l u d e s t h e v a l u e , a t spot p r i c e s , o f s e v e n m i l l i o n o u n c e s o f t h e s i l v e r r e p r e s e n t e d by t h e c o i n o p t i o n s a s s i g n e d b y IMIC. 157/ - On a n d a f t e r March 2 6 , e q u i t y ( d e f i c i t ) h e r e d e scribed includes the value, at spot prices, of the f i v e m i l l i o n ounces of b u l l i o n received t h a t day. 158/ - On a n d a f t e r March 2 7 , e q u i t y ( d e f i c i t ) h e r e d e scribed includes t h e value, a t spot prices, of t h e t h r e e m i l l i o n ounces of leased s i l v e r assigned by IMIC t h a t day.

1. T h e $ 2 0 0 M i l l i o n S u b o r d i n a t i o n

Merrill h a d s u b m i t t e d t o t h e NYSE b y March 2 1 , a d r a f t subordination agreement designed to subordinate t o t h e claims o f o t h e r c r e d i t o r s and c u s t o m e r s $200 m i l l i o n o f l e n d i n g f r o m M & C o . t o Merrill Lynch. T h i s L would e n a b l e t h e f i r m t o i n c l u d e t h a t l o a n amount i n i t s regulatory capital calculations. A c c o r d i n g t o Merrill Lynch w i t n e s s e s , t h e d e c i s i o n t o s u b o r d i n a t e t h a t a l r e a d y e x i s t i n g l o a n was t a k e n some t i m e b e f o r e t h e c r i s i s a n d represented a response to c a p i t a l needs a r i s i n g p r i n c i p a l l y from h e i g h t e n e d c u s t o m e r a c t i v i t y and c e r t a i n o t h e r financial factors. The p o s s i b i l i t y o f u s i n g a s u b o r d i nated loan to b o l s t e r t h e f i r m ' s n e t c a p i t a l p o s i t i o n was r a i s e d a s e a r l y a s 1 9 7 8 b u t h a d n o t b e e n c o m p l e t e d C e r t a i n Merrill Lynch o f f i c i a l s p r i o r to March 1 9 8 0 . t o l d t h e NYSE a n d l a t e r t e s t i f i e d t h a t n e i t h e r t h e r a t i o n a l e n o r t h e t i m i n g o f t h e s u b o r d i n a t i o n were s p e c i f i c a l l y r e l a t e d t o t h e Hunt s i t u a t i o n . M e r r i l l s u b m i t t e d t o t h e NYSE a n e x e c u t e d s u b o r d i n a t i o n a g r e e m e n t o n o r a b o u t March 26. NYSE o f f i c i a l s L h a v e t o l d t h e s t a f f t h a t o n or a b o u t t h a t d a t e , M & Co. c h a i r m a n D o n a l d T. R e g a n ( " R e g a n " ) t o l d t h e NYSE t h a t t h e p r o p o s e d s u b o r d i n a t i o n was b e i n g e f f e c t e d i n a n t i c i p a t i o n o f p o t e n t i a l f i r m e x p o s u r e c o n c e r n s r e g a r d i n g t h e Hunt accounts. I n a d d i t i o n , Regan n o t e d t h a t o n Wednesday, M a r c h 26 h e h a d t a l k e d t o R o a e r B i r k a b o u t t h e H u n t a c c o u n t s and t h a t i n a m e e t i n g w i t h B i r k , F i t z g e r a l d , N e i l a n d C o n h e e n e y a b o u t t h e s i l v e r s i t u a t i o n i t was d e c i d e d t o a d d $ 2 0 0 m i l l i o n i n c a p i t a l t o Merrill L y n c h . A c c o r d i n g t o Merrill Lynch w i t n e s s e s , t h e NYSE a g r e e d and a u t h o r i z e d t h e f i r m t o u t i l i z e t h e $200 m i l l i o n t h u s s u b o r d i n a t e d i n i t s FOCUS r e p o r t f o r March 2 8 , t h e r e b y r a i s i n g t o a p p r o x i m a t e l y $360 m i l l i o n t h e n e t c a p i t a l i n e x c e s s o f 4 % minimum r e f l e c t e d i n t h e r e p o r t . 2. S e e k i n g t h e H u n t s ' G u a r a n t e e o f t h e IMIC Account
A s d e s c r i b e d e a r l i e r i n t h i s r e p o r t , Merrill Lynch management b e l i e v e d t h a t t h e H u n t s , s p e c i f i c a l l y B u n k e r and H e r b e r t Hunt, s t o o d behind I M I C ' s o b l i g a t i o n s t o t h e f i r m e v e n t h o u g h t h e r e was n o w r i t t e n d o c u m e n t t o t h a t e f f e c t . Merrill p e r s o n n e l h a d a t o n e t i m e c o n s i d e r e d o b t a i n i n g a w r i t t e n c r o s s - g u a r a n t e e o f a l l t h e Hunt a c c o u n t s . An i n t e r n a l memorandum i n d i c a t e s t h a t t h i s e f f o r t was a b a n d o n e d a t l e a s t i n p a r t b e c a u s e t h e H u n t s had responded a d v e r s e l y t o earlier a t t e m p t s to g a i n s u c h guarantees.

I n March 1 9 8 0 , h o w e v e r , t h e s i t u a t i o n became m o r e a c u t e . By a t l e a s t March 2 7 , 1 9 8 0 , Merrill r e q u e s t e d a g u a r a n t e e o f t h e IMIC a c c o u n t b y B u n k e r a n d H e r b e r t a t a m e e t i n g a t Merrill's o f f i c e s w i t h Hunt a t t o r n e y s . The Hunts and t h e i r r e p r e s e n t a t i v e s d i d n o t a g r e e to s i g n a w r i t t e n g u a r a n t e e o f t h e IMIC account a t t h a t t i m e . On A p r i l 1, 1 9 8 0 , S c h r e y e r a n d o t h e r M e r r i l l Lynch o f f i c e r s m e t w i t h B u n k e r a n d Herbert H u n t a n d t h e i r a t t o r n e y s i n D a l l a s . Among t h e t o p i c s d i s c u s s e d was a g u a r a n t e e o f t h e IMIC a c c o u n t b y t h e t w o b r o t h e r s . Lengthy n e g o t i a t i o n s o v e r t h i s i s s u e ensued and s e v e r a l d r a f t a g r e e m e n t s were e x c h a n g e d . F i n a l l y on t h e n i g h t o f A p r i l 1, B u n k e r a n d H e r b e r t H u n t s i g n e d a d o c u m e n t c o n c e r n i n g t h e i r r e l a t i o n s h i p t o I M I C ' s o b l i g a t i o n t o Merrill. The agreement c o n t a i n e d t h e f o l l o w i n g s a l i e n t p r o v i s i o n s : 1 ) ' ~ e r b e r and Bunker a u t h o r i z e d Merrill " t o h o l d " t t h e assets i n t h e i r i n d i v i d u a l a c c o u n t s as "sec u r i t y f o r a n y loss o r d e b i t b a l a n c e d u e or o w i n g by IMIC" ; 2 ) Merrill w o u l d l i q u i d a t e t h e IMIC a c c o u n t " i n a n o r d e r l y , p r u d e n t and b u s i n e s s l i k e manner" w i t h t h e "cooperation o f and [ i n ] c o n s u l t a t i o n with t h e Hunts";
3 ) I f IMIC d i d n o t p a y a n y d e f i c i t r e m a i n i n g a f t e r l i q u i d a t i o n , t h e H u n t s a u t h o r i z e d Merrill "to t r e a t o u r i n d i v i d u a l a c c o u n t s i n a manner ( o t h e r t h a n .by s a l e ) w h i c h p e r m i t s [ M e r r i l l ] t o u s e a n y and a l l e q u i t i e s , s e c u r i t i e s or o t h e r collateral i n such accounts as c a p i t a l f o r r e g u l a t o r y purposes" ;
4 ) H e r b e r t and Bunker a g r e e d to d e p o s i t w i t h i n f o u r

d a y s o f n o t i c e " c a s h i n a n amount e q u i v a l e n t t o any regulatory deduction" still required a f t e r Merrill t o o k t h e s t e p s o u t l i n e d i n Item 3 ; a n d

5) I f a n y d e f i c i t i n t h e IMIC a c c o u n t remained o u t s t a n d i n g f o r 60 d a y s , or i f H e r b e r t and Bunker f a i l e d t o d e p o s i t c a s h t o o f f s e t a r e q u i r e d ded u c t i o n , Merrill c o u l d l i q u i d a t e t h e i r i n d i v i d u a l p o s i t i o n s to pay t h e o b l i g a t i o n .

A c c o r d i n g t o Merrill Lynch c o u n s e l , t h e f i r m v i e w e d t h e A p r i l 1 agreement as c o n s t i t u t i n g t h e Hunts' p e r s o n a l g u a r a n t e e o f t h e IMIC a c c o u n t a n d c o n t e m p l a t e d t h a t e x c e s s collateral i n Herbert and Bunker's accounts could, u n d e r t h e a g r e e m e n t , be c o n s i d e r e d a s h a v i n g b e e n p o s t e d i n s a t i s f a c t i o n o f IMIC's margin c a l l s , n o t w i t h s t a n d i n g t h a t it r u l e d o u t s a l e o f t h e i n d i v i d u a l Hunts' a s s e t s as a n immediate means o f s a t i s f y i n g r e g u l a t o r y c a p i t a l

requirements. The a g r e e m e n t a s a w h o l e , h o w e v e r , d o e s a p p e a r t o make i t p o s s i b l e f o r t h e f i r 3 t o s e l l t h e Hunts' i n d i v i d u a l assets i f necessary t o cover a c a p i t a l charge a r i s i n g i n t h e IMIC account a f t e r an unsuccessful Indeed, a t t e m p t t o o b t a i n c a s h from t h e i n d i v i d u a l Hunts. X e r b e r t H u n t , a c c o r d i n g to a May 27 d g r e e i n e n t among I M I C , P l a c i d I n v e s t m e n t s , H e r b e r t and Merrill, acknowledged t h a t t h e A p r i l 1 agreement c o n s t i t u t e d a p e r s o n a l g u a r a n t e e of t h e I M I C account. 159/ On T h u r s d a y , A p r i l 3 , a c c o r d i n g t o Merrill Lynch w i t n e s s e s , t h e f i r m o b t a i n e d a d v i c e f r o m t h e CFTC a n d t h e NYSE t o t h e e f f e c t t h a t t h e A p r i l 1 a g r e e m e n t would s u f f i c e to e n a b l e t h e f i r m to t r e a t t h e Bunker and H e r b e r t Hunt and t h e I M I C a c c o u n t s a s o n e f o r m a r g i n and r e g u l a t o r y c a p i t a l purposes. Merrill d i d so by t r e a t i n g m a r g i n c a l l s o u t s t a n d i n g i n t h e I M I C account a s having been m e t b y a p p l i c a t i o n o f e x c e s s e q u i t y i n t h e H e r b e r t Hunt account.
F.

Liquidations

On t h e m o r n i n g o f March 2 7 , a f t e r r e c e i v i n g f r o m t h e Cotnex i t s f i n a l d e t e r m i n a t i o n t h a t t h e s i l v e r m a r k e t would o p e n a s u s u a l t h a t d a y , Merrill b e g a n t o l i q u i d a t e Hunt p o s i t i o n s . - / P u r s u a n t t o a j o i n t l i q u i d a t i o n 16@ 159/ - I t s h o u l d b e n o t e d t h a t Merrill a t n o t i m e d u r i n g o r a f t e r the crisis sought o r obtained a guarantee o f t h e I M I C a c c o u n t by a n y Hunt f a m i l y members o r rel a t e d e n t i t i e s o t h e r t h a n H e r b e r t and B u n k e r H u n t . The s t a f f h a s i n c l u d e d e q u i t i e s i n o t h e r H u n t - r e l a t e d accounts i n its evaluation f o r a n a l y t i c a l purposes o n l y and w i t h o u t s u g g e s t i n g w h e t h e r o r n o t Merrill c o u l d have succeeded i n a p p l y i n g t h o s e e q u i t i e s to the IMIC d e f i c i t . 160/ A s d i s c u s s e d a b o v e a t p a g e 9 2 , Bache r e q u e s t e d o n March 26 a n d a g a i n a t a m e e t i n g a t M e r r i l l ' s o f f i c e s o n t h e m o r n i n g o f March 2 7 , t h a t t h e Comex b o a r d o f g o v e r n o r s A t the meeting n o t o p e n i t s s i l v e r m a r k e t o n March 27. i n Merrill's o f f i c e s t h a t m o r n i n g , a t t e n d e d by r e p r e s e n t a t i v e s o f t h e Comex, E l e r r i l l , B a c h e , a n d A C L I , Merrill m a i n t a i n e d a n e u t r a l p o s i t i o n a s t o c l o s i n g L a t e r i n t h a t m o r n i n g , a f t e r Comex the s i l v e r market. b o a r d had d e t e r m i n e d t o k e e p t h e m a r k e t o p e n , C o n h e e n e y r e c e i v e d a c a l l f r o m CFTC C o m m i s s i o n e r Reed Dunn. Dunn s o u g h t C o n h e e n e y ' s a d v i c e f r o m t h e Merrill Lynch comm o d i t i e s d i v i s i o n d i r e c t o r a s to whether a " n a t i o n a l emergency" e x i s t e d i n l i g h t o f e v e n t s o c c u r r i n g i n t h e

Footnote continued on n e x t page.

arrangement with Bache, Bache senior vice president, Frederick Horn, liquidated approximately 300 silver contracts on Merrill's behalf that day. Merrill Lynch, through its New York commodities sales office began liquidating Treasury bill currency future, platinum future and gold future positions in the IMIC account. At that point, according to Conheeney, it was Merrill's intention to liquidate the positions as rapidly as possible. In a meeting on the evening of March 27, senior executives in the firm decided to begin liquidating physical silver positions the next day. The firm on March 28, liquidated the five million ounces of London silver it had received from IMIC on March 26. It also succeeded in switching out -161/ of approximately 312 Comex silver futures contracts and liquidated an additional 115 contracts in CBT silver. According to Merrill Lynch records, at the close of business on March 28, the IMIC account had a net position of 2,662 silver futures contracts and 5.24 million ounces of physical silver. On Sunday evening, March 30, 1980, Schreyer, Conheeney and others met at the Essex House in New York City to discuss the silver situation. According to Arnold, participants in the meeting made the determination to hedge 25% of the remaining IMIC domestic futures position by establishing a short silver position in the London market. Footnote continued from previous page. silver markets, the only condition under which Dunn would consider clcsing those markets. Conheeney responded that he did not believe a national emergency existed. Later that day, after hearing rumors of Bache's financial troubles as a result of the Hunt silver positions at the firm, Conheeney called Dunn. Conheeney reported the rumors to Dunn and added that if a firm the size of Bache collapsed it might have serious effects on the entire financial community. Dunn responded, according to Conheeney, that such an eventuality would not constitute a national emergency. According to Regan, he spoke on March 27, 1980 to Fed Chairman Volcker and Bache president Sherrill about closing the silver market. Regan informed them that Merrill Lynch would not recommend that the market be closed, but would not object to such an action to protect Bache. 161/ - See discussion of switch transactions at n. 83.

The firm would leave the remaining 75% of the futures position unhedged hoping to avoid losses by liquidating more slowly and at favorable prices. Conheeney testified that Merrill Lynch executives based their position on the fact that "at that stage of the game [they] were not sure if the Hunts were going to pay [them] what they owed [them]." In addition, Merrill Lynch executives believed that the proceeds the firm would have realized had it hedged or otherwise liquidated the entire silver position at that time would not have covered the deficits in the account. The next day, Monday, March 31, Merrill established a short hedge against approximately 900 contracts in the IMIC position by selling in London 4.5 million ounces of silver for three months forward delivery. It was able to switch out of an additional 492 Comex contracts in the May and July maturities. Merrill also liquidated $9 million in shares of Penn Central and Dome Petroleum collateralizing the account. Sometime that day, however, Herbert Hunt requested that the firm suspend liquidations in the IMIC account pending a meeting the next day in Dallas. As described above at pages 162 through 164, the Hunts agreed in that April 1 meeting with Schreyer and other Merrill Lynch executives to indemnify the firm for any regulatory capital charges it might be required to take on the IMIC account. According to Merrill Lynch witnesses, after obtaining that agreement, the firm believed that the combined equity in the individual accounts of Herbert and Bunker Hunt was sufficient to satisfy outstanding margin calls and any liquidating deficits in the IMIC account. The firm, accordingly, adopted a gradual policy of liquidating in the IMIC account. Occasionally, the Hunts would request that the firm cease its'liquidation of their accounts, often indicating a major development was underway in response to their silver problems. Merrill usually complied with these requests, but continued the liquidation when no major development materialized. From March 31 to April 30, 1980, Merrill disposed of 902 silver futures contracts representing a sale of 4,510,000 ounces. Merrill disposed of approximately 2186 futures contracts and 1.6 million ounces of silver during the period from May 1 through May 27, 1980. On May 27, 1980, Merrill sold the remaining IMIC physical silver positions to Placid Investments, Ltd. which fully paid the deficits remaining in the account out of the proceeds of the Placid loan transaction.

G.

P u b l i c Disclosure Concerning t h e C r i s i s

Apart from Conheeney's testimony before t h e Senate A g r i c u l t u r e C o m m i t t e e and d i s c l o s u r e i n v a r i o u s f i l i n g s c o n c e r n i n g t h e e x i s t e n c e o f t h i s i n v e s t i g a t i o n , Merrill L y n c h h a s made n o p u b l i c d i s c l o s u r e c o n c e r n i n g i t s r o l e i n t h e s i l v e r crisis or t h e impact o f t h e crisis on t h e I t d i d , h o w e v e r , c i r c u l a t e a n a l l - o f f i c e wire firm. i n t e r n a l l y o n M a r c h 2 7 , 1 9 8 0 , a n d Merrill L y n c h w i t n e s s e s h a v e t e s t i f i e d t h a t t h e y a s s u m e d t h a t t h e wire w o u l d become p u b l i c l y a v a i l a b l e . The s t a t e m e n t a p p e a r e d o v e r t h e s i g n a t u r e s o f Messrs. R e g a n , B i r k a n d S c h r e y e r . I t n o t e d t h e " u n u s u a l developments" t h a t had o c c u r r e d i n t h e commodities and s e c u r i t i e s m a r k e t s , and t h e n a s s u r e d e m p l o y e e s t h a t " M e r r i l l Lynch i s f i n a n c i a l l y s t r o n g and h e a l t h y and w i l l c o n t i n u e t o b e so i n t h e f u t u r e . " T h e w i r e a d m i t t e d t h a t t h e d a y ' s e v e n t s m i g h t h a v e "some e f f e c t " o n M e r r i l l , b u t a s s e r t e d t h a t t h e f i r m was i n a " s t r o n g c a p i t a l p o s i t i o n " w i t h more t h a n " $ 2 5 0 m i l l i o n i n e x c e s s c a p i t a l o v e r a n d a b o v e t h e minimums r e q u i r e d . " F u r t h e r , t h e w i r e s t a t e d t h a t t h e f i r m ' s commodity p o s i t i o n s were f u l l y c o l l a t e r a l i z e d , a n d i t s t a t e d t h a t t h e s i t u a t i o n i n t h e m a r k e t s was " a n a f t e r m a t h o f t h e government's r e c e n t severe c r e d i t r e s t r i c t i n g policy" and p l e d g e d t o t a k e " a l l n e c e s s a r y and p r u d e n t s t e p s " t o p r o t e c t t h e employees, customers and s t o c k h o l d e r s o f Merrill L y n c h .

PART FOUR THE E . F . HUTTON GROUP I N C .

I.

THE E.F. HUTTON COMPLEX A. The Holding Company

) The E. F. Hutton Group Inc. ( "Hutton Group1' , incorporated in Delaware, is a holding company principally engaged, through approximately 22 subsidiaries, in retail and institutional securities brokerage, investment banking, commodities futures merchandising and life insurance. It is a publicly held company whose common stock is registered with the Commission pursuant to Section 12(b) of the Exchange Act and listed on the New York, Pacific and London Stock Exchanges. At December 31, 1979, its 6.4 million outstanding common shares were in the hands of 11,800 holders of record.

For the fiscal year ending December 31, 1979, Hutton Group reported after-tax income of $37.3 million on revenues of $750.3 million. The company derived its revenues principally from commissions on securities transactions ($189.4 million) interest on customer margin accounts ($106.3 million) and on resale agreements ($105.4 million), investment banking ($72.0 million), commodity commissions ($67.9 million), principal transactions ($63.2 million) and insurance ($60.8 million). Its principal expenses were employee compensation and benefits ($271.6 million), interest ($185.3 million), communications ($39.8 million) and occupancy and equipment ($37.0 million). Hutton Group reported net worth of $173.9 million at December 31, 1979. B

. The Broker-Dealer

Hutton Group's principal subsidiary is E.F. Hutton & Company Inc. ("Hutton"), a broker-dealer registered with the Commission pursuant to Section 15(b) of the Exchange Act. Huttpn Group reports that at December 31, 1979, Hutton had approximately 400,000 clients serviced by 3,475 account executives in domestic and overseas branch offices. Hutton or its subsidiaries are members of major securities and commodities exchanges in the United States and in other countries. As a registered broker-dealer and as a member of the NYSE, Hutton is subject to the Uniform Net Capital Rule. At December 31, 1979, Hutton's net capital of $121.5 million was 11.64% of aggregate debit items, $48.4 million above the 7% "early warning" level and $79.8 million above the 4% minimum requirement, $60.0 million of subordinated debit contributed to these amounts. Hutton Group conducted all of its Hunt-related commodity futures and financing business through Hutton.

11.

THE BUILDUP I N SILVER - JULY 3 1 , 1 9 7 9 THROUGH J A N U A R Y 3 1 , 1 9 8 0 A.

The H u n t A c c o u n t s C o m e t o H u t t o n

I n A u g u s t 1 9 7 9 , when L o e b R h o a d e s m e r g e d w i t h S h e a r s o n H a y d e n S t o n e I n c . , A l a n Cohen ( " C o h e n " ) moved f r o m L o e b R h o a d e s t o H u t t o n t o become H u t t o n ' s A t l a n t i c R e g i o n commod i t y s a l e s manager. 162/ C o h e n b r o u g h t w i t h him t o H u t t o n n o t o n l y s e v e r a l y e a r s o f experience i n commodities, b u t a b u s i n e s s r e l a t i o n s h i p w i t h t h e Hunt b r o t h e r s o f Dallas as well. Lamar H u n t w a s t h e f i r s t member o f t h e H u n t f a m i l y t o o p e n a n a c c o u n t w i t h Cohen. By t h e summer o f 1 9 7 9 , B u n k e r H u n t h a d a l s o e s t a b l i s h e d a n a c c o u n t w i t h Cohen a t Loeb R h o a d e s . 1 6 3 / N e i t h e r o f t h e s e a c c o u n t s was v e r y l a r g e . L a m a r ' s a c c o u n t c a r r i e d a p p r o x i m a t e l y 30 s i l v e r c o n t r a c t s and B u n k e r ' s a c c o u n t a c o m p a r a b l e number o f p r e c i o u s metal futures contracts.
He C o h e n t e s t i f i e d t h a t h e h a d n e v e r met t h e H u n t s . d e s c r i b e d h i s f u n c t i o n a s m e r e l y a r r a n g i n g f o r Loeb R h o a d e s , and l a t e r Hutton, t o clear t r a d e s t h e Hunts p l a c e d w i t h A l v i n B r o d s k y o n t h e Comex f l o o r . Cohen's o n l y a c t u a l cont a c t w i t h t h e H u n t o r g a n i z a t i o n was t o c a l l H u n t E n e r g y a s s i s t a n t t r e a s u r e r C h a r l e s Mercer a t t h e c l o s e o f b u s i n e s s to r e p o r t t r a n s a c t i o n s executed t h a t day i n t h e Hunts' accounts. I t a p p e a r s t h a t o n l y t w o Hunt a c c o u n t s e x i s t e d a t H u t t o n b e f o r e Cohen j o i n e d t h e f i r m i n A u g u s t 1 9 7 9 . One was a c o m m o d i t y a c c o u n t i n H e r b e r t H u n t ' s name t r a d i n g i n c a t t l e a n d t h e o t h e r was a s e c u r i t i e s a c c o u n t i n P o r t l a n d , O r e g o n owned j o i n t l y by B u n k e r a n d H e r b e r t H u n t .

162/ -

P r i o r t o t h a t d a t e , Cohen h a d s e r v e d i n t h a t same c a p a c i t y f o r Loeb Rhoades. Cohen b e c a m e a H u n t a c c o u n t e x e c u t i v e i n l a t e 1 9 7 8 o r e a r l y 1 9 7 9 when A l v i n B r o d s k y b e g a n t o d i r e c t H u n t b u s i n e s s t o Cohen. Brodsky and Cohen h a d known e a c h o t h e r s i n c e a b o u t 1 9 7 1 . B r o d s k y ' s b r o t h e r is a c o u s i n by m a r r i a g e o f C o h e n ' s w i f e ' s and C o h e n h a d d i s c u s s e d e m p l o y m e n t w i t h B r o d s k y when C o h e n was f i r s t e n t e r i n g t h e c o m m o d i t i e s b u s i n e s s . t h e Hunts a l s o had a n a c c o u n t w i t h S c o t t McFarland ("McFarland") i n a w e s t c o a s t o f f i c e o f Loeb R h o a d e s . T h e s e a c c o u n t s were b r o u g h t t o L o e b R h o a d e s b y M c F a r l a n d when h e moved t o t h a t f i r m f r o m D r e x a l Burnham L a m b e r t , I n c o r p o r a t e d . On o r a b o u t S e p t e m b e r 1 9 7 9 , M c F a r l a n d , a n d h i s H u n t a c c o u n t s , moved t o B a c h e H a l s e y .
As described earlier i n t h i s report,

163/ -

Bunker t r a n s f e r r e d h i s a c c o u n t from Loeb Rhoades t o Hutton i n l a t e August 1979. Lamar t r a n s f e r r e d h i s s i l v e r Meanwhile, i n t r a d i n g a c c o u n t t o H u t t o n i n e a r l y December. mid-November 1 9 7 9 , H e r b e r t H u n t o p e n e d a c o m m o d i t i e s a c c o u n t w i t h Cohen.
B.

Futures Trading i n t h e Hunts' Accounts

From t h e 2 8 t h t h r o u g h t h e 3 0 t h o f A u g u s t , B u n k e r H u n t He p u r c h a s e d 3 5 0 c o n t r a c t s o f March 1 9 8 0 Comex s i l v e r . i n c r e a s e d h i s p o s i t i o n t o 500 c o n t r a c t s e a r l y i n O c t o b e r w i t h a d d i t i o n a l p u r c h a s e s o f 150 c o n t r a c t s o f December 1979 Comex s i l v e r . I n November h e b o u g h t a n o t h e r 250 December Comex c o n t r a c t s . I n a d d i t i o n , 1 3 8 March Comex f u t u r e s appeared i n t h e account as a r e s u l t o f "ex-pit" t r a n s a c tions. Those c o n t r a c t s o r i g i n a l l y had been p u r c h a s e d t h e previous July. Meanwhile, H e r b e r t Hunt opened a n a c c o u n t w i t h t h e f i r m a n d o n November 1 4 p u r c h a s e d 1 0 0 c o n t r a c t s o f March 1 9 8 0 Comex s i l v e r . I n sum, b y t h e e n d o f November Bunker and H e r b e r t ' s p o s i t i o n combined t o t a l e d 988 c o n t r a c t s . I n December Lamar Hunt b e g a n t r a d i n g s i l v e r f u t u r e s i n h i s a c c o u n t a n d by month-end h e h a d e s t a b l i s h e d a 2 2 5 c o n t r a c t l o n g p o s i t i o n i n March 1 9 8 0 Comex s i l v e r a n d a 1 0 0 c o n t r a c t l o n g p o s i t i o n i n t h e September 1980 c o n t r a c t . H e r b e r t m a i n t a i n e d h i s 1 0 0 c o n t r a c t l o n g p o s i t i o n i n March 1 9 8 0 Comex s i l v e r t h r o u g h o u t t h e m o n t h . Bunker, meanwhile s t o o d f o r d e l i v e r y o n h i s 400 c o n t r a c t l o n g p o s i t i o n i n t h e December 1 9 7 9 m a t u r i t y , w h i c h l e f t a t o t a l H u n t f u t u r e s Just prior p o s i t i o n a t month-end o f 9 1 3 c o n t r a c t s l o n g . t o t h e market b r e a k on J a n u a r y 22, H e r b e r t and Bunker had l i q u i d a t e d 5 5 0 c o n t r a c t s o f t h e i r p o s i t i o n i n March 1 9 8 0 s i l v e r and Bunker had r o l l e d t h e 38 c o n t r a c t s r e m a i n i n g i n t o t h e May 1 9 8 0 m a t u r i t y . M e a n w h i l e , d u r i n g J a n u a r y , Lamar r o l l e d 1 4 5 c o n t r a c t s i n t h e March 1 9 8 0 p o s i t i o n h e h a d p u t o n i n December i n t o t h e S e p t e m b e r 1 9 8 0 m a t u r i t y a n d a d d e d a n a d d i t i o n a l 314 S e p t e m b e r c o n t r a c t s t o h i s p o s i t i o n . During February, he r o l l e d t h e e n t i r e p o s i t i o n forward i n t o t h e A t F e b r u a r y 2 9 , 1 9 8 0 , Lamar h e l d 639 March 1 9 8 1 m a t u r i t y . c o n t r a c t s and Bunker h e l d 38 f o r a t o t a l Hunt p o s i t i o n a t H u t t o n o f 677 l o n g s i l v e r f u t u r e s c o n t r a c t s . C. F i n a n c i n q P h v s i c a l S i l v e r
A s a l r e a d y n o t e d , when h i s p o s i t i o n i n D e c e m b e r 1 9 7 9 Comex s i l v e r a t H u t t o n m a t u r e d , B u n k e r H u n t d e t e r m i n e d t o stand for delivery. Through Brodsky, Bunker a s k e d t h a t Hutton f i n a n c e t h e s e d e l i v e r i e s as w e l l a s d e l i v e r i e s o n December c o n t r a c t s i n B u n k e r ' s a c c o u n t a t P a i n e W e b b e r . -- 4 1 16

164/ - A s d e s c r i b e d e l s e w h e r e i n t h i s r e p o r t , P a i n e Webber declined to d o t h i s financing.

A t a s p e c i a l m e e t i n g e a r l y i n D e c e m b e r 1 9 7 9 , H u t t o n ' s commo-

d i t y c r e d i t committee a u t h o r i z e d t h e f i r m t o f i n a n c e t h e s e d e l i v e r i e s by l e n d i n g B u n k e r u p t o $100 m i l l i o n a g a i n s t 7 5 % o f t h e v a l u e of warehouse r e c e i p t s i n h i s accounts. From December 7 t h r o u g h December 1 3 , H u t t o n l e n t Bunker $ 3 0 . 1 m i l l i o n u n d e r t h i s l i n e o f c r e d i t s e c u r e d b y w a r e h o u s e rec e i p t s r e c e i v e d i n d e l i v e r y o n B u n k e r ' s December 1 9 7 9 f u t u r e s From J a n u a r y 1 4 t h r o u g h J a n u a r y 2 1 , p o s i t i o n a t Hutton. H u t t o n made a d d i t i o n a l l o a n s s u c h t h a t a t J a n u a r y 2 1 , 1 9 8 0 , i t h a d $ 1 0 2 m i l l i o n o u t s t a n d i n g t o B u n k e r Hunt s e c u r e d by 4.1 m i l l i o n ounces of s i l v e r . Hutton charged i n t e r e s t o f 1 . 5 p e r c e n t o v e r t h e New York b r o k e r s c a l l r a t e o n t h i s f i n a n c i n g . Of t h e i n t e r e s t income r e c e i v e d by H u t t o n , H u t t o n p a i d o n e - t h i r d t o B r o d s k y as a " f i n d e r ' s f e e " . U n l i k e Bache Group, Hutton d i d n o t engage i n s i l v e r - c o l l a t e r a l i z e d borrowing to fund t h e l o a n s t o Bunker; r a t h e r , it r e l i e d on its i n t e r n a l l y g e n e r a t e d f u n d s a n d i t s o r d i n a r y s o u r c e s o f bank f i n a n c i n g s e c u r e d by customer marginable s e c u r i t i e s and f i r m s e c u r i t i e s p o s i t i o n s t o o b t a i n t h e money i t l e n t t o B u n k e r . C. M a n a g e m e n t D e c i s i o n s C o n c e r n i n g The Hunt A c c o u n t s
A s was t h e case w i t h o t h e r f i r m s H u t t o n ' s c o m m o d i t y c r e d i t committee e s t a b l i s h e d s u b s t a n t i a l c o m m o d i t y p o s i t i o n l i m i t s f o r t h e Hunts, and a u t h o r i z e d l a r g e l o a n s t o them, without s p e c i f i c information concerning t h e extent of t h e H u n t s ' f i n a n c i a l c o n d i t i o n , t h e a v a i l a b i l i t y o f c e r t a i n Hunt a s s e t s t o a p p l y t o p o t e n t i a l losses i n t h e i r a c c o u n t s w i t h Hutton or t h e e x t e n t of t h e Hunts' o v e r a l l p o s i t i o n s i n t h e s i l v e r market.

I n September, s h o r t l y a f t e r it w a s opened, B u n k e r ' s a c c o u n t w a s approved f o r p o s i t i o n s r e q u i r i n g up t o $25 A s n o t e d , i n e a r l y December, m i l l i o n i n o r i g i n a l margin. t h e c o m m o d i t y c r e d i t committee a p p r o v e d w a r e h o u s e r e c e i p t On e a c h o f t h e s e o c c a s i o n s t h e f i n a n c i n g t o $100 m i l l i o n . committee h a d b e f o r e i t n o t h i n g more t h a n a f o r m " s t a t e m e n t o f f i n a n c i a l c o n d i t i o n " , a p p a r e n t l y s i g n e d by B u n k e r , t h a t l i s t e d as " t o t a l a l l a s s e t s " $400 m i l l i o n and set f o r t h B u n k e r ' s n e t worth as $400 m i l l i o n . The s t a t e m e n t c o n t a i n e d n o e n t r i e s showing t h e c o m p o s i t i o n o f Bunker's assets, n o r d i d it c o n t a i n any e n t r i e s whatever on t h e l i a b i l i t i e s s i d e of the balance sheet. Bunker l i s t e d h i s s a l a r y and i n v e s t m e n t i n c o m e e a c h a s " $ 1 m i l l i o n +" a n d c l a i m e d " r i s k c a p i t a l a v a i l a b l e f o r commodity t r a d i n g " o f $50 m i l l i o n . The f o r m a l s o a s k e d : "Do y o u h a v e a c o m m o d i t y a c c o u n t w i t h a n o t h e r I n response, broker? I f so, p l e a s e g i v e g e n e r a l d e t a i l s . "

B u n k e r r e p l i e d w i t h o n e word " B a c h e " . Moreover, B u n k e r ' s c r e d i t f i l e c o n t a i n e d n o b a n k o r o t h e r o u t s i d e c r e d i t ref e r e n c e s o n Bunker Hunt h i m s e l f , a l t h o u g h H u t t o n had r e c e i v e d a Dun & B r a d s t r e e t r e p o r t o n H I R C O . A c c o r d i n g t o c r e d i t committee member A r n o l d P h e l a n ( " P h e l a n " ) , H u t t o n ' s s e n i o r v i c e p r e s i d e n t f o r commodities o p e r a t i o n s and a d m i n i s t r a t i o n , i n c o n s i d e r i n g Bunker's f i n a n c i n g r e q u e s t i n December 1 9 7 9 t h e committee c o n s i d e r e d t h e l i q u i d i t y o f t h e s i l v e r c o l l a t e r a l t h a t Bunker proposed t o p o s t f o r t h e l o a n a s w e l l a s whether t h e Hunts had subs t a n t i a l s i l v e r p o s i t i o n s a t o t h e r houses. Phelan t e s t i f i e d t h a t a l t h o u g h t h e committee " t h o u g h t t h e m a r k e t c o u l d h a n d l e t h i s p o s i t i o n i f w e needed to g e t o u t " it n e v e r g a v e r e a l consideration to t h e prospect of a forced l i q u i d a t i o n . Phelan stated that: [wle n e v e r d o u b t e d t h a t [ t h e H u n t s ] would be a b l e t o come u p w i t h t h e money b e c a u s e t h e y h a d r e l a t e d t o u s t h a t t h e y had X m i l l i o n s o f d o l l a r s , p l u s t h e f a c t t h a t i t ' s a l m o s t common k n o w l e d g e t h a t t h e y were billionaires. W were t a l k i n g a b o u t m i l l i o n s a n d t h e y e were b i l l i o n a i r e s . Why s h o u l d I b e i n s e c u r e ?
N o o n e a t t h e committee m e e t i n g s u g g e s t e d t h a t H u t t o n i n q u i r e o f t h e Hunts c o n c e r n i n g t h e amount o f t h e i r a g g r e g a t e s i l v e r commitments. There was, moreover, no d i s c u s s i o n a s t o whether B u n k e r , t h e b o r r o w e r i n t h i s i n s t a n c e , had a c c e s s t o f a m i l y assets i n o r d e r t o r e p a y Hutton.

None o f t h e H u t t o n w i t n e s s e s d e p o s e d o n t h e s u b j e c t r e c a l l discussion concerning trading l i m i t s i n t h e Herbert H u n t a c c o u n t . Nor d i d t h e H e r b e r t Hunt c r e d i t f i l e s p r o d u c e d t o t h e s t a f f c o n t a i n t h e c r e d i t summary s h e e t t h a t i s o r d i n a r i l y t h e v e h i c l e by which H u t t o n c r e d i t d e p a r t m e n t p e r s o n n e l c o n v e y i n f o r m a t i o n t o t h e commodity c r e d i t committee f o r i t s u s e i n c o n n e c t i o n w i t h c r e d i t d e c i s i o n s . H e r b e r t H u n t ' s c r e d i t f i l e d i d , however, c o n t a i n a "customer f i n a n c i a l s t a t e m e n t " d a t e d November 2 6 , 1 9 7 9 , a p p a r e n t l y s i g n e d by H e r b e r t , t h a t was f i l l e d o u t i n p r e c i s e l y t h e same manner, and w i t h i d e n t i c a l i n f o r m a t i o n , a s t h a t s u b m i t t e d Despite t h i s l a c k o f by Bunker Hunt s e v e r a l months e a r l i e r . information, Hutton approved Herbert Hunt's t r a d i n g l i m i t f o r p o s i t i o n s r e q u i r i n g i n i t i a l m a r g i n o f a s much a s $ 3 m i l l i o n , a c c o r d i n g t o d a i l y "commodity s t a t u s r e p o r t s " g e n e r a t e d d a i l y 165/ by t h e f i r m . 165/ I t s h o u l d b e n o t e d t h a t a f t e r J a n u a r y 1980, H e r b e r t had no f u t u r e s p o s i t i o n with t h e firm. On March 1 4 , h o w e v e r , H u t t o n l e n t him $ 1 3 m i l l i o n a g a i n s t s i l v e r b u l l i o n c o l l a t e r a l without having obtained any a d d i t i o n a l information concerning h i s financing.

T h e c o m m o d i t y c r e d i t committee c o n s i d e r e d Lamar H u n t ' s t r a d i n g l i m i t s on or a b o u t J a n u a r y 24, 1980, approximately s e v e n weeks a f t e r Lamar opened h i s a c c o u n t w i t h t h e f i r m . Lamar s i g n e d a n d s u b m i t t e d o n J a n u a r y 8 t h e same " c u s t o m e r f i n a n c i a l s t a t e m e n t " as had Bunker and H e r b e r t and completed i t w i t h p r e c i s e l y t h e same n u m b e r s : assets $ 4 0 0 m i l l i o n , no l i a b i l i t i e s i n d i c a t e d , n e t w o r t h $400 m i l l i o n , a v a i l a b l e r i s k c a p i t a l $50 m i l l i o n . T h e c r e d i t summary s h e e t s u b m i t t e d t o t h e c o m m o d i t y c r e d i t committee, h o w e v e r , s t a t e d t h a t " [ e l f f o r t s to obtain a f i n a n c i a l statement through a c c o u n t e x e c u t i v e A 1 Cohen h a v e p r o v e n f r u i t l e s s , " a n d i n d i c a t e d t h a t L a m a r ' s n e t w o r t h w a s "N/AM. I n m i d - J a n u a r y , commodity c r e d i t d e p a r t m e n t p e r s o n n e l a l s o o b t a i n e d a bank r e f e r e n c e f r o m Morgan G u a r a n t y T r u s t C o . , w h i c h s t a t e d t h a t : On y o u r b e h a l f w e c o n t a c t e d a D a l l a s , T e x a s b a n k s o u r c e . They r e p o r t e d t h a t Lamar Hunt o p e n e d a n a c c o u n t w i t h them i n 1943. B a l a n c e s i n t h i s a c c o u n t are s u b s t a n t i a l The b a n k e r s t a t e d and handled i n a s a t i s f a c t o r y manner. t h a t a l l l o a n e x p e r i e n c e w i t h Lamar H u n t h a s b e e n c o n T h e b a n k e r was u n w i l d u c t e d i n a s a t i s f a c t o r y manner. l i n g to reveal additional c r e d i t information concerning t h i s inquiry. On t h e b a s i s o f t h e f o r e g o i n g i n f o r m a t i o n t h e c o m m o d i t y c r e d i t committee approved a 500 c o n t r a c t t r a d i n g l i m i t i n s i l v e r f o r Lamar. E. H u n t A c c o u n t s a t t h e M a r k e t B r e a k On J a n u a r y 2 1 , t h e H u n t s ' a c c o u n t s w i t h H u t t o n h e l d s i l v e r f u t u r e s c o n t r a c t s a n d s i l v e r w a r e h o u s e r e c e i p t s rep r e s e n t i n g a n a g g r e g a t e o f 7.4 m i l l i o n o u n c e s o f s i l v e r . A t m a r k e t p r i c e s p r e v a i l i n g a t t h e close o n J a n u a r y 2 1 t h e s e Hutton had o u t s t a n d i n g p o s i t i o n s were v a l u e d a t $325 m i l l i o n . t o Bunker $102 m i l l i o n i n l o a n s c o l l a t e r a l i z e d by 4 . 1 m i l l i o n ounces o f s i l v e r v a l u e d a t t h e e n d o f t h a t day a t $180 m i l l i o n . A t t h e end o f J a n u a r y , t h e f i r m w a s p r o t e c t e d a g a i n s t a $12.50, or 36%, d e c l i n e i n t h e p r i c e o f s i l v e r .
111. THE MARKET BREAK

- JANUARY 1 7 THROUGH THE C R I S I S AT HUTTON

I n c o n t r a s t to t h e s i t u a t i o n a t Bache H a l s e y and Merrill Lynch, t h e H u n t s c o n t i n u e d u n t i l March 26, 1 9 8 0 , t o w i r e c a s h to Hutton i n s a t i s f a c t i o n o f calls i n t h e s i l v e r accounts. Meanwhile, H u t t o n f i r s t reduced its e x p o s u r e i n t h e Hunt a c c o u n t s i n l a t e J a n u a r y by c a n c e l l i n g t h e $100 m i l l i o n l i n e o f c r e d i t it e x t e n d e d t o Bunker, and t h e n , i n mid-March, i n c r e a s e d i t s e x p o s u r e a g a i n by r e i n s t a t i n g t h e l o a n , a l b e i t a t a 10% h i g h e r c o l l a t e r a l i z a t i o n ratio.

A.

C a n c e l l i n g t h e S i l v e r Loan

On J a n u a r y 2 1 , 1 9 8 0 , w i t h i n d a y s o f B u n k e r H u n t d r a w i n g t h e f i n a l $77 m i l l i o n a d v a n c e u n d e r t h e December f i n a n c i n g , t h e Comex i m p o s e d l i q u i d a t i o n - o n l y t r a d i n g i n s i l v e r . On J a n u a r y 22 t h e s p o t m a r k e t e x p e r i e n c e d a $10 p e r o u n c e d r o p . A t a b o u t t h a t t i m e R o b e r t Fomon, c h a i r m a n o f H u t t o n G r o u p , concluded t h a t t h e p r o f i t s from t h e Bunker Hunt f i n a n c i n g d i d n o t j u s t i f y t h e r i s k s i n h e r e n t i n e x t e n d i n g $100 m i l l i o n to one customer. Phelan t e s t i f i e d t h a t Hutton o f f i c i a l s m e t t o d i s c u s s Fomon's c o n c e r n , and t h a t , e x c e p t f o r h i m s e l f , a l l a g r e e d w i t h Fomon t h a t t h e l o a n s h o u l d b e t e r m i n a t e d . 166/ On J a n u a r y 2 3 , 1 9 8 0 , a f t e r P h e l a n n o t i f i e d Mercer o f H u t t o n ' s d e c i s i o n , Bunker p a i d H u t t o n a p p r o x i m a t e l y $102.9 Hutton i n t u r n r e l e a s e d m i l l i o n i n p r i n c i p a l and i n t e r e s t . t o S w i s s Bank C o r p o r a t i o n t h e s i l v e r w a r e h o u s e r e c e i p t s i t held as collateral f o r t h e loan. Terminating t h e l o a n g r e a t l y reduced Hutton's exposure t o Hunt a c t i v i t i e s i n t h e s i l v e r m a r k e t s . A l t h o u g h Lamar opened a s p e c u l a t i v e a c c o u n t i n c o p p e r on February 1 2 , 167/ u n t i l mid-March H u t t o n ' s s i l v e r r e l a t e d e x p o s u r e w a s l i m i t e d to L a m a r ' s 639 and B u n k e r ' s 38 c o n t r a c t p o s i t i o n . B. Re-establishing t h e S i l v e r Loan

On M a r c h 1 4 , 1 9 8 0 , H u t t o n l e n t B u n k e r a n d H e r b e r t $ 1 0 0 m i l l i o n . 1 6 8 / T h e terms were t h e same a s t h e e a r l i e r l o a n t o B u n k e r , e x c e p t t h a t t h e m a r g i n was s e t a t 6 5 % . 166/ Phelan and o t h e r s t e s t i f i e d t h a t t h e e v e n t s a t t h e Comex o n J a n u a r y 2 1 a n d t h e p r i c e d r o p o n J a n u a r y 2 2 had n o t h i n g to d o w i t h t h e d e c i s i o n to t e r m i n a t e t h e l o a n , a l t h o u g h P h e l a n r e c a l l e d t h a t Fomon w a s c o n cerned with s i l v e r v o l a t i l i t y i n general. On F e b r u a r y 1 2 Lamar e x e c u t e d a d d i t i o n a l d o c u m e n t a t i o n to open a n account with Hutton to c a r r y copper f u t u r e s . He again executed a "customer f i n a n c i a l statement." T h i s t i m e , h e s t a t e d assets o f $400 m i l l i o n , i n d i c a t e d n o l i a b i l i t i e s , a n d d e s c r i b e d h i s n e t w o r t h a s $50 million. Without seeking f u r t h e r information, Button s e t Lamar's c o p p e r t r a d i n g l i m i t a t $30 m i l l i o n i n i n i t i a l margin. 168/ Bunker r e c e i v e d $87 m i l l i o n and H e r b e r t $13 m i l l i o n . Bunker d e p o s i t e d 1,509 s i l v e r warehouse r e c e i p t s o n M a r c h 1 4 , 1 9 8 0 , a n d H e r b e r t d e p o s i t e d 2 4 0 s i l v e r wareh o u s e r e c e i p t s o n March 1 4 a n d March 1 9 , 1 9 8 0 , t o collateralize t h i s financing.

B o t h P h e l a n a n d H u t t o n c h i e f f i n a n c i a l o f f i c e r Thomas L y n c h ( " L y n c h " ) t e s t i f i e d a s t o how t h i s f i n a n c i n g came into existence. T h e i r e x p l a n a t i o n s d i f f e r i n many r e s p e c t s . P h e l a n t e s t i f i e d t h a t B r o d s k y a s k e d him i f H u t t o n would b e Phelan s a i d i n t e r e s t e d i n e x t e n d i n g f i n a n c i n g to t h e Hunts. h e d o u b t e d t h a t t h e f i r m w o u l d b e i n t e r e s t e d , b u t when B r o d s k y s u g g e s t e d t h a t a l o a n - t o - c o l l a t e r a l p e r c e n t a g e of 65% would b e a c c e p t a b l e t o t h e H u n t s , P h e l a n s a i d h e would d i s c u s s t h e matter w i t h o t h e r s a t t h e f i r m . Phelan t e s t i f i e d t h a t he t h e n c o n t a c t e d Lynch a b o u t t h e f i n a n c i n g , a n d t h a t L y n c h s t a t e d t h a t h e w o u l d t a l k t o some o f t h o s e p r e s e n t a t t h e m e e t i n g a t which t h e t e r m i n a t i o n o f t h e f i r s t f i n a n c i n g w a s discussed. P h e l a n a l s o d i s c u s s e d t h e matter w i t h some o f t h e p a r t i c i p a n t s a t t h a t meeting. The n e x t d a y , a c c o r d i n g t o P h e l a n , Lynch c a l l e d him a n d t o l d him t h a t t h e $100 m i l l i o n f i n a n c i n g t o B u n k e r a n d H e r b e r t H u n t was a p p r o v e d .
G.

Lynch t e s t i f i e d t h a t t h e f i r s t t i m e h e was i n f o r m e d o f t h e s e c o n d H u n t f i n a n c i n g was when B a l l t o l d h i m t h a t H u t t o n was g o i n g t o l e n d B u n k e r a n d H e r b e r t H u n t $ 1 0 0 m i l l i o n . L y n c h t e s t i f i e d t h a t h e d i d n o t know how B a l l h a d h e a r d o f t h e H u n t s r e q u e s t , o r w h e t h e r B a l l d i s c u s s e d t h e matter w i t h anyone p r i o r to approval o f t h e loan. Lynch a l s o t e s t i f i e d t h a t when h e l a t e r i n f o r m e d t h e c o m m o d i t y c r e d i t committee o f t h e d e c i s i o n , t h e g e n e r a l r e a c t i o n w a s surprise. B a l l a t t e n d e d t h e m e e t i n g i n which t h e t e r m i n a t i o n o f B a l l , however, d o e s n o t t h e f i r s t f i n a n c i n g was d i s c u s s e d . recall t h e e v e n t s s u r r o u n d i n g a p p r o v a l o f t h e second $100 million loan. H e d o e s recall d i s c u s s i n g t h e proposed l o a n w i t h Fomon a n d t e s t i f i e d t h a t i t was Fomon who a p p r o v e d t h e H e also t e s t i f i e d t h a t both P h e l a n ' s and second financing. L y n c h ' s v e r s i o n o f how t h e M a r c h f i n a n c i n g was a p p r o v e d were plausible. I f L y n c h ' s v e r s i o n o f t h e a p p r o v a l o f t h e second $100 m i l l i o n H u t t o n l o a n t o t h e Hunts is correct, t h e n it means t h a t t h e commodity c r e d i t a p p a r a t u s and p r o c e d u r e s e s t a b l i s h e d b y H u t t o n were n o t f o l l o w e d i n t h e l a r g e s t c o m m o d i t i e s l o a n e v e r e x t e n d e d by t h e f i r m t o a s i n g l e c u s t o m e r . Even P h e l a n ' s v e r s i o n i n d i c a t e s t h a t t h e n o r m a l c r e d i t p r o c e d u r e s were n o t s t r i c t l y followed. T h e r e is n o e v i d e n c e t h a t t h e f i r m h a d r e c e i v e d a n y a d d i t i o n a l f i n a n c i a l i n f o r m a t i o n a b o u t e i t h e r Bunker o r H e r b e r t H u n t b y March 1 9 8 0 . Thus, t h e o n l y knowledge Hutton p o s s e s s e d a b o u t t h e H u n t s ' f i n a n c i a l c o n d i t i o n when i t approved t h i s l o a n w a s t h e i n f o r m a t i o n t h a t t h e Hunts had

s u b m i t t e d when t h e y f i r s t o p e n e d t h e i r a c c o u n t s a t H u t t o n o v e r f o u r months e a r l i e r , as w e l l a s t h i s s u b s e q u e n t f a v o r A s d e s c r i b e d e a r l i e r by a b l e e x p e r i e n c e with t h e Hunts. Phelan, Hutton e s s e n t i a l l y r e l i e d on t h e b e l i e f " t h a t i t ' s a l m o s t common k n o w l e d g e t h a t t h e y were b i l l i o n a i r e s . " On March 1 4 , 1 9 8 0 , H u t t o n w i r e d $ 1 0 0 m i l l i o n t o t h e H u n t s ' a c c o u n t w i t h F i r s t i n Dallas. Once a g a i n , t h e f i r m a r r a n g e d f o r Brodsky t o r e c e i v e o n e - t h i r d o f H u t t o n ' s i n t e r e s t s p r e a d on t h e l o a n . Hutton subsequently i s s u e d f o u r margin c a l l s t o Bunker and H e r b e r t Hunt i n c o n n e c t i o n w i t h t h i s f i n a n c i n g . On March 1 8 , 1 9 8 0 , H u t t o n i s s u e d a c a l l o f a b o u t $11.5 m i l l i o n t o Bunker Hunt. The n e x t d a y i t i s s u e d a c a l l o f a l m o s t $1.2 m i l l i o n t o H e r b e r t Hunt. The b r o t h e r s m e t b o t h o f t h e s e c a l l s . On March 2 6 , 1 9 8 0 , H u t t o n i s s u e d a c a l l t o Bunker f o r a b o u t $580,000 and t h e n e x t d a y i s s u e d a n a d d i t i o n a l c a l l t o him f o r n e a r l y $ 1 1 . 9 m i l l i o n . B u n k e r d i d I n s t e a d , Hutton l i q u i d a t e d t h e coln o t meet t h e s e c a l l s . l a t e r a l Bunker and H e r b e r t m a i n t a i n e d t o s u p p o r t t h e l o a n .
IV.

THE CRISIS PERIOD AT HUTTON MARCH 26 THROUGH 2 8 , 1 9 8 0

A.

The H u n t s D e c l i n e t o Meet M a r g i n C a l l s

On t h e m o r n i n g o f March 2 6 , 1 9 8 0 , t h e H u n t s h e l d 6 7 7 l o n g s i l v e r f u t u r e s c o n t r a c t s and 8 . 7 m i l l i o n o u n c e s o f b u l l i o n . C o m p u t i n g Hunt f u t u r e s p o s i t i o n s a t f u t u r e s p r i c e s , i n a c c o r d w i t h r e c o g n i z e d i n d u s t r y p r a c t i c e , t h e combined H u n t a c c o u n t s were $ 7 9 . 5 m i l l i o n i n e q u i t y ; a t t h e s p o t p r i c e s t h a t r e p r e sented the a c t u a l value of the accounts i n liquidation equity w a s o n l y $49 m i l l i o n , enough t o p r o t e c t t h e f i r m from a dec l i n e i n t h e s p o t p r i c e o f s i l v e r t o approximately $11.75 p e r ounce. Due t o m a r k e t f l u c t u a t i o n , H u t t o n i s s u e d t h r e e m a r g i n c a l l s t o t h e Hunts t h a t day. I t i s s u e d one t o Bunker f o r a p p r o x i m a t e l y $ 5 7 8 r 0 0 0 , a n o t h e r t o Lamar f o r a b o u t $ 3 . 2 m i l l i o n i n c o n n e c t i o n w i t h h i s s i l v e r a c c o u n t , and a n o t h e r Jim f o r $195,000 i n c o n n e c t i o n w i t h Lamar's copper a c c o u n t . C u r l e y , H u t t o n ' s d i r e c t o r o f commodity o p e r a t i o n s a t t h e t i m e , c a l l e d Mercer t h a t a f t e r n o o n t o i n f o r m him o f t h e c a l l s . - Mercer r e s p o n d e d t h a t b e c a u s e o n e o f t h e b r o t h e r s , 169/ a p p a r e n t l y Bunker, w a s u n a v a i l a b l e , he could n o t inform C u r l e y u n t i l 10:OO t h e n e x t m o r n i n g a s t o w h e t h e r t h e c a l l s would b e m e t . Normally Mercer responded t o c a l l s more q u i c k l y ,

169/ - T h i s w a s t h e u s u a l manner i n which Hutton informed t h e Hunts o f margin calls.

179

so C u r l e y i m m e d i a t e l y i n f o r m e d P h e l a n o f t h i s d e v e l o p m e n t . P h e l a n was n o t c o n c e r n e d by t h i s n e w s , a p p a r e n t l y f i g u r i n g t h a t t h e r e c o u l d b e many i n n o c u o u s r e a s o n s f o r t h e d e l a y . 170/ P h e l a n a r r i v e d a t work a t 8:00 Thursday morning unaware o f t h e m e e t i n g t h e H u n t s had h e l d a t t h e Drake Hotel w i t h ACLI, B a c h e H a l s e y a n d M e r r i l l Lynch t h e n i g h t b e f o r e , i n w h i c h t h e y h a d a n n o u n c e d t h e i r i n a b i l i t y t o meet m a r g i n H e a l s o was u n a w a r e o f t h e m e e t i n g w i t h Comex p r e calls. s i d e n t L e e B e r e n d t t o d i s c u s s c l o s i n g t h e Comex s i l v e r m a r k e t . Accordingly, h e went a b o u t h i s r e g u l a r b u s i n e s s , i n c l u d i n g a t t e n d i n g a meeting a c r o s s t h e s t r e e t from H u t t o n ' s o f f i c e s concerning business i n Australia.
A t a b o u t 9:45, w h i l e s t i l l a t t h e m e e t i n g o n A u s t r a l i a n b u s i n e s s , Phelan r e c e i v e d a c a l l from Curley. Curley report e d t h a t Mercer h a d c a l l e d t o s a y t h a t t h e H u n t s would b e u n a b l e t o meet t h e i r c o m m i t m e n t t o H u t t o n . Curley reported Phelan t h a t Mercer s a i d h e would c a l l b a c k i n t e n m i n u t e s . immediately returned to Hutton's o f f i c e s .

C h a r l e s Mercer d i d n o t c a l l C u r l e y b a c k i n t e n m i n u t e s ; C u r l e y a n d P h e l a n s p o k e t o him o n a s p e a H e r b e r t Hunt d i d . ker-phone. H e r b e r t e x p l a i n e d t h a t t h e H u n t s 1 7 1 / were i l l i q u i d a n d would t h u s b e u n a b l e t o meet t h e i r c a l l s i n t h e n e a r f u t u r e , a l t h o u g h h e a s s u r e d them t h a t t h e y would h o n o r a l l o f t h e i r o b l i g a t i o n s to Hutton. Apparently n e i t h e r Phelan, Curley, n o r H e r b e r t m e n t i o n e d t h e word " l i q u i d a t i o n " , b u t P h e l a n made i t c l e a r t h a t h e w o u l d a c t " i n a c c o r d a n c e w i t h t h e c u s t o m e r ' s a g r e e m e n t " a n d t h a t h e w o u l d d o so i m m e d i a t e l y . H e r b e r t s a i d h e u n d e r s t o o d t h a t , and mentioned t h a t h e would a t t e m p t t o see P h e l a n l a t e r t h a t d a y .
B.

Liquidating t h e Accounts

P h e l a n began s e l l i n g o u t t h e Hunt a c c o u n t s i m m e d i a t e l y a f t e r h i s c o n v e r s a t i o n w i t h H e r b e r t Hunt. On t h e Comex, h e worked w i t h A 1 Brodsky and a n o t h e r f l o o r t r a d e r , Marty Greenberg. On t h e CBT, P h e l a n u s e d N i c k y Bank o f H u t t o n . 170/ - P h e l a n w a s n o t c e r t a i n , b u t h e may h a v e i n f o r m e d J o h n Daly o f t h e H u n t s ' s h o r t d e l a y i n meeting t h e morning calls. 171/ Although P h e l a n r e l a t e d H e r b e r t H u n t ' s s t a t e m e n t s a s employing t h e f i r s t person s i n g u l a r , Hutton d i d n o t have a n y c a l l s o u t s t a n d i n g t o H e r b e r t o n March 2 6 , 1 9 8 0 . F u r t h e r , t h e s u b s e q u e n t a c t i o n t a k e n by Hutton and t h e H u n t s i n d i c a t e t h a t H u t t o n assumed t h a t H e r b e r t Hunt was s p e a k i n g f o r B u n k e r a n d Lamar a s w e l l a s f o r h i m s e l f .

Phelan c o n c e n t r a t e d on l i q u i d a t i n g t h e Hunts' p h y s i c a l s i l v e r p o s i t i o n s throughout Thursday. H e accomplished t h i s w h i l e t h e d o m e s t i c m a r k e t s were o p e n p r i m a r i l y by s e l l i n g Comex A p r i l 8 0 s i l v e r c o n t r a c t s . B e c a u s e much o f t h e p h y s i c a l s i l v e r i n t h e H u n t a c c o u n t s w a s CBT s i l v e r , C u r l e y l a t e r a r r a n g e d f o r a s w i t c h t o e n a b l e Hutton t o o f f s e t t h e j u s t p u r c h a s e d Comex c o n t r a c t s w i t h t h e H u n t s ' CBT p o s i C u r l e y a r r a n g e d t h e s w i t c h w i t h S w i s s Bank, which tion. provided t h i s s e r v i c e f o r a f e e of 1 5 c e n t s p e r ounce. Hutton switched approximately 2.5 m i l l i o n ounces w i t h Swiss Bank, t h u s i n c u r r i n g a commission cost o f a p p r o x i m a t e l y $375,000. Some t i m e d u r i n g T h u r s d a y m o r n i n g , P h e l a n t o l d o t h e r s e n i o r management a t H u t t o n o f t h e s i t u a t i o n , i n c l u d i n g Ball. Fomon w a s i n t h e h o s p i t a l t h a t d a y a n d i t i s u n c l e a r when h e l e a r n e d o f t h e d a y ' s e v e n t s .
Near t h e e n d o f t h e t r a d i n g d a y o n t h e Comex, P h e l a n , C u r l e y and a n A s s o c i a t e G e n e r a l Counsel f o r Hutton, Loren S c h e c h t e r , were i n P h e l a n ' s o f f i c e d i s c u s s i n g t h e d a y ' s e v e n t s . T h e y r e c e i v e d a m e s s a g e t h e r e t h a t " s o m e b o d y " was i n C u r l e y ' s o f f i c e who w a n t e d t o s e e him. Curley went t o see who i t w a s , a n d r e t u r n e d s h o r t l y t h e r e a f t e r t o i n f o r m t h e o t h e r s t h a t t h e i r v i s i t o r s were Lamar a n d H e r b e r t H u n t .

The t w o Hunt b r o t h e r s , a l o n g w i t h t h r e e o r f o u r o f t h e i r Phelan advised a i d e s , were u s h e r e d i n t o P h e l a n ' s o f f i c e . D a l y , who i n t u r n a d v i s e d B a l l o f t h e H u n t s ' a r r i v a l . B a l l i n v i t e d t h e g r o u p t o a c o n f e r e n c e room n e a r h i s o f f i c e . T h e r e , H e r b e r t a g a i n e x p l a i n e d t h a t t h e y c o u l d n o t meet t h e i r commitments i m m e d i a t e l y , b u t t h a t t h e y would h o n o r t h e i r obligations. A g a i n , t h e word " l i q u i d a t i o n " w a s a p p a r e n t l y never used. B a l l , however, a d v i s e d t h e Hunts t h a t t h e f i r m would a c t u n d e r t h e c u s t o m e r a g r e e m e n t s . Herbert's o n l y r e s p o n s e , a p p a r e n t l y , was a r e q u e s t t h a t H u t t o n d o so i n a p r o f e s s i o n a l manner. N e i t h e r P h e l a n n o r B a l l c o u l d r e c a l l t h e H u n t s revealing t h e i r s i l v e r positions a t other firms. Herbert d i d mention t h a t h e had m e t t h e p r e v i o u s n i g h t w i t h r e p r e s e n t a t i v e s from o t h e r b r o k e r - d e a l e r s , however, and a p o l o gized f o r Hutton's not having received an i n v i t a t i o n to t h e 172/ meeting. Hutton issued t h r e e a d d i t i o n a l calls to t h e Hunts on March 2 7 , 1 9 8 0 . T h e s e were a n a p p r o x i m a t e l y $ 3 . 2 m i l l i o n c a l l t o Lamar o n h i s s i l v e r a c c o u n t , a $ 1 2 7 , 5 0 0 c a l l t o Lamar f o r h i s c o p p e r a c c o u n t , a n d a n a p p r o x i m a t e l y $ 1 1 . 9 m i l l i o n c a l l t o Bunker. A t t h e close o f t r a d i n g on 172/ P h e l a n t e s t i f i e d t h a t h e had l e a r n e d o f t h a t m e e t i n g e a r l i e r i n t h e day.

d o m e s t i c e x c h a n g e s , t h e Hunt a c c o u n t s s t i l l h e l d l a r g e positions in s i l v e r physicals. Further, their s i l v e r Account f u t u r e s p o s i t i o n s had n o t been reduced a t a l l . d o c u m e n t a t i o n r e f l e c t s e q u i t y o f $ 3 6 . 2 m i l l i o n i n t h e comb i n e d a c c o u n t s v a l u i n g Lamar a n d B u n k e r ' s l o n g f u t u r e s position a t futures p r i c e s i n accordance with recognized industry practice. A t s p o t p r i c e s , however, t h e Hunt a c c o u n t s o n March 27 h e l d a n u n s e c u r e d d e b i t b a l a n c e o f $8.9 m i l l i o n . P h e l a n and C u r l e y d e t e r m i n e d t h a t it w a s n e c e s s a r y to continue to liquidate. The n e x t e x c h a n g e t o open would b e t h e Hong Kong e x c h a n g e , a n d t h e y h a d n o c o n t a c t t h e r e . A c c o r d i n g l y , t h e y c a l l e d S a l A z z a r r a o f Mocatta Metals a t h i s o f f i c e i n New York. P h e l a n a n d A z z a r r a h a d known e a c h o t h e r p r o f e s s i o n a l l y H u t t o n d i d n o t h a v e a n a c c o u n t a t Mocatta, for several years. s o P h e l a n f i r s t a s k e d A z z a r r a how much c r e d i t Mocatta w o u l d g i v e t h e f i r m o v e r t h e phone. Azzarra said, according to P h e l a n , t h a t H u t t o n c o u l d h a v e a s much c r e d i t a s i t n e e d e d . Then, i n P h e l a n ' s words:
I s a i d , " F i n e , how l a t e a r e y o u o p e n ? " H e s a i d , "We're o p e n , o b v i o u s l y , d u r i n g t h e h o u r s o f Hong Kong". I s a i d , " S a l , I d o n ' t know a n y b o d y t h e r e . How l a t e w i l l you b e t h e r e ? " H e s a i d " I c a n b e h e r e t i l l 6:OO." I s a i d , " I t ' s my u n d e r s t a n d i n g t h a t Hong Kong o p e n s a t 8:30." H e s a i d , " T h a t ' s correct." I s a i d , "Can I a s k H e s a i d , "You c o u l d . " I you t o s t a y till you open?" s a i d , " I am." He s a i d , " I ' l l stay."

P h e l a n and A z z a r r a t a l k e d a p p r o x i m a t e l y e v e r y f i f t e e n m i n u t e s from t h e t i m e o f t h a t c o n v e r s a t i o n u n t i l a b o u t 6:30, w h e n , a l o n g w i t h C u r l e y , t h e y met f o r d i n n e r . Phelan w a s p l a n n i n g t o s e l l b u l l i o n i n Hong Kong a n d l a t e r t h a t n i g h t i n L o n d o n , y e t h e h a d w a r e h o u s e r e c e i p t s f r o m t h e Comex a n d CBT, n e i t h e r o f w h i c h c o u l d b e u s e d a s d e l i v e r y o n a Hong Kong o r London t r a n s a c t i o n . Hutton d i d n o t have a n i n t e r n a l cache o f Hong Kong s i l v e r b u l l i o n w i t h w h i c h t o e f f e c t u a t e a s w i t c h ; Mocatta d i d . A t t h e d i n n e r , P h e l a n a s k e d A z z a r r a i f Mocatta c o u l d e x t r i c a t e H u t t o n from t h i s dilemma. A z z a r r a a g r e e d to h a v e Mocatta s w i t c h w i t h H u t t o n t o a l l o w d e l i v e r y o n w h a t e v e r s i l v e r they sold that night. F u r t h e r , Mocatta w o u l d d o so a t no charge. At a b o u t 8:15, P h e l a n , C u r l e y , and A z z a r r a r e t u r n e d to their respective offices. They e s t a b l i s h e d b o t h t e l e p h o n e a n d t e l e x h o o k - u p s b e t w e e n Mocatta a n d H u t t o n , a n d A z z a r r a e s t a b l i s h e d a t e l e x c o n n e c t i o n w i t h Hong Kong.

T h e Hong Kong s i l v e r m a r k e t o p e n e d T h u r s d a y n i g h t a t a b o u t 8 : 3 0 p.m. EST. Every t e n or f i f t e e n minutes, Azzarra would r e l a y q u o t e s from t h a t m a r k e t t o P h e l a n , and P h e l a n would p l a c e a n o r d e r . Phelan described t h e o r d e r s he placed as small--10,000 t o 25,000 ounces. When Mocatta a n d H u t t o n f i r s t b e g a n s e l l i n g i n Hong Kong, P h e l a n c l a i m s A z z a r r a s a i d t h a t t h e y were t h e o n l y s e l l e r s i n t h e m a r k e t . L a t e r t h e m a r k e t t h e r e "sot e n e d " , and Phelan h e l d back some o r d e r s . Hutton l i q u i d a t e d approximately 160,000 ounces o f s i l v e r d u r i n g t h a t n i g h t i n Hong Kong. A f t e r a s h o r t n a p , C u r l e y , P h e l a n , and A z z a r r a r e t u r n e d t o t h e i r r e s p e c t i v e o f f i c e s and p r e p a r e d to c o n t i n u e l i q u i d a t i o n o f t h e Hunt a c c o u n t s i n London. P h e l a n had c a l l e d J i m S w e e n e y , h e a d o f H u t t o n ' s London o p e r a t i o n , e a r l i e r t h a t n i g h t t o a r r a n g e f o r H u t t o n ' s London o f f i c e s t o b e r e a d y t o assist t h e f i r m ' s l i q u i d a t i o n o f t h e Hunt a c c o u n t s i f n e c e s sary. To a v o i d r e v e a l i n g t h a t H u t t o n was a h e a v y s i l v e r seller, however, P h e l a n c h o s e t o c o n t i n u e s e l l i n g through Mocatta. Mocatta a n d H u t t o n w o r k e d t h e London s i l v e r m a r k e t s i n t h e same f a s h i o n t h a t t h e y w o r k e d t h e Hong Kong s i l v e r markets earlier, although t h e s i z e of t h e lots traded i n London were g e n e r a l l y s m a l l e r t h a n t h o s e t r a d e d i n Hong Kong. By t h e t i m e t h e L o n d o n m a r k e t c l o s e d , t h e e n t i r e p h y s i c a l s i l v e r p o s i t i o n i n t h e Hunt a c c o u n t s a t H u t t o n was liquidated. The o n l y Hunt s i l v e r p o s i t i o n s a t H u t t o n r e m a i n i n g u n h e d g e d o n F r i d a y m o r n i n g when t h e d o m e s t i c c o m m o d i t i e s m a r k e t s o p e n e d were t h e 6 3 9 M a r c h 8 1 s i l v e r c o n t r a c t s owned b y Lamar a n d t h e 3 8 May 8 0 s i l v e r c o n t r a c t s owned b y Bunker. 173/ T o l i q u i d a t e L a m a r H u n t ' s f u t u r e p o s i t i o n s , w h i c h were i n a c o n t r a c t m o n t h almost a y e a r a w a y , P h e l a n h a d t o d o double switches. P h e l a n u s e d t h e same t w o b r o k e r s h e h a d u s e d o n t h e Comex t h e p r e v i o u s d a y , B r o d s k y a n d G r e e n b e r g . By t h e t i m e Comex c l o s e d , t h e n e t p o s i t i o n r e m a i n i n g i n Lamar's account stood a t n i n e s i l v e r c o n t r a c t s long. Bunker H u n t ' s 3 8 May 8 0 s i l v e r c o n t r a c t s h a d b e e n l i q u i d a t e d o n Friday. T r a n s a c t i o n s e x e c u t e d t h e f o l l o w i n g week c o m p l e t e l y liquidated t h e accounts.

173/ -

Lamar Hunt a l s o h a d 300 December 8 0 c o p p e r c o n t r a c t s i n h i s account on Friday. T h e s e were l i q u i d a t e d t h a t d a y .

A t some t i m e o n M a r c h 2 8 , P h e l a n l e a r n e d t h a t B u n k e r a n d H e r b e r t Hunt m a i n t a i n e d a j o i n t s e c u r i t i e s a c c o u n t a t a w e s t coast H u t t o n o f f i c e . P h e l a n i n f o r m e d Mercer - t h a t H u t t o n 174/ w o u l d n o t s e l l o u t t h a t a c c o u n t u n l e s s i t was n e c e s s a r y t o p r e v e n t a loss i n t h e Hunt commodities a c c o u n t s . 175/ I t was n o t n e c e s s a r y t o d o so. By A p r i l 2 , 1 9 8 0 , P h e l a n h a d s u c c e e d e d i n c o m p l e t e l y l i q u i d a t i n g t h e Hunt commodities a c c o u n t s . There remained a d e f i c i t o f $1.2 m i l l i o n , r e p r e s e n t i n g s t o r a g e c h a r g e s o n t h e Hunts' b u l l i o n and losses on t h e l i q u i d a t i o n o f t h e E!unts1 T r e a s u r y b i l l p o s i t i o n . Placid O i l repaid t h i s amount o n t h e Hunts' b e h a l f o n A p r i l 8 , 1980, o u t of t h e proceeds of i n t e r i m banks loans. S i n c e t h e s i l v e r crisis H u t t o n h a s i s s u e d n o p r e s s r e l e a s e s n o r made a n y d i s c l o s u r e i n i t s p u b l i c f i l i n g s c o n c e r n i n g i t s r o l e i n t h e c r i s i s or t h e impact on t h e firm.

174/ 175/ -

Phelan could n o t recall i f t h i s conversation took p l a c e o n F r i d a y n i g h t o r Monday m o r n i n g . Many o f t h e t r a d e s e x e c u t e d o n M a r c h 27 a n d M a r c h 2 8 , 1 9 8 0 , d i d n o t clear u n t i l April 1 or A p r i l 2 , 1980. T h u s e v e n i f t h i s c o n v e r s a t i o n d i d t a k e p l a c e o n Monday m o r n i n g , A p r i l 1, 1 9 8 0 , P h e l a n c o u l d n o t be s u r e t h a t h e had managed to l i q u i d a t e t h e H u n t a c c o u n t s w i t h o u t incurring a deficit.

PART FIVE
P A I N E WEBBER INCORPORATED

I.

THE PAINE WEBBER COMPLEX

A.

The H o l d i n s C o m ~ a n v

P a i n e Webber I n c o r p o r a t e d ( " P W I " ) , a h o l d i n g company i n c o r p o r a t e d i n Delaware, is engaged through v a r i o u s s u b s i d i a r i e s i n r e t a i l and i n s t i t u t i o n a l s e c u r i t i e s brokerage, i n v e s t m e n t b a n k i n g , i n v e s t m e n t management a n d c o m m o d i t i e s f u t u r e s brokerage. PWI i s a p u b l i c l y - h e l d company w h o s e common s t o c k i s r e g i s t e r e d w i t h t h e C o m m i s s i o n p u r s u a n t t o S e c t i o n 1 2 ( b ) o f t h e E x c h a n g e A c t a n d l i s t e d o n t h e N e w York S t o c k Exchange. A t September 1 8 , 1 9 7 9 , its 5,361,006 o u t s t a n d i n g common s h a r e s were i n t h e h a n d s o f 3 , 3 2 7 h o l d e r s o f record. F o r t h e f i s c a l y e a r e n d e d S e p t e m b e r 2 0 , 1 9 7 9 , PWI rep o r t e d p r e - t a x income o f $24.5 m i l l i o n on r e v e n u e s o f $507 m i l l i o n . The company d e r i v e d i t s r e v e n u e s p r i n c i p a l l y from commissions o n s e c u r i t i e s t r a n s a c t i o n s ($178 m i l l i o n ) , i n t e r e s t ($220 m i l l i o n ) , t r a n s a c t i o n s as p r i n c i p a l ($43 m i l l i o n ) , i n v e s t m e n t b a n k i n g ( $ 3 7 m i l l i o n ) , and commodity commissions ($22 m i l l i o n ) . I t s p r i n c i p a l e x p e n s e s were employee compensation b e n e f i t s ($190 m i l l i o n ) , i n t e r e s t ($188 m i l l i o n ) , communications ($30 m i l l i o n ) and o f f i c e and equipment r e n t a l ($16.7 m i l l i o n ) . PWI r e p o r t e d a n e t w o r t h o f $101 m i l l i o n a t September 28, 1979.
B.

The B r o k e r - D e a l e r

PWI's p r i n c i p a l w h o l l y - o w n e d s u b s i d i a r y i s P a i n e , Webber, J a c k s o n & C u r t i s I n c o r p o r a t e d ( " P a i n e Webber"), a b r o k e r - d e a l e r r e g i s t e r e d w i t h t h e Commission p u r s u a n t t o S e c t i o n 1 5 ( b ) o f t h e Exchange A c t . PWI r e p o r t s t h a t i n f i s c a l y e a r 1 9 7 9 , P a i n e Webber's s h a r e o f round l o t volume t r a d e d o n t h e NYSE was 2 . 9 4 % a n d t h a t i t was o n e o f t h e nation's l a r g e s t financial services firms. P a i n e Webber i s a member o f a l l major s e c u r i t i e s a n d c o m m o d i t i e s e x c h a n g e s i n t h e U n i t e d S t a t e s a n d i t a n d i t s s u b s i d i a r i e s or a f f i l i a t e s hold memberships o r a s s o c i a t e memberships o n s e v e r a l f o r e i g n s e c u r i t i e s and commodities exchanges.
A s a r e g i s t e r e d b r o k e r - d e a l e r a n d a s a member o f t h e NYSE, P a i n e Webber i s s u b j e c t t o t h e U n i f o r m N e t C a p i t a l Rule. A t March 3 1 , 1 9 8 0 , P a i n e W e b b e r ' s n e t c a p i t a l was $14 m i l l i o n above t h e 7% " e a r l y warning" l e v e l and $66 m i l l i o n a b o v e p r e s c r i b e d minimums. The H u n t s c o n d u c t e d a l l o f t h e i r s i l v e r f u t u r e s t r a d i n g w i t h PWI t h r o u g h P a i n e Webber.

During t h e t h r e e months p r i o r to t h e s i l v e r crisis, a s e r i e s o f e v e n t s o c c u r r e d i n P a i n e Webber t h a t r e n d e r e d t h e problems encountered by t h e f i r m i n c o n n e c t i o n w i t h t h e H u n t s ' a c t i v i t i e s more a c u t e t h a n o t h e r w i s e w o u l d h a v e b e e n

the case. After the close of business on December 31, 1979, Blyth Eastman Dillon & Co. Inc., ("BEDCO"), a registered broker-dealer, was merged into PWI. The merger resulted in an increase of approximately 100,000 customer accounts handled by Paine Webber's operations system. The merger, one of the largest in the securities industry, created an entity with combined revenues of over $900 million and capitalization in excess of $220 million, It resulted, however, in bookkeeping problems that rendered Paine Webber's books and records substantially unreliable in major respects. 176/ 11. INCEPTION AND DEVELOPMENT OF THE HUNT RELATIONSHIP

A. Background
Hunt commodity accounts first came to Paine Webber in 1977 as a result of its acquisition of Mitchell Hutchins, another broker-dealer. At that time, Paine Webber account executive John Wagner ("Wagner") learned from Hunt silver

176/ - On December 17, 1980, the Commission issued an Order

Instituting Proceedings and Findings and Opinion in the matter of Paine Webber and PWI. The Order, to which Paine Webber and PWI consented without admitting or denying any of the allegations, facts, findings or other conclusions contained in the order, was based upon findings that: (1) Paine Webber willfully violated the financial responsibility, securities count, bookkeeping, and supplemental reporting provisions of the Exchange Act; and (2) PWI filed with the Commission a quarterly report on Form 10-Q for the three month period ended March 31, 1980, which failed to comply with the reporting and disclosure provisions of the Exchange Act. The Order censured Paine Webber and required it, through December 31, 1981, to submit to the Commission staff reports concerning certain aspects of its operations and financial condition. The Order imposed limitations on the firm's ability to expand its business through December 31, 1981, and directed the firm to conduct all securities counts and to make and keep current its books and records in compliance with the Exchange Act. Securities Exchange Act Release No. 34-17384 (December 17, 1980). The NYSE censured Paine Webber and fined it $300,000 based on these and other allegations arising from its operational difficulties in early 1980.

b r o k e r A l v i n B r o d s k y t h a t t h e r e was a p o s s i b i l i t y t h a t some Hunt s i l v e r b u s i n e s s c o u l d b e d i r e c t e d t o P a i n e Webber. Wagner wrote a n d t e l e p h o n e d t h e H u n t s i n v i t i n g t h e m t o d o 177/ business with the firm. On A p r i l 2 0 , 1 9 7 7 , B u n k e r a n d H e r b e r t H u n t e a c h o p e n e d a new c o m m o d i t i e s a c c o u n t w i t h t h e f i r m . They b e g a n t r a d i n g s i l v e r i n t h e s e a c c o u n t s and by J u l y 31, 1979, t h e combined accounts held a total of 1713 s i l v e r f u t u r e s c o n t r a c t s r e p r e s e n t i n g 8.6 m i l l i o n o u n c e s o f s i l v e r .
A s a t Bache H a l s e y , t h e H u n t s p l a c e d t h e i r s i l v e r o r d e r s i n t h e P a i n e Webber a c c o u n t s d i r e c t l y w i t h B r o d s k y o n t h e f l o o r o f Comex. B r o d s k y " g a v e up" P a i n e Webber o n c e r t a i n o f t h e t r a d e s a n d h e a n d Wagner s p l i t 6 0 % o f t h e c o m m i s s i o n s t h e H u n t s p a i d t o P a i n e Webber. B r o d s k y r e c e i v e d more t h a n h a l f o f t h i s amount. Wagner's role i n t h e p r o c e s s w a s t o t e l e p h o n e Mercer o r a n a s s o c i a t e a t t h e H u n t E n e r g y C o r p o r a t i o n o f f i c e s i n D a l l a s t o r e p o r t t h e number o f c o n t r a c t s t r a d e d and t h e p r i c e s .
B.

Establishing Trading Limits i n t h e Hunt Accounts

The m a g n i t u d e o f t h e t r a d i n g t h e Hunts c o n d u c t e d i n t h e i r s i l v e r and o t h e r commodity a c c o u n t s w i t h P a i n e Mebber r e q u i r e d t h e a p p r o v a l o f t h e f i r m ' s n a t i o n a l commodity c r e d i t committee, t h e more s e n i o r o f t w o s u c h g r o u p s t h a t t h e f i r m r e q u i r e d t o p a s s upon a l l b u t t h e s m a l l e s t c o m m o d i t y t r a d i n g l i m i t r e q u e s t s . - E a r l y i n 1 9 7 8 , how178,' e v e r , t h e n a t i o n a l c o m m o d i t y c r e d i t committee d e t e r m i n e d t h a t t h e c r e d i t d e c i s i o n i n t h e H u n t s ' case w o u l d h a v e t o rest w i t h s e n i o r management. It arrived a t t h i s conclusion

177/ -

Wagner r e m e m b e r e d s p e a k i n g w i t h B u n k e r b u t d i d n o t r e c a l l if he spoke with Herbert.

1 7 8 / P a i n e Webber b r a n c h o f f i c e m a n a g e r s c o u l d a p p r o v e c u s tomer c o m m o d i t y p o s i t i o n s r e q u i r i n g $ 2 0 , 0 0 0 o r l e s s i n i n i t i a l margin. P o s i t i o n s r e q u i r i n g from $20,000 t o $150,000 i n i n i t i a l margin r e q u i r e d t h e a p p r o v a l o f t h e "New York" c o m m o d i t y c r e d i t committee. If a position r e q u i r e d m a r g i n o v e r $ 1 5 0 , 0 0 0 , P a i n e Webber p r o c e d u r e s r e q u i r e d t h e a p p r o v a l o f t h e " n a t i o n a l " commodity c r e d i t committee.

b e c a u s e i t had o b t a i n e d n o c r e d i t i n f o r m a t i o n o n t h e a c c o u n t s . - A memorandum d a t e d J a n u a r y 9 , 1 9 7 8 , t o 179/ members o f t h e n a t i o n a l commodity c r e d i t c o m m i t t e e r e f l e c t s that: The b a c k g r o u n d a n d n a t u r e o f t h e Hunt a c c o u n t s were discussed. T h e r e is no c r e d i t i n f o r m a t i o n i n t h e i r files. I n d i c a t i o n s a r e t h a t i t would b e f u t i l e t o a t t e m p t t o o b t a i n a n y s t a t e m e n t s , e t c . The d e c i s i o n a s t o t h e e x t e n t of t r a d i n g with these accounts w i l l h a v e t o r e s t w i t h s e n i o r management r a t h e r t h a n w i t h t h e c r e d i t committee. 180/ I n accordance w i t h i t s J a n u a r y 1978 d e t e r m i n a t i o n t h a t s e n i o r management s h o u l d make c r e d i t d e c i s i o n s i n t h e H u n t a c c o u n t s , t h e n a t i o n a l commodity c r e d i t c o m m i t t e e c o n s i s t e n t l y l e f t u l t i m a t e d e c i s i o n making i n t h e h a n d s o f P a i n e Webber p r e s i d e n t J o h n F. C u r l e y ( " C u r l e y " ) o v e r t h e e n s u i n g two y e a r s , a l t h o u g h i t e n t e r t a i n e d a n d d i s c u s s e d i n c r e a s e d t r a d i n g a n d l i m i t r e q u e s t s i n H u n t a c c o u n t s and made recomm e n d a t i o n s t o s e n i o r management. Thus, on February 1 2 , 1979, P a i n e Webber t r e a s u r e r , H e r b e r t Z . G e i g e r ( " G e i g e r " ) , w r o t e Curley t h a t : The N a t i o n a l commodity c r e d i t c o m m i t t e e h a s recommended f o r y o u r a p p r o v a l t h e a s s i g n m e n t o f $ 2 m i l l i o n m a r g i n l i m i t s f o r e a c h o f t h e s i x Hunt a c c o u n t s , f o r a t o t a l o f $12 m i l l i o n .

1 7 9 / S e c t i o n BPA.11.2 o f t h e P a i n e Webber B u s i n e s s P o l i c i e s - Manual - C o m m o d i t i e s i s c a p t i o n e d " R e s t r i c t i o n s f o r l a c k o f ~ o c u m e n t a t i o n "a n d r e a d s i n p a r t a s f o l l o w s : i f t h e required documentation f o r opening a commodity a c c o u n t h a s n o t b e e n r e c e i v e d by t h e N a t i o n a l Commodities C r e d i t O f f i c e r w i t h i n 1 5 b u s i n e s s d a y s a f t e r t h e account has been opened, t h e s e r v i c i n g branch o f f i c e w i l l be a d v i s e d t h a t t h e a c c o u n t i s r e s t r i c t e d t o l i q u i d a t i o n s u n t i l s u c h t i m e a s t h e documents are r e c e i v e d by t h e N a t i o n a l C o m m o d i t i e s C r e d i t O f f i c e r . 180 -/ f i l e s s u b s t a n t i a l l y confirms t h e statement quoted i n t h e t e x t . Each o f t h e H u n t b r o t h e r s e x e c u t e d t h e P a i n e Webber " C l i e n t Q u a l i f i c a t i o n Form - C o m m o d i t i e s " when h e o p e n e d h i s s i l v e r a c c o u n t with t h e firm. I n H e r b e r t H u n t ' s c a s e , t h e form p r o v i d e d n o r e s p o n s e t o t h e i n q u i r y c o n c e r n i n g a n n u a l income o r t a x b r a c k e t , showed a $10 m i l l i o n n e t w o r t h , $ 2 m i l l i o n i n " L i q u i d N e t Worth" and $1 m i l l i o n i n " A v a i l a b l e Speculative Capital". Bunker H u n t ' s c l i e n t q u a l i f i c a t i o n f o r m was i d e n t i c a l e x c e p t t h a t i t showed n e t w o r t h o f $ 1 1 m i l l i o n and " L i q u i d N e t W o r t h " o f $ 3 m i l l i o n .
A review o f P a i n e Webber's

. . .

S p e c i f i c d e t a i l e d f i n a n c i a l i n f o r m a t i o n is n o t a v a i l a b l e on t h e Hunts. They a r e r e p u t e d t o b e v e r y w e a l t h y T e x a s m i l l i o n a i r e s w i t h l a r g e h o l d i n g s i n o i l and g a s and commodities. T h e s e a c c o u n t s have b e e n heavy t r a d e r s w i t h u s and A l l commitments have been m e t Mitchell Hutchins. promptly. T r a d i n g v o l u m e was m a t e r i a l l y i n e x c e s s 181/ of current l i n e requests. On F e b r u a r y 1 5 , 1 9 7 9 , C u r l e y a p p r o v e d t h e f o r e g o i n g recommendation. S i m i l a r l y , o n A p r i l 6 , 1 9 7 9 , G e i g e r wrote C u r l e y s t a t i n g t h a t t h e n a t i o n a l c o m m o d i t y c r e d i t committee h a d recommended a $ 1 m i l l i o n m a r g i n l i n e f o r B u n k e r H u n t ' s s o n Houston. Geiger reminded Curley t h a t " s p e c i f i c d e t a i l e d f i n a n c i a l i n f o r m a t i o n is g e n e r a l l y n o t a v a i l a b l e on t h e Hunts" b u t t h a t Houston Hunt had s i g n e d a c l i e n t q u a l i f i c a t i o n form d i s c l o s i n g a n e t worth o f $3 m i l l i o n , l i q u i d a s s e t s o f $100,000 and a n a n n u a l income o f $150,000. The On f i r m a l s o had a f a v o r a b l e b a n k r e p o r t o n H o u s t o n H u n t . A p r i l 1 0 , 1979, C u r l e y approved a $1 m i l l i o n margin l i n e f o r Houston Hunt.
C.

Hunt Accounts a t J u l y 31, 1979

A t J u l y 3 1 , 1 9 7 9 , H u n t a c c o u n t s w i t h P a i n e Webber h e l d 1 7 1 3 s i l v e r f u t u r e s c o n t r a c t s r e p r e s e n t i n g 8.6 m i l l i o n ounces of s i l v e r . E q u i t y i n t h e a c c o u n t s t o t a l e d $10 m i l l i o n a n d w a s s u f f i c i e n t t o p r o t e c t t h e f i r m a g a i n s t a l i t t l e more t h a n a $ 1 p e r ounce d e c l i n e i n t h e p r i c e of s i l v e r .

111. THE BUILDUP AND DECLINE I N SILVER - JULY 3 1 , 1 9 7 9

THROUGH MARCH 2 7 , 1 9 8 0
A.

~ a n a ~ e m e n te c i s i o n s C o n c e r n i n g Hunt T r a d i n g D

D u r i n g t h e f a l l o f 1 9 7 9 , Hunt l o n g s i l v e r f u t u r e s a t P a i n e Webber i n c r e a s e d t o 2 0 4 6 c o n t r a c t s . The i n c r e a s e In was d u e e x l u s i v e l y t o a c t i v i t y i n B u n k e r ' s a c c o u n t .

181/ -

The s t a f f q u e s t i o n e d G e i g e r a b o u t t h e a p p a r e n t i n c o n s i s t e n c y b e t w e e n t h e committee's r e c o m m e n d a t i o n t h a t H e r b e r t Hunt b e p e r m i t t e d t o t r a d e u p t o $ 2 m i l l i o n i n m a r g i n s and t h e d i s c l o s u r e i n h i s 1977 c l i e n t q u a l i f i c a t i o n form t h a t he had o n l y $1 m i l l i o n i n a v a i l a b l e speculative capital. G e i g e r t e s t i f i e d t h a t t h e comm i t t e e had no a d v e r s e f i n a n c i a l i n f o r m a t i o n and assumed t h a t t h e 1977 form c o n t a i n e d " s t a l e " information. He s t a t e d , h o w e v e r , t h a t t h e c o m m i t t e e had no more r e c e n t i n f o r m a t i o n i n 1979 t h a n t h a t c o n t a i n e d i n t h e form.

O c t o b e r a n d November h e e s t a b l i s h e d a 2 0 9 c o n t r a c t l o n g p o s i t i o n i n D e c e m b e r 1 9 7 9 Comex s i l v e r a n d a d d e d 200 c o n t r a c t s t o h i s March 1 9 8 0 p o s i t i o n . Near t h e e n d o f November h e r o l l e d 1 3 3 D e c e m b e r c o n t r a c t s f o r w a r d i n t o t h e March m a t u r i t y a n d t o o k d e l i v e r y o n t h e r e m a i n i n g 76 December c o n t r a c t s . I n J a n u a r y b o t h Bunker and H e r b e r t r e d u c e d t h e i r p o s i t i o n s s u b s t a n t i a l l y by c l o s i n g o u t or taking delivery. A t m o n t h - e n d , t h e i r c o m b i n e d p o s i t i o n was 7 1 0 c o n t r a c t s i n t h e May m a t u r i t y , w h i c h t h e y m a i n t a i n e d u n t i l t h e crisis. The f u t u r e s t r a d i n g l i m i t s C u r l e y e s t a b l i s h e d i n t h e Hunt a c c o u n t s i n F e b r u a r y and A p r i l 1979 remained i n e f f e c t u n t i l a p p r o x i m a t e l y November 1 9 7 9 , when t h e n a t i o n a l commod i t y c r e d i t c o m m i t t e e d e c i d e d t o recommend t o C u r l e y t h a t h e a p p r o v e a $5 m i l l i o n l i n e i n t h e Hunt a c c o u n t s . On J a n u a r y 1 6 , 1 9 8 0 , G e i g e r s e n t C u r l e y a memorandum c o n t a i n i n g t h e committee's r e c o m m e n d a t i o n ; a n d o n J a n u a r y 1 8 , C u r l e y r e p l i e d t h a t t h e r e q u e s t " p r o b a b l y m a k e s s e n s e " , b u t w a n t e d t o know (1) t h e b a s i s f o r t h e $ 5 m i l l i o n l i m i t , a n d ( 2 ) a t t h a t l i m i t t h e f i r m ' s maximum e x p o s u r e u n d e r a d v e r s e c o n d i t i o n s i n t h e Curley c o m m o d i t i e s i n which t h e a c c o u n t s would b e t r a d i n g . r e c e i v e d no r e p l y to h i s i n q u i r i e s and recalls n o f u r t h e r 182/ d i s c u s s i o n o n t h e matter. M e a n w h i l e , a s Comex a n d CBT i n c r e a s e d m a r g i n r e q u i r e ments i n s i l v e r , Bunker and H e r b e r t H u n t ' s s i l v e r a c c o u n t s 183/ s u b s t a n t i a l l y exceeded approved t r a d i n g l i m i t s . - T h i s g e n e r a t e d " v i o l a t i o n s i g n a l s " i n P a i n e F J e b b e r t s D a i l y Commodity C r e d i t Report a s e a r l y as September 4 , 1979, and f r e q u e n t l y t h e r e a f t e r u n t i l t h e H u n t a c c o u n t s were l i q u i d a t e d o n March 2 7 a n d 2 8 , 1 9 8 0 . A l t h o u g h J o h n G . C a p p s ( " C a p p s " ) , v i c e p r e s i d e n t i n P a i n e W e b b e r ' s n a t i o n a l comm m o d i t i e s d e p a r t m e n t , r e c a l l s t e l l i n g Wagner i n J a n u a r y 1 9 8 0 t o a c c e p t n o f u r t h e r H u n t b u s i n e s s , a n d P a i n e Webber r e c o r d s c o n f i r m t h a t t h e a c c o u n t s were r e s t r i c t e d , W a g n e r d o e s n o t r e c a l l s u c h a c o n v e r s a t i o n and Hunt a c c o u n t s cont i n u e d t o c a r r y p o s i t i o n s beyond t h e i r a u t h o r i z e d m a r g i n

182/ C u r l e y t e s t i f i e d t h a t w h i l e h e d i d n o t c o n s i d e r h i s J a n u a r y 1 8 r e p l y to c o n s t i t u t e h i s a u t h o r i z a t i o n f o r a $5 m i l l i o n c r e d i t l i m i t , i t a p p a r e n t l y was c o n s t r u e d a s s u c h s i n c e h e s u b s e q u e n t l y l e a r n e d t h a t t h e a c c o u n t was permitted to t r a d e on t h a t b a s i s .

- earlier trading

1 8 3 / P a i n e W e b b e r ' s D a i l y Commodity C r e d i t R e p o r t s h o w s t h e l i m i t ($2 m i l l i o n p e r account) remaining i n e f f e c t t h r o u g h March 2 6 , 1 9 8 0 .

l i n e t h r o u g h o u t t h e p e r i o d . 1 8 4 / On J a n u a r y 7 a n d a g a i n o n F e b r u a r y 1 2 , 1 9 8 0 , t h e H u n t a c c o u n t s were i n c l u d e d i n a c c o u n t s t a t u s memoranda r e g u l a r l y s e n t t o P a i n e W e b b e r c h a i r m a n J a m e s W. D a v a n t ( " D a v a n t " ) and t h e members o f P a i n e W e b b e r ' s a u d i t committee. N e i t h e r Davant n o r G e i g e r n o r o t h e r P a i n e Webber w i t n e s s e s t e s t i f y i n g o n t h e s u b j e c t r e c a l l e d a u d i t , committee d i s c u s s i o n c o n c e r n i n g t h e s t a t u s o f t h e Hunt a c c o u n t s . 185/
B.

S t a t u s o f t h e Hunt Accounts Immediately Prior to the S i l v e r C r i s i s

On March 2 6 , 1 9 8 0 , t h e H u n t a c c o u n t s c o n t a i n e d 7 1 0 s i l v e r f u t u r e s c o n t r a c t s , 3 , 0 0 0 T r e a s u r y b i l l f u t u r e s cont r a c t s , 500 B r i t i s h pound f u t u r e s c o n t r a c t s , 300 f e e d e r c a t t l e f u t u r e s c o n t r a c t s , and a s u b s t a n t i a l amount o f f u l l y paid-for Treasury b i l l s . T h e s e p o s i t i o n s had a combined e q u i t y , computing s i l v e r p o s i t i o n s a t f u t u r e s p r i c e s , o f $38.6 m i l l i o n . Computing t h e v a l u e o f t h e Hunts' s i l v e r p o s i t i o n a t s p o t p r i c e s , however, e q u i t y i n t h e combined a c c o u n t s t o t a l e d o n l y $6.2 m i l l i o n . A l t h o u g h Capps had s e e n March 26 p r e s s r e p o r t s o n t h e Hunts' proposed s i l v e r - b a c k e d d e b t o f f e r i n g , and s p e c u l a t e d t h a t t h e Hunts might be having l i q u i d i t y problems, no one a t P a i n e Webber a t t e m p t e d t o f i n d o u t how t h e H u n t s s t o o d i n r e g a r d t o t h e i r s i l v e r p o s i t i o n s b e c a u s e t h e H u n t s were meeting t h e i r d a i l y margin calls.

184/ - A t M a r c h 1 0 , 1 9 8 0 , f o r e x a m p l e , t h e D a i l y Commodity C r e d i t R e p o r t shows H e r b e r t H u n t ' s a c c o u n t s w i t h a margin l i n e o f $4 m i l l i o n . M a r g i n r e q u i r e m e n t s o n t h a t d a t e were $ 2 3 . 6 I n Bunker H u n t ' s t w o Chicago million i n the t w o accounts. a c c o u n t s , t h e m a r g i n l i n e was $ 4 m i l l i o n a n d r e q u i r e m e n t s were $ 1 2 . 9 m i l l i o n . T h e r e p o r t r e f l e c t e d 1 0 0 d a y s o f v i o l a t i o n s i n Bunker H u n t ' s a c c o u n t . 185/ - T h e J a n u a r y 7 memorandum d e s c r i b e d i n t h e t e x t r e f l e c t e d t h a t Bunker H u n t ' s Chicago a c c o u n t s had margin l i m i t s o f $ 4 m i l l i o n a n d c u r r e n t r e q u i r e m e n t s o f $ 1 2 . 6 m i l l i o n . The F e b r u a r y 1 2 memorandum s t a t e s t h a t t h e C h i c a g o a c c o u n t s had r e q u i r e m e n t s o f $11.9 m i l l i o n and t h e Bunker Hunt T e x a s c u r r e n c y f u t u r e s a c c o u n t s had a m a r g i n l i m i t o f $ 5 m i l l i o n and a t h e n - c u r r e n t r e q u i r e m e n t o f $6.9 m i l l i o n . B o t h memoranda s a i d t h a t t h e H u n t a c c o u n t s were b e i n g handled "on a businessman's r i s k b a s i s " by Curley and o t h e r s i n P a i n e Webber's Chicago commodities o p e r a t i o n .

IV.

THE CRISIS AT PAINE WEBBER THROUGH APRIL 1 4 , 1 9 8 0

A.

MARCH 27

L i q u i d a t i o n o f t h e Hunt A c c o u n t s

On March 2 6 , 1 9 8 0 , t h e f i r m i s s u e d m a r g i n c a l l s i n c o n nection w i t h t h e accounts i n t h e aggregate of approximately $5,100,000. T h e s e c a l l s were n o t m e t o n t h a t d a y o r t h e s u b s e q u e n t day. On T h u r s d a y , March 2 7 , Wagner a r r i v e d i n t h e o f f i c e a b o u t 9 a.m. a n d f o u n d o u t t h a t t h e H u n t s h a d n o t s e n t i n t h e money f r o m t h e d a y b e f o r e . Wagner r e c a l l s t h a t a p p r o x i m a t e l y a n h o u r l a t e r P a i n e Webber l e a r n e d f r o m t h e H u n t s t h a t t h e y had c a s h f l o w p r o b l e m s a n d were u n a b l e t o meet t h e i r m a r g i n c a l l s . Wagner b e l i e v e s h e t r i e d t o c a l l Mercer w h i l e n a t i o n a l c o m m o d i t y d e p a r t m e n t d i r e c t o r D a v i d G a n i s ( " G a n i s " ) t r i e d to c a l l Bunker Hunt. B o t h were unsuccessful. C a p p s , G a n i s , Wagner a n d o t h e r s h e l d a b r i e f m e e t i n g t o d e c i d e how t o s e l l o u t t h e H u n t p o s i t i o n s , i n c l u d i n g t h e c a t t l e , f o r e i g n c u r r e n c y , f i n a n c i a l f u t u r e s and T r e a s u r y b i l l a c c o u n t s . According to Capps, t h e d e c i s i o n to l i q u i d a t e t h e Hunt p o s i t i o n s w a s a u t o m a t i c , and t h e o n l y d i s c u s s i o n concerned how t o d o i t . T h o s e a s s e m b l e d t o l d Wagner t o l i q u i d a t e t h e s i l v e r account. Capps a r r a n g e d f o r l i q u i d a t i o n o f t h e c a t t l e a c c o u n t and a d v i s e d t h e D a l l a s o f f i c e t h a t t h e Hunt a c c o u n t s w o u l d b e l i q u i d a t e d t h r o u g h t h e n a t i o n a l commodity d e p a r t m e n t i n Chicago. Wagner p o i n t e d o u t t h a t f u t u r e s c o n t r a c t s c o u l d n o t b e l i q u i d a t e d o n t h e CBT i n a l i m i t - d o w n m a r k e t , b u t t h a t o n t h e Comex t h e y c o u l d b e l i q u i d a t e d a t t h e s p o t p r i c e by means o f a s w i t c h t r a n s a c t i o n . The g r o u p d i s c u s s e d t h e p r i c e s needed Capps t e s t i f i e d f o r t h e account not to l i q u i d a t e to a d e b i t . t h a t h e and t h e o t h e r s a t t e n d i n g t h e meeting, reviewing t h e s t a t u s of t h e a c c o u n t s as a g r o u p , b e l i e v e d t h a t t h e l i q u i d a t i o n w o u l d l e a v e a c r e d i t b a l a n c e o f a p p r o x i m a t e l y $6 million. Wagner had a d i r e c t l i n e t o B r o d s k y o n t h e Comex f l o o r , s o a s s o o n a s t h e m e e t i n g e n d e d Wagner c a l l e d B r o d s k y a n d 186/ s t a r t e d s e l l i n g s i l v e r . - Wagner s a y s t h a t h e t o l d B r o d s k y t h a t P a i n e Webber w a n t e d a c o n s t a n t o r d e r l y l i q u i d a t i o n . B r o d s k y w o u l d a d v i s e P a i n e Webber w h a t t h e b i d s were a n d g e t a u t h o r i z a t i o n f r o m P a i n e Webber t o e x e c u t e t h e t r a d e . 1 8 6 / Wagner was aware t h a t i t w a s g e n e r a l l y known o n t h e f l o o r t h a t Brodsky h a n d l e d t h e Hunt s i l v e r t r a d e s , b u t c a n n o t remember w h e t h e r t h e r e was a n y d i s c u s s i o n a b o u t n o t u s i n g him f o r t h e l i q u i d a t i o n s b e c a u s e o f t h i s .

Wagner b e l i e v e s h e d i d n o t g i v e B r o d s k y t h e w h o l e s e l l o r d e r a t o n c e , b u t g a v e him 50 o r 100 c o n t r a c t s a t a t i m e and as s o o n a s t h o s e h a d b e e n d o n e h e g a v e h i m more. Brodsky or h i s p e o p l e r e p o r t e d e a c h e x e c u t i o n t o W a g n e r , i n c l u d i n g t h e number o f c o n t r a c t s and t h e p r i c e . Wagner i n f o r m e d C a p p s a n d P a i n e Webber s e n i o r v i c e p r e s i d e n t , R o b e r t R a c l i n ( " R a c l i n " ) o f e a c h s a l e a n d a l s o a d v i s e d Mercer i n t h e H u n t E n e r g y o f f i c e s i n Dallas. 187/ D u r i n g t h e d a y o n T h u r s d a y , R a c l i n a n d Mercer r e a c h e d a n agreement p e r m i t t i n g t h e proceeds of l i q u i d a t i o n s i n t h e Bunker Hunt a c c o u n t t o be a p p l i e d to d e f i c i t s i n t h e H e r b e r t A l l o f t h e l i q u i d a t i o n s t o o k p l a c e o n Comex Hunt a c c o u n t . a n d most o f t h e m were a c c o m p l i s h e d b y t h e u s e o f s w i t c h 188/ t r a n s a c t i o n s . - A s Wagner r e c e i v e d r e p o r t s o f s a l e s , h e attempted to monitor prices. A t o n e p o i n t , P a i n e Webber Wagner d i d s t o p p e d s e l l i n g b e c a u s e t h e m a r k e t was so b a d . n o t t h i n k t h a t t h e r e were a n y f o r m a l m e e t i n g s a f t e r t h e c l o s e t h a t d a y , b u t h e was s u r e t h a t h e h a d c o n v e r s a t i o n s w i t h Capps. Wagner t h i n k s some i n f o r m a l t a l l i e s were made t h a t A t t h e close o f b u s i n e s s o n March 2 7 , 1 9 8 0 , 1 8 6 evening. c o n t r a c t s remained i n t h e accounts. The d e f i c i t a t f u t u r e s A t s p o t p r i c e s , t h e d e f i c i t was p r i c e s was $ 1 2 . 0 m i l l i o n . $24.3 m i l l i o n . On F r i d a y , M a r c h 2 8 , s h o r t l y a f t e r t h e m a r k e t o p e n e d , P a i n e Webber b e g a n s e l l i n g , u s i n g Brodsky t o c o n t i n u e t h e l i q u i d a t i o n o f t h e Hunt a c c o u n t s . T h e m a r k e t was b e t t e r o n F r i d a y t h a n i t h a d b e e n o n T h u r s d a y a n d Wagner b e l i v e d t h e y were g e t t i n g b e t t e r p r i c e s . Wagner r e p o r t e d t o C a p p s a s e a c h s a l e was made o n F r i d a y a n d a l s o c o n t i n u e d t o r e p o r t t o Mercer o n t h e p r o g r e s s o f t h e l i q u i d a t i o n s . P a i n e Webber c o m p l e t e d t h e l i q u i d a t i o n o f t h e Hunt s i l v e r c o n t r a c t s o n F r i d a y , M a r c h 2 8 , b e t w e e n 11 a . m . a n d n o o n , C h i c a g o t i m e , e x c e p t f o r o n e s m a l l o r d e r w h i c h was d o n e o n Monday. At m i d - d a y , o n F r i d a y , a c c o r d i n g t o W a g n e r , P a i n e Webber l e a r n e d t h a t t h e l i q u i d a t i o n would p r o d u c e m i l l i o n s i n d e b i t s i n t h e Hunt a c c o u n t s , and a t t h e end o f t h e d a y it a p p e a r s t h e l i q u i d a t i o n had l e f t $8.4 m i l l i o n i n d e f i c i t s . B. T h e E r r o n e o u s M a r c h 2 7 " A l l C l e a r " R e p o r t M e a n w h i l e , e a r l y i n t h e d a y o n M a r c h 2 7 , NYSE S e n i o r
V i c e P r e s i d e n t R o b e r t Bishop c a l l e d Davant and asked whether At the P a i n e Webber h a d e x p o s u r e i n t h e H u n t a c c o u n t s .

187/ -

W a g n e r was a b l e t o g e t t h r o u g h t o H u n t E n e r g y b e g i n n i n g a b o u t n o o n a n d b e l i e v e s t h a t h e s p o k e w i t h Mercer s e v e r a l t i m e s t h a t day. See d i s c u s s i o n o f s w i t c h e s i n n. 8 4 a b o v e .

188/ -

c l o s e o f t h a t c o n v e r s a t i o n , D a v a n t c a l l e d G a n i s , who a t t h a t t i m e w a s m e e t i n g w i t h Capps a n d Wagner i n C h i c a g o p r i o r t o l i q u i d a t i n g t h e Hunt a c c o u n t , t o o b t a i n a n answer t o B i s h o p ' s question. D u r i n g t h e c o u r s e o f t h i s m e e t i n g , a h a s t y comp u t a t i o n o f t h e s t a t u s o f t h e Hunt a c c o u n t s had been p r e p a r e d T h a t comu s i n g f u t u r e s p r i c e s a s o f t h e c l o s e o f March 2 6 . p u t a t i o n s u g g e s t e d t h a t Hunt a c c o u n t s would l i q u i d a t e to a n equity. A c c o r d i n g to D a v a n t , G a n i s c a l l e d him back a s h o r t t i m e l a t e r t o t e l l him t h a t it a p p e a r e d t h a t t h e r e would b e no d i f f i c u l t i e s i n t h e a c c o u n t . Davant also recalls t h a t G a n i s and R a c l i n c a l l e d him twice l a t e r i n t h e d a y a s l i q u i d a t i o n s p r o g r e s s e d to r e p o r t t h a t a l l appeared w e l l i n t h e H u n t a c c o u n t s . - D a v a n t , b a s e d o n t h e i n f o r m a t i o n h e re189/ c e i v e d from Chicago, r e p o r t e d back t o Bishop t h a t " t h i n g s looked reasonably w e l l . " S o m e t i m e d u r i n g t h e a f t e r n o o n o f March 2 7 , a Wall S t r e e t According to Davant, i n J o u r n a l reporter c a l l e d Davant. r e s p o n s e to q u e s t i o n s from t h e r e p o r t e r h e i n d i c a t e d t h a t h e had b e e n a d v i s e d t h a t P a i n e Webber " d i d n o t h a v e a problem". Davant t e s t i f i e d t h a t h e d o e s n o t remember t h e e x a c t words t h a t h e used i n h i s c o n v e r s a t i o n w i t h t h e r e p o r t e r a l t h o u g h h e i s c e r t a i n t h a t , b e c a u s e h e knew t h a t l i q u i d a t i o n w a s n o t The Dow c o m p l e t e , h e d i d n o t t e l l t h e reporter t h a t it w a s . J o n e s Wire S e r v i c e n e v e r t h e l e s s c a r r i e d a r e p o r t q u o t i n g D a v a n t a s s a y i n g t h a t P a i n e TVebber " h a s l i q u i d a t e d t h e H u n t s ' s i l v e r c o n t r a c t s a t no loss to t h e f i r m

. . ."

A c c o r d i n g t o P a i n e Webber w i t n e s s e s , it was n o t u n t i l t h e completion o f l i q u i d a t i o n s t h e next day t h a t t h e firm l e a r n e d o f t h e $8.4 m i l l i o n i n l i q u i d a t i n g d e f i c i t s i n t h e Hunt a c c o u n t s . On M a r c h 2 8 , PWI i s s u e d a n e w s r e l e a s e a n d i n t e r n a l a l l - o f f i c e w i r e , e a c h o f w h i c h a n n o u n c e d t h a t P a i n e Webber t h a t d a y had l i q u i d a t e d t w o commodity a c c o u n t s d u e t o t h e i r The release and w i r e a l s o f a i l u r e t o meet m a r g i n c a l l s . both stated t h a t the liquidation resulted i n estimated d e f i c i t s o f $10 m i l l i o n i n t h e a c c o u n t s a n d t h a t a n e a r l i e r i n d i c a t i o n t h a t t h e r e were n o s u c h d e f i c i t s p r o v e d u n f o u n d e d . They b o t h c o n t i n u e d t h a t t h e f i r m d i d n o t have s u f f i c i e n t i n f o r m a t i o n t o assess t h e c o l l e c t i b i l i t y o f t h e d e f i c i t s ,

189/ - Capps t e s t i f i e d t h a t R a c l i n l a t e r s a i d t h a t h e had t o l d Davant t h a t t h e a c c o u n t would l i q u i d a t e to no loss, n o t w i t h s t a n d i n g t h a t t h e l i q u i d a t i o n a t t h a t t i m e was f a r from c o m p l e t e and t h e f i r m w a s r e a l i z i n g s u b s t a n t i a l l y l e s s o n t h e s a l e o f t h e p o s i t i o n s t h a n i t had a n t i c i p a t e d earlier.

b u t t h a t t h e f i r m ' s c a p i t a l was s a t i s f a c t o r y and i n a c c o r d a n c e w i t h r e g u l a t o r y s t a n d a r d s , even i f t h e f u l l amount o f 190/ t h e d e f i c i t s were t o b e c h a r g e d a g a i n s t t h e f i r m ' s c a p i t a l . -C. F r e e z i n q t h e H u n t A c c o u n t s On March 2 8 , G e i g e r s e n t a memorandum t o t h e members o f t h e n a t i o n a l c r e d i t committee w h i c h s t a t e d : U n t i l t h e a i r h a s c l e a r e d , t h e r e i s t o b e n o more t r a d i n g w i t h a n y o f t h e Hunt a c c o u n t s e x c e p t f o r l i q u i dation of trades. According to Capps, t h e Hunts have n o t done any commodities b u s i n e s s w i t h t h e f i r m s i n c e t h e s i l v e r crisis. M e a n w h i l e , t w o P l a c i d O i l a c c o u n t s a t P a i n e Wehber had e q u i t y o f a p p r o x i m a t e l y $54 m i l l i o n . P a i n e Webber c o n s i d e r e d t h e p o s s i b i l i t y of looking to t h e s e accounts f o r reimbursem e n t when i t r e a l i z e d t h a t t h e H u n t a c c o u n t s w o u l d l i q u i d a t e t o a d e f i c i t . The f i r m w a s n o t i n a p o s i t i o n t o l i q u i d a t e t h e p o s i t i o n s i n t h e s e two s e c u r i t i e s a c c o u n t s i n o r d e r t o s a t i s f y d e f i c i t s i n H u n t s ' commodity a c c o u n t s b e c a u s e t h e r e were n o g u a r a n t e e s o r c r o s s - c o l l a t e r a l i z a t i o n a g r e e m e n t s b e t w e e n them a n d t h e H u n t c o m m o d i t i e s a c c o u n t s . Paine Webber n e v e r t h e l e s s f r o z e t h e s e a c c o u n t s p e n d i n g r e c e i p t o f amounts owing from t h e Hunts i n d i v i d u a l l y i n o r d e r t o e n s u r e t h a t n o e q u i t y w o u l d b e w i t h d r a w n f r o m Hunt r e l a t e d a c c o u n t s a t t h e f i r m u n t i l t h e H u n t s s a t i s f i e d t h e i r commodity o b l i gation.
D.

P a i n e Webber C o l l e c t s f r o m t h e H u n t s

A s p r e v i o u s l y d e s c r i b e d , a n $8.6 m i l l i o n Hunt d e f i c i t remained o n P a i n e Webber's books u n t i l t h e f i r m r e c e i v e d f u n d s i n t h a t amount from t h e Hunts o n A p r i l 1 4 . I n t h e i n t e r i m , a c c o r d i n g t o D a v a n t , G a n i s had n u m e r o u s c o n v e r s a t i o n s w i t h Mercer i n a t t e m p t s to h a v e t h e H u n t s p a y t h e f i r m and o n t w o o c c a s i o n s Davant h i i n s e l f s p o k e w i t h H e r b e r t Hunt r e q u e s t i n g t h a t t h e f i r m be p a i d .

On A p r i l 1 4 , 1 9 8 0 , P a i n e Webber r e c e i v e d $ 8 . 6 m i l l i o n i n repayment from t h e Hunts o u t of t h e p r o c e e d s of " b r i d g e " l o a n s from v a r i o u s banks pending t h e c o m p l e t i o n of a r r a n g e ments f o r t h e Placid loan.

190/ - The s t o r y a p p e a r e d o n t h e D o w J o n e s b r o a d t a p e a t 2 : 5 5 p.m.

E. T h e N Y S E E x c u s e s P a i n e W e b b e r f r o m Taking C a p i t a l Charges i n Connection w i t h t h e Hunt D e f i c i t P a i n e W e b b e r f i l e d i t s FOCUS r e p o r t a s o f March 3 1 , 1 9 8 0 , a f t e r i t r e c e i v e d t h e H u n t p a y m e n t as d e s c r i b e d a b o v e . According to C u r l e y , p r i o r t o r e c e i v i n g t h e payment t h e f i r m had t a k e n a p p r o p r i a t e c h a r g e s i n its weekly i n t e r n a l c a p i t a l computations. A f t e r b e i n g p a i d by t h e Hunts however, P a i n e Webber o f f i c i a l s t o o k t h e p o s i t i o n w i t h E x c h a n g e p e r s o n n e l John Senkewich and R o b e r t Bishop t h a t t h e s u b s e q u e n t r e p a y m e n t made i t u n n e c e s s a r y t o c h a r g e t h e H u n t d e f i c i t s t o t h e f i r m ' s c a p i t a l p o s i t i o n i n i t s FOCUS r e p o r t f o r March 31, 1 9 8 0 . A c c o r d i n g t o C u r l e y , t h e NYSE a g r e e d w i t h P a i n e Webber's p o s i t i o n , and i n computing its n e t c a p i t a l f o r p u r p o s e s o f t h a t r e p o r t P a i n e Webber d i d n o t t a k e a s a c h a r g e a n y amount a t t r i b u t a b l e t o t h e d e f i c i t s i n t h e Hunt a c c o u n t s a s o f M a r c h 31.

PART SIX DEAN WITTER REYNOLDS ORGANIZATION INC.

I.

THE DEAN WITTER COMPLEX -----A.

-- e Th

H o l d i n g -. Company -- . .

Dean W i t t e r R e y n o l d s O r g a n i z a t i o n I n c . ("DWRO") is a D e l a w a r e h o l d i n g company w i t h i t s p r i n c i p a l o f f i c e s A s o f November 1 9 7 9 , D R WO i n San Francisco, C a l i f o r n i a . h a d o u t s t a n d i n g 7 , 9 6 8 , 4 7 1 s h a r e s o f common s t o c k a n d 193,300 s h a r e s of S e r i e s A P r e f e r r e d Stock. I t s common s t o c k was r e g i s t e r e d w i t h t h e C o m m i s s i o n p u r s u a n t t o S e c t i o n 1 2 ( b ) o f t h e Exchange A c t a n d was l i s t e d o n t h e N e w Y o r k S t o c k E x c h a n g e . --/ 191 D R was formed i n t h e m e r g e r , e f f e c t i v e J a n u a r y 3 , WO 1 9 7 8 , o f R e y n o l d s S e c u r i t i e s I n t e r n a t i o n a l I n c . a n d Dean Witter O r g a n i z a t i o n I n c . DWRO's p r i n c i p a l s u b s i d i a r i e s a r e Dean W i t t e r R e y n o l d s I n c . ( " D e a n W i t t e r " ) , a b r c k e r d e a l e r r e g i s t e r e d with t h e Comnission; S u r e t y L i f e Insurance Company, a n d Dean W i t t e r R e y n o l d s I n t e r c a p i t a l I n c . I n 1979, D R d e r i v e d 32.5% o f its revenues from WO commissions on l i s t e d s e c u r i t i e s and 6.1% o f its r e v e n u e s from commissions on commodities t r a n s a c t i o n s . I n 1980, DWRO d e r i v e d 2 8 . 4 % o f r e v e n u e s f r o m c o m m i s s i o n s o n l i s t e d s e c u r i t i e s and 5.4% from commissions on commodities t r a n s actions.
B.

T h e B r o k e r - D e a l e r-

Dean Witter R e y n o l d s I n c . ( " D e a n W i t t e r " ) , a r e g i s t e r e d broker-dealer w i t h p r i n c i p a l o f f i c e s i n New York, New Y o r k , was i n c o r p o r a t e d i n t h e s t a t e o f D e l a w a r e o n A p r i l 1 5 , 1968. Dean W i t t e r i s t h e p r o d u c t o f Dean Witter* & Co. I n c . a n d R e y n o l d s S e c u r i t i e s I n c . , t h e w h o l l y - o w n e d b r o k e r - d e a l e r s u b s i d i a r i e s w h i c h were c o m b i n e d u p o n t h e m e r g e r o f t h e i r r e s p e c t i v e h o l d i n g c o m p a n i e s i n t o DWRO. Dean Witter i s a f i n a n c i a l s e r v i c e s company p r o v i d i n g s e r v i c e s t o i n d i v i d u a l , c o r p o r a t e and i n s t i t u t i o n a l c u s t o m e r s a s : a b r o k e r i n s e c u r i t i e s , c o m m o d i t i e s , and i n t e r e s t r a t e f u t u r e m a r k e t s ; a d e a l e r i n c o r p o r a t e , m u n i c i p a l a n d U.S. governmental s e c u r i t i e s , an investment hanker: a c o n s u l t a n t

191/ -

A s o f D e c e m b e r 3 1 , 1 9 8 1 DWRO common s t o c k w a s d e l i s t e d from t h e N e w York S t o c k Exchange. Since t h a t date,

DWRO h a s o p e r a t e d a s a w h o l l y - o w n e d R o e b u c k & Co.

subsidiary of Sears,

i n p e r s o n a l f i n a n c i a l p l a n n i n g a c t i v i t i e s , . and a n a g e n t f o r l i f e insurance sales. A s o f A u g u s t 3 1 , 1 9 8 0 , Dean Witter e s t i m a t e d t h a t i t had i n e x c e s s o f 571,000 a c t i v e i n d i v i d u a l and i n s t i t u t i o n a l c u s t o m e r a c c o u n t s , s e r v e d by a p p r o x i m a t e l y 3 , 8 0 0 r e g i s t e r e d r e p r e s e n t a t i v e s i n 280 sales o f f i c e s t h r o u g h o u t t h e U n i t e d S t a t e s , Canada, Europe and A s i a . Dean Witter h o l d s m e m b e r s h i p s o n a l l m a j o r s e c u r i t i e s and commodity e x c h a n g e s i n t h e U n i t e d S t a t e s . A major p o r t i o n o f t h e f i r m ' s r e v e n u e s is d e r i v e d f r o m c o m m i s s i o n s o n b r o k e r a g e t r a n s a c t i o n s i n common a n d p r e f e r r e d s t o c k s , and c o r p o r a t e d e b t s e c u r i t i e s o n exchanges and i n over-thec o u n t e r markets. 192/ Dean Witter a l s o a c t s a s b r o k e r i n t h e p u r c h a s e and s a l e o f commodity f u t u r e s c o n t r a c t s , b u t d o e s n o t make a p r a c t i c e o f d e a l i n g i n a c t u a l o r " s p o t " c o m m o dities.
11.

DEVELOPMENT OF THE HUNT RELATIONSHIP A. Backqround

H e r b e r t and Bunker Hunt e a c h had i n d i v i d u a l a c c o u n t s i n which s i l v e r f u t u r e s were bought and s o l d , c o l l a t e r a l i z e d by T r e a s u r y b i l l s . T h e s e a c c o u n t s were o p e n e d i n l a t e 1 9 7 3 or e a r l y 1974 i n r e s p o n s e t o a s o l i c i t a t i o n by F r e d e r i c k H o r n , t h e n h e a d o f Dean W i t t e r ' s Commodity D i v i s i o n . O r d e r s were p l a c e d e i t h e r w i t h t h e D e a n W i t t e r o r d e r d e s k or w i t h Alvin Brodsky, t h e Hunts' broker on t h e f l o o r of t h e Comex. B r o d s k y ' s a r r a n g e m e n t w i t h Dean W i t t e r e n t i t l e d him t o h a l f o f t h e commissions g e n e r a t e d by t h o s e o r d e r s . T h e a c c o u n t s , h o w e v e r , were h o u s e a c c o u n t s h a n d l e d o u t o f t h e c e n t r a l c o m m o d i t i e s o f f i c e i n New Y o r k a n d n o D e a n Witter p e r s o n n e l r e c e i v e d c o m m i s s i o n s . After t h e merger o f Dean Witter a n d R e y n o l d s , t h e s u r v i v i n g a c c o u n t s i n w h i c h s i l v e r f u t u r e s w e r e t r a d e d w e r e t h e Dean Witter a c c o u n t s . 193/ T h e H u n t s h a d t w o o t h e r a c t i v e a c c o u n t s a t Dean W i t t e r . One w a s a j o i n t a c c o u n t f o r H e r b e r t a n d B u n k e r H u n t , w i t h s u b s t a n t i a l e q u i t y s e c u r i t i e s h o l d i n g s , opened i n December 1 9 7 5 t h r o u g h R e y n o l d s ' Oklahoma C i t y , Oklahoma o f f i c e . The o t h e r , o p e n e d b y B u n k e r H u n t i n November 1 9 7 9 , h e l d a n d t r a d e d c o m m o d i t i e s o t h e r t h a n s i l v e r and was h a n d l e d o u t o f 192/ The f i r m a c t s a s p r i n c i p a l w i t h c u s t o m e r s i n t h e o v e r - t h e - c o u n t e r m a r k e t s , p r i m a r i l y w h e r e t h e f i r m is a market maker. Dean Witter makes a m a r k e t i n a p p r o x i m a t e l y 500 u n l i s t e d s e c u r i t i e s . 1 9 3 / T h e s e a c c o u n t s were n o t n e c e s s a r i l y a c t i v e t h r o u g h o u t t h e p e r i o d from 1974 to 1978.

Dean W i t t e r ' s C h i c a g o o f f i c e . By v i r t u e o f i t s c u s t o m e r a g r e e m e n t , Dean Witter c o n s i d e r e d a l l a c c o u n t s a t t h e f i r m i n t h e name o f a n y c u s t o m e r t o b e c r o s s - c o l l a t e r a l i z e d .

B.

T r a d i n a L i m i t s i n Hunt A c c o u n t s

When t h e H u n t s b e g a n t o d o b u s i n e s s w i t h Dean W i t t e r , t h e i r c r e d i t l i m i t s were b a s e d u p o n a c t u a l t r a n s a c t i o n s a n d the firm's experience with t h e i r accounts r a t h e r than the e s t a b l i s h m e n t of d o l l a r l i n e s o f c r e d i t or a n y n e t w o r t h A t t h a t t i m e , customer t r a d i n g i n commodities analysis. a t Dean Witter w a s r i n g e n e r a l , l i m i t e d o n l y b y t h e money t h e c u s t o m e r had p u t i n t h e a c c o u n t . T h e r e was no d i f f e r e n c e i n t r e a t m e n t between s p e c u l a t i v e a c c o u n t s and t r a d e customers. More f o r m a l p r o c e d u r e s were e s t a b l i s h e d b y Dean W i t t e r i n 1975. T h e r e a f t e r , customers opening commodities a c c o u n t s were a s k e d t o s u p p l y i n f o r m a t i o n a s t o t h e i r n e t w o r t h a n d n e t l i q u i d a s s e t s e i t h e r o r a l l y or i n writing. Using t h i s information, t h e firm established its " c a l l d o l l a r lines", a l i m i t o n t h e amount o f b u s i n e s s t h e f i r m was w i l l i n g t o d o w i t h a p a r t i c u l a r c u s t o m e r , b a s e d upon t h e c u s t o m e r ' s n e t worth and n e t l i q u i d assets. Smaller account l i m i t s were s e t b y t h e c r e d i t a n a l y s i s s e c t i o n . Larger accounts, i n e x c e s s o f $ 1 0 0 , 0 0 0 - $ 2 0 0 , 0 0 0 were p r e s e n t e d t o a c r e d i t committee. - T h e r e r e m a i n e d , h o w e v e r , n o u p p e r l i m i t a s 194/ t o t h e l i n e of c r e d i t t h a t could be requested.
A t some p o i n t , p r o b a b l y b e f o r e t h e i n s t i t u t i o n o f f o r m a l p o l i c i e s , l i m i t s o f $ 1 m i l l i o n were e s t a b l i s h e d f o r e a c h Hunt s i l v e r a c c o u n t . 195/ Horn s t a t e d t h a t n o r e q u e s t s were made t o i n c r e a s e t h e Hunts' c r e d i t l i m i t s b e t w e e n 1 9 7 5 and 1978. Thus, w i t h c r e d i t h a v i n g been e s t a b l i s h e d i n a n e a r l i e r t i m e , o n c e t h e c r e d i t committee was f o r m e d , t h e r e was n o o c c a s i o n f o r t h e H u n t a c c o u n t s t o g o b e f o r e i t .

Following t h e 1978 merger, no a d d i t i o n a l f i n a n c i a l i n f o r m a t i o n w a s s o u g h t from t h e Hunts and t h e r e a p p e a r s t o b e n o n e o n f i l e o t h e r t h a n new a c c o u n t p a p e r s . There were n o r e q u e s t s f o r i n c r e a s e s i n c r e d i t l i m i t s i n t h i s period e i t h e r . T h e r e f o r e , c o n s i s t e n t w i t h Dean W i t t e r ' s g e n e r a l p o l i c y f o l l o w i n g t h e m e r g e r , s i n c e t h e r e were n o l i m i t v i o l a t i o n s or o t h e r problems w i t h t h e a c c o u n t s , no r e v i e w was made o f t h e a c c o u n t s a s t o c r e d i t l i m i t s . 194/ A f o r m a l c r e d i t committee was n o t e s t a b l i s h e d u n t i l

some t i n e i n 1 9 7 7 .

195/ The o r i g i n o f t h e s e l i m i t s is u n c l e a r . C u r r e n t em- p l o y e e s were o n l y a b l e t o s a y t h a t t h e l i m i t s were e s t a b l i s h e d b e f o r e t h e merger w i t h Reynolds and maintained thereafter.

111. HUNT ACCOUNTS D U R I N G THE RISE AND DECLINE I N SILVER A.

Futures Positions

A s o f J u l y 1 9 7 9 , t h e s i l v e r a c c o u n t s o f B u n k e r Hunt a n d H e r b e r t Hunt a t Dean Witter c a r r i e d o p e n p o s i t i o n s i n Comex s i l v e r o f 1 6 0 a n d 1 5 0 c o n t r a c t s , r e s p e c t i v e l y . 1 9 6 / The a c c o u n t s were r e l a t i v e l y i n a c t i v e a n d t h e s i z e o f t h e open p o s i t i o n s remained c o n s t a n t throughout t h e p e r i o d w h i c h f o l l o w e d . T h e H u n t s n e i t h e r s o u g h t n o r were g r a n t e d increases i n f u t u r e s trading l i m i t s with the firm.

I n S e p t e m b e r 1 9 7 9 , Dean W i t t e r i m p o s e d a " l i q u i d a t i o n only" trading r u l e on customers with p o s i t i o n s i n s i l v e r . On S e p t e m b e r 2 1 , 1 9 7 9 , t h e f i r m a n n o u n c e d t h a t a s o f S e p t e m b e r 1 8 , n o new b u s i n e s s w o u l d be a c c e p t e d i n s i l v e r o r s i l v e r c o i n s . O n l y l i q u i d a t i o n o r d e r s would b e a c c e p t e d and such o r d e r s should b e so marked. T h e r e a f t e r , Dean Witter c o n t i n u e d t o a d j u s t m a r g i n r e q u i r e m e n t s i n a c c o r d a n c e w i t h commodity e x c h a n g e r e q u i r e m e n t s a n d i n t e r n a l considerations. The f i r m ' s l i q u i d a t i o n o n l y p o l i c y rem a i n e d i n e f f e c t u n t i l mid-March 1 9 8 0 . 197/ Dean Witter p e r s o n n e l t e s t i f i e d t h a t t h e r e a s o n f o r imposing a l i q u i d a t i o n o n l y r u l e w a s b e c a u s e of t h e i r p e r c e p t i o n t h a t t h e m a r k e t i n s i l v e r was b e c o m i n g c h a o t i c . They s t a t e d t h e y were c o n c e r n e d t h a t t h e v o l a t i l i t y demons t r a t e d by t h e m a r k e t up t o t h a t p o i n t would n o t e n a b l e

196/ - E a r l i e r i n 1979 t h e s i z e of t h e p o s i t i o n s i n e a c h a c c o u n t was somewhat l a r g e r . For t h e f i r s t h a l f o f t h e y e a r , r e a l i z e d and u n r e a l i z e d p r o f i t s i n t h e s e a c c o u n t s t o t a l l e d $3.9 m i l l i o n and $2.6 m i l l i o n , respectively. 197/ - On March 2 1 , 1 9 8 0 , Dean W i t t e r r e s c i n d e d i t s l i q u i d a A s to s i l v e r ,

t i o n o n l y r e s t r i c t i o n on t r a d i n g i n precious metals. t h a t d e c i s i o n was s a i d t o b e b a s e d upon t h e f a c t t h a t t h e p r i c e had d r o p p e d t o t h e l o w o r mid 2 0 ' s per o u n c e ; a n d , i t a p p e a r e d t o t h e f i r m , a t t h a t p o i n t i n t i m e , t h a t some s t a b i l i t y had r e - d e v e l o p e d i n t h e m a r k e t ; o r , a t l e a s t t h a t t h e u p s i d e moves were o v e r . A t t h e same t i m e , t h e f i r m r e q u i r e d t h a t t h e o r i g i n a l margin necessary to c a r r y a customer's p o s i t i o n , $ 6 0 , 0 0 0 per c o n t r a c t , h a d t o b e i n t h e a c c o u n t p r i o r t o t h e t i m e t h a t a n y o r d e r s were e n t e r e d , a n d t h a t v a r i a t i o n m a r g i n s had t o b e m a i n t a i n e d a t 100%.

c u s t o m e r s t o g e t i n a n d o u t of t h e m a r k e t i n a n o r d e r l y m a n n e r a n d t h a t t h e y were u n c e r t a i n o v e r t h e d i r e c t i o n 198/ t h a t t h e market might take. T h e r e w e r e some e x c e p t i o n s g r a n t e d w i t h r e s p e c t t o the liquidations only policy, but only the director of commodities o p e r a t i o n s , t h e n a t i o n a l s a l e s manager, and t h e comlnercial s a l e s manager had t h a t a u t h o r i t y . These e x c e p t i o n s were g r a n t e d o n l y t o i n d i v i d u a l s o r c o r p o r a t e c u s t o m e r s t h a t met t h e f i r m ' s t h e n c u r r e n t c r e d i t and margin p o l i c i e s , had a l e g i t i m a t e r e a s o n t o be t r a d i n g i n t h e m a r k e t p l a c e a n d were s o p h i s t i c a t e d and u n d e r s t o o d t h e r i s k o f t h e m a r k e t . The Hunt a c c o u n t s w e r e n o t among t h e e x c e p t i o n s t o Dean W i t t e r ' s l i q u i d a t i o n o n l y p o l i c y . In f a c t , n o i n c r e a s e s i n c r e d i t o r p o s i t i o n l i m i t s were req u e s t e d b y o r e x t e n d e d t o t h e Hunt a c c o u n t s f o r t k e p e r i o d i n w h i c h t h e p o l i c y was i n f o r c e . I n t h e latter h a l f of 1979, a s t h e p r i c e o f s i l v e r r o s e , t h e Hunts' e q u i t y i n t h e i r s i l v e r accounts i n c r e a s e d . I n g e n e r a l , t h e a c c o u n t s r e g u l a r l y withdrew most o f t h e e x c e s s e q u i t y , o r used it t o p u r c h a s e a d d i t i o n a l Treasury b i l l s w h i c h were u s e d a s m a r g i n . I n e a r l y 1980, a s t h e p r i c e of s i l v e r began t o f l u c t u a t e , f u n d s f r e q u e n t l y p a s s e d A l l t h e Hunt commodity i n and o u t o f t h e s i l v e r a c c o u n t s . a c c o u n t s a t Dean Witter were h a n d l e d t h r o u g h H u n t E n e r g y . F i r m p e r s o n n e l c o m m u n i c a t e d w i t h e i t h e r C h a r l e s Mercer o r Hunt E n e r g y e m p l o y e e D e b b i e L e a c h w i t h r e s p e c t t o m a r g i n c a l l s o r excess. I n each c a s e , whether e x c e s s margin w a s i n t h e account o r a d d i t i o n a l v a r i a t i o n margin w a s r e q u i r e d , t h e p a r t y s e e k i n g t h e f u n d s would make a r e q u e s t by t e l e p h o n e and m o n i e s would b e f o r w a r d e d by w i r e t r a n s f e r . 199/ The o n l y p u r c h a s e a f t e r J u l y 1 9 7 9 i n e i t h e r o f t h e H u n t s ' Dean W i t t e r s i l v e r a c c o u n t s came on J a n u a r y 2 8 , 1 9 8 0 . A t t h a t time, t h e 1 6 0 c o n t r a c t s o f March 1 9 8 0 Comex

198/ - Firm personnel indicated t h a t i n such a v o l a t i l e m a r k e t , n o t o n l y was t h e r e a m a r k e t r i s k t o t h e c u s t o m e r a n d t h e f i r m , b u t t h e r e a l s o was a n i n c r e a s e d r i s k t h a t improper o r d e r h a n d l i n g could r e s u l t i n expensive mistakes.

- c a l l s could o n l y be m e t with cash o r its e q u i v a l e n t

( i . e . f e d e r a l f u n d s ) . Dean Witter m i g h t p e r m i t v a r i a t i o n m a r g i n c a l l s t o be met by s u b s e q u e n t m a r k e t appreciation, but only a t the customer's request. The Hunt a c c o u n t s n e v e r r e q u e s t e d s u c h t r e a t m e n t .

1 9 9 / Dean W i t t e r had a f i r m p o l i c y t h a t v a r i a t i o n m a r g i n

s i l v e r i n B u n k e r H u n t ' s a c c o u n t were r o l l e d f o r w a r d t o May 1 9 8 0 . The p r o f i t r e a l i z e d a s a r e s u l t o f t h e t r a n s a c t i o n was i n e x c e s s o f $ 2 1 . 3 m i l l i o n . . 200/ B.

Dean W i t t--. - Rejects - a H -n t B o r r o w-n g --- q-. -er u i -- R e . u e s t -

A t some t i m e i n J a n u a r y or F e b r u a r y 1 9 8 0 , A l v i n B r o d s k y a p p r o a c h e d t h e d i r e c t o r o f Dean W i t t e r ' s c o m m o d i t y d i v i s i o n , A r t h u r Marcus, and a s k e d , o n b e h a l f o f t h e Hunt b r o t h e r s , i f t h e f i r m would p r o v i d e some f i n a n c i n g o f s i l v e r w a r e h o u s e receipts. The a m o u n t o f f i n a n c i n g s o u g h t w a s $ 1 0 0 m i l l i o n . The terms were t o be 1 1 / 2 8 o v e r p r i m e o n a f l o a t i n g b a s i s . T h e r e was n o d i s c u s s i o n o f w h a t d i s c o u n t would b e a p p l i e d t o t h e r e c e i p t s a n d no d o c u m e n t a t i o n w a s o f f e r e d a t t h e time. Marcus a d v i s e d t h a t h e would p a s s t h e r e q u e s t on t o s e n i o r management. Marcus w a s l a t e r a d v i s e d t h a t management "decided n o t t o do t h e business." Brodsky d i d n o t i n d i c a t e whether he w a s seeking similar financing elsewhere.

Dean W i t t e r p e r s o n n e l h a v e s t a t e d i t was t h e i r r e c o l l e c t i o n t h a t u n t i l l a t e March 1 9 8 0 , t h e H u n t a c c o u n t s were a l w a y s p r o m p t i n t h e i r p a y m e n t when v a r i a t i o n m a r g i n w a s requested. Nevertheless, account statements i n d i c a t e t h a t beginning on February 20, 1980, Bunker H u n t ' s s i l v e r a c c o u n t The same p a t t e r n began t o a c c r u e v a r i a t i o n margin c a l l s . o c c u r r e d beginning on February 21 i n H e r b e r t H u n t ' s s i l v e r I t a p p e a r s t h a t t h e s e "aged c a l l s , " which remained account. o u t s t a n d i n g u n t i l March 1 3 , 1 9 8 0 , were a r e s u l t o f a m a r g i n c l e r k ' s f a i l u r e t o r e q u e s t t h e r e q u i r e d margin on a t i m e l y b a s i s . - When t h e c a l l s were made o n o r a b o u t March 1 2 , 201/ t h e a c c r u e d b a l a n c e s of $3.8 m i l l i o n and $2.85 m i l l i o n , r e s p e c t i v e l y , were p r o m p t l y p a i d i n f u l l . By t h a t t i m e , however, t h e p r i c e o f s i l v e r i n t h e m a r k e t had begun i t s l i m i t - d o w n r e t r e a t w h i c h was n o t t o e n d u n t i l March 2 7 .

2 0 0 / The t r a n s a c t i o n a l s o g e n e r a t e d a n o r i g i n a l m a r g i n c a l l of $5.6 m i l l i o n which w a s n o t s a t i s f i e d u n t i l F e b r u a r y 5 , 1980.

I t is u n c l e a r w h e t h e r a m a r g i n c l e r k f a i l e d t o make a t i m e l y r e q u e s t f o r v a r i a t i o n margin o r whether t h e m a r g i n c a l l s h a d g o n e unmet f o r t h e e n t i r e F e b r u a r y 2 1 t o March 1 3 p e r i o d . Edward K a s s a k i a n , t h e d i r e c t o r o f commodity o p e r a t i o n s , i n d i c a t e d t h a t h e w o u l d n o t h a v e been o v e r l y concerned e v e n i f t h e v a r i a t i o n margin c a l l s h a d b e e n o u t s t a n d i n g f o r t h e e n t i r e t h r e e week p e r i o d because t h e a c c o u n t s were s t i l l " i n e q u i t y " , t h a t is, h a d Dean W i t t e r l i q u i d a t e d t h e T r e a s u r y b i l l s h e l d a s c o l l a t e r a l , t h e a c c o u n t s t i l l would h a v e had a p o s i t i v e balance.

A f t e r March 1 3 , v a r i a t i o n m a r g i n c a l l s were a g a i n allowed t o accrue i n t h e respective accounts u n t i l paid down i n f u l l o n March 1 9 . T h e r e a f t e r , v a r i a t i o n m a r g i n was p a i d i n t h e r e s p e c t i v e a c c o u n t s o n a d a i l y b a s i s u n t i l p a y m e n t s c e a s e d a l t o g e t h e r a f t e r March 24.
IV.

C R I S I S PERIOD EVENTS A.

The H u n t s Miss M a r g i n C a l l s

On o r a b o u t March 2 5 , 1 9 8 0 , Edward K a s s a k i a n , h e a d o f commodity o p e r a t i o n s , c o n t a c t e d A r t h u r Marcus, d i r e c t o r o f t h e commodity d i v i s i o n , r e g a r d i n g t h e t h e n c u r r e n t o u t A t t h e close s t a n d i n g m a r g i n c a l l s i n t h e Hunt a c c o u n t s . o n March 2 5 , Hunt a c c o u n t s r e m a i n e d $ 2 2 . 7 m i l l i o n i n e q u i t y a t f u t u r e s p r i c e s , a l t h o u g h a t s p o t p r i c e s e q u i t y was o n l y a p p r o x i m a t e l y $14 m i l l i o n . Dean W i t t e r p e r s o n n e l c a l l e d H u n t E n e r g y a n d a d v i s e d t h a t t h e r e were o u t s t a n d i n g m a r g i n c a l l s i n t h e Hunt a c c o u n t s a g g r e g a t i n g i n e x c e s s o f $ 3 million. A s a r e s u l t o f m a r k e t a c t i o n o n March 2 6 t h , a d d i t i o n a l m a r g i n was r e q u i r e d . When n o f u n d s were f o r t h coming, Marcus c a l l e d Hunt Energy to a s c e r t a i n t h e s t a t u s of t h e outstanding margin calls. After s e v e r a l attempts t o s p e a k w i t h Mercer o r o n e o f t h e H u n t s , M a r c u s was a d v i s e d t h a t Mercer would n o t b e a b l e t o s p e a k w i t h him t h a t day. T h e r e a f t e r , Marcus d i s c u s s e d h i s c o n c e r n s w i t h s e n i o r m a n a g e m e n t o f Dean W i t t e r o v e r t h e n o n - c o l l e c t i o n of f u n d s and t h e i n a c c e s s i b i l i t y o f t h e p a r t i e s i n v o l v e d . A t t h e c l o s e o n March 2 6 , e q u i t y i n Hunt a c c o u n t s a t f u t u r e s p r i c e s had f a l l e n t o $20.2 m i l l i o n , w h i l e a t s p o t p r i c e s , which r e f l e c t e d t h e t r u e v a l u e o f t h e Hunts' s i l v e r p o s i t i o n i n l i q u i d a t i o n , o n l y $5.8 m i l l i o n i n e q u i t y remained.
A s o f a b o u t March 2 6 , Dean W i t t e r i n t e r n a l l y b e g a n t o t a k e account of t h e s p o t p r i c e of s i l v e r i n its margin c a l c u l a t i o n s and a d j u s t e d i t s margln c a l l s t o t h e Hunts 202/ T h e H u n t s were l o n g 310 c o n t r a c t s o f May accordingly. 1 9 8 0 Comex s i l v e r a t Dean W i t t e r . The d e c i s i o n was made t o i g n o r e t h e May p r i c e b e c a u s e i t was a r t i f i c i a l l y h i g h a n d t o v a l u e t h e H u n t s ' c o n t r a c t s b a s e d upon t h e A p r i l s p o t market. The d i f f e r e n c e i n t h e t w o p r i c e s a t t h a t d a t e w a s o v e r $6 p e r ounce which, on o n e and one h a l f m l l l i o n o u n c e s , w o u l d r e d u c e t h e e q u i t y i n t h e H u n t a c c o u n t s by o v e r $ 9 million. On March 2 6 t h , a m a r g i n c a l l was i s s u e d t o t h e H u n t s f o r r o u g h l y $ 1 5 . 3 m i l l i o n b a s e d o n t h e s p o t month price. H u n t r e c o r d s i n d i c a t e t h a t s u c h a c a l l was r e c e l v e d o n March 27.

202/ -

The a d j u s t m e n t s were $ 7 . 8 3 m i l l i o n f o r H e r b e r t H u n t , $7.53 m i l l i o n f o r Bunker Hunt and $.41 m i l l i o n f o r B u n k e r H u n t ' s n o n - s i l v e r f u t u r e s a c c o u n t s i n Dean W i t t e r ' s C h i c a g o o f f ice.

On t h e m o r n i n g o f M a r c h 2 7 t h , M a r c u s L e a r n e d t h a t Mercer w o u l d a g a i n b e u n a b l e t o s p e a k w i t h h l m a n d t h a t nc m a r g i n monies would be i m m e d i a t e l y f o r t h c o m i n g . By t h l s t i m e r u m o r s f r o m t h e Comex f l o o r were s p r e a d i n g t h a t t h e Hunts were having very s i z e a b l e problems and t h a t they were unable to meet margin calls a t o t h e r f i r m s . A t t e m p t s were m a d e t o s u b s t a n t i a t e t h e r u m o r t h a t t h e H u n t s were n o t A Hunt r e p r e s e n t a t i v e g o i n g t o meet t h e i r o b l i g a t i o n s . a d v i s e d Dean Witter p e r s o n n e l t h a t s h e h a d i n s t r u c t i o n s from t h e Hunts n o t t o t r a n s f e r any f u r t h e r funds. She c o u l d n o t s a y when o r w h e t h e r f u n d s would b e f o r t h c o m i n g . B. Liquidation

Marcus d i s c u s s e d t h e s i t u a t i o n w i t h members o f t h e D e a n W i t t e r e x e c u t i v e committee i n a c o n f e r e n c e c a l l o n March 27. H e a d v i s e d t h e members c f t h e c o m m i t t e e t h a t t h e H u n t s w e r e l o n g 310 c o n t r a c t s o f s i l v e r and t h a t t h e y had n o t i n d i c a t e d whether t h e o u t s t a n d i n g margin calls w o u l d be m e t . Although Marcus was g i v e n a u t h o r i t y t o l i q u i d a t e t h e Hunt a c c o u n t s o n March 2 7 t h , h e recommended t h a t b e c a u s e t h e m a r k e t w a s u n d e r s e v e r e p r e s s u r e , Dean Witter s h o u l d n o t a t t e m p t t o l i q u i d a t e a n y p o r t i o n o f t h e s i l v e r p o s i t i o n s during trading hours t h a t day. The f i r m made t h e d e c i s i o n w i t h r e s p e c t t o t h e s i l v e r a c c o u n t s t h a t it would w a i t and m o n i t o r t h e m a r k e t s , h o p i n g t o h e a r f r o m t h e H u n t s l a t e r t h a t a f t e r n o o n or e v e n i n g . 203/ Dean Witter p e r s o n n e l b e l i e v e d i t l i k e l y t h a t t h e f i r m would have to t a k e l i q u i d a t i n g a c t i o n t h e following day. D u r i n g t h e a f t e r n o o n o f t h e 2 7 t h , Dean Witter's d e c i s i o n to t o t a l l y l i q u i d a t e t h e Hunt s i l v e r a c c o u n t s f i r m e d . D e a n W i t t e r o b s e r v e d t h a t t h e m a r k e t h a d s t a b i l i z e d somew h a t g o i n g i n t o t h e close a n d d e t e r m i n e d t h a t t h e r e m i g h t be a n o p p o r t u n i t y to sell s i l v e r t h e f o l l o w i n q d a y a t b e t t e r p r i c e s t h a n t h e y h a d s e e n a t t h e lows o n t h e 2 7 t h . A t t h e close on March 27, e q u i t y i n Hunt a c c o u n t s c o m p u t e d a t f u t u r e s prices d e c l i n e d t o $ 1 8 . 1 m i l l i c n . At spot p r i c e s , however, a n unsecured d e b i t balance o f approxim a t e l y $3.2 m i l l i o n had developed i n t h e account. Dean W i t t e r c o n s i d e r e d t h a t l i q u i d a t i o n o n t h e Comex w o u l d b e most c o n v e n i e n t , b u t c o n s i d e r e d t h e u s e o f L o n d o n a n d t h e CBT a s o p t i o n s . I n f a c t , t h e f i r m m o n i t o r e d t h e London m a r k e t c l o s e l y d u r i n g t h e e a r l y morning h o u r s o f March 28th.

203/ -

B e c a u s e t h e m a r k e t s i n o t h e r c o m m o d i t i e s w e r e more o r d e r l y , l i q u i d a t i o n s o f Bunker Hunt's d i v e r s i f i e d commodities account, n o t c o n t a i n i n g s i l v e r , began on March 2 7 t h w h i l e t h e m a r k e t s i n t h o s e c o m m o d i t i e s were still open.

A t a p p r o x i m a t e l y 8 : 2 5 a . m . ( C S T ) o n March 2 8 , M e r c e r d e f i n i t i v e l y i n f o r m e d Dean Witter t h a t t h e Hunt b r o t h e r s would p o s t n o a d d i t i o n a l m a r g i n and t h a t Dean \ J i t t e r s h o u l d d o whatever it determined w a s appro2riate. Thereafter i n s t r u c t i o n s were g i v e n f o r t h e l i q u i d a t i o n o f t h e H u n t s ' silver positions. The l i q u i d a t i o n w a s accomplished o n t h e f l o o r o f t h e Comex o n t h e m o r n i n g o f F r i d a y , M a r c h 2 8 , 1 9 8 0 . T h e H u n t p o s i t i o n s h e l d b y D e a n W i t t e r were i n May 1 9 8 0 Comex s i l v e r . S i n c e , i n p a s t d a y s t h e m a r k e t h a d r a p i d l y moved l i m i t down, t h e f i r m c o u l d n o t l i q u i d a t e i n o f f s e t t i n g t r a n s a c t i o n s i n May s i l v e r . R a t h e r , it used t r a n s a c t i o n s i n t h e s p o t market. Dean Witter i n s t r u c t e d i t s f l o o r b r o k e r t o s e l l 3 1 0 A p r i l Comex s i l v e r c o n t r a c t s " a t m a r k e t - n o t h e l d . " T h i s w a s a c c o m p l i s h e d b y a p p r o x i m a t e l y 9:40 a . m . ( C S T ) . T h e r e a f t e r , a s p r e a d was d o n e i n o r d e r t o u n w i n d t h e p o s i t i o n s and p r o v i d e f o r t o t a l l i q u i d a t i o n o f t h e accounts. The l i q u i d a t i o n o f Bunker and H e r b e r t H u n t ' s s i l v e r p o s i t i o n s and t h e Treasury b i l l s a s s o c i a t e d with t h o s e a c c o u n t s l e f t a d e f i c i t o f a p p r o x i m a t e l y $ 3 . 3 m i l l i o n . 204/ With c r e d i t from t h e l i q u i d a t i o n o f Bunker H u n t ' s divers i f i e d c o m m o d i t i e s a c c o u n t i n Dean Witter's C h i c a g o o f f i c e , t h e d e b i t b a l a n c e o f t h e t w o H u n t b r o t h e r s a t D e a n Witter w a s s l i g h t l y i n e x c e s s o f $3 m i l l i o n . Once t h i s f i g u r e was a s c e r t a i n e d , t h e d e f i c i t w a s s a t i s f i e d t h r o u g h t h e l i q u i d a t i o n o f a s u f f i c i e n t q u a n t i t y o f Asamera O i l a n d Global Marine e q u i t y s e c u r i t i e s i n t h e t w o b r o t h e r s ' j o i n t stock account.
N e t C a p i t a l P o s i t i o n and P u b l i c D i s c l o s u r e s

Despite widespread p u b l i c i t y concerning t h e p o s s i b l e i m p a i r m e n t o f c e r t a i n members o f t h e s e c u r i t i e s i n d u s t r y o n March 2 7 , 1 9 8 0 , Dean Witter w a s n o t c o n c e r n e d a b o u t t h e e f f e c t s o f t h e c r i s i s w i t h r e s p e c t t o i t s own c a p i t a l position. The f i r m had v e r y few c u s t o m e r s i n t h e s i l v e r m a r k e t a t t h a t t i m e , a n d most of t h e m were f u l l y h e d g e d . With r e s p e c t to t h e Hunt a c c o u n t s , Marcus i n d i c a t e d t h a t h e was c o n f i d e n t t h a t h e w o u l d b e a b l e t o l i q u i d a t e t h e m w e l l w i t h i n t h e bounds o f t h e collateral held by t h e firm.

204/ - D e a n Witter i n d i c a t e d t h a t a l t h o u g h c o m m o d i t i e s were c a r r i e d i n more t h a n o n e a c c o u n t , t h i s w a s m e r e l y a n administrative convenience. Once a n y a c c o u n t f a i l s to p r o f f e r r e q u i r e d margin, a l l commodities accounts i n t h a t i n d i v i d u a l ' s name w i l l b e t o t a l l y l i q u i d a t e d pursuant to t h e p r o v i s i o n s o f t h e standard customer agreement.

An a l l o f f i c e w i r e i s s u e d o n March 2 7 , 1 9 8 0 b y Andrew J . M e l t o n , J r . , C h a i r m a n o f Dean W i t t e r ' s B o a r d , c o n f i r m e d Dean Witter p e r s o n n e l h a v e s t a t e d t h a t t h a t p o s i t i o n . 205/ t h e substance o n h e a l l o f f i c e w i r e appeared i n t h e press. Following t h e l i q u i d a t i o n s , on A p r i l 2, 1980, a second
A l l O f f i c e Wire a d v i s e d t h a t t h e " r e c e n t d e v e l o p m e n t s i n

t h e s i l v e r m a r k e t s have had n o i m p a c t o n t h e o p e r a t i n g p r o f i t s o r c a p i t a l p o s i t i o n " o f Dean W i t t e r .

205/ - T h e A l l O f f i c e Wire r e a d s a s f o l l o w s : "Andrew J . M e l t o n , J r . , C h a i r m a n o f t h e B o a r d o f Dean W i t t e r R e y n o l d s , I n c . , s t a t e d t h a t w h i l e t h e company h a s customer accounts with s i l v e r f u t u r e s c o n t r a c t s , t h e t o t a l n u m b e r o f c o n t r a c t s is s m a l l a n d t h a t i f c u s t o m e r s f a i l e d t o m e e t m a r g i n c a l l s i t would n o t s e r i o u s l y e f f e c t t h e company's f i n a n c i a l p o s i t i o n . "

PART SEVEN
A.G.

EDWARDS

&

SONS, INC.

I.

THE FIRM

A . G . E d w a r d s a n d S o n s , I n c . ( " E d w a r d s " ) is a p u b l i c l y - h e l d Delaware c o r p o r a t i o n w i t h p r i n c i p a l o f f i c e s i n St. Louis, Missouri. I t is t h e s u c c e s s o r t o a p a r t n e r s h i p founded i n 1887. Edwards is r e g i s t e r e d w i t h t h e Commission as a b r o k e r - d e a l e r p u r s u a n t to S e c t i o n 1 5 ( b ) o f t h e Exchange Its s e c u r i t i e s are r e g i s t e r e d p u r s u a n t t o S e c t i o n Act. 1 2 ( b ) o f t h e E x c h a n g e A c t a n d a r e l i s t e d o n t h e NYSE. As o f F e b r u a r y 1 9 8 0 , E d w a r d s h a d 4 , 7 7 4 , 5 0 0 s h a r e s o f common stock outstanding.

Edwards is a b r o k e r - d e a l e r o p e r a t i n g e x c l u s i v e l y i n Its b u s i n e s s t h e s e c u r i t i e s and commodities i n d u s t r i e s . i n c l u d e s l i s t e d s e c u r i t i e s , l i s t e d and u n l i s t e d o p t i o n s , p r i n c i p a l and agency t r a n s a c t i o n s i n u n l i s t e d s e c u r i t i e s , u n d e r w r i t i n g s , d i s t r i b u t i o n o f mutual f u n d s and t a x s h e l t e r p r o g r a m s , commodity f u t u r e s c o n t r a c t s , l i f e i n s u r a n c e a g e n c y and o t h e r f i n a n c i a l s e r v i c e s . E d w a r d s is a member o f t h e NYSE, t h e A m e r i c a n S t o c k Exchange, I n c . , t h e C h i c a g o Board o f O p t i o n s Exchange, I n c . , o t h e r s e c u r i t i e s and commodities exchanges and t h e N a t i o n a l A s s o c i a t i o n o f S e c u r i t i e s Dealers.
A s o f F e b r u a r y 1 9 8 0 , t h e f i r m employed 2 , 3 5 5 p e r s o n s , including 1,175 registered representatives. Edwards s e r v e s a p p r o x i m a t e l y 125,000 a c t i v e i n d i v i d u a l and i n s t i t u t i o n a l c u s t o m e r s t h r o u g h 1 6 1 o f f i c e s i n 33 states l o c a t e d p r i n c i p a l l y i n t h e s o u t h e a s t e r n , s o u t h w e s t e r n and m i d w e s t e r n United S t a t e s .

11.

INCEPTION AND DEVELOPMENT OF HUNT RELATIONSHIP -- -.---

H e r b e r t and Bunker Hunt e a c h opened a c c o u n t s a t Edwards i n December 1976. 206/ -T h e a c c o u n t s were i n t r o d u c e d t o E d w a r d s by A l v i n B r o d s k y , t h e H u n t s ' Comex f l o o r b r o k e r , 207 Throughout t h e i r t h r o u g h a v i c e p r e s i d e n t o f E d w a r d s . -- / r e l a t i o n s h i p w i t h Edwards, t h e Hunts e n t e r e d t h e i r o r d e r s d i r e c t l y w i t h B r o d s k y o n t h e f l o o r o f t h e Comex. Edwards

206/ 207/ -

E a c h b r o t h e r ' s new a c c o u n t f o r m i n d i c a t e s h i s n e t w o r t h a t $100 m i l l i o n p l u s . T h e a c c o u n t s were c o n s i d e r e d home o f f i c e a c c o u n t s . No o n e a t Edwards r e c e i v e d commissions on t h e a c c o u n t s .

w a s to be t h e c l e a r i n g and c a r r y i n g broker f o r t r a n s a c t i o n s i n both s u g a r and s i l v e r f u t u r e s .

I n A p r i l 1 9 7 9 , a r e q u e s t was m a d e o n b e h a l f o f b o t h t h e Hunts to increase t h e i r t r a d i n g l i m i t s . The Hunt a c c o u n t s were a l r e a d y a p p r o v e d b y t h e c o m m o d i t y c r e d i t d e p a r t m e n t f o r e x c h a n g e minimum m a r g i n s , a n d , b y t h e s p r i n g o f 1979, l i m i t s had been e s t a b l i s h e d f o r e a c h a c c o u n t a t a total o f 300 c o n t r a c t s f o r b o t h s u g a r and s i l v e r , w i t h n o more t h a n 2 0 0 c o n t r a c t s i n a n y o n e c o m m o d i t y . --- / 208 In April 1979, t h e Hunts, through Brodsky, requested t h a t t h e i r c r e d i t l i m i t b e i n c r e a s e d t o a maximum l i n e o f 3 0 0 c o n tracts of s i l v e r f o r each account, with sugar c o n t r a c t s to be deleted. An i n t e r n a l m e m o r a n d u m c r e a t e d i n r e s p o n s e t o t h a t r e q u e s t i n d i c a t e d t h a t t h e Hunts had a f a v o r a b l e c r e d i t h i s t o r y w i t h r e s p e c t to margin calls and included d e t a i l e d supporting information with respect to c r e d i t It a l s o indicated t h a t l i n e s a n d n e t w o r t h estimates. Brodsky was c o n f i d e n t t h a t b o t h gentlemen " a r e aware o f and can f u l l y handle t h i s t y p e o f r i s k . " 208/ A c c o u n t s are c l a s s i f i e d by Edwards e i t h e r as s p e c u l a t i v e a c c o u n t s or h e d g e a c c o u n t s . Within each account c a t e g o r y t h e r e are f o u r s u b c l a s s e s r a n g i n g f r o m small a c c o u n t s , w h i c h e s s e n t i a l l y are d e a l t w i t h a t t h e d i s c r e t i o n o f t h e manager o f t h e branch, to l a r g e a c c o u n t s , f o r w h i c h c r e d i t l i m i t s are e s t a b l i s h e d by t h e e x e c u t i v e committee. The c r e d i t class w i t h i n which a n a c c o u n t f a l l s is a f u n c t i o n o f t h e c u s t o m e r ' s n e t w o r t h a n d p e r c e n t l i q u i d i t y o f assets a v a i l a b l e to t h e c u s t o m e r . " S m a l l a c c o u n t s " are t h o s e w i t h i n i t i a l m a r g i n r e q u i r e m e n t s o f less t h a n $ 5 , 0 0 0 ( h o u s e b a s i s ) a n d are o p e n e d s o l e l y a t t h e d i s c r e t i o n o f t h e branch manager. The branch manager determines s u i t a b i l i t y . "Medium a c c o u n t s " are t h o s e w i t h m a r g i n r e q u i r e m e n t between $5,000 and $12,000. B r a n c h o f f i c e s are r e q u i r e d t o m a i n t a i n f i n a n c i a l c r e d i t information and to determine suitability. " Q u a s i - l a r g e a c c o u n t s " are t h o s e w i t h Both t h e b r a n c h up to $20,000 margin requirements. o f f i c e a n d t h e Commodity D e p a r t m e n t are r e q u i r e d t o m a i n t a i n f i n a n c i a l and c r e d i t information, a customer A definite p r o f i l e and to update t h e s e i t e m s r e g u l a r l y . maximum l i n e m u s t h a v e b e e n r e c o m m e n d e d a n d a p p r o v e d b y t h e Commodity D e p a r t m e n t . "Large a c c o u n t s " are t h o s e o v e r $ 2 0 , 0 0 0 , a n d a r e g o v e r n e d b y t h e same c r e d i t r e q u i r e m e n t s as q u a s i - l a r g e accounts. These b a s i c c r e d i t g u i d e l i n e s are t h e n a d j u s t e d by v a r i o u s factors. The f a c t o r s i n c l u d e e x p e r i e n c e o f t h e b r o k e r , e x p e r i e n c e o f t h e customer, income o f t h e customer, w h e t h e r or n o t t h e c u s t o m e r h a s a n y d e p e n d e n t s a n d t h e age of t h e customer.

The r e q u e s t s f o r i n c r e a s e d t r a d i n g l i m i t s o n e a c h a c c o u n t were c o n s i d e r e d t o g e t h e r , a n E d w a r d s e x e c u t i v e e x p l a i n e d , because i t had been t h e f i r m ' s e x p e r i e n c e t h a t the brothers normally acted together. T h a t i s , when t r a n s a c t i o n s were t e n d e r e d t o B r o d s k y , t h e y were n o r m a l l y s i m i l a r f o r b o t h a c c o u n t s . -209/ Thus, t h e r e q u e s t f o r i n c r e a s e s i n e a c h a c c o u n t were h a n d l e d t o g e t h e r " i n o r d e r t o h a v e t h e p r o p e r p e r s p e c t i v e o f t h e commitment," and b e c a u s e t h e f i r m " d i d n ' t r e a l l y b e l i e v e t h a t t h e y [ t h e Hunt b r o t h e r s ] would a c t s e p a r a t e l y t o meet t h e i r c o m m i t m e n t s . " E d w a r d s ' e x e c u t i v e committee a p p r o v e d t h e r e q u e s t f o r i n c r e a s e d t r a d i n g l i m i t s i n s i l v e r o n A p r i l 24, 1979. D e s p i t e t h e a p p r o v a l , t h e M u n t s n e v e r made u s e o f the increased l i m i t s . A l t h o u g h t h e r e were s e v e r a l p u r c h a s e s a n d s a l e s o f Comex s i l v e r i n b o t h a c c o u n t s , a n d Bunker H u n t ' s a c c o u n t r o l l e d forward 100 c o n t r a c t p o s i t i o n s s e v e r a l t i m e s , h i s a c c o u n t h e l d n o more t h a n 1 3 0 c o n t r a c t s a t any one t i m e . Herbert H u n t ' s a c c o u n t , s l i g h t l y l e s s a c t i v e , n e v e r e x c e e d e d 1 0 0 Comex s i l v e r c o n t r a c t s . On J a n u a r y 1 4 , 1980, H e r b e r t Hunt l i q u i d a t e d h i s a c c o u n t a t Edwards and it remained i n a c t i v e , a t l e a s t t h r o u g h A p r i l 1980. The Munts d i d n o t a p p r o a c h Edwards f o r l o a n s a g a i n s t s i l v e r collateral.
111. THE C R I S- AT EDWARDS I SA.

B u n k e r H u n- Misses a C ---- n March 2 5 , 1 9 8 0 t all o -

Computed a t s p o t p r i c e s i n t h e l i m i t - d o w n s i l v e r m a r k e t , t h e Bunker Hunt a c c o u n t w i t h Edwards f e l l i n t o a l i q u i d a t i n g d e f i c i t o f a p p r o x i m a t e l y $2.8 m i l l i o n a t least a s e a r l y a s March 1 4 . U n t i l March 2 4 , h o w e v e r , t h e M u n t s m e t a l l m a r g i n c a l l s i s s u e d t o t h e m by E d w a r d s . 210/ On March 2 4 , 1 9 8 0 , E d w a r d s i s s u e d a m a r g i n c a l l i n t h e a m o u n t

209/ 210/ -

The Edwards o f f i c i a l d i s c l a i m e d any knowledge o f w h e t h e r t h e b r o t h e r s were a c t i n g w i t h c o m b i n e d r e s o u r c e s .

It should be noted t h a t from a t least February 4 through M a r c h 1 4 , 1 9 8 0 , t h e B u n k e r H u n t a c c o u n t was u n d e r m a r gined. Edwards' p e r s o n n e l a t t r i b u t e t h i s to t h e i r n o t h a v i n g r e c e i v e d n o t i c e o f i n c r e a s e s i n Comex m a r g i n r e q u i r e m e n t s t h a t t o o k e f f e c t o n F e b r u a r y 1 4 . When t h e y l e a r n e d o f t h e i n c r e a s e d r e q u i r e m e n t s i n mid-March, t h e y c a l l e d f o r , and r e c e i v e d , a d d i t i o n a l f u n d s .

o f $1.5 m i l l i o n on Bunker H u n t ' s a c c o u n t . On C7ednesday, March 2 6 , L a r r y H e n d r i c k s , a n a s s i s t a n t v i c e p r e s i d e n t a t E d w a r d s , i n q u i r e d w h e t h e r t h e c a l l had b e e n m e t and was a d v i s e d t h a t Edward's bank had n o t y e t r e c e i v e d a n y f u n d s . Hendricks c o n t a c t e d Debbie Leach, a Hunt Energy employee, a n d r e q u e s t e d h e r t o make t h e n e c e s s a r y f u n d s a v a i l a b l e . 211/ H e also r e q u e s t e d a n a d d i t i o n a l $500,000 to keep t h e a c c o u n t p r o p e r l y m a r g i n e d i n l i g h t o f t h e a d v e r s e m a r k e t movement on t h a t day. By t h e c l o s e o f b u s i n e s s t h a t d a y , t h e H u n t a c c o u n t w a s o n l y $1 m i l l i o n i n e q u i t y a t f u t u r e s p r i c e s and a t s p o t p r i c e s it held a d e f i c i t of $3.5 m i l l i o n .
B.

A t t e m p t s t o Collect

On T h u r s d a y m o r n i n g , March 2 7 , H e n d r i c k s t e l e p h o n e d L e a c h t o c o n i r m w h e t h e r money h a d b e e n w i r e d t o E d w a r d s . S h e a d v i s e d him t h a t s h e had p r e p a r e d t h e a u t h o r i z a t i a n , b u t had b e e n i n s t r u c t e d by M r . H u n t n o t t o t r a n s f e r t h e money. She c o u l d s u p p l y no f u r t h e r i n f o r m a t i o n . Hendricks a s k e d t o s p e a k t o Mercer a n d w a s a d v i s e d t h a t h e was n o t Hendricks again telephoned t o available a t that time. In a t t e m p t t o r e a c h Mercer a b o u t o n e - h a l f h o u r l a t e r . t h i s conversation, although llercer w a s still unavailable, H e n d r i c k s l e a r n e d t h a t M r . Hunt h a d i n s t r u c t e d t h a t n o m a r g i n c a l l s would b e m e t a t a n y f i r m . On March 2 7 t h , t h e m a r g i n c a l l t o t h e B u n k e r H u ~ t account w a s i n c r e a s e d t o a t o t a l of $2.5 m i l l i o n . Robert D i s s e t t , m a n a g e r o f E d w a r d s ' N e w York o p e r a t i o n s , i n f o r m e d Raymond A. ~ a l i n o w s k i , t h e n d i r e c t o r o f a l l o p e r a t i o n s , o f t h e o u t s t a n d i n g margin c a l l s to Bunker Hunt. Kalinowski o r d e r e d t h a t a n o t i c e b e p r e p a r e d w h i c h would i n f o r m H u n t t h a t Edwards would t a k e l i q u i d a t i n g a c t i o n a t t h e m a r k e t o p e n i n g o n t h e f o l l o w i n g m o r n i n g , March 2 8 , i f E d w a r d s w a s n o t p r o v i d e d w i t h m a r g i n , e i t h e r i n t h e form o f c a s h o r acceptable collateral. The "demand n o t i c e " w a s hand d e l i v e r e d t o Mercer e a r l y i n t h e a f t e r n o o n o f March 2 7 . K a l i n o w s k i i n s t r u c t e d D i s s e t t t o v i s i t t h e Comex o f f i c e s o n t h e a f t e r n o o n o f March 27 t o d e t e r m i n e w h e t h e r there was a possibility that trading i n silver futures D i s s e t t later informed c o n t r a c t s would b e s u s p e n d e d . K a l i n o w s k i t h a t h e w a s a s s u r e d by t h e p r e s i d e n t o f Comex

211/ - Hunt E n e r g y a s s i s t a n t t r e a s u r e r C h a r l e s Mercer, L e a c h ' s s u p e r v i s o r , had b e e n Edwards' c o n t a c t f o r t h e Hunts s i n c e t h e i n c e p t i o n o f t h e a c c o u n t s .

t h a t a l l m a r g i n c a l l s d u e t h e Comex c l e a r i n g h o u s e woult3 b e s e t a n d t h a t s i l v e r f u t u r e s t r a d i n g w ~ u l dc o n t i n u e o n F r i d a y , M a r c h 2 8 . 212/

A t 5:00 p . m . o n March 2 7 , 1 9 8 0 , H e n d r i c k s f i r s t s p o k e w i t h Mercer. Hendricks inquired about t h e g e n e r a l s t a t u s o f Bunker H u n t ' s a c c o u n t and s p e c i f i c a l l y a b o u t Edwards' m a r g i n c a l l . Plercer r e p l i e d t h a t h e c o u l d n o t t e l l H e n d r i c k s a n y t h i n g a t t h a t time. H e n d r i c k s s u g g e s t e d t h a t E d w a r d s would n o t l i k e to t a k e rnarket a c t i o n and o f f e r e d t o f i n a n c e Iiunt's p o s i t i o n i f it could be c o l l a t e r a l i z e d . Mercer r e s p o n d e d t h a t h e would b e t a l k i n g to Hunt s h o r t l y and w o u l d see how H u n t f e l t a b o u t t h e p r o p o s i t i o n . The p a r t i e s agreed to speak a g a i n t h e following morning.

A t t h e c l o s e o n March 2 7 , t h e Hunt a c c o u n t w i t h Edwards h a d e q u i t y o f $ 5 0 0 , 0 0 0 v a l u e d a t f u t u r e s p r i c e s i n accord a n c e w i t h r e c o g n i z e d i n d u s t r y practice. A t spot p r i c e s , h o w e v e r , t h e a c c o u n t was $ 6 . 1 m i l l i o n i n d e f i c i t .

C.

Liquidations

A t a p p r o x i m a t e l y 8 : 1 5 a . m . o n t h e 2 8 t h , Mercer a d v i s e d H e n d r i c k s t h a t t h e r e w o u l d b e n o m a r g i n money a n d n o c o l lateral forthcoming. Mercer i n d i c a t e d t h a t t h e H u n t s w o u l d l i k e t h e f i r m to "hold on" because they f e l t t h a t t h e market w a s g o i n g t o come b a c k , b u t t h a t t h e f i r m w o u l d h a v e t o u s e i t s own d i s c r e t i o n a s t o w h a t t o d o a b o u t t h e a c c o u n t . H e n d r i c k s a l l u d e d t o a report i n t h e N e w York Times o f a m e e t i n g a t Merrill L y n c h a t w h i c h t h e H u n t s p u r p o r t e d l y r e q u e s t e d Merrill L y n c h t o f o r e b e a r so t h a t smaller m a r g i n calls could be s a t i s f i e d . Hendricks also i n q u i r e d as to when money m i g h t b e a v a i l a b l e t o t h e f i r m i f Edwards d e c i d e d to h o l d o n to Bunker EIunt's p o s i t i o n and f i n a n c e t h e corresponding v a r i a t i o n margin call with t h e clearingPlercer r e p l i e d t h a t h e was n o t i n a p o s i t i o n t o house. r e v e a l t h e Hunts' r e l a t i o n s h i p with o t h e r brokerage f i r m s a n d t h a t h e c o u l d n o t s p e c u l a t e o n a n y time f r a m e . Mercer d i d i n d i c a t e t h a t t h e H u n t s were c u r r e n t l y w o r k i n g o n " s o m e t h i n g " and would c o n t i n u e working o n i t t h a t weekend as well. 213/

212/ - Kalinowski s t a t e d h e w a s concerned t h a t s u s p e n d e d a n d c o n t r a c t s were c l o s e d o u t t r a d i n g price, s e l l i n g t h e Hunt a c c o u n t price would create a d e f i c i t t h a t m i g h t to j u s t i f y .

if at a t be

t r a d i n g was the last t h e spot difficult

213/ H e n d r i c k s also a s k e d i f t h e f i r m s t h a t l i q u i d a t e d - p o s i t i o n s o n t h e 2 7 t h by s e l l i n g A p r i l c o n t r a c t s would close o u t t h e p o s i t i o n s or l e a v e them i n a spread. Mercer r e p l i e d t h a t h e b e l i e v e d t h a t i n some o f t h e l i q u i d a t i o n s , t h e A p r i l p o s i t i o n s w e r e unwound.

S h o r t l y a f t e r t h e f i r s t c o n v e r s a t i o n , Aendricks telep h o n e d Mercer a g a i n a n d a d v i s e d him t h a t t h e f i r m h a d d e c l d e d to g o a h e a d a n d unwind Bunker H u n t ' s p o s i t i o n a n y way p o s s i b l e . H e i n d i c a t e d t h a t Edwards would f i r s t a t t e m p t t o t r y and t r a n s f e r t h e p o s i t i o n s t o a n o t h e r b r o k e r , or f a i l i n g t h a t , t o g o a h e a d a n d s e l l s p o t c o n t r a c t s a n d unwind t h e spread. Kalinowski then i n s t r u c t e d Martin K r u l i k , a n E d w a r d s e m p l o y e e o n t h e f l o o r o f t h e Comex, t o c o n t a c t Brodsky. K a l i n o w s k i was t o a d v i s e him t h a t t h e m a r g i n c a l l had n o t been m e t , and s u g g e s t t h e t w o a l t e r n a t i v e s d i s c u s s e d Kalinowski l a t e r received a r e p o r t t h a t t h e w i t h Mercer. t r a n s f e r t o a n o t h e r c a r r y i n g b r o k e r was n o t p o s s i b l e and t h a t t h e l i q u i d a t i o n was p r o c e e d i n g . I n e f f e c t i n g t h e l i q u i d a t i o n s , Edwards s o l d s h o r t A p r i l 80 c o n t r a c t s a t p r i c e s o f $12 and a f r a c t i o n t o s p r e a d t h e a c c o u n t s ' e x i s t i n g l o n g May p o s i t i o n a g a i n s t t h e A p r i l spot price. Edwards t h e n e n t e r e d a s p r e a d o r d e r t o p u r c h a s e The 100 t h e A p r i l c o n t r a c t s a n d s e l l t h e May p o s i t i o n . A p r i l 8 0 s were p u r c h a s e d a t $ 2 0 ; 1 0 0 Mays were s o l d a t $ 2 0 . 0 5 . T h e f i r m unwound i t s s p r e a d a t a 5 c e n t d i f f e r e n t i a l . The r e s u l t o f t h e s e t r a n s a c t i o n s was a d e f i c i t o f nearly $6 m i l l i o n ; or, taking i n t o account t h e approximately $1.9 m i l l i o n i n T r e a s u r y b i l l s h e l d by t h e f i r m a s c o l l a t e r a l , a n e t d e f i c i t s l i g h t l y i n e x c e s s of $4 m i l l i o n . E d w a r d ' s n e t c a p i t a l p o s i t i o n d u r i n g March 1980 was a p p r o x i m a t e l y $40 m i l l i o n , $32 m i l l i o n i n e x c e s s o f r e q u i r e d minimiums. The f i r m c h a r g e d t h e $4 m i l l i o n Hunt d e f i c i t a g a i n s t t h i s a c c o u n t u n t i l i t was r e c o v e r e d . On M a r c h 2 8 , 1 9 8 0 , E d w a r d s i s s u e d t w o news r e l e a s e s . The f i r s t , a t 9:00 a.m., a n n o u n c e d t h a t a c u s t o m e r h o l d i n g s i l v e r f u t u r e s c o n t r a c t s h a d f a i l e d t o meet m a r g i n c a l l s . I t s t a t e d t h a t a l t h o u g h t h e number o f c o n t r a c t s was n o t s u b s t a n t i a l , c l o s i n g t h e p o s i t i o n s would r e s u l t i n a subs t a n t i a l unsecured r e c e i v a b l e . F a i l u r e to collect t h e r e c e i v a b l e would n o t have a m a t e r i a l a d v e r s e e f f e c t on Edwards' f i n a n c i a l c o n d i t i o n . The l a t e r r e l e a s e , a t 1 0 5 0 a.m., c l a r i f i e d t h e amount o f t h e r e c e i v a b l e t o be a p p r o x i m a t e l y $4 m i l l i o n a n d i n d i c a t e d t h a t t h e f i r m had n o t y e t determined t h e c o l l e c t i b i l i t y of the receivable. In that connection, a s a r e s u l t of the liquidating d e f i c i t , the f i r m t o o k a c h a r g e a g a i n s t n e t c a p i t a l o f approximately $ 4 million. L a t e r i n t h e day on t h e 28th, Hendricks telephoned Mercer t o a d v i s e him o f t h e e x e c u t i o n s w i t h r e s p e c t t o l i q u i d a t i o n o f t h e Bunker Hunt a c c o u n t . Mercer i n d i c a t e d t h a t t h e firm could use its d i s c r e t i o n with respect to

r e t a i n i n g or l i q u i d a t i n g t h e T-bills. Regarding t h e r e m a i n i n g b a l a n c e , however, Mercer s t a t e d : "That w e ' l l have t o take a t a l a t e r d a t e . I d o n ' t have a n y a n s w e r s a t t h i s time." R e c o v e r y from tlie H u n t s On Monday, March 3 1 , K a l i n o w s k i t e l e p h o n e d Mercer w i t h r e g a r d t o t h e d e f i c i t i n t h e Bunker Hunt a c c o u n t . Mercer a d v i s e d K a l i n o w s k i t h a t t h e H u n t s were i n Boca Raton and t h a t i t would b e l a t e i n t h e d a y b e f o r e Mercer would h a v e any advice f o r t h e firm. I n a subsequent conversation, s u b s t a n t i v e d i s c u s s i o n s were p o s t p o n e d u n t i l t h e f o l l o w i n g morning. On t h e m o r n i n g o f A p r i l l s t , Mercer a d v i s e d K a l i n o w s k i t h a t , b a s e d upon m e e t i n g s t h a t t h e H u n t s were c u r r e n t l y h a v i n g , h e e x p e c t e d t h a t t h e H u n t s would b e a b l e t o f o r w a r d money t o t h e f i r m l a t e r i n t h e d a y . T h a t a f t e r n o o n , $4.1 m i l l i o n w a s t r a n s f e r r e d by wire and t h e f i r m was i n s t r u c t e d t o l i q u i d a t e the T-bills i n its possession, thereby clearing t h e d e f i c i t i n t h e Bunker Hunt a c c o u n t . On A p r i l 1, 1 9 8 0 , Edwards i s s u e d a news r e l e a s e a n n o u n c i n g t h a t i t had r e c e i v e d f u l l payment o f i t s $4 m i l l i o n 214/ unsecured r e c e i v a b l e -

IV.

REMEDIAL MEASURES FOLLOWING THE CRISIS

A s a r e s u l t o f i t s e x p e r i e n c e i n March 1 9 8 0 , Edwards h a s a d o p t e d s e v e r a l new p r o c e d u r e s w i t h r e s p e c t t o commod i t i e s transactions. Edwards ' new p r o c e d u r e s f o r m a l l y recognize t h a t accounts maintaining positions in the spot month c a n be s u b j e c t t o e x t r e m e e q u i t y loss. A c c o r d i n g l y , m a r g i n s f o r v a r i o u s c a t e g o r i e s o f c o m m o d i t i e s must now b e e s t a b l i s h e d i n a n amount commensurate w i t h t h e a c t u a l r i s k presented. Customers i n t e n d i n g t o remain i n l o n g o r s h o r t p o s i t i o n s a f t e r t h e t e r m i n a t i o n o f t h e t r a d i n g cont r a c t a r e required t o d e p o s i t t h e necessary funds to accept d e l i v e r y , i f l o n g , or t h e a p p r o p r i a t e documentation to complete t h e t r a n s a c t i o n , i f s h o r t .

The m a r g i n d e p a r t m e n t a l s o h a s been g i v e c o n s i d e r a t i o n t o t h e s p o t market i n m a r g i n c a l l s where t h e r e a p p e a r s t o be a s p o t a n d b a c k month c o n t r a c t p r i c e s . In

instructed to fixing variation d i s t o r t i o n between such s i t u a t i o n s ,

214/ - NYSE t o o k n o d i s c i p l i n a r y a c t i o n r e g a r d i n g t h e d i s c r e p a n c y i n Edwards' s t a t e m e n t s .

t h e margin department has d i s c r e t i o n t o c a l l f o r a n inc r e a s e d amount o f v a r i a t i o n m a r g i n b a s e d upon t h e amount o f t h e d i s t o r t i o n , t h e t y p e o f commodity, t h e f i r n ' s e x p e r i e n c e w i t h t h e customer, and t h e c u s t o m e r ' s r e l i a b i l i t y i n meeting margin c a l l s . I n t h i s manner, t h e f i r m c a n p u t t h e c u s t o m e r o n n o t i c e a s t o t h e amount o f m a r g i n i t n e e d s t o m a i n t a i n t h e c u s t o m e r ' s p o s i t i o n ; t h e c u s t o m e r c a n e i t h e r meet t h e c a l l s , l i q u i d a t e f u l l y or p a r t i a l l y , o r t r a n s f e r t h e p o s i t i o n to a n o t h e r b r o k e r . C r e d i t g u i d e l i n e s were r e v i s e d i n J a n u a r y 1 9 8 1 . The d o l l a r l i m i t s f o r e a c h t y p e o f a c c o u n t s u b c l a s s were r a i s e d t o $ 2 5 , 0 0 0 , $ 5 0 r 0 0 O t $ 9 9 , 0 0 0 , a n d $ 1 0 0 , 0 0 0 a n d o v e r , res p e c t i v e l y . The l a r g e a c c o u n t c l a s s now r e q u i r e s a p p r o v a l o f t h e e x e c u t i v e committee. In establishing credit l i m i t s f o r large accounts, c e r t i f i e d financial statements o r o t h e r s u i t a b l e c r e d i t i n f o r m a t i o n must be o b t a i n e d from t h e c u s t o m e r which d e m o n s t r a t e s t h a t t h e c u s t o m e r h a s t h e r e q u i s i t e l i q u i d i t y and n e t w o r t h . For s p e c u l a t i v e a c c o u n t s , although s i t u a t i o n s can vary g r e a t l y , the individual cust o m e r ' s s i t u a t i o n is c o n s i d e r e d i n l i g h t o f t h e a b i l i t y o f t h a t c u s t o m e r t o meet m a r g i n c a l l s , e i t h e r t h r o u g h h i s own f u n d s or c u r r e n t a b i l i t y to borrow from banks o r f i n a n c e companies. Edwards h a s also m o d i f i e d i t s p r o c e d u r e s t o e n a b l e i t t o more r e a d i l y d e t e r m i n e i t s e x p o s u r e i n c u s t o m e r commodity accounts. It developed a r e p o r t t h a t r e v e a l s customer p o s i t i o n s o n a n e t l o n g o r s h o r t b a s i s b y s h o w i n g a n d rep o r t i n g t h e t r u e e x t e n t o f i t s unhedged c u s t o m e r p o s i t i o n s .

PART EIGHT THE NEW YORK STOCK EXCHANGE

I.

BACKGROUND - ORGANIZATION AND RESPONSIBILITIES OF THE EXCHANGE UNITS RESPONSIBLE FOR SURVEILLANCE OF MEMBER FIRMS

The S u r v e i l l a n c e D e p a r t m e n t o f t h e N e w York S t o c k E x c h a n g e ' s Member F i r m R e g u l a t i o n a n d S u r v e i l l a n c e D i v i s i o n is r e s p o n s i b l e f o r t h e Exchange's s u r v e i l l a n c e o f member f i r m s . During t h e p e r i o d p r i o r to t h e s i l v e r crisis, t h i s D e p a r t m e n t was composed o f t w o s e c t i o n s : the Field 215/ E x a m i n a t i o n S e c t i o n a n d t h e C o o r d i n a t i o n S e c t i o n . - The F i e l d E x a m i n a t i o n S e c t i o n was r e s p o n s i b l e f o r p e r f o r m i n g a n a n n u a l c o m p r e h e n s i v e e x a m i n a t i o n o f e v e r y E x c h a n g e member and s p e c i a l examinations, o n a c a u s e b a s i s . The S u r v e i l l a n c e C o o r d i n a t i o n S e c t i o n was r e s p o n s i b l e f o r o v e r s e e i n g t h e s u r v e i l l a n c e o f t h e NYSE's member f i r m s , a n d f o r c o o r d i n a t i n g a l l o f t h e r e g u l a t o r y a c t i v i t i e s o f t h e Exchange a f f e c t i n g those firms. S p e c i f i c a l l y , t h e c o o r d i n a t o r s reviewed a l l o f t h e f i n a n c i a l and o p e r a t i o n a l reports f i l e d p e r i o d i c a l l y w i t h t h e E x c h a n g e b y t h e member f i r m s . Each c o o r d i n a t o r maintained personal contacts with representatives a t each f i r m and t y p i c a l l y spoke w i t h t h e s e c o n t a c t s a t least once a month. I d e a l l y , each c o o r d i n a t o r w a s to have a f u l l awareness of t h e b u s i n e s s and h e a l t h o f t h e f i r m s a s s i g n e d t o him. A c c o r d i n g t o E x c h a n g e o f f i c i a l s , t h e c o o r d i n a t o r s made a c o n c e n t r a t e d e f f o r t t o s t a y a b r e a s t o f new d e v e l o p m e n t s i n t h e brokerage industry. Each c o o r d i n a t o r team w a s a s s i g n e d a s p e c i a l p r o d u c t area, such as commodities, t o s t u d y and m o n i t o r t h r o u g h t h e p r e s s , t r a d e j o u r n a l s and In c o n t a c t s w i t h s p e c i a l i s t s i n t h e p a r t i c u l a r area. a d d i t i o n , p r o c e d u r e s e x i s t e d t o m o b i l i z e t h e e n t i r e Coord i n a t i o n S e c t i o n f o r t h e purpose of a s s e s s i n g t h e impact o f c u r r e n t t r e n d s o r e v e n t s o n t h e f i n a n c i a l and o p e r a t i o n a l c a p a b i l i t i e s o f t h e member f i r m s . These e f f o r t s were known a s " S u r v e y s . " When a p a r t i c u l a r t r e n d o r e v e n t was i d e n t i f i e d a s p o t e n t i a l l y a f f e c t i n g t h e f i n a n c i a l o r o p e r a t i o n a l w e l l - b e i n g o f some o r a l l o f t h e E x c h a n g e ' s m e m b e r s , t h e c o o r d i n a t o r s would c o n t a c t t h e members f o r relevant information. By t e l e p h o n e c a l l s t o f i n a n c i a l o f f i c e r s o f member f i r m s , t h e c o o r d i n a t o r s a s k e d i f t h e r e were f i r m i n v e n t o r y l o s s e s o r u n d e r m a r g i n e d c u s t o m e r a c c o u n t s which would r e s u l t i n c a p i t a l c h a r g e s to t h e f i r m and t h e e f f e c t o f such c h a r g e s o n t h e f i r m ' s e x c e s s net capital. According t o Exchange o f f i c i a l s , t h e S u r v e i l l a n c e C o o r d i n a t i o n S e c t i o n w o r k e d c l o s e l y w i t h t h e F i e l d Examinat i o n Section. P r i o r to a f i e l d examination, t h e s u r v e i l l a n c e c o o r d i n a t o r p r e p a r e d f o r t h e e x a m i n e r a summary o f a l l o f 215/ - D u r i n g t h e s p r i n g o f 1 9 8 2 , t h e Member F i r m S u r v e i l l a n c e D e p a r t m e n t was r e o r g a n i z e d a n d t h e F i e l d E x a m i n a t i o n S e c t i o n and t h e C o o r d i n a t i o n S e c t i o n w e r e merged.

t h e d a t a a b o u t t h e f i r m known t o t h e E x c h a n g e , and a "memorandum o f u n d e r s t a n d i n g , " w h i c h d e f i n e d t h e s c o p e o f t h e 216/ examination. - During t h e examination, t h e examiners were e x p e c t e d t o b e i n p e r i o d i c c o n t a c t w i t h t h e c o o r d i n a t o r s t o r e p o r t any s i g n i f i c a n t f i n d i n g s during t h e course o f t h e e x a m i n a t i o n , a n d , i f problems arose, t h e c o o r d i n a t o r s would o f f e r g u i d a n c e a n d a s s i s t a n c e .
11.

THE NYSE'S SURVEILLANCE OF I T S MEMBER FIRMS DEALING I N SILVER - SEPTEMBER 1 9 7 9 THROUGH MARCH 26. 1 9 8 0

I n e a r l y S e p t e m b e r 1 9 7 9 , i n d i v i d u a l s i n t h e NYSE's S u r v e i l l a n c e D e p a r t m e n t ' s C o o r d i n a t i o n S e c t i o n became concerned a b o u t t h e s h a r p i n c r e a s e i n p r i c e s o f g o l d and s i l v e r a n d w h e t h e r t h e i n c r e a s e would c a u s e u n d u e e x p o s u r e to firms with p r o p r i e t a r y or customer p o s i t i o n s i n t h e Between September 1 7 and 21, p r e c i o u s metals m a r k e t s . 1979, t h e c o o r d i n a t o r s conducted a survey o f t h e firms known t o d e a l i n c o m m o d i t y f u t u r e s . They a s k e d q u e s t i o n s 217/ f r o m a c h e c k l i s t - c o n c e r n i n g t h e make-up o f c u s t o m e r s and p r o p r i e t a r y a c c o u n t s , c l e a r i n g a r r a n g e m e n t s , and m a r g i n r e q u i r e m e n t s f o r p u b l i c and t r a d e a c c o u n t s . The E x c h a n g e s o u g h t s p e c i f i c d e t a i l s r e g a r d i n g l a r g e a c c o u n t s and g e n e r a l o b s e r v a t i o n s c o n c e r n i n g t h e p r e c i o u s metals m a r k e t s . I n a c c o r d a n c e w i t h E x c h a n g e p r o c e d u r e s , t h e s u r v e y was c o n d u c t e d e n t i r e l y by t e l e p h o n e , a n d , e x c e p t i n t h e c a s e o f Merrill L y n c h , t h e E x c h a n g e d i d n o t v e r i f y t h e i n f o r m a t i o n As f a r a s the staff r e p o r t e d t o t h e E x c h a n g e by t h e f i r m s . could determine, i n only one case d i d t h e coordinators r e q u e s t i n f o r m a t i o n from a f i r m r e g a r d i n g t h e s p e c i f i c i d e n t i t y o f t h o s e a c c o u n t s w i t h p o s i t i o n s , a n d i n n o cases d i d t h e coordinators request information concerning p o s s i b l e financing arrangements with customers, concentrated p o s i t i o n s , o r p o s i t i o n s o f a f f i l i a t e d e n t i t i e s . The s u r v e y d i s c l o s e d t h a t v e r y few f i r m s h a d p r o p r i e t a r y p o s i t i o n s , a n d t h a t f o r t h e most p a r t , a l l o u t s t a n d i n g m a r g i n c a l l s were b e i n g met. I n t h e summary memorandum c o n c e r n i n g B a c h e H a l s e y ' s r e s p o n s e s t o t h i s s u r v e y , i t was n o t e d t h a t on t h e b a s i s of t h e conversations with t h e firm "it appear[ed] t h a t management h a l d l t h e n e c e s s a r y c o n t r o l s i n e f f e c t t o p r e clude any problems." 216/ F o r e x a m p l e , t h e c o o r d i n a t o r , k n o w i n g t h a t t h e f i r m had r e c e n t l y e x p a n d e d i t s b u s i n e s s i n a c e r t a i n p r o d u c t a r e a , had t h e a u t h o r i t y and r e s p o n s i b i l i t y t o d i r e c t t h e examiner t o pay p a r t i c u l a r a t t e n t i o n to t h a t a r e a . 217/ T h i s c h e c k l i s t was u s e d i n s u b s e q u e n t s u r v e y s t h r o u g h o u t t h e p e r i o d p r i o r t o March 2 7 , 1 9 8 0 .

D u r i n g t h e p e r i o d t h i s s u r v e y was c o n d u c t e d , t h e coo r d i n a t o r s became aware o f two i m p o r t a n t f a c t s . First, a t t h e time o f t h e s u r v e y , E x c h a n g e e x a m i n e r s were c o n d u c t i n g a n e x a m i n a t i o n o f Merrill Lynch. The c o o r d i n a t o r c o n d u c t i n g t h e s u r v e y o f Merrill Lynch a s k e d t h e e x a m i n e r s t o r e v i e w t h o s e c u s t o m e r s ' a c c o u n t s w h i c h m e t t h e d a i l y CFTC r e p o r t ing requirements. Among s u c h a c c o u n t s were t h o s e w i t h n e t p o s i t i o n s e x c e e d i n g 250 c o n t r a c t s . The c o o r d i n a t o r ' s workpapers r e f l e c t t h a t t h e examiners provided d e t a i l s to t h e c o o r d i n a t o r s a s t o t h e s e a c c o u n t s b y a c c o u n t number. One o f t h e s e a c c o u n t n u m b e r s was 542-762578 b e l o n g i n g t o H e r b e r t Hunt. A n o t h e r was 5 4 2 - 9 3 6 9 4 , b e l o n g i n g t o I M I C . A c c o r d i n g t o t h e w o r k p a p e r s , o n l y t h e I X I C a c c o u n t was i d e n t i f i e d b y name a n d r e p o r t e d t o t h e c o o r d i n a t o r s . Apparently, t h e examiners d i d n o t look i n t o t h e ownership o f I M I C , - d i d n o t d e t e r m i n e w h e t h e r t h e r e were a n y re218/ l a t e d a c c o u n t s , and d i d n o t i d e n t i f y t h e h o l d e r o f a c c o u n t number 542-76257. 219/ On S e p t e m b e r 2 6 , t h e s u p e r v i s o r y c o o r d i n a t o r f o r B a c h e H a l s e y r e p o r t e d t o t h e d i r e c t o r o f t h e S u r v e i l l a n c e Coord i n a t i o n S e c t i o n t h a t t h e H u n t s were t r a n s f e r r i n g t h e i r commodity a c c o u n t s , which c o n s i s t e d e n t i r e l y o f l o n g p o s i t i o n s i n s i l v e r , t o B a c h e f r o m S h e a r s o n Loeb R h o d e s , I n c . ("Shearson"). According t o t h e supervisory c o o r d i n a t o r ' s memorandum, t h e t r a n s f e r was d u e t o t h e f a c t t h a t t h e H u n t s t h o u g h t S h e a r s o n ' s m a r g i n r e q u i r e m e n t s were e x c e s s i v e . 220/ The s u p e r v i s o r y c o o r d i n a t o r c o n c l u d e d t h a t " t h e t r a n s f e r d o e s n o t p r e s e n t a n y problem ( i . e . added e x p o s u r e ) . " T h e i n s p e c t i o n d i s c l o s e d t h a t w h i l e t h i s s u r v e y was b e i n g c o n d u c t e d , t h e E x c h a n g e was i n c o n t a c t w i t h t h e Comex a n d CFTC. A c c o r d i n g t o a n E x c h a n g e i n t e r n a l memorandum,

218/ -

N o t u n t i l March 2 7 , 1 9 8 0 , d i d t h e s u r v e i l l a n c e c o o r d i n a t o r f i n d o u t t h a t t h e I M I C a c c o u n t was a Hunt-related account.

- Hutton.
.

219/ D u r i n g t h e f a l l o f 1 9 7 9 , t h e E x c h a n g e a l s o e x a m i n e d The e x a m i n e r ' s w o r k p a p e r s i n c l u d e d a n o t a t i o n t o t h e e f f e c t t h a t a n a c c o u n t o f N e l s o n B. Hunt l a c k e d a signed loan agreement. I t was n o t u n t i l March 2 6 - 2 7 , 1980, t h a t t h e S u r v e i l l a n c e Coordination Section learned t h a t t h e Hunts had a n a c c o u n t a t Hutton and t h a t H u t t o n had l o a n e d t h e Hunts f u n d s .
A t t h e t i m e , t h e Comex r e q u i r e d a minimum o f $ 5 , 0 0 0 per c o n t r a c t . S h e a r s o n r e q u i r e d $ 2 0 , 0 0 0 i n Hunt s i l v e r a c c o u n t s , w h i l e Bache o n l y r e q u i r e d $7,500.

220/ -

t h e Comex a d v i s e d o n e o f t h e s e n i o r s t a f f o f t h e S u r v e i l l a n c e C o o r d i n a t i o n S e c t i o n t h a t t h e H u n t b r o t h e r s "may b e involved" i n t h e trading of t h a t period, but t h a t t h e i r names h a d " n o t y e t a p p e a r e d anywhere." A c c o r d i n g t o a n o t h e r memorandum, a CFTC r e p r e s e n t a t i v e a d v i s e d t h e D i r e c t o r o f the Surveillance Coordination Section t h a t the long pasit i o n s were o f p a r t i c u l a r c o n c e r n b e c a u s e t h e p r o f e s s i o n a l s , f e e l i n g t h e market w a s o v e r i n f l a t e d , might sell o f f t h e i r According to p o s i t i o n s c a u s i n g a "roller coaster" e f f e c t . t h i s memorandum, t h e D i r e c t o r o f t h e S u r v e i l l a n c e C o o r d i n a t i o n S e c t i o n o f f e r e d t h e CFTC r e p r e s e n t a t i v e i n f o r m a t i o n This o f f e r c o n c e r n i n g t h e r e s u l t s o f t h e NYSEvs s u r v e y . was d e c l i n e d . Between t h i s i n i t i a l s u r v e y and J a n u a r y 1980 t h e E x c h a n g e c o n d u c t e d t w o more s u r v e y s . I n b o t h cases, t h e E x c h a n g e c o o r d i n a t o r s u s e d t h e same c h e c k l i s t a n d p r o c e d u r e s a s b e f o r e , and a g a i n l e a r n e d t h a t , e x c e p t f o r a few m i n o r i n s t a n c e s , n o f i r m was e x p e r i e n c i n g a n y p r o b l e m s . Another survey w a s conducted i n e a r l y January, 1980 and o n January 23, 1980, t h e d i r e c t o r o f t h e S u r v e i l l a n c e C o o r d i n a t i o n S e c t i o n r e p o r t e d t o Commission s t a f f t h a t t h e E x c h a n g e members s u r v e y e d h a d b e e n c a u t i o u s i n t h e i r s i l v e r a c t i v i t i e s a n d " h a v e s u f f i c i e n t l y i n s u l a t e d thems e l v e s a g a i n s t e x p o s u r e . " On o r a b o u t t h a t same d a t e , t h e Exchange conducted a n o t h e r s u r v e y . T h e summary o f B a c h e v s responses stated: "The f i r m r e f e r r e d t o its commodity T h i s is a t t r i accounts as being i n super condition. b u t e d t o t h e i r c o n s e r v a t i v e and v e r y close m o n i t o r i n g o f a c c o u n t s . " As i n t h e case o f t h e p r e v i o u s s u r v e y s , t h e Exchange l e a r n e d o f no s i g n i f i c a n t problems. On J a n u a r y 2 5 , 1 9 8 0 t h e E x c h a n g e r e c e i v e d a FOCUS P a r t I1 R e p o r t f o r Bache H a l s e y . 221/ T h e R e p o r t showed a 3 7 3 % i n c r e a s e ( f r o m $16,279,000 t o $ 6 0 , 8 3 4 , 0 0 0 ) o v e r two months i n commodities r e c e i v a b l e s . T h e s h a r p i n c r e a s e was n o t 222/ n o t i c e d by t h e c o o r d i n a t o r s r e v i e w i n g t h e documents. On J a n u a r y 2 6 , 1 9 8 0 , t h e E x c h a n g e b e g a n a r e g u l a r l y s c h e d u l e d r o u t i n e e x a m i n a t i o n of B a c h e H a l s e y . The e x a m i n a t i o n , conducted a c c o r d i n g t o Exchange p r o c e d u r e s , 2 2 1 / T h e FOCUS P a r t I1 R e p o r t i s a summary s t a t e m e n t o f - c e r t a i n f i n a n c i a l and o p e r a t i o n a l d a t a f i l e d q u a r t e r l y b y b r o k e r - d e a l e r s who c a r r y c u s t o m e r a c c o u n t s . 222/ A d d i t i o n a l r e s e a r c h by t h e Exchange, s i n c e t h e s t a f f I s i n s p e c t i o n , d i s c l o s e d t h a t o t h e r f i r m s , s u c h as H u t t o n and S h e a r s o n , e x p e r i e n c e d marked i n c r e a s e s (206% and 438% r e s p e c t i v e l y ) i n t h i s l i n e i t e m d u r i n g a p p r o x i T h e E x c h a n g e was n o t aware m a t e l y t h e same p e r i o d . of these facts a t that time.

e n t a i l e d among o t h e r t h i n g s , a r e v i e w o f t h e a c c u r a c y o f t h e f i r m ' s December 3 1 , 1 9 7 9 FOCUS r e p o r t . Thus it i n cluded a d e t a i l e d review o f Bache's customer commodities o p e r a t i o n s a s o f t h a t d a t e , t h e same t i m e t h a t t h e s i l v e r m a r k e t was n e a r i t s h i s t o r i c h i g h . On F e b r u a r y 4 , 1 9 8 0 , t h e c o o r d i n a t o r s s e n t t h e e x a m i n e r s a memorandum w h i c h n o t e d t h a t t h e f i r m was a d e q u a t e l y c a p i t a l i z e d a n d t h a t t h e c o o r d i n a t o r ' s d a i l y m o n i t o r i n g o f t h e f i r m had n o t d i s c l o s e d any problems. T h e memorandum d i d n o t m e n t i o n t h e f i r m ' s commodities o p e r a t i o n s . During F e b r u a r y and t h e f i r s t h a l f o f March, t h e Exchange d i d n o t c o n d u c t a n y s i l v e r s u r v e y s a l t h o u g h t h e r e w a s a g e n e r a l a w a r e n e s s t h a t t h e p r i c e o f s i l v e r was d e c l i n i n g f r o m i t s h i g h s o f a b o u t $50 p e r o u n c e r e a c h e d i n January. During F e b r u a r y , t h e Exchange e x a m i n e r s c o n t i n u e d t h e i r e x a m i n a t i o n o f Bache H a l s e y . It took t h r e e examiners t h e e n t i r e month t o r e v i e w t h e f i r m ' s commodities o p e r a t i o n s . The e x a m i n e r s were l o c a t e d i n t h e f i r m ' s c o m m o d i t i e s o f f i c e s a n d were i n d a i l y c o n t a c t w i t h t h e c o m m o d i t i e s m a n a g e r s . The r e v i e w , f o l l o w i n g E x c h a n g e p r o c e d u r e s , i n c l u d e d a n e x a m i n a t i o n o f many c u s t o m e r a c c o u n t s a s o f December 3 1 , 1979, even though examiners involved i n t h e commodities a s p e c t s o f t h e e x a m i n a t i o n knew o f t h e downward t r e n d i n t h e s i l v e r p r i c e s t h a t h a d o c c u r r e d s i n c e December 31. A c c o u n t s w h i c h e x h i b i t e d n o p r o b l e m s a s o f December 3 1 , 1 9 7 9 were o n l y c u r s o r i l y r e v i e w e d . The Hunt a c c o u n t s , w h i c h , a c c o r d i n g t o E x c h a n g e d o c u m e n t s , were l o n g 6 9 0 0 f u t u r e s c o n t r a c t s and had e q u i t y o f $171 m i l l i o n a s o f t h a t d a t e , p r e s e n t e d n o p r o b l e m s , a n d t h e r e f o r e were n e i t h e r s p e c i f i c a l l y i d e n t i f i e d n o r r e v i e w e d i n d e p t h . 223,' A t n o time was t h e r e a s u g g e s t i o n t h a t t h e a c c o u n t s s h o u l d be reviewed i n l i g h t of t h e c u r r e n t market developments, o r e v a l u a t e d i n terms o f p o t e n t i a l f i r m e x p o s u r e . D u r i n g F e b r u a r y , t h e e x a m i n e r s were r a r e l y i n c o n t a c t with.the coordinators. I n a c c o r d a n c e w i t h Exchange p r o cedures, t h e examination d i d n o t include a review of t h e books or r e c o r d s o f Bache H a l s e y S t u a r t M e t a l s , I n c . , a n a f f i l i a t e d c o r p o r a t i o n n o t w i t h i n t h e Exchange's r e g u l a t o r y jurisdiction. 224/

223/ -

The f i g u r e s i n t h e t e x t , d e r i v e d from Exchange documents appear n o t to r e f l e c t a l l Hunt-related p o s i t i o n s c a r r i e d b y B a c h e H a l s e y a t December 3 1 , 1 9 7 9 . By t h e e n d o f F e b r u a r y , B a c h e Metals h a d l o a n s o f a p p r o x i m a t e l y $233 m i l l i o n t o t h e H u n t s w h i c h were c o l l a t e r a l i z e d by s i l v e r w i t h a m a r k e t v a l u e , a t t h a t t i m e , o f a p p r o x i m a t e l y $400 m i l l i o n .

224/ -

On o r a b o u t March 1, 1 9 8 0 , t h e Exchange e x a m i n e r s a t Bache H a l s e y b e g a n t o w r i t e up t h e v a r i o u s p o r t i o n s o f t h e i r e x a m i n a t i o n r e p o r t , i n a room s p e c i a l l y p r o v i d e d f o r t h e i r u s e b y Bache. From t h a t d a t e o n , t h e e x a m i n e r s working on t h e commodities a s p e c t s o f t h e examination had l i t t l e c o n t a c t w i t h t h e c o m m o d i t i e s d e p a r t m e n t . The examiner i n charge of t h e commodities review s p e n t t h e e n t i r e month o f March f i n a l i z i n g h i s r e p o r t o n Bache Halsey's premises. On March 1 8 , 1 9 8 0 , t h e Exchange c o n d u c t e d a n o t h e r s i l v e r s u r v e y o f i t s member o r g a n i z a t i o n s , u s i n g t h e same p r o c e d u r e s and c h e c k l i s t a s i n p r i o r s u r v e y s . The m e m o randum, s e n t t o t h e s u p e r v i s o r y c o o r d i n a t o r s d i r e c t i n g t h e s u r v e y , n o t e d t h a t t h e Comex l i m i t s o n t h e number o f f u t u r e c o n t r a c t s t h a t c o u l d b e h e l d were a " s a v i n g f a c t o r , " a n d t h a t t h e Exchange had n o r e p o r t s o f p r o b l e m s . The summary o f Merrill's r e s p o n s e t o t h a t s u r v e y noted t h a t t h e f i r m was e x p e r i e n c i n g a n i n c r e a s e i n m a r g i n c a l l s , b u t t h a t t h e c a l l s were " f o r t h e m o s t p a r t , b e i n g m e t w i t h a t r a n s f e r o f c a s h " and n o t s i g n i f i c a n t l y by l i q u i d a t i o n s . I t went on to s t a t e t h a t " t h e r e is no s i z a b l e customer account t h a t d o e s n ' t m a i n t a i n s u f f i c i e n t e q u i t y t o meet t h e i r [sic] c u r r e n t margin c a l l s . " A t t h e t i m e , Merrill Lynch had o u t s t a n d i n g m a r g i n c a l l s t o t h e I M I C a c c o u n t t o t a l i n g $158 m i l l i o n which had n o t b e e n m e t , a s i n t h e p a s t , w i t h c a s h w i t h i n 24 h o u r s , a n d I M I C had f a i l e d t o p a y f o r 6 5 0 , 0 0 0 ounces of b u l l i o n d e l i v e r e d i n its account with t h e firm. Merrill c o n s i d e r e d t h e o u t s t a n d i n g m a r g i n c a l l s t o be a d e q u a t e l y " c o l l a t e r a l i z e d " by b u l l i o n i n I M I C ' s a c c o u n t . Bache H a l s e y s i m i l a r l y r e p o r t e d t h a t t h e r e were no p r o b l e m s , a l t h o u g h i t h a d , by t h a t t i m e , l e a r n e d f r o m t h e H u n t s t h a t t h e y had no c a s h w i t h w h i c h t o meet c a l l s . The Commission s t a f f f o u n d n o e v i d e n c e t h a t t h e E x c h a n g e , i n conducting t h i s or p r e v i o u s s u r v e y s , o b t a i n e d any det a i l s a s to t h e i d e n t i t y of l a r g e accounts or t h e p o t e n t i a l c a p i t a l i m p a c t o n f i r m s i f t h e downward t r e n d o f s i l v e r p r i c e s continued. The c o o r d i n a t o r s d i d n o t r e q u e s t t h e Exchange e x a m i n e r s , s t i l l o n Bache H a l s e y ' s p r e m i s e s , t o v e r i f y t h e d a t a r e p o r t e d b y Bache. On March 1 9 , 1 9 8 0 , Bache N a l s e y i n f o r m e d t h e Exchange t h a t i t was g o i n g t o t a k e down $5 m i l l i o n o f s u b o r d i n a t e d s t a n d b y c a p i t a l so a s t o i n c r e a s e i t s n e t c a p i t a l p e r c e n t a g e t o 7 . 6 8 % . The n e x t d a y , t h e f i r m a d v i s e d t h e Exchange t h a t i t would t a k e down a n a d d i t i o n a l $5 m i l l i o n " t o p o s i t i v e l y avoid any problems," and t o i n c r e a s e its c a p i t a l p e r c e n t a g e t o 8 . 1 0 % . On March 2 5 , 1 9 8 0 , t h e Exchange a p p r o v e d t h e s e i n f u s i o n s e f f e c t i v e a s o f March 2 4 t h .

T h e E x c h a n g e c o n d u c t e d more s u r v e y s o n March 2 4 t h a n d March 2 5 t h . The f i r m s c o n t a c t e d c o n t i n u e d t o a d v i s e t h e E x c h a n g e t h a t w h i l e m a r g i n c a l l s were h i g h e r t h a n u s u a l , t h e s i t u a t i o n was u n d e r c o n t r o l , s i n c e " f o r t h e most p a r t " According to t h e c a l l s were b e i n g met o n a t i m e l y b a s i s . a n E x c h a n g e d o c u m e n t , t h e f i r m s were w e a t h e r i n g t h e s i t u a t i o n " w i t h o u t much d i f f i c u l t y . " I n c o n d u c t i n g t h e March 25th survey, t h e coordinator f o r aache Halsey d i d n o t s p e a k t o e i t h e r o f t h e i n d i v i d u a l s who were i n c h a r g e o f B a c h e ' s margin and commodities o p e r a t i o n s . Rather, he spoke to a f i r s t v i c e p r e s i d e n t i n charge of f i n a n c i a l r e p o r t i n g , who, a c c o r d i n g t o E x c h a n g e d o c u m e n t s , t o l d h i m 225/ t h a t t h e r e were n o p r o b l e m s . - E x c h a n g e d o c u m e n t s r e p o r t e d t h a t t h e c o o r d i n a t o r d i d n o t f e e l i t w a s n e c e s s a r y to contact t h e heads o f t h e margin and commodities departments, b e c a u s e t h e r e was n o i n d i c a t i o n o f a n y p r o b l e m s . The c o o r d i n a t o r d i d n o t c o n t a c t t h e Exchange commodities e x a m i n e r s who were s t i l l o n B a c h e H a l s e y ' s p r e m i s e s . The Commission s t a f f d i d n o t f i n d a n y Exchange d o c u m e n t s e v i d e n c i n g c o n t a c t s o n March 2 4 o r 2 5 w i t h Merrill L y n c h i n c o n n e c t i o n w i t h i t s p r e c i o u s metals s u r v e y s . On March 2 5 , 1 9 8 0 , h o w e v e r , Merrill Lynch f i l e d d o c u m e n t s w i t h t h e Exchange f o r a p p r o v a l o f a $200 m i l l i o n c a s h s u b o r d i n a t i o n f r o m i t s p a r e n t company. I n a memorandum t o t h e f i l e s , t h e s u p e r v i s i n g c o o r d i n a t o r f o r Merrill Lynch n o t e d t h a t a c c o r d i n g t o t h e c h i e f f i n a n c i a l o f f i c e r o f Merrill L y n c h , t h e s u b o r d i n a t e d n e t c a p i t a l was d e s i r e d t o s u p p o r t t h e f i r m ' s i n c r e a s i n g d e b i t s and to p r e p a r e f o r expqcted new g r o w t h . According to t h e c o o r d i n a t o r , h e v e r i f i e d t h a t t h e f i r m had no c u r r e n t c a p i t a l problems. The i n f u s i o n would i n c r e a s e t h e f i r m ' s c a p i t a l p e r c e n t a g e from

225/ - A t t h a t p o i n t , t h e r e were i n f a c t s e r i o u s p r o b l e m s w i t h t h e Hunt a c c o u n t s . On March 1 7 , a c c o r d i n g t o a n E x c h a n g e document, Bache H a l s e y i s s u e d t h e Hunts a $20 m i l l i o n m a r g i n c a l l , a n d o n t h e f o l l o w i n g d a y s i s s u e d more c a l l s . According to a n Exchange document, it was d u r i n g t h e week o f March 1 7 , t h a t t h e f i r m l e a r n e d t h a t t h e H u n t s were " c a s h p o o r " a n d w o u l d n o t meet t h e c a l l s . On F r i d a y o f t h a t w e e k , h o w e v e r , t h e H u n t s m e t t h e c a l l s by d e p o s i t i n g $100 m i l l i o n i n s i l v e r . T h i s was n o t a c c e p t a b l e t o B a c h e a n d o n Monday, March 2 4 , B a c h e H a l s e y t o l d t h e H u n t s to d e p o s i t c a s h or f a c e l i q u i d a tion. Bache H a l s e y d i d n o t c r e d i t t h e Hunt a c c o u n t s w i t h t h e $100 m i l l i o n s i l v e r and i n s t e a d t r e a t e d it a s a d d i t i o n a l c o l l a t e r a l . When t h e H u n t s f a i l e d t o m e e t i t s c a l l s w i t h c a s h o n March 2 4 , B a c h e b e g a n t o l i q u i d a t e t h e s i l v e r , c r e d i t i n g t h e sales p r o c e e d s to t h e Hunt a c c o u n t . C e r t a i n o f t h e i n f o r m a t i o n o b t a i n e d by t h e E x c h a n g e is i n c o n s i s t e n t w i t h i n f o r m a t i o n d e v e l o p e d i n the staff's investigation.

9 . 2 % t o 1 5 % . A c c o r d i n g t o Merrill Lynch, t h e s u b o r d i n a t i o n had b e e n p l a n n e d by t h e f i r m f o r some t i m e and was n o t i n a n t i c i p a t i o n o f any p o t e n t i a l n e t c a p i t a l problems. The Exchange a p p r o v e d a d r a f t o f t h e s u b o r d i n a t i o n a g r e e m e n t 226/ o n March 2 6 , 1 9 8 0 . - A s f a r a s t h e s t a f f c a n d e t e r m i n e , t h e a g r e e m e n t became e f f e c t i v e March 3 1 , 1980.
111. THE SILVER CRISIS MARCH 3 1 , 1 9 8 0

MARCH 26 THROUGH

On March 2 6 , 1 9 8 0 , t h e Exchange s u r v e i l l a n c e c o o r d i n a t o r s were w o r k i n g o n a m o n t h l y GNMA s u r v e y . The H u t t o n c o o r d i n a t o r c a l l e d h i s c o n t a c t a t t h e f i r m to r e q u e s t t h e GNMA d a t a . During t h e c o n v e r s a t i o n , t h e Hutton c o n t a c t m e n t i o n e d t h a t h e had had a phone c a l l from t h e Commission s t a f f , i n q u i r i n g a s t o w h a t H u t t o n ' s e x p o s u r e would b e i f s i l v e r d r o p p e d t o $15. - A f t e r t h e c o o r d i n a t o r t o l d h i s 227/ s u p e r v i s o r o f t h e c a l l , t h e s u p e r v i s o r asked t h e o t h e r supervisory c o o r d i n a t o r s to begin another survey o f t h e As commodities f i r m s , r e g a r d i n g t h e i r s i l v e r p o s i t i o n s . f a r a s t h e s t a f f c a n d e t e r m i n e , w h a t e v e r c a l l s were made on t h e s u p e r v i s o r y c o o r d i n a t o r ' s prompting y i e l d e d no information o f import. T h a t m o r n i n g , t h e s e n i o r v i c e p r e s i d e n t o f t h e Member Firm R e g u l a t i o n & S u r v e i l l a n c e D i v i s i o n was s c h e d u l e d t o meet w i t h t h e c h i e f o p e r a t i o n s o f f i c e r o f Bache H a l s e y o n a personal matter. The Bache i n d i v i d u a l c a l l e d t h e s e n i o r According t o v i c e p r e s i d e n t t o c a n c e l a t t h e l a s t minute. t h e NYSE o f f i c e r , t h e Bache r e p r e s e n t a t i v e a s k e d him c r y p t i c a l l y i f t h e g e n e r a l c o u n s e l o f Bache H a l s e y had s p o k e n t o him. H e had n o t , a n d t h e Bache r e p r e s e n t a t i v e o f f e r e d t h e NYSE o f f i c e r no d e t a i l s . Late i n the afternoon, t h e s e n i o r vice president r e c e i v e d a t e l e p h o n e c a l l from someone a t t h e CBT C l e a r i n g Corporation. The CBT C l e a r i n g C o r p o r a t i o n r e p r e s e n t a t i v e a s k e d him i f h e knew why Bache H a l s e y management was p a n i c k i n g a b o u t s i l v e r p r i c e s , s u g g e s t i n g t h a t Bache management had c a l l e d t h e CBT a n d a h i g h l e v e l g o v e r n m e n t 228/ o f f i c i a l - w i t h some o v e r l y p e s s i m i s t i c m a r g i n c o m p u t a t i o n s 226/ S e e , - - h o w e v e r , d i s c u s s i o n a t p. 2 3 2 , below.

227/ S i l v e r had c l o s e d t h e d a y b e f o r e a t $20.20. The H u t t o n - r e p r e s e n t a t i v e t o l d t h e c o o r d i n a t o r t h a t h e had t o l d t h e Commission s t a f f t h a t i f t h e p r i c e o f s i l v e r d r o p p e d t o $ 1 5 , H u t t o n ' s e x p o s u r e would b e $ 2 m i l l i o n , and i f t h e p r i c e o f s i l v e r d r o p p e d t o SO, H u t t o n ' s e x p o s u r e would b e $60 m i l l i o n ( $ 3 0 m i l l i o n a f t e r t a x e s ) . 228/ The o f f i c i a l was P a u l V o l c k e r , t h e Chairman o f t h e - F e d e r a l R e s e r v e Board.

- 230 -

a n d h a d r e q u e s t e d a c l o s i n g of t h e c o m m o d i t i e s m a r k e t s and/or a reduction o f margin requirements. The A u n t a c c o u n t s were mentioned s p e c i f i c a l l y . According t o him, i t was h i s i m p r e s s i o n t h a t t h e C l e a r i n g C o r p o r a t i o n t h o u g h t t h a t Bache was o v e r r e a c t i n g . The s e n i o r v i c e p r e s i d e n t t o l d t h e v i c e p r e s i d e n t o f t h e Member F i r m S u r v e i l l a n c e D e p a r t m e n t o f t h e p h o n e c a l l . The v i c e p r e s i d e n t c a l l e d B a c h e H a l s e y a n d o b t a i n e d some p r e l i m i n a r y n u m b e r s . A c c o r d i n g t o t h e NYSE v i c e p r e s i d e n t , B a c h e was p l a c a t o r y , and s a i d t h e r e w a s no problem. The f i g u r e s t h e y g a v e w e r e n o t a l a r m i n g . 229/ T h e v i c e p r e s i d e n t t h e n c a l l e d t h e s e n i o r v i c e p r e s i d e n t w i t h t h e f i g u r e s and agreed t h a t no f u r t h e r immediate a c t i o n was n e c e s s a r y . As f a r a s t h e s t a f f c o u l d d e t e r m i n e , moreover, t h e Exchange examiners o n Bache's p r e m i s e s were n o t n o t i f i e d o f t h e p o s s i b l e e x i s t e n c e o f a problem. During t h i s period, t h e v i c e p r e s i d e n t advised t h e Surveillance Coordination Section of the substance of the CBT C l e a r i n g C o r p o r a t i o n ' s p h o n e c a l l . Several surveillance coordinators contacted t h e i r firms late t h a t a f t e r noon and a s k e d s p e c i f i c a l l y w h e t h e r t h e f i r m s had Hunt a c c o u n t s and d e t a i l s a s to s u c h a c c o u n t s . The c o o r d i n a t o r f o r H u t t o n c a l l e d back h i s c o n t a c t , and w a s i n f o r m e d t h a t H u t t o n d i d h a v e f o u r Hunt a c c o u n t s , a n d t h a t t h e r e was a $10 m i l l i o n m a r g i n c a l l o u t s t a n d i n g f o r a Hunt a c c o u n t w h i c h H u t t o n e x p e c t e d would b e p a i d t h e next day. A coordinator also spoke with an individual a t E d w a r d s ' c o m m o d i t i e s d e p a r t m e n t , a n d was i n f o r m e d t h a t E d w a r d s h a d a H u n t a c c o u n t , b u t h a d n o p r o b l e m s w i t h comm o d i t i e s c u s t o m e r s g e n e r a l l y o r w i t h t h e Hunt a c c o u n t specifically.
- T h e c o o r d i n a t o r f o r M e r r i l l Lynch a l s o c a l l e d Merrill o n t h e a f t e r n o o n of M a r c h 2 6 , a n d s p o k e w i t h t h e m a n a g e r o f Merrill's commodity o p e r a t i o n s d e p a r t m e n t . Exchange r e c o r d s r e f l e c t t h a t it w a s i n t h i s conversation t h a t t h e coordinator l e a r n e d , f o r t h e f i r s t t i m e , t h a t Merrill Lynch h a d H u n t H i s memorandum a c c o u n t s and a b u l l i o n l o a n to t h e Hunts. o f t h e c a l l r e f l e c t s t h a t h e was t o l d t h a t t h e r e were n o o u t s t a n d i n g m a r g i n c a l l s f o r t h e Hunt a c c o u n t s , t h a t t h e H u n t a c c o u n t s h a d " t o n s o f c o l l a t e r a l ," t h a t m a r g i n c a l l s were b e i n g met m a i n l y t h r o u g h c a s h t r a n s f e r s a n d t h a t t h e

229/ A c c o r d i n g t o t h e V i c e P r e s i d e n t ' s n o t e s o f t h e t e l e p h o n e - c a l l , B a c h e r e p o r t e d t h a t i t h a d i s s u e d $35 m i l l i o n i n m a r g i n c a l l s a g a i n s t t h e Hunt a c c o u n t s and t h a t t h e a c c o u n t s had e q u i t y o f $150 m i l l i o n . According to o t h e r Exchange r e c o r d s , t h e n e x t morning, o u t s t a n d i n g Bache margin c a l l s i s s u e d a g a i n s t t h e Hunts t o t a l e d , i n f a c t , $146 m i l l i o n .

Hunt accounts had met their calls for the last several weeks. In connection with the staff's investigation, Merrill's commodity operations manager testified that although he could not recall the details of his conversation with the Exchange, he is certain that he would not have told the coordinator that the Hunts had been paying cash. In fact, as of the close of business on March 25, there were margin calls of approximately $100 million outstanding in the Hunt accounts, the Hunts had not met their margin calls of the previous weeks through cash 230/ transfers, - and according to the staff's investigation, Merrill Lynch was actively soliciting the Hunts to deposit more collateral with the firm. The next morning, March 27, the senior vice president, through the vice president, directed the Exchange examiners on Bache's premises to find out exactly what Bache's situation was. The supervisory coordinator for Bache joined the examiners in the firm's commodities department. By midmorning, he was able to report back to his supervisors at the Exchange that Bache's situation was deteriorating rapidly as the price of silver dropped during the day. Meanwhile, the surveillance coordinators had contacted all commodities firms and identified seven firms as having Hunt accounts. Also on the morning of March 27, the senior vice president spoke to the chairman of ML & Co. who informed him that the night before, the Hunts had advised the firm that they would not meet their margin calls. According to the senior vice president's recollection and notes of the call, the ML & Co. chairman informed him that there was no cause for worry despite the large Hunt silver positions, because the firm had, in anticipation of potential exposure, infused $200 million in subordinated funds. Other reasons had been given by Merrill Lynch for the loan several days earlier, and the ML & Co. chairman was the only person at the firm that the senior vice president was aware of who tied the subordination to the silver situation. -231/

230/ See - -- discussion at pp. 147 through 155, above. 231/ - The senior vice president later made inquiry of other Merrill Lynch officials who told him, as they had earlier told other NYSE personnel, that the subordination had been planned for some time for reasons independent of any anticipated problems in silver accounts. Information on this subject developed in the staff's investigation of ML & Co. is described at p. 162.

A f t e r t h i s r e p o r t , a d e c i s i o n was made t o s e n d e x a m i n e r s t o t h e f o u r f i r m s , i n a d d i t i o n t o B a c h e , l o c a t e d i n N e w York T h e s e f i r m s were C i t y and known t o h a v e Hunt a c c o u n t s . 232/ Merrill L y n c h , H u t t o n , Dean Witter, a n d a i n e t J e b b e r . The e x a m i n e r s r e v i e w e d Hunt p o s i t i o n s , t h e f i r m s ' n e t c a p i t a l s i t u a t i o n s , and m o n i t o r e d t h e f i r m s ' a c t i o n s i n r e s p o n s e t o t h e c r i s i s . The e x a m i n e r s r e p o r t e d t h e d a t a t o t h e Exchange a s i t became a v a i l a b l e . The Merrill Lynch coo r d i n a t o r j o i n e d t h e e x a m i n e r s o n Merrill's p r e m i s e s and l e a r n e d f o r t h e f i r s t t i m e o f t h e r e l a t i o n s h i p between t h e H u n t s and I M I C . During t h e day, t h e Hutton c o o r d i n a t o r c o n t a c t e d H u t t o n a n d was i n f o r m e d t h a t H u t t o n had l i q u i d a t e d 700 o f t h e Hunts' 1700 s i l v e r c o n t r a c t s a t e q u i t y w i t h no loss t o t h e firm. A s u r v e i l l a n c e c o o r d i n a t o r a l s o s p o k e t o Edwards, l o c a t e d i n S t . L o u i s , and was t o l d t h a t t h e Hunt a c c o u n t s had e q u i t y o f $1.4 m i l l i o n . The C o o r d i n a t i o n S e c t i o n a l s o c o n t a c t e d Howard, Weil, L a b o u i s s e , F r i e d r i c h s , I n c . Howard, Weil r e p o r t e d n o s i l v e r h o l d i n g s and s a t i s f a c t o r y e q u i t y i n i t s Hunt a c c o u n t s . 233/ T h r o u g h o u t t h e m o r n i n g , t h e Commission s t a f f d i s c u s s e d w i t h Exchange o f f i c i a l s t h e i n c r e a s i n g l y a c t i v e t r a d i n g i n Bache G r o u p , t h e NYSE l i s t e d p a r e n t company o f Bache. In the early afternoon, the director of the Commission's D i v i s i o n o f Market R e g u l a t i o n a d v i s e d t h e Exchange t h a t t h e Commission had o r d e r e d a 10-day t r a d i n g s u s p e n s i o n i n Bache Group e f f e c t i v e a t 2:15 p.m., t h e c l o s i n g t i m e o f s i l v e r f u t u r e s t r a d i n g on t h e commodity e x c h a n g e s . The Exchange h a l t e d t r a d i n g i n Bache Group a t 2:13 p.m. 234/
A t 5:00 p.m., t h e NYSE's S u r v e i l l a n c e C o m m i t t e e m e t to d i s c u s s t h e e v e n t s o f t h e d a y . The v i c e p r e s i d e n t a d v i s e d t h e g r o u p t h a t , a s o f t h a t m o r n i n g , Bache had m a r g i n c a l l s o u t s t a n d i n g f o r $146 m i l l i o n f o r v a r i o u s

- l o c a t e d i n S t . L o u i s , a n d Howard, Weil, L a b o u i s s e ,
F r i e d r i c h s , Inc. l o c a t e d i n New Orleans. W e i l had n o Hunt s i l v e r a c c o u n t s . Howard

232/ The o t h e r t w o f i r m s w i t h Hunt a c c o u n t s were Edwards,

- Howard,

233/ On A p r i l 7 , 1 9 8 0 , t h e Exchange s e n t a n e x a m i n e r t o Weil. H e v e r i f i e d t h a t t h e f i r m had p r o v i d e d c o r r e c t f i g u r e s to t h e E x c h a n g e .

234/ T h a t a f t e r n o o n , t h e Exchange a l s o h a l t e d t r a d i n g i n t h e - s t o c k o f Dean Witter a n d S h e a r s o n , d u e t o i m b a l a n c e s i n trading orders.

c r o s s - g u a r a n t e e d Hunt a c c o u n t s and had l i q u i d a t e d n i n e m i l l i o n o u n c e s o f s i l v e r d u r i n g t h e d a y and p r i o r n i g h t a t p r i c e s r a n g i n g from $12 t o $16 p e r ounce. Bache had Soon e x c e s s n e t c a p i t a l o f $17 m i l l i o n a t t h e 7% l e v e l . t h e r e a f t e r , t h e c h i e f e x e c u t i v e o f f i c e r s o f Bache, r e p r e s e n t a t i v e s o f t h e Commission's s t a f f and t h e s u p e r v i s o r y c o o r d i n a t o r f o r Bache and o n e o f t h e e x a m i n e r s a s s i g n e d t o t h e Bache e x a m i n a t i o n , j o i n e d t h e m e e t i n g . Those p r e s e n t were i n f o r m e d b y t h e B a c h e r e p r e s e n t a t i v e s t h a t t h e H u n t s h a d commenced m e e t i n g m a r g i n c a l l s w i t h s i l v e r w a r e h o u s e r e c e i p t s r a t h e r t h a n c a s h a s e a r l y a s March 1 8 , a n d o n March 2 5 t h e y h a d i n f o r m e d B a c h e t h a t t h e y d i d n o t i n t e n d t o h o n o r a d d i t i o n a l m a r g i n c a l l s . The B a c h e r e p r e s e n t a t i v e s s t a t e d t h a t 1 5 m i l l i o n ounces of s i l v e r , r a t h e r than t h e n i n e m i l l i o n o u n c e s r e p o r t e d by t h e v i c e p r e s i d e n t , h a d b e e n sold. They f u r t h e r r e p o r t e d t h a t a t t h a t p o i n t , Bache had a loss o f $4-5 m i l l i o n r e l a t i n g to t h e Hunt a c c o u n t s , t h a t t h e f i r m ' s n e t c a p i t a l could absorb an additional drop i n t h e p r i c e o f s i l v e r t o $8.00 p e r ounce b e f o r e b e i n g i n n e t c a p i t a l v i o l a t i o n , t h a t a number o f b a n k s were w i l l i n g t o l e n d s u b o r d i n a t e d c a p i t a l t o t h e f i r m , and t h a t Hunt a c c o u n t s s t i l l c a r r i e d 30 m i l l i o n ounces o f s i l v e r a f t e r liquidations. A f t e r t h e Bache and Commission r e p r e s e n t a t i v e s l e f t t h e m e e t i n g , t h e C o m m i t t e e c a l l e d a n o u t s i d e e x p e r t , who o p i n e d t h a t t h e s i l v e r m a r k e t would d e c l i n e s l i g h t l y F r i d a y a n d t h a t i t was u n l i k e l y t h a t l a r g e commercial b u y e r s would e n t e r t h e m a r k e t a t t h a t t i m e . Consequently, t h e C o m m i t t e e d e t e r m i n e d t h a t i t c o u l d n o t make a n y p o s i t i v e p u b l i c s t a t e m e n t r e g a r d i n g B a c h e o r recommend l i f t i n g o f t h e s u s p e n s i o n o f B a c h e s t o c k t r a d i n g , a s u r g e d by t h e Bache r e p r e s e n t a t i v e s . Furthermore, t h e C o m m i t t e e agreed t o r e q u e s t t h a t Bache p r e p a r e a c a p i t a l p o s i t i o n as o f t h e n e x t n i g h t f o r r e v i e w e a r l y t h e n e x t week. The C o m m i t t e e a n d t h e E x c h a n g e o f f i c i a l s were a l s o c o n c e r n e d a b o u t t h e f i n a n c i a l w e l l b e i n g a f Merrill Lynch b e c a u s e , t h r o u g h o u t t h e d a y , t h e Exch-ange h a d b e e n u n a b l e t o o b t a i n f i r m f i g u r e s f r o m Merrill Lynch a s t o i t s H u n t a c c o u n t s . Numerous NYSE p e r s o n n e l s t a t e d t h a t t h e y w o r k e d unu s u a l l y late t h a t Thursday n i g h t , a s s i m i l a t i n g information a s i t came i n f r o m t h e f i v e f i r m s v i s i t e d t h a t d a y , a n d evaluating the situation. However, E x c h a n g e o f f i c i a l s d i d not prepare a formal contingency plan i n t h e event of a s e v e r e d r o p i n t h e p r i c e o f s i l v e r t h e next day. The p r e d i c t i o n s o f a c o n t i n u i n g d e c l i n i n g s i l v e r market on Friday proved f a l s e . The s i l v e r m a r k e t s opened s l i g h t l y up, t h e r e b y a l l e v i a t i n g a n immediate crisis.

Exchange e x a m i n e r s s p e n t t h e d a y a t t h e f i r m s t h a t h e l d Hunt a c c o u n t s , m o n i t o r i n g t h e f i r m s ' l i q u i d a t i o n and c o v e r i n g o f Hunt a c c o u n t s , r e v i e w i n g margin c a l l s and The e x a m i n e r s p e r f o r m e d v e r i f y i n g n e t capital f i g u r e s . s p o t c h e c k s o f t h e f i g u r e s b e i n g s u p p l i e d t o t h e Exchange by t h e f i r m s . Sometime d u r i n g t h e d a y , t h e Exchange l e a r n e d v i a t h e Dow J o n e s tape t h a t E d w a r d s h a d s u f f e r e d a $ 3 . 7 5 m i l l i o n loss i n t h e l i q u i d a t i o n o f t h e Hunt a c c o u n t s . The d a y b e f o r e , E d w a r d s h a d t o l d t h e E x c h a n g e t h a t t h e r e was $ 1 . 4 m i l l i o n e q u i t y i n t h e Hunt a c c o u n t s . Edwards' t r e a s u r e r e x p l a i n e d t o t h e Exchange t h a t t h i s d i s c r e p a n c y was d u e t o t h e f a c t t h a t t h e e q u i t y r e p o r t e d t o t h e NYSE o n T h u r s d a y was b a s e d o n t h e s i l v e r f u t u r e s price o f $21.00 a n o u n c e , w h e r e a s t h e l i q u i d a t i o n s , commenced a f t e r t h e H u n t s ref u s e d t o meet a m a r g i n c a l l b a s e d u p o n t h e s p o t p r i c e , were a c c o m p l i s h e d a t a p p r o x i m a t e l y $ 1 1 per o u n c e . A s i m i l a r p r o b l e m o c c u r r e d w i t h P a i n e W e b b e r , w h i c h , accord i n g t o NYSE p e r s o n n e l , i n f o r m e d t h e E x c h a n g e o n M a r c h 2 7 t h a t i t would e x p e r i e n c e n o l o s s e s , o n l y t o report o n March 28 a l o s s o f $ 8 . 6 m i l l i o n l i q u i d a t i n g t h e H u n t a c c o u n t s . W h i l e P a i n e W e b b e r ' s m i s r e p r e s e n t a t i o n was a separate cause of a c t i o n i n a subsequent enforcement proceeding l a r g e l y r e l a t i n g t o o t h e r matters, n o a c t i o n was t a k e n r e g a r d i n g Edwards, o t h e r t h a n t o warn t h e f i r m o r a l l y to provide accurate information i n the future. The c o o r d i n a t o r f o r Hutton l e a r n e d on Friday, from a n o u t s i d e s o u r c e , t h a t H u t t o n h a d made a $ 1 0 0 m i l l i o n When h e a s k e d h i s l o a n to t h e Hunts backed by b u l l i o n . c o n t a c t a t H u t t o n why t h e NYSE h a d n o t b e e n i n f o r m e d o f t h e l o a n sooner, t h e c o n t a c t responded t h a t it " d i d n ' t matter" b e c a u s e t h e l o a n c o l l a t e r a l h a d b e e n l i q u i d a t e d . A c c o r d i n g t o t h e c o o r d i n a t o r , h e was s a t i s f i e d w i t h t h i s r e s p o n s e a t t h e t i m e b e c a u s e t h e r e was n o e x p o s u r e . The H u t t o n r e p r e . s e n t a t i v e t o l d him t h a t t h e f i r m s t i l l h e l d a $42.6 m i l l i o n T r e a s u r y b i l l p o s i t i o n i n t h e Hunt a c c o u n t s . The c o o r d i n a t o r v e r i f i e d w i t h H u t t o n t h a t n o losses h a d o c c u r r e d e i t h e r i n l i q u i d a t i o n o f l o a n collateral or t h e 235/ Hunts' f u t u r e s p o s i t i o n . 2 3 5 / On A p r i l 2 , 1 9 8 0 , H u t t o n r e p o r t e d t o t h e E x c h a n g e , i n

- " t h e i n t e r e s t o f f u l l d i s c l o s u r e , ' ' its loss o f $800,000

i n its l i q u i d a t i o n o f t h e Hunt p o s i t i o n s . A H u t t o n r e p r e s e n t a t i v e e x p l a i n e d t h a t t h i s was d u e to t h e f a c t t h a t t h e e a r l i e r r e p o r t e d $42.6 m i l l i o n T r e a s u r y b i l l holdings i n t h e Hunts' accounts were l i q u i d a t e d a t a loss. H e also d i s c l o s e d t o t h e c o o r d i n a t o r t h a t o n Wednesday, March 2 6 , t h e l o a n had r e q u i r e d a d d i t i o n a l c o l l a t e r a l d u e t o t h e collapse o f t h e s i l v e r p r i c e , a n d t h a t o n T h u r s d a y , M a r c h 2 7 , a d e c i s i o n w a s made t o l i q u i d a t e the loan.

Thursday afternoon and throughout Friday, the Commission staff had discussions with representatives of Bache and the NYSE concerning the lifting of the trading suspension in Bache Group stock. The Commission staff was not satisfied, however, that Bache Halsey's Friday press release provided fully accurate and complete information concerning Bache's financial condition. Late Friday afternoon, the Commission staff furnished Bache and its accountants with a schedule of questions for response over the weekend. Throughout Saturday and Sunday, the Commission staff maintained regular contact with Bache and other firms concerning their financial condition. On Sunday night, Bache delivered to the Commission staff a formal written response to Friday's schedule of questions. During the weekend, most of the officers of the Member Firm Regulation and Surveillance Division as well as the supervisory coordinators reported to the Exchange's offices and maintained contact with the firms involved as they worked to resolve the crisis. Among other things, they reviewed drafts of a response of Bache Halsey to the questions asked by the Commission. During the weekend, examiners remained only at Bache. They spent both days working with firm personnel reviewing daily receipts and the firm's capital position. Late Sunday afternoon, the Exchange learned, from the Commission staff, that Bache had discovered an additional Hunt account. By Monday, March 31, the immediate financial crisis appeared to have passed. Following publication of a more detailed press release by Bache Halsey, trading in Bache Group stock resumed. The Exchange continued to monitor the situation with frequent contacts to the firms. Bache Halsey was placed on the NYSE's internal alert list and required to report orally, and on a daily basis, all material events relating to its financial condition. This special surveillance continued until April 17, 1980. Almost immediately, the Exchange began to assess whether it should bring disciplinary actions against any of its members. A pending action against Paine Webber was amended to include a charge for failing to give the Exchange accurate information. A case was brought against Bache Halsey. Bache Halsey consented, without admitting or denying that it violated the Constitution or Rules of the Exchange, to findings of an Exchange Nearing Panel, that it had violated Exchange Rule 401 by failing to adhere to the principles of good business practice, engaged in acts detrimental to the Exchange, engaged in conduct inconsistent with just and equitable principles of trade and violated Exchange Rule 342 by failing to establish adequate procedures of supervision and control to provide for the

d e s s i m i n a t i o n o f a c c u r a t e and r e l i a b l e d a t a c o n c e r n i n g i t s financial condition. The f i r m a g r e e d t o be c e n s u r e d a n d No o t h e r a c t i o n s a r e contemplated. f i n e d $400,000. The E x c h a n g e a l s o b e g a n a n a s s e s s m e n t o f i t s p e r formance. From t h e s t a f f ' s r e v i e w , i t a p p e a r s t h a t t h e Whatever d o u b t s E x c h a n g e e x p e r i e n c e d some s e l f - d o u b t . e x i s t e d , however, a p p e a r to t h e s t a f f to have been v i t i a t e d by a p e r c e p t i o n t h a t whatever shortcomings t h e r e were i n t h e E x c h a n g e ' s p e r f o r m a n c e , were d u e t o f a c t o r s Exchange documents r e f l e c t , and beyond i t s c o n t r o l . Exchange o f f i c i a l s v o i c e , f r u s t r a t i o n o v e r t h e f a i l u r e o f Bache H a l s e y , M e r r i l l L y n c h , t h e Commission a n d t h e CFTC t o c o m m u n i c a t e w i t h t h e E x c h a n g e and f r u s t r a t i o n o v e r t h e f a i l u r e o f i t s members t o s u p p l y i t w i t h a c c u r a t e and timely financial data. I n t h e s t a f f ' s view, t h e Exchange's f a i l u r e t o i d e n t i f y a n impending crisis and its c o n s e q u e n t f a i l u r e to t a k e a p p r o p r i a t e p r o p h y l a c t i c a c t i o n , was d u e t o t h e f a c t t h a t t h e E x c h a n g e b a s e d i t s s u r v e i l l a n c e o f Exchange members d e a l i n g i n s i l v e r o n a b e l i e f t h a t t h e members w o u l d p r o v i d e c a n d i d , a c c u r a t e , and c o m p l e t e i n f o r m a t i o n to t h e Exchange s t a f f , p r o m p t l y and s p o n t a n e o u s l y . A s o u t l i n e d a b o v e , t h i s assumption proved f a l s e . Based upon t h e s t a f f ' s r e v i e w , t h e D i v i s i o n o f M a r k e t ~ e g u l a t i o nb e l i e v e s t h a t t h e E x c h a n g e s h o u l d implement b e t t e r c o n t r o l s f o r t h e conduct o f s u r v e y s t h a t , i n c a s e s o f s u b s t a n t i a l consequence such as encountered d u r i n g t h e s i l v e r c r i s i s , would i n c l u d e , a t a minimum, s u b m i s s i o n t o t h e Exchange o f h a r d c o p y d a t a , i n f i e l d v e r i f i c a t i o n o f s u c h d a t a , and a t t e s t a t i o n of t h e a c c u r a c y o f d a t a s u b m i t t e d t o t h e Exchange by a s e n i o r o f f i c e r o f a firm. A s d e t a i l e d i n t h i s r e p o r t , t h e Exchange's f a i l u r e s were d u e a l s o t o a s e r i o u s b r e a k d o w n i n t h e c o o r d i n a t i o n and exchange of i n f o r m a t i o n between t h e F i e l d Examination S e c t i o n a n d t h e S u r v e i l l a n c e C o o r d i n a t i o n S e c t i o n . The Exchange's o r g a n i z a t i o n a l b i f u r c a t i o n of s u r v e i l l a n c e r e s p o n s i b i l i t i e s between t h e s e s e c t i o n s c l e a r l y d i d n o t work. A l t h o u g h t h e E x c h a n g e h a s r e c e n t l y merged t h e s e s e c t i o n s , t h e Exchange s h o u l d a d o p t p r o c e d u r e s and s u p e r v i s o r y c o n t r o l s to a s s u r e t h e closest p o s s i b l e i n t e r r e l a t i o n s h i p between t h e i n d i v i d u a l s performing t h e s u r v e i l l a n c e and examining f u n c t i o n s .

PART NINE

LEGAL AND POLICY IMPLICATIONS OF THE SILVER CRISIS

I.

INTRODUCTION

The events surrounding the silver crisis raise a number of significant legal and policy issues. This part of the report identifies several areas in which the staff believes that Commission should consider proposing rules or recommending legislation designed to reduce the possibility that the financial instability occasioned by the crisis could recur. The staff believes certain of the issues raised warrant immediate consideration by the Commission; others may require more comprehensive consideration in order to determine an appropriate 236/ response. A. Excessive Exposure to particular Customers or Markets The silver crisis demonstrated that financial instability can occur at even a large broker-dealer 237/ when obligations associated with a customer position in a single commodity are substantial in relation to the firm's capital resources. If the financial stability of the broker-dealer community is to be assured, it is essential for the Commis238/ sion to limit a broker-dealer's exposure - to loss arising

236/ -

The observations herein may not apply to all brokeqdealers, or may do so to varying degrees. firms registered with the Commodity Futures Trading Commission ("CFTC") as futures commission merchants ("FCM"). Although these recommendations grew out of the staff's investigation of broker-dealers who were registered FCM's, the recommendations are intended to address analogous issues at non-FCM broker-dealers.

237/ - When used herein, the term "broker-dealer" includes

238/ - The term "exposuren as used in this part means the potential for loss associated with:

(1) The obligation to clearinghouses incurred by a broker-dealer as guarantor of its customers' obligations on commodity futures contracts, I P. Johnson, Commodities Regulation S2.43 at 279 (1982).
Footnote continued on next page.

from s u b s t a n t i a l i n v o l v e m e n t w i t h a s i n g l e c u s t o m e r - or 239/ c u s t o m e r g r o u p , o r t h e e s t a b l i s h m e n t o f p r o p r i e t a r y or customers' p o s i t i o n s t h a t are h i g h l y concentrated i n a p a r t i c u l a r commodity. A c c o r d i n g l y , t h e s t a f f recommends t h a t t h e Commission commence r u l e m a k i n g o r recommend l e g i s l a t i o n t o e s t a b l i s h a c e i l i n g on t h e d e g r e e o f e x p o s u r e t h a t a b r o k e r - d e a l e r o r , i n c e r t a i n s i t u a t i o n s , i t s p a r e n t , may i n c u r i n conn e c t i o n w i t h t h e t r a n s a c t i o n s or a c c o u n t s o f a p a r t i c u l a r c u s t o m e r or c u s t o m e r g r o u p . The s t a f f s u g g e s t s t h a t s u c h a l i m i t a t i o n c o u l d be b a s e d o n a f o r m u l a r e l a t i n g t o a f i r m ' s n e t c a p i t a l and e x c e s s n e t c a p i t a l . 240/ I n a d d i t i o n , t h e s t a f f recommends r e v i s i o n o f t h e Uniform N e t C a p i t a l R u l e ( a l s o r e f e r r e d t o a s t h e " n e t c a p i t a l r u l e " ) to restore or enhance d i s i n c e n t i v e s to e x c e s s i v e c o n c e n t r a t i o n i n p r o p r i e t a r y or c u s t o m e r commodity p o s i t i o n s .
B. Weaknesses i n t h e Commodity A s p e c t s o f t h e Uniform N e t C a p i t a l R u l e

The s i l v e r c r i s i s r e v e a l e d w e a k n e s s e s i n t h e U n i - ' form N e t C a p i t a l R u l e a s i t r e l a t e s t o c u s t o m e r commotlity a c c o u n t s . A s d e s c r i b e d e l s e w h e r e t h r o u g h o u t t h i s report', use of f u t u r e s p r i c e s i n v a l u i n g f u t u r e s p o s i t i o n s i n l i m i t - u p or limit-down m a r k e t s d i s t o r t s t h e t r u e v a l u e o f those positions. During t h e s i l v e r crisis, t h i s p r a c t i c e

F o o t n o t e c o n t i n u e d from p r e v i o u s p a g e .
( 2 ) Mqrgin e x t e n d e d t o c u s t o m e r s i n s e c u r i t i e s a c c o u n t s ;

( 3 ) Loans t o c u s t o m e r s a g a i n s t c a s h c o m m o d i t i e s ; a n d

( 4 ) A l l b t h e r e x t e n s i o n s o f c r e d i t , advances, receiva b l e s from t h e c u s t o m e r , d e b i t / d e f i c i t b a l a n c e s , g u a r a n t e e s o f c u s t o m e r a c c o u n t s by f i r m s , o r negat i v e a m o u n t s . i n a c c o u n t s , o f w h a t e v e r form.

239/ A s u s e d i n t h i s r e p o r t , t h e meaning o f " c u s t o m e r n o f - a b r o k e r - d e a l e r i n c l u d e s a l l p e r s o n s or e n t i t i e s , i n cluding o t h e r broker-dealers. T h i s i s intended to be b r o a d e r t h a n t h e d e f i n i t i o n o f " c u s t o m e r " u n d e r cert a i n s e c t i o n s o f t h e S e c u r i t i e s Exchange A c t o f 1 9 3 4 , et se ( 1 9 7 6 & Supp. I V 1 9 8 0 ) 1 5 U.S.C. S78a - -q . ( "Exchange A c t " )

240/ A s u s e d h e r e i n , " e x c e s s n e t c a p i t a l " r e f e r s t o a n amount - o f n e t c a p i t a l c a l c u l a t e d by t a k i n g t o t a l r e g u l a t o r y n e t c a p i t a l and s u b t r a c t i n g r e g u l a t o r y minimums.

had the effect of delaying recognition of the actual rate at which the value of Hunt silver accounts was declining and masking the extent of customerst, and thus brokerdealerst, exposure to loss. The staff recommends that the Commission, in coordination with CFTC, commence rulemaking to require valuation of back month commodity futures positions at spot month or cash commodity prices in adverse limit-move market conditions. The silver crisis also illustrated the extent to which the protections of the net capital rule may be impaired by the unilateral action of commodity exchanges in altering margin requirements on customer positions. The net capital rule incorporates by reference certain rules of commodity exchanges, including those setting margin requirements. Actions by commodity exchanges thus can determine, among other things, the timing and amount of charges to capital. There is the possibility, as happened in silver on March 26, 1980r that a change in margin requirements by a commodities exchange will enable a firm to postpone charging unmet margin calls to capital without receiving any cash from its customer, without favorable market movement and without the liquidating value of the account having been increased. The staff recommends that an alternative to the current scheme of regulation be developed that will assure that the levels of financial protection afforded by the net capital rule are not subject to reduction by the action of commodities exchanges, C. Adequacy of Financial Information Another troublesome feature of the silver crisis was the extent to which broker-dealers extended substantial credit to the Hunts without information concerning the amounts and maturities of the Huntst liabilities, the extent and availability of their assets or the magnitude of their overall silver positions. Present "know your customer" rulesr whether in their design or because of the discretionary nature of their provisions, cannot assure that credit decisionmakers will have all financial information necessary to an informed judgment, While it may be possible and beneficial for the Commission to promulgate regulations that would require firms to obtain current and complete financial information from customers, there are several drawbacks to this approach, Moreover, the staff believes the need for such regulation will be substantially reduced or eliminated if the Commission adopts an effective limitation on a broker-dealer's exposure to loss, The staff, accordingly, recommends that the Commission develop limitations on exposure to l ~ s s rather than additional regulations to insure adequacy of financial information.

D. Public Disclosure Each of the securities firms carrying Hunt accounts was either itself a publicly-held corporation or the principal subsidiary of a publicly-held holding company. As such, these firms were required to comply with the registration and periodic reporting requirements of the federal securities laws. These disclosure requirements to be effective must inform investors and regulators of the existence of business conditions within public corporations that may cause material losses to an issuer upon an event of default by a single customer or customer group. The suddenness with which the silver crisis came to public attention and the' length of time during which significant exposure to the Hunts existed without disclosure in certain firms prior to the crisis,'suggests that issuers need to be reminded of their obligations to timely disclose this type of material information. E. Self-Regulatory Organization Oversight This report described the failure of the New York Stock Exchange to identify in advance the circumstances at member firms that contributed to the silver crisis. Accordingly, the staff suggests that the Commission offer recommendations to the Exchange on gathering and identifying information and on operating its surveillance and examining functions. F. Segregation of Commodity and Securities Activities Most broker-dealers conduct commodities and securities business in the same entity. The Commission could require broker-dealers to segregate their commodities activities into a separate subsidiary to achieve industry stability and the Commission may wish to consider this approach. An exhaustive analysis of the issues implicit in corporate structure alternatives for broker-dealers is beyond the scope of this report and the staff makes no recommendation on the subject. The remainder of this part will discuss in more detail each of the foregoing matters.

11.

EXPOSURE TO LOSS
A.

Introduction

The s i l v e r c r i s i s j e o p a r d i z e d a t l e a s t o n e m a j o r b r o k e r d e a l e r because t h a t f i r m permitted a s i n g l e group of r e l a t e d c u s t o m e r s t o e s t a b l i s h a n unhedged l o n g p o s i t i o n i n s i l v e r f u t u r e s and t o borrow a g a i n s t s i l v e r c o l l a t e r a l i n d i s p r o p o r t i o n a t e l y l a r g e amounts r e l a t i v e t o t h e r e s o u r c e s of t h e f i r m and t h e c a p a c i t y o f t h e market to r e a d i l y a b s o r b 241/ t h e p o s i t i o n i n t h e event of l i q u i d a t i o n . I n s t a b i l i t y i d e n t i f i e d w i t h c o n c e n t r a t e d commodities p o s i t i o n s i s n e i t h e r a n o v e l o c c u r r e n c e n o r unknown t o t h e Commission. S i m i l a r c i r c u m s t a n c e s h a v e b r o u g h t a b o u t t h e b a n k r u p t c y o f o t h e r b r o k e r - d e a l e r s , most n o t a b l y N e w York

241/ - The p o t e n t i a l l y f a r - r e a c h i n g i m p a c t upon t h e i n t e -

g r i t y o f t h e U.S. f i n a n c i a l s y s t e m i n t h e e v e n t o f t h e f a i l u r e of a m a j o r f i r m h a s been r e c o g n i z e d by v i r t u a l l y > I 1 a u t h o r i t a t i v e observers. Apart f r o m such i n t a n g i b l e s a s loss o f i n v e s t o r c o n f i d e n c e , p o s s i b l e c o l l a t e r a l e f f e c t s o f t h e c o l l a p s e of o n e o r more l a r g e b r o k e r - d e a l e r s i n c l u d e (1) c o l l a p s e o f commodity c l e a r i n g a s s o c i a t i o n s , ( 2 ) e x h a u s t i o n o f t h e SIPC f u n d , and ( 3 ) m a t e r i a l losses t o b a n k s .

* * * f i n a n c i a l m a r k e t s i n t h e United S t a t e s and a r o u n d t h e w o r l d h a v e become i n t e g r a t e d t o t h e p o i n t where i t i s v e r y d i f f i c u l t , a s a p r a c t i c a l m a t t e r , to s e g r e g a t e one market or one i n s t i t u t i o n from o t h e r s . For e x a m p l e , some of t h e i n s t i t u t i o n s with t h e g r e a t e s t exposure i n t h e s i l v e r s i t u a t i o n had f a r f l u n g a c t i v i t i e s i n many o t h e r m a r k e t s . Had o n e o f t h o s e i n s t i t u t i o n s become i n s o l v e n t , t h e p r o b l e m would h a v e q u i c k l y s p r e a d t o o t h e r m a r k e t s , many o f which a r e f a r removed from s i l v e r * * *
Margin R e q u i r e m e n t s f o r T r a n s a c t i o n s i n F i n a n c i a l Instruments: Hearings on S.2704 Before t h e Senate Comrn. o n B a n k i n g , H o u s i n g , and Urban A f f a i r s , 9 6 t h Cong., 2d S e s s . 5 ( 1 9 8 0 ) ( s t a t e m e n t o f P a u l v o l c k e r , Chairman, F e d e r a l R e s e r v e B o a r d ) . S e e a l s o o t h e r statements therein.

S t o c k Exchange ("NYSE") member I r a H a u p t & C o . ( " H a u p t " ) 242/ a n d J.R. W i l l i s t o n & B e a n e I n c . ( " B e a n e " ) i n t h e w e l l - k n o w n 243/ " s a l a d o i l s w i n d l e " o f 1963. - With t h e r e c u r r e n c e i n t h e s i l v e r c r i s i s o f many o f t h e same c o n d i t i o n s t h a t u n d e r l a y t h e H a u p t a n d Beane b a n k r u p t c i e s , i t is e s s e n t i a l t h a t t h e Commission a c t t o p r e v e n t f u t u r e i n s t a b i l i t y c a u s e d by c o n c e n t r a t e d c o m m o d i t i e s p o s i t i o n s and o t h e r f o r m s o f o v e r e x p o s u r e to loss. The s t a f f p r o p o s e s t w o r e m e d i a l m e a s u r e s . 244/ First, t h e Commission s h o u l d r e s t o r e t o t h e n e t c a p i t a n u l e , a n d p o s s i b l y enhance, d i s i n c e n t i v e s to e x c e s s i v e c o n c e n t r a t i o n i n a b r o k e r - d e a l e r ' s customer commodities accounts. Second, a l i m i t a t i o n s h o u l d be p l a c e d o n t h e t o t a l exposure t h a t a b r o k e r - d e a l e r s may i n c u r f r o m t h e a c c o u n t s o f , or t r a n s 245/ a c t i o n s w i t h , a s i n g l e customer or customer group. -

242/ S e e e . g . - --, S e c u r i t i e s Exchange A c t R e l e a s e N o . 7 6 1 1 ( J u n e 2 , 1 9 6 5 ) , 9 8 9 1 ( D e c . 5 , 1 9 7 2 ) ; N. Miller, The Great S a l a d O i l S w i n d l e , 1 9 6 5 , c i t e d i n ~ e l i g s o n v . N e w York P r o d u c e E x c h a n g e , 378 F.Supp. 1 0 7 6 (S.D.N.Y. 1 9 7 4 ) . "A c o n c e n t r a t i o n i n t h e l o n g i n t e r e s t * * * is f r a u g h t w i t h p o t e n t i a l d a n g e r t o t h e m a r k e t , i n a s much a s i t r e d u c e s l i q u i d i t y , l e s s e n s p r i c e s t a b i l i t y , heightens t h e r i s k of a disorderly liquidation of c o n t r a c t s * * * a n d i n g e n e r a l t h r e a t e n s t h e mainA t t h e same t i m e , a tenance of a n o r d e r l y market. c o n c e n t r a t e d l o n g p o s i t i o n l e a v e s t h e p e r s o n who a c c u m u l a t e s i t e x c e e d i n g l y v u l n e r a b l e to d e c l i n e s i n t h e market". S e l i g s o n , 3 7 8 F.Supp. a t 1081-82. See t t n , - e . g . , M i8t 2e n d o r f v . J . R1.9 7W )i .l l i s no M i&t t Bean rIfn c t. h e 372 F.Supp. 1 (S.D.N.Y. 4 I endo , C o u r t ( q u o t i n g t h e Wall S t r e e t J o u r n a l ) n o t e d t h a t "losses [from t h e c o m m o d i t i e s d e b a c l e ] r e v e r b e r a t e d t h r o u g h o u t t h e f i n a n c i a l world." I d . a t 824, n.2. 244/ A t h i r d m e a s u r e , d i s c u s s e d b e l o w a t 266-272, would b e - to r e q u i r e t h a t customers provide firms with complete information on t h e i r f i n a n c i a l c o n d i t i o n , including s e c u r i t i e s and commodities p o s i t i o n s . The s t a f f d o e s not believe t h a t t h i s a l t e r n a t i v e o f f e r s assurance of f i n a n c i a l s t a b i l i t y f o r broker-dealers. 245/ To b e e f f e c t i v e , a n y s u c h l i m i t a t i o n m u s t i n c l u d e a l l - f o r m s o f a b r o k e r - d e a l e r ' s e x p o s u r e t o l o s s . See, n . 238 a t 241, s u p r a .

B.

Regulatory Disincentives to Excessive Commodity C o n c e n t r a t i o n

1. B a c k g r o u n d : ~ e g u l a t i o nP r i o r t o J u l y 1 9 7 9

A f t e r t h e c o l l a p s e o f H a u p t a n d B e a n e , 246/ t h e NYSE i n 1 9 6 4 amended i t s c a p i t a l r e q u i r e m e n t s i n NYSE R u l e 3 2 5 t o i n c r e a s e t h e miniinum c a p i t a l f o r member f i r m s c a r r y i n g commodities p o s i t i o n s . The amendments r e q u i r e d t h e f i r m s t o t a k e d e d u c t i o n s from n e t w o r t h d e p e n d i n g o n commoditi.es p o s i t i o n s i n p r o p r i e t a r y and c u s t o m e r a c c o u n t s and o n t h e f i n a n c i a l c o n d i t i o n o f t h e a c c o u n t . 247/ T h e s e c h a r g e s to c a p i t a l provided s i g n i f i c a n t d i s i n c e n t i v e s to overexposure to loss from t r a d i n g and h o l d i n g c a s h commodities

246/ A l t h o u g h t h e r e were d i f f e r e n c e s , B a c h e ' s p o s t u r e i n t h e

- s i l v e r s i t u a t i o d was s o m e w h a t a n a l o g o u s t o t h e p o s t u r e

o f Haupt i n t h e s a l a d o i l crisis o f 1963. Both c a r r i e d v e r y l a r g e unhedged l o n g f u t u r e s p o s i t i o n s . Both l e n t a g a i n s t w h a t a p p e a r e d t o be v a l i d w a r e h o u s e r e c e i p t s and accepted warehouse r e c e i p t s i n l i e u o f c a s h margin as t h e m a r k e t c o l l a p s e d . Both f i r m s ' c u s t o m e r s had m e t s u b s t a n t i a l e a r l i e r m a r g i n c a l l s and had r e p u t a t i o n s Bache u l t i m a t e l y f o r extensive financial resources. r e c e i v e d payment f o r t h e H u n t s ' o b l i g a t i o n s and t h e w a r e h o u s e r e c e i p t s i t h e l d a s c o l l a t e r a l were v a l i d ; H a u p t h e l d f i c t i t i o u s c o l l a t e r a l , a n d , u n l i k e ache, H a u p t ' s c u s t o m e r w a s n o t a b l e t o meet i t s o b l i g a t i o n s and Haupt d i d n o t r e c e i v e payment, which l e d to its bankruptcy. 247/ T h e s e a m e n d m e n t s , w h i c h were e f f e c t i v e o n May 1, 1 9 6 4 , - a r e o u t l i n e d i n N e w Y o r k S t o c k E x c h a n g e , M.F. Educat i o n a l C i r c u l a r No. 1 8 8 (March 20, 1 9 6 4 ) . P r i o r t o 1975, t h e Commission's n e t c a p i t a l r u l e exempted from i t s r e q u i r e m e n t s b r o k e r - d e a l e r s who were members o f a n a t i o n a l s e c u r i t i e s exchange and thus s u b j e c t to a n exchange c a p i t a l r u l e . S e e Report of t h e Subcomm. o n S e c u r i t i e s o f t h e S e n a t e Committee on Banking, Housing a n d U r b a n A f f a i r s , 9 3 r d C o n s . , 1st S e s s . , S e c u r i t i e s I n d u s t r y S t u d y 1 6 5 ( 1 9 7 3 ) . - ~ f e c t i v e~ e p t e m b e r1, 1 9 7 5 , t h e C o m m i s s i s n ' s U n i f o r m N e t C a p i t a l R u l e became a p p l i c a b l e to a l l b r o k e r - d e a l e r s and s u p p l a n t e d t h e see S e c u r i t i e s E x c h a n g e A c t exchange c a p i t a l r u l e s . R e l e a s e No. 11497 ( J u n e 2 6 , 1 9 7 5 ) .
7

a n d f u t u r e s c o n t r a c t s a n d t o o v e r c o n c e n t r a t i o n i n commodities. 248/ The Commission also e s t a b l i s h e d n e t c a p i t a l d i s i n c e n t i v e s to e x c e s s i v e e x p o s u r e i n c o n c e n t r a t e d commodities p o s i t i o n s a f t e r t h e f a i l u r e o f Haupt and Beane. I t s i g n i f i c a n t l y e n h a n c e d t h e s e d i s i n c e n t i v e s when i t p r o m u l g a t e d t h e Uniform N e t C a p i t a l Rule to d i s p l a c e exchange n e t c a p i t a l r e g u l a t i o n . 249/ A c c o r d i n g l y , p r i o r t o J u n e 1 9 7 9 , t h e Uniform N e t c a p i t a l Rule c o n t a i n e d t h e following d i s incentives:

1. A c h a r g e t o c a p i t a l o f 3 0 % o f t h e m a r k e t v a l u e o f spot c o m m o d i t i e s l o n g o r s h o r t i n c u s t o m e r ' s a n d non-customer's a c c o u n t s l i q u i d a t i n g to a d e f i c i t ;

2. A c h a r g e f o r t h e a m o u n t b y w h i c h t h e d a i l y l i m i t f l u c t u a t i o n s o f a l l f u t u r e commodity c o n t r a c t s c a r r i e d f o r a customer's and non-customer's a c c o u n t or a c c o u n t s would e x c e e d 1 5 % o f t h e f i r m ' s debt-equity total; 3. A c h a r g e f o r t h e amount b y w h i c h e q u i t y i n a Cash a c c o u n t is less t h a n 20% o f t h e m a r k e t v a l u e o f the position; 4. A c h a r g e f o r t h e e n t i r e amount o f l o a n s a g a i n s t u n h e d g e d c o l l a t e r a l w h e r e - c o l l a t e r a l is o t h e r t h a n l i c e n s e d receipts o b t a i n e d w i t h i n t h e p r e v i o u s 90 days i n a d e l i v e r y on f u t u r e s c o n t r a c t s ; and

- r e q u i r e d t o d e d u c t , w i t h some a d j u s t m e n t s , (1) 3 0 % o f
t h e m a r k e t v a l u e o f unhedged p r o p r i e t a r y and customer spot c o m m o d i t i e s p o s i t i o n s ; ( 2 ) 1 . 5 % o f t h e m a r k e t v a l u e s of t h e g r e a t e r o f e i t h e r o f total long or total s h o r t f u t u r e c o n t r a c t s i n e a c h commodity. c a r r i e d f o r a l l c u s t o m e r s ; and ( 3 ) total o f t h e amount by which t h e d a i l y l i m i t f l u c t u a t i o n o f a l l f u t u r e commodity c o n t r a c t s carried f o r a c u s t o m e r ' s a c c o u n t or a c c o u n t s c o n t r o l l e d by a c u s t o m e r e x c e e d s 1 0 % o f t h e n e t w o r t h o f t h e member o r g a n i z a t i o n . 249/ S e e S e c u r i t i e s E x c h a n g e A c t Release N o s . 7 6 1 1 ( J u n e 2 , 1 9 6 5 ) , 9 8 9 1 (Dec. 5 , 1 9 7 2 ) a n d 1 1 4 9 7 ( J u n e 2 6 , 1975).

248/ F o r e x a m p l e , u n d e r t h e NYSE c a p i t a l r u l e , f i r m s were

5. A c h a r g e f o r .5% o f o n e p e r c e n t o f t h e market 250/ v a l u e o f n e t l o n g or s h o r t c u s t o m e r p o s i t i o n s . Had t h e y c o n t i n u e d i n e f f e c t , t h e s e p r o v i s i o n s may h a v e had a r e s t r a i n i n g e f f e c t on t h e w i l l i n g n e s s o f t h e brokerd e a l e r s t o permit t h e H u n t s t o m a i n t a i n e x t r e m e l y l a r g e f u t u r e s p o s i t i o n s or t o f i n a n c e d e l i v e r i e s o f s i l v e r f o r t h e Hunts. 251/ 250/ S e e e . g . - -, -, Rule 1 5 c 3 - l b as it e x i s t e d i n 1977; 1 7 C.F.R. S 2 4 0 . 1 5 ~ 3 - l b ( 1 9 7 6 ) . S e e also i n s t r u c t i o n s t o FOCUS R e p o r t - P a r t 11, F e d x e c . L. Rep. (CCH) 1 33,928 a t 22,813-17 2 2 , 8 1 3 - 1 8 ( a l t h o u g h t h e comm o d i t y c o n c e n t r a t i o n " h a i r c u t s " h a v e b e e n removed from t h e r u l e , t h e i n s t r u c t i o n s r e m a i n ) . R e c e n t l y t h e C o m m i s s i o n r e i n s t i t u t e d h a i r c u t s when p h y s i c a l c o m m o d i t i e s a r e u s e d t o m a r g i n , g u a r a n t e e or s e c u r e a commodities f u t u r e account. See S e c u r i t i e s Exchange A c t R e l e a s e N o s . 17564 ( F e b r u a r y 20, 1 9 8 1 ) , 17927 ( J u l y 9 , 1 9 8 1 ) d i s c u s s e d f u r t h e r below.

- o r i n v e s t m e n t e l s e w h e r e i n o r d e r to e n s u r e t h e a v a i l By e f f e c t i v e l y a b i l i t y o f l i q u i d assets f o r c u s t o m e r s . freezing portions of c a p i t a l , the charges provide a n o b v i o u s d i s i n c e n t i v e to unsecured l e n d i n g or m a s s i v e l o n g p o s i t i o n s . Despite t h e e x a m p l e b e l o w , i t i s , o f course, impossible to s a y whether t h e p a s t disincent i v e s c o u l d h a v e p r e v e n t e d t h e crisis. The s t a f f b e l i e v e s , however, t h a t had t h e c a p i t a l c h a r g e s cont i n u e d i n e x i s t e n c e t h e y would have d i s c o u r a g e d b r o k e r - d e a l e r s from p e r m i t t i n g t h e b u i l d u p o f Hunt s i l v e r p o s i t i o n s t h u s reducing t h e impact of t h e Hunts' d e f a u l t i n t h e d e c l i n i n g s i l v e r market.
A t Bache H a l s e y , a s s u m i n g a g g r e g a t i o n o f Hunt a c c o u n t s ,

251/ S t a t e d s i m p l y , c a p i t a l c h a r g e s r e m o v e c a s h f r o m u s e

t h e p r o v i s i o n s d e s c r i b e d i n t h e t e x t w o u l d h a v e occas i o n e d s u b s t a n t i a l c h a r g e s to c a p i t a l i n Hunt f u t u r e s A t December 3 1 , 1 9 7 9 , f o r e x a m p l e , Hunt accounts. a c c o u n t s h e l d a n a g g r e g a t e of 7 3 0 4 d o m e s t i c f u t u r e s contracts. L i m i t m o v e s i n s i l v e r o n Comex w e r e $ 1 . 0 0 p e r o u n c e ( $ 1 . 2 0 o n t h e CBT) f o r a maximum d a i l y f l u c t u a t i o n o f a p p r o x i m a t e l y $36.5 m i l l i o n on t h e Hunt position. T h i s e x c e e d e d by a p r o x i m a t e l y $12.9 m i l l i o n 1 5 % o f B a c h e ' s d e b t - e q u i t y total as r e p o r t e d a t O c t o b e r 31. Bache would h a v e b e e n r e q u i r e d to t a k e a c a p i t a l c h a r g e o f a p p r o x i m a t e l y t h a t amount o n December 3 1 , 1979 had t h e p r o v i s i o n s d e s c r i b e d above been i n e f f e c t .

The CFTC, in promulgating minimum financial requirements for futures commission merchants, the CFTC's counterpart to the SEC's Uniform Net Capital Rule, determined for various reasons to eliminate these "haircutsgg open on futures contracts held by the customers. 252/ In June 1979 the Commission amended Appendix B of the Uniform Net Capital Rule to conform the Commission's rules to those of the CFTC. 253/ This amendment had the effect of essentially e l i m i n a m g the disincentives for customer positions at broker-dealers. 2. Remedial Measures Since the Crisis Following the silver crisis both the Commission and the CFTC have restored, in part, haircuts to spot commodity positions and accelerated the timing of capital charges in accounts with aged margin calls or unsecured debit balances. - Specifically, these provisions: 254/ (1) reduce the time margin calls on customer commodity futures accounts may be outstanding before they must be deducted from net worth from four business days to three business days;
-

(2) accelerate the time period in which brokerdealers must collect the deficit or debit'balance from the close of the second business day following the adverse market movement giving rise to the deficit to the close of the next business day on which the market movement caused the debit/def icit account; and

252/ - Commodity Futures Trading Commission, "Final Rules:

Minimum Financial Requirements," 43 Fed. Reg. 39956 (Sept. 8, 1978). Overall, the rules significantly See also improved the financial regulation of FCMs. -Commodity-Futures Trading Commission, "Proposed Rulemaking : Minimum Financial Requirements ,' 42 Fed. I Reg. 27166 (May 26, 1977). 1979 1.

253/ - Securities Exchange Act Rel. No. 15898, (June 15, 254/ In addition, the CFTC has discussed its concern
- that "large concentrations of positions in customer

* * * accounts held in a particular commodity * * * can greatly increase an FCM's financial exposure in the event of large price movements." Commodity Futures Trading Commission, "Proposed Rules: Minimum Financial and Related Reporting Requirements," 45 Fed. Reg. 79498, 79498-79499 (Dec. 1, 1980). -See also Commodity Futures Trading Commission, 'Final Rules: Minimum Financial and Related Reporting Requirements ," 45 Fed. Reg. 79416 (Dec. 1 , 1980).

( 3 ) r e q u i r e t h a t any non-cash c o l l a t e r a l s e c u r i n g a commodities r e l a t e d r e c e i v a b l e b e s u b j e c t t o a " h a i r c u t " as i f t h e b r o k e r - d e a l e r owned t h e c o l l a t e r a l , f o r p u r p o s e s o f d e t e r m i n i n g t h e e x t e n t t o w h i c h t h e r e c e i v a b l e is s e c u r e d f o r purposes of the n e t c a p i t a l r u l e , I n a d d i t i o n , i f t h e proceeds of a loan to a customer a r e u t i l i z e d t o g u a r a n t e e , s e c u r e o r m a r g i n a commodity f u t u r e s a c c o u n t , t h e non-cash c o l l a t e r a l f o r t h e l o a n must be v a l u e d a t t h e lesser o f t h e v a l u e allowed t h e asset by t h e m a r g i n r u l e s o f t h e a p p l i c a b l e commodity e x c h a n g e o r t h e v a l u e of t h e asset a f t e r b e i n g reduced by any r e l e v a n t haircut. W h i l e t h e s e r e c e n t amendments b y t h e Commission a n d t h e CFTC a r e s i g n i f i c a n t r e g u l a t o r y i m p r o v e m e n t s , t h e y d o n o t restore t o t h e n e t c a p i t a l r u l e h a i r c u t s f o r e x c e s s i v e commodity f u t u r e s p o s i t i o n s i n i n d i v i d u a l c u s t o m e r a c c o u n t s and f o r t h e f i r m ' s a g g r e g a t e c u s t o m e r l o n g o r s h o r t p o s i tions. 3. R e i n t r o d u c t i o n o f Commodity F u t u r e s Concentration Haircuts Based o n e x p e r i e n c e i n t h e s i l v e r c r i s i s , 255/ t h e s t a f f b e l i e v e s t h a t t h e pre-1979 n e t c a p i t a l d i s i n c e n t i v e s s e r v e d a u s e f u l p u r p o s e i n d i s c o u r a g i n g e x c e s s i v e commodity c o n c e n t r a t i o n a n d s h o u l d b e r e s t o r e d . 256/ C o n s i d e r a t i o n should be given, of course, to modifications to r e f l e c t conditions i n the securities industry that increase the 255/ The s t a f f b e l i e v e s t h a t e x c e s s i v e commodities c o n c e n given s u f f i c i e n t l y l a r g e adverse market conditions leading t o customer d e f a u l t , could bankrupt a brokerd e a l e r . The b a n k r u p t c y o f a major b r o k e r - d e a l e r f i r m , i n view o f its p o t e n t i a l to b a n k r u p t o t h e r f i r m s from c o l l a t e r a l e f f e c t s , m i g h t e x h a u s t t h e SIPC f u n d . One p u r p o s e o f t h e U n i f o r m N e t C a p i t a l R u l e is t o p r o t e c t t h e SIPC f u n d .
I t is * * * t h e o b j e c t i v e o f t h e u n i f o r m n e t c a p i t a l r u l e n o t o n l y to enhance t h e p r o t e c t i o n o f customer f u n d s and s e c u r i t i e s h e l d by b r o k e r - d e a l e r s b u t t o p r o t e c t t h e SIPC f u n d b y r e q u i r i n g a l l b r o k e r - d e a l e r s to o p e r a t e under a sound c a p i t a l base. Securities Exchange A c t R e l e a s e N o . 9 8 9 1 (Dec. 5 , 1 9 7 2 ) .

- t r a t i o n s a t b r o k e r - d e a l e r s is a c o n d i t i o n which,

- these "haircuts."

256/ The s t a f f d o e s n o t o f f e r a s p e c i f i c f o r m u l a t i o n f o r Consideration should be given to t h e pre-1979 approach, a s w e l l as t h e r e l a t i v e v o l a t i l i t y a p p r o a c h a r t i c u l a t e d by t h e CFTC i n a 1 9 7 7 release. S e e Commodity F u t u r e s T r a d i n g Commission, " P r o p o s e d m e m a k i n g : Minimum F i n a n c i a l R e q u i r e m e n t s , " 4 2 Fed. Reg. 27166 (May 2 6 , 1 9 7 7 ) .

dangers associated with t h e f a i l u r e of a major firm, a s w e l l as r e c e n t r e d u c t i o n s i n t h e c a p i t a l r e q u i r e m e n t s 257/ I n a d d i t i o n , i t s h o u l d be n o t e d f o r broker-dealers. t h a t r e c e n t CFTC p r o n o u n c e m e n t s e v i d e n c e s i g n i f i c a n t c o n c e r n w i t h c o m m o d i t i e s c o n c e n t r a t i o n , a n d Commission a c t i o n t o r e e s t a b l i s h a form o f d i s i n c e n t i v e s t o concent r a t i o n a p p e a r s c o n s i s t e n t b o t h w i t h i t s own h i s t o r i c a l c o n c e r n s - a n d w i t h t h e CFTC's c u r r e n t p o s t u r e . 258/
C.

D i r e c t L i m i t a t i o n on Exposure to Loss

There are no d i r e c t l i m i t a t i o n s o n t h e e x t e n t t o which a b r o k e r - d e a l e r c a n i n c u r e x p o s u r e t h r o u g h l e n d i n g to a s i n g l e customer, through its g u a r a n t e e of customer c o m m i t m e n t s o n commodity f u t u r e s a c c o u n t s , t h r o u g h l e n d i n g i n s e c u r i t i e s m a r g i n a c c o u n t s , 259/ o r t h r o u g h o t h e r t r a n s a c t i o n s involving r i s k f o r t h e f i r m . In contrast, since 260/ 1864, f e d e r a l s t a t u t e - h a s l i m i t e d t h e total o b l i g a t i o n s t o any n a t i o n a l banking a s s o c i a t i o n o f any p e r s o n , c o - p a r t n e r s h i p , a s s o c i a t i o n , or c o r p o r a t i o n t o 10%of its unimpaired paid-in c a p i t a l s t o c k p l u s 1 0 %of its unimpaired s u r p l u s fund. The i n t e n t o f t h i s l e n d i n g l i m i t a t i o n i s , among o t h e r t h i n g s , t o s a f e g u a r d t h e b a n k ' s d e p o s i t o r s by s p r e a d i n g l o a n s e x t e n d e d b y a b a n k among a r e l a t i v e l y l a r g e number o f p e r s o n s e n g a g e d i n d i f f e r e n t l i n e s o f b u s i n e s s , 261/ t o p r e v e n t u n d u e r e l i a n c e upon t h e f i n a n c i a l s t a n d i n g o f a s i n g l e b o r rower, - t o g u a r d n a t i o n a l b a n k s f r o m t h e h a z a r d s 262/

257/ S e e - - S e c u r i t i e s Exchange A c t No.

18417 ( J a n . 25, 1 9 8 2 ) .

- 9891

258/

F o r e x a m p l e , i n S e c u r i t i e s E x c h a n g e A c t R e l e a s e No. ( D e c , 5 , 1 9 7 2 ) , t h e Commission s t a t e d t h a t t h e : "uniform n e t c a p i t a l r u l e addresses i t s e l f t o * * * t h e i n j u d i c i o u s employment o f c a p i t a l , p a r t i c u l a r l y i n t h e a r e a o f undue c o n c e n t r a t i o n o f r e s o u r c e s * * *"

259/ - The l i m i t s t o l e n d i n g a g a i n s t s e c u r i t i e s a r e b a s e d o n l y on t h e percentages o f t h e value of s e c u r i t i e s being Given s u f f i c i e n t p u r c h a s e d or u s e d a s c o l l a t e r a l . q u a l i f i e d c o l l a t e r a l , t h e r e is no l i m i t o n t h e t o t a l amount t h a t c a n be l o a n e d . 260/ 1 2 U.S.C. 261/ - 1 2 C.F.R, S84 ( 1 9 7 6 S7.1310
&

Supp.

I V 1980).

(1982). 68 (1919).

262/ C o r s i c a n a N a t i o n a l Bank v . J o h n s o n , 2 5 1 U.S.

o f s p e c u l a t i v e l o a n s , and, g e n e r a l l y , t o i n s u r e sound banking p r a c t i c e s . 263/ The same c o n s i d e r a t i o n s t h a t u n d e r l i e bank l e n d i n g l i m i t a t i o n s s u p p o r t t h e c o n c e p t o f a l i m i t a t i o n on e x p o s u r e t o l o s s by b r o k e r - d e a l e r s . Although b r o k e r - d e a l e r s r e l y t o a g r e a t e r e x t e n t t h a n do banks on t h e s e c u r i t y of l i q u i d a s s e t s i m m e d i a t e l y a v a i l a b l e i n c u s t o m e r s ' a c c o u n t s , 264/ a n d t h u s may n o t a p p e a r t o r e q u i r e t h e p r o t e c t i o n a f f o r d e d by t h e c o n c e p t o f c u s t o m e r d i v e r s i f i c a t i o n i n h e r e n t i n

263/ u n i t e d S t a t e s v . P h i l a d e l p h i a N a t i o n a l Bank, 374 U.S. 3 2 1 , 329-330 ( 1 9 6 3 ) . 264/ Banks e x t e n d c r e d i t f o r many d i f f e r e n t p u r p o s e s o n a n - u n s e c u r e d b a s i s o r s e c u r e d by a w i d e v a r i e t y o f c o l l a t e r a l t h a t is o f t e n d i f f i c u l t t o v a l u e . A c c o r d i n g l y , t h e s a f e t y o f a p a r t i c u l a r l o a n is judged by t h e f i n a n c i a l c o n d i t i o n o f t h e b o r r o w e r a s w e l l a s by t h e n a t u r e and e x t e n t o f c o l l a t e r a l . The s t a b i l i t y o f t h e bank a s a n i n s t i t u t i o n is a s s u r e d by d i v e r s i f y i n g t h e l o a n p o r t f o l i o among a l a r g e number o f c u s t a m e r s . Broker-dealers, on t h e o t h e r hand, extend c r e d i t p r i n c i p a l l y t o finance or guarantee customers' s e c u r i t i e s o r c o m m o d i t i e s p o s i t i o n s and h a v e t r a d i t i o n a l l y p l a c e d g r e a t e r e m p h a s i s on t h e l i q u i d i t y and m a r k e t v a l u e of t h e a s s e t s i n customers1 a c c o u n t s . Brokerd e a l e r s g e n e r a l l y a v o i d u n s e c u r e d d e b i t b a l a n c e s by r e q u i r i n g c u s t o m e r s t o f u l l y match t h e i r o b l i g a t i o n s t o t h e b r o k e r - d e a l e r s w i t h d e p o s i t s of cash or r e a d i l y m a r k e t a b l e s e c u r i t i e s or c o m m o d i t i e s . Even a v e r y l a r g e a c c o u n t , assuming i t s h o l d i n g s a r e d i v e r s i f i e d , c a n be s o l d o u t r a p i d l y i n t h e e v e n t o f d e f a u l t . The importance of l i q u i d c o l l a t e r a l i n b r o k e r - d e a l e r s * e x t e n s i o n o f c r e d i t is r e c o g n i z e d i n t h e Uniform N e t C a p i t a l R u l e , which h e a v i l y p e n a l i z e s u n s e c u r e d c r e d i t by r e q u i r i n g a n i m m e d i a t e c h a r g e t o c a p i t a l f o r t h e e n t i r e amount o f a n y u n s e c u r e d c u s t o m e r d e b i t b a l a n c e s and r e q u i r e s s u b s t a n t i a l d e d u c t i o n s f r o m r e g u l a t o r y c a p i t a l f o r i l l i q u i d assets. a brokerd e a l e r cannot r e l y f o r p r o t e c t i o n on t h e a s s e t s i n an immediately a v a i l a b l e account, i f t h e a s s e t s a r e so c o n c e n t r a t e d i n a p a r t i c u l a r commodity t h a t a n a t t e m p t t o s e l l them would s e v e r e l y d e p r e s s t h e p r i c e o f t h e collateral.
AS d e m o n s t r a t e d i n t h e s i l v e r c r i s i s , h o w e v e r ,

253

bank-type lending limitation, the silver crisis has highlighted the weakness inherent in the present reliance on net capital rule concentration penalties to deter excessive exposure. In the crisis, the Hunts spread their highly concentrated silver position among a number of firms.' An individual firm carrying part of the Hunt position thus had no basis upon which to evaluate the degree of concentration in the portion of the overall position the Hunts maintained with it. - In addition, it is difficult 265/ to establish realistic objective standards of concentration in each of the different commodities, maturities and markets in which a firm's customers maintain positions. For both of these reasons, exposure limitation based on market concentration in accounts of an individual customer or customer group is uncertain in application and difficult to monitor, administer and enforce. 266/ 265/ It is particularly difficult for a firm to obtain in- formation about a customer's overall position in the

commodities markets. Knowledge of traderst positions is considered sensitive market information. I P. Johnson, Commodities Regulation S3.125 at 575-576 (1982). While the CFTC can collect this type of information, the commodity Exchange Act currently bars the CFTC from disclosing traders' positions, except to Congress, a court or, under carefully defined circumstances, a contract market. See Sections 8(a), (b) and (e) and 8a(6) of the Commodities Exchange Act, 7 U.S.C. SS12(a), (b) and (e) and 12a(6) (Supp. IV 1980). In order to enhance its monitoring capability the Commission has amended its Financial and Operational Combined Uniform Single Report (FOCUS Report) to require disclosure by broker-dealers of concentrated securities and commodities positions on a firm wide basis. See Items 5371, 5372, 5375 and 5376 of Form X-17A-5, E u rities Exchange Act Release No. 17534 (April 1, 1981). The disclosure by firms does not include information on individual customer positions.
- for significant commodity positions.

266/ There are no mandatory public reporting requirements Securities traders are required to publicly disclose certain significant securities positions by mandatory reporting See requirements. - e.g. Section 13(d), (f) and (g) of the Exchange Act, 15 U.S.C. S78m(d), (f), (g) (1976 & Supp. IV 19801, and rules thereunder. The staff believes that the historical ban on disclosure by the CFTC of trader positions reported to it and the lack of mandatory public disclosure requirements for trader positions need a fresh analysis.

A l i m i t a t i o n o n t h e amount o f e x p o s u r e t o a p a r t i c u l a r c u s t o m e r w o u l d a v o i d many o f t h e f o r e g o i n g d i f f i c u l t i e s b e c a u s e i t s e f f i c a c y would n o t depend o n t h e f i r m ' s a b i l i t y to o b t a i n i n f o r m a t i o n a b o u t t h e c u s t o m e r ' s o v e r a l l p o s i t i o n i n a market or on a s u b j e c t i v e e v a l u a t i o n of market l i q u i dity. T h e r e a r e a d d i t i o n a l a d v a n t a g e s as w e l l . First, s i n c e t h e p r o p o s e d l i m i t a t i o n on e x p o s u r e t o loss c o u l d b e f o r m u l a t e d t o r e a c h o n l y u n u s u a l s i t u a t i o n s , i t would have l i t t l e a p p r e c i a b l e impact on t h e day-to-day compliance burden on b r o k e r - d e a l e r s . S e c o n d , by f o s t e r i n g a n a p p r o a c h c o n s i s t e n t w i t h t h a t employed i n t h e banking i n d u s t r y , t h e Commission may f a c i l i t a t e u n i f o r m i t y i n r e g u l a t i o n 267/ o f e s s e n t i a l l y s i m i l a r economic f u n c t i o n s . -

Whereas a b a n k ' s e x p o s u r e l i m i t a t i o n s relate o n l y t o lending, t o be e f f e c t i v e a broker-dealer's exposure l i m i t a t i o n m u s t e n c o m p a s s o t h e r forms o f e x p o s u r e a s w e l l a s lending. Included i n t h i s c a t e g o r y are t h e o b l i g a t i o n s to c l e a r i n g h o u s e s i n c u r r e d by a b r o k e r - d e a l e r a s g u a r a n t o r o f i t s c u s t o m e r o b l i g a t i o n s o n commodity f u t u r e s c o n t r a c t s , r e c e i v a b l e s from c u s t o m e r s , d e b i t b a l a n c e s i n a c c o u n t s , a d v a n c e s t o c u s t o m e r s a n d o t h e r t r a n s a c t i o n s or r e l a t i o n s h i p s i n which loss t o a b r o k e r - d e a l e r could o c c u r .
A p r e c i s e recommendation a s to t h e measure o f an e x p o s u r e l i m i t a t i o n i s beyond t h e s c o p e o f t h e p r e s e n t report. Based o n i t s e x p e r i e n c e i n t h e i n v e s t i g a t i o n , however, t h e s t a f f b e l i e v e s t h a t a l i m i t a t i o n formula s h o u l d r e l a t e p e r m i s s i b l e e x p o s u r e t o t h e amount o f a f i r m ' s t o t a l n e t c a p i t a l and e x c e s s n e t c a p i t a l . While a l i m i t a t i o n based s o l e l y on a p e r c e n t a g e o f n e t c a p i t a l w i l l e n s u r e t h a t a b r o k e r - d e a l e r ' s exposure to l o s s to a s i n g l e c u s t o m e r o r c u s t o m e r g r o u p i s a p p r o p r i a t e i n rel a t i o n s h i p t o t h e c a p i t a l p o s i t i o n o f t h e f i r m as a w h o l e , i t w i l l n o t e n s u r e t h a t a f i r m e x p e r i e n c i n g d e f a u l t by s u c h customer or customer g r o u p w i l l have s u f f i c i e n t r e g u l a t o r y c a p i t a l t o a b s o r b t h e loss without experiencing

- i n t h e a p p l i c a t i o n of t h e lending l i m i t a t i o n t o banks.

267/

T h e s t a f f is a w a r e o f t h e i n t e r p r e t i v e i s s u e s i n v o l v e d

I t h e Commission w e r e t o a d o p t s u c h a l i m i t , i t would be a p p r o p r i a t e to c o n s i d e r i s s u e s c o n t i n u a l l y faced i n t h e a d m i n i s t r a t i o n o f l i m i t a t i o n s , s u c h as a g g r e g a t i o n of customers and e n t i t i e s f o r purposes o f t h e l i m i t . A s t h e s t a f f h a s a r t i c u l a t e d such a l i m i t , t h e Commiss i o n w o u l d be r e q u i r e d t o d e f i n e " c u s t o m e r g r o u p . "

deficiencies. A possible formulation, then, is defined as a percentage of firm's net capital, not to exceed an amount larger than its excess net capital. 268/ Most importantly, the silver crisis has demonstrated the degree to which the increasing centralization of securities and commodities business in a few very large concerns renders the stability of the financial system as a whole more susceptible to disruption by the failure of an individual firm. A direct limit on exposure to loss would, in our opinion, go a long way to'insure that these firms would no longer carry the potential for a major dislocation in the financial system. For the reasons stated above, the staff recommends that the Commission commence rulemaking or propose legislation to limit the degree of exposure that a broker-dealer can incur in connection with the transactions or accounts of a particular customer or customer group. 269/ The staff also recommends that the Commission, in advance of rulemaking, direct a staff study of the issues and recommend an exposure to loss limitation based on a percentage of an easily ascertainable objective measure.

- single-customer commodity credit limit of 15%, and a

268/ After the crisis, Bache Group established internally a securities credit limit of 20%, of Bache Group's equity capital

- ment pursuant to Section 15(c) (3) of the Exchange Act,

15 U.S.C. S78o(c)(3) (1976), which authorizes it to prescribe as necessary or appropriate in the public interest or for the protection of investors to provide safeguards with respect to the financial responsibility and related practices of brokers and dealers * * *

269/ The Commission has authority to establish such a require-

* * *

To the extent that transactions by the non-broker-dealer parent or affiliates of a broker-dealer carry the potential to impair the financial responsibility of the broker-dealer, Section 15(c)(3) empowers the Commission to promulgate rules establishing appropriate safeguards.

To the extent that the purpose of a limitation on exposure to loss is to protect the stability of these entities as financial institutions, rather than merely to further broker-dealer stability, the Commission may wish to recommend legislation that would provide for greater authority to direct the overall activities of a brokerdealer's holding company in instances in which a brokerdealer is the principal asset of the holding company in order to ensure financial stability.

111. THE NET CAPITAL RULE A. Introduction The net capital rule is the cornerstone of the Commission's financial responsibility requirements for brokerdealers. As the Commission stated in promulgating the 271/ rule, 270/ and as has been reiterated in Comlnission - and judici~decisions,272/ the basic concept of the rule is liquidity. The rule'sobjective is to insure that a brokerdealer has at all times sufficient liquid assets to cover its current indebtedness. A broker-dealer's "net capital", accordingly, is essentially its net worth less deductions for illiquid assets. 273/ Nonmarketable securities, for example, are entirelyexcluded from net capital, and marketable securities are includable in net capital subject to deductions (known as "haircuts") to take into account fluctuations in market value. Concentrations of securities are subject to additional "haircuts" to take into consideration the illiquidity of such positions. Regulations related to the net capital rule provide for "early warning" of potential capital deficiencies. Rule 17a-11 and related rules of the SROs require every broker-dealer subject to the net 274/ capital rule to give notice to the Commission - and the 270/ Securities Exchange Act Release No. 8024 (Jan. 18, 1967). As indicated above the Uniform Net Capital See Rule was not promulgated until 1975. - discussion supra n. 249 at 248. 967, 970-71 (1942); John W. Yeaman, Inc., Securities Exchange Act Release No. 7527, February 10, 1965: Lowell H. Listrom Company, Inc. , Securities Exchange Act Release No. 16750 (April 16, 1980).

271/ See, e.g., Guy D. Marionette, 11 S.E.C. - - -

272/ Don D. Anderson v. Securities and Exchange Commission, 423 F.2d 813 (10th Cir. 1970): Securities and Exchange Commission v. C.H. Abraham & Co. Inc. et al., 186 F.Supp. 19 (S.D.N.Y. 1960). 273/ See - - Rule 15c3-1(~)(2), 17 C.F.R. (1981). 240.15c3-1(~)(2)

274/ The rule provides for notice to the Commission's prin- cipal office and regional office for the region in which

the broker-dealer has its principal place of business. In addition, it requires notice to the Commodity Futures Trading Commission if the broker-dealer is registered with See the CFTC. - Rule 17a-ll(f), 17 C.F.R. ~240.17a-ll(f) (1981).

SROs o f c o n d i t i o n s t h a t may i n d i c a t e p o t e n t i a l p r o b l e m s . 275/ Both t h e p r o t e c t i o n s o f t h e n e t c a p i t a l r u l e and t h e p r o p e r f u n c t i o n i n g o f t h e e a r l y warning p r o v i s i o n s depend o n a c c u r a t e v a l u a t i o n o f customer and p r o p r i e t a r y commodities positions.
B.

U s e o f F u t u r e s P r i c e s to Value Customer Accounts

Throughout t h e long h i s t o r y of t h e n e t c a p i t a l r u l e , t h e v a l u e a s s i g n e d t o s e c u r i t i e s and commodity p o s i t i o n s h a s b e e n pr) "market value". Thus, Rule 1 5 ~ 3 - 1 ( ~ ) ( 2 ) ( i ) ( B ) ( l ovides: I n determining n e t worth, * * * a l l * * * s e c u r i t i e s and c o m m o d i t i e s p o s i t i o n s s h a l l b e marked t o t h e i r 276/ market value * * * Appendix B t o t h e Uniform N e t Capital R u l e , which 277/ a p p l i e s s p e c i f i c a l l y t o commodity t r a n s a c t i o n s , - d o e s n o t otherwise a d d r e s s t h e value to be assigned to open t r a d e f u t u r e s p o s i t i o n s i n customer accounts. - Not278/ w i t h s t a n d i n g t h e l a n g u a g e j u s t q u o t e d , i n d u s t r y practice h a s been to v a l u e open t r a d e f u t u r e s p o s i t i o n s i n o t h e r t h a n t h e spot month a t t h e s e t t l e m e n t price q u o t e d
-

275/ I n l i e u o f t e l e g r a p h i c n o t i c e s , r e p o r t s may b e r e q u i r e d - to be f i l e d . S e e e . g . , R u l e 1 7 a - l l ( b ) ( l ) , 1 7 C.F.R. ~ 2 4 0 . 1 7 a - l l ( b ) ( l ) (1981).

- large p o s i t i o n i n a s t o c k t h a t is o t h e r w i s e e a s i l y

276/ 1 7 C.F.R.

240.15~3-1(~)(2)(i)(B)(l)( 1 9 8 1 ) .

A very

m a r k e t a b l e may b e d i f f i c u l t t o d i s p o s e o f w i t h o u t a s i g n i f i c a n t r e d u c t i o n i n c u r r e n t m a r k e t price and a d i s c o u n t w i l l be a p p l i e d i n its v a l u a t i o n . See e.g., Wolfson and Guttman, The N e t C a p i t a l Rule f o r r o k e r s a n d Dealers, 24 S t a n f o r d L.R. 6 0 3 , 6 2 3 ( 1 9 7 2 ) . I l l i q u i d assets must be c o m p l e t e l y excluded. Carter H a r r i s o n C o r b r e y , 29 S.E.C. 2 8 3 , 287 ( 1 9 4 9 ) 277/ - R u l e 1 5 c 3 - l b , 1 7 C.F.R. S240.15~3-lb (1981).

278/ A t t h e t i m e o f t h e e v e n t s d e s c r i b e d i n t h e r e p o r t o f - i n v e s t i g a t i o n , t h e r u l e s o f c o n t r a c t markets (e.g. Comex a n d CBT) f u r n i s h e d l i t t l e g u i d a n c e i n t h i s a r e a . A s d i s c u s s e d h e r e i n , Comex O r i g i n a l M a r g i n R u l e Q , a d o p t e d May 2 8 , 1 9 8 2 , i n p a r t a d d r e s s e s t h e v a l u a t i o n issue discussed i n the text.

by t h e e x c h a n g e s f o r e a c h m a t u r i t y o f e a c h c o n t r a c t i n t h e p o s i t i o n . T h i s p r a c t i c e h a s been followed even i n markets i n w h i c h p r i c e movement l i m i t a t i o n s h a v e c r e a t e d d r a m a t i c s p r e a d s between q u o t e d f u t u r e s p r i c e s and t h e t r u e market value of the position. T h i s v a l u a t i o n h a s been used i n computing e q u i t y or d e f i c i t i n a c c o u n t s , as w e l l as margin requirements. A s noted elsewhere throughout t h i s r e p o r t , t h i s p r a c t i c e c o n t r i b u t e d t o t h e s i l v e r c r i s i s by a l l o w i n g b r o k e r - d e a l e r s to a s s i g n i n f l a t e d v a l u e s to t h e Hunts1 s i l v e r f u t u r e s accounts, t h e r e b y reducing or delaying m a r g i n c a l l s and masking l i q u i d a t i n g d e f i c i t s i n t h e accounts. Commodity e x c h a n g e s o f t e n i m p o s e d a i l y f l u c t u a t i o n l i m i t a t i o n s o n t h e t r a d i n g p r i c e of commodity f u t u r e s G e n e r a l l y i n t h e s p o t month, as w e l l as c o n t r a c t s . 279/ i n t h e cash= physicals market, p r i c e s f l u c t u a t e freely. I n a r a p i d l y d e c l i n i n g m a r k e t , p r i c e s c a n rise o r f a l l f a r f a s t e r t h a n f u t u r e s p r i c e s r e s t r a i n e d by p r i c e f l u c t u a t i o n l i m i t a t i o n s . While i n o r d i n a r y m a r k e t s s p r e a d s between s p o t p r i c e s a n d f u t u r e s p r i c e s may b e r e l a t i v e l y s t a b l e , i n highly v o l a t i l e markets containing s u b s t a n t i a l unid i r e c t i o n a l m a r k e t p r i c e movement, s u c h a s s i l v e r i n e a r l y 1 9 8 0 , t h o s e s p r e a d s c a n become v e r y w i d e . When p r i c e l i m i t e d t r a d i n g c o n d i t i o n s e x i s t , a s t h e y d i d i n Comex s i l v e r o n many o f t h e t r a d i n g d a y s from J a n u a r y 1 t h r o u g h March 3 1 , 1 9 8 0 , 280/ i t i s , a s a p r a c t i c a l matter, imposs i b l e t o liquidates l o n g b a c k month f u t u r e s p o s i t i o n a t t h e q u o t e d f u t u r e s p r i c e ; t h e c a s h o r s p o t month p r i c e , l e s s a t r a n s a c t i o n premium, i s t h e o n l y v a l u e t h a t may b e o b t a i n e d o n l i q u i d a t i o n of t h e p o s i t i o n .

279/ P r i c e f l u c t u a t i o n l i m i t a t i o n s may b e v a r i a b l e .

For

- e x a m p l e , Comex S i l v e r R u l e 5 p r o v i d e s a b a s i c p e r d a y l i m i t of f i f t y c e n t s p e r o u n c e , w h i c h c a n b e e x p a n d e d

t o s e v e n t y - f i v e c e n t s p e r o u n c e or o n e d o l l a r p e r ounce, depending on t r a d i n g c o n d i t i o n s . Commodity E x c h a n g e , I n c . , - B ~ - L ~ W S~ u l e s R e g u l a t i o n s , c h a p t e r , & 9 a t 9 ( 1 9 8 2 ) . The CFTC is c o n c e r n e d w i t h t h i s i s s u e . S e e C o m m o d i t i e s F u t u r e s T r a d i n g Commission, "Advance Notice of P r o p o s e d R u l e m a k i n g : C o n t r a c t M a r k e t S a l e s a n d P r a c t i c e s G o v e r n i n g t h e I m p o s i t i o n and M a i n t e n a n c e of P r i c e L i m i t s , " 45 Fed. Reg. 5 5 4 6 9 (Aug. 2 0 , 1 9 8 0 ) . 280/ I n t h e s i l v e r m a r k e t s i n March 1 9 8 0 t h e d i f f e r e n c e s b e t w e e n Comex f u t u r e s a n d s p o t p r i c e s w a s , a t l e a s t a t o n e d a t e , o v e r $13 p e r ounce. Thus, t h e v a l u e d i s t o r t i o n i n a n a c c o u n t w i t h o n e 5 , 0 0 0 o u n c e c o n t r a c t would be $65,000, i n a 50 c o n t r a c t account, t h e d i s t o r t i o n would b e $ 3 , 2 5 0 , 0 0 0 a n d i n a 1 , 0 0 0 c o n t r a c t a c c o u n t , t h e d i s t o r t i o n would b e $ 6 5 , 0 0 0 , 0 0 0 . This distortion would n o t b e r e f l e c t e d o n s t a n d a r d a c c o u n t d o c u m e n t a t i o n . The a r t i f i c i a l v a l u e s a r e , u n d e r c u r r e n t i n d u s t r y p r a c t i c e , used i n computing whether a n account is i n deficit.

The n e t c a p i t a l r u l e r e q u i r e s commodity p o s i t i o n s t o be valued a t "market value". A s i n d i c a t e d , b a c k month f u t u r e s p r i c e s may n o t be r e a l i z a b l e upon l i q u i d a t i o n o f the position i n adverse price limited trading conditions. T h e s t a f f b e l i e v e s t h e u s e of f u t u r e s p r i c e s i n t h e s e c o n d i t i o n s is i n a p p r o p r i a t e and c o n t r a v e n e s t h e p r i n c i p l e of t h e n e t c a p i t a l r u l e t h a t c o m m o d i t i e s p o s i t i o n s b e valued a t market value. I n a declining p r i c e limited market, valuing n e t long open t r a d e f u t u r e s p o s i t i o n s a t f u t u r e s s e t t l e m e n t prices i n price limited trading conditions inflates the liquid a t i n g v a l u e o f a c u s t o m e r p o s i t i o n and masks t h e t r u e w o r t h o f t h e a c c o u n t . 281/ It results i n d e f i c i t s not 282/ b e i n g r e c o g n i z e d when i n c u r r e d a n d d e l a y s m a r g i n c a l l s t h a t would o t h e r w i s e b e g e n e r a t e d i n a n a c c o u n t .
A s a h y p o t h e t i c a l example o f t h i s d e l a y i n g e f f e c t , assume t h a t a n a c c o u n t h o l d s l o n g back month s i l v e r f u t u r e s p o s i t i o n s and t h a t t h e a c c o u n t c a n w i t h s t a n d a $3 p e r ounce d r o p i n t h e p r i c e o f s i l v e r b e f o r e generating a m a r g i n c a l l and a $10 p e r o u n c e d r o p i n p r i c e b e f o r e a l i q u i d a t i n g d e f i c i t w i l l a r i s e . - Assume a l s o t h a t t h e 283/

281/ V a l u i n g s h o r t f u t u r e s p o s i t i o n s a t f u t u r e s p r i c e s - i n a p r i c e - l i m i t e d r i s i n g m a r k e t h a s t h e same e f f e c t .

- q u i r e m e n t s o f t h e a p p l i c a b l e b o a r d o f t r a d e or c l e a r i n g
a s s o c i a t i o n t o d e t e r m i n e t h e t i m e and amount o f v a r i a t i o n margin calls i n customer accounts. A s indicated above, i n d u s t r y p r a c t i c e is to u s e f u t u r e s p r i c e s to value these positions. U n t i l May 2 8 , 1 9 8 2 , Comex r u l e s were s i l e n t a s t o t h e v a l u a t i o n o f o p e n p o s i t i o n s f o r purposes of determining margin calls. 283/ I n c o n s i d e r i n g t h i s s i m p l i f i e d h y p o t h e t i c a l , it s h o u l d - b e b o r n e i n mind t h a t b r o k e r - d e a l e r s a r e f r e e to r e q u i r e , l a r g e r margin d e p o s i t s from a l l or s e l e c t e d customers. Many b r o k e r - d e a l e r s o f t e n d o r e q u i r e l a r g e r d e p o s i t s . S e e Commodity F u t u r e s T r a d i n g C o m m i s s i o n , R e p o r t t o the C o n g r e s s i n R e s p o n s e t o S e c t i o n 2 1 o f t h e Commodity E x c h a n g e A c t , Pub. L. N o . 9 6 - 2 7 6 , 9 6 t h Cong., 2d S e s s . S e c t i o n 7 , 9 4 S t a t . 5 4 2 ( J u n e 1, 1 9 8 0 ) P a r t I1 a t 8 ( 1 9 8 1 ) . The example i n t h e t e x t is f o r i l l u s t r a t i v e purposes only. Actual p o s i t i o n s , margin requirements, p r i c e f l u c t u a t i o n l i m i t a t i o n s , e q u i t i e s i n customer a c c o u n t s and o t h e r f a c t o r s would a l l f i g u r e i n t h e m a g n i t u d e of t h e d e l a y i n g e f f e c t i n a n y p a r t i c u l a r instance.

282/ T h e U n i f o r m N e t C a p i t a l R u l e l o o k s t o t h e m a r g i n re-

m a r k e t f o r s i l v e r d r o p s and t h u s t h e c a s h m a r k e t o r s p o t month p r i c e o f t h e commodity d r o p s $5 p e r o u n c e p e r d a y f o r t h r e e days. Assume a l s o t h a t t h e e x c h a n g e l i m i t e d movement i n b a c k month f u t u r e s p r i c e s i s $ 1 p e r d a y . Under t h e s e c o n d i t i o n s , o n t h e s e c o n d d a y t h e a c t u a l v a l u e o f t h e account w i l l be negative--a l i q u i d a t i n g d e f i c i t . Under c u r r e n t i n d u s t r y p r a c t i c e , h o w e v e r , t h e f i r s t m a r g i n c a l l would n o t b e g e n e r a t e d u n t i l t h e t h i r d d a y ( t h e d a y a f t e r a d e f i c i t i n t h e a c c o u n t a r o s e ) and t h e c a l l would It n o t b e i s s u e d t o t h e c u s t o m e r u n t i l t h e f o u r t h day. w i l l t a k e s i x more d a y s a f t e r t h e d a t e o f t h e f i r s t m a r g i n c a l l i s c o m m u n i c a t e d t o t h e c u s t o m e r f o r t h e f u l l amount o f t h e l o s s o c c u r r i n g i n a two d a y p e r i o d e i g h t d a y s e a r l i e r , t o b e r e c o g n i z e d i n a c c o u n t d o c u m e n t s . Obviously, s u c h a system can r e s u l t i n t h e accumulation of s t a g g e r i n g potenOn t i a l losses b e f o r e t h e f i r s t m a r g i n c a l l i s g e n e r a t e d . t h e o t h e r h a n d , i f c a s h m a r k e t o r s p o t month p r i c e s a r e u s e d , a m a r g i n c a l l would b e g e n e r a t e d , commu,nicated t o t h e c l i e n t , a g e d , and c h a r g e d t o c a p i t a l , t h e r e b y a s s u r i n g a n accurate evaluation of the firm's capital position. This method would a l s o h a v e t h e s a l u t a r y e f f e c t o f a l e r t i n g b o t h t h e c l i e n t and t h e f i r m to a c t u a l market c o n d i t i o n s .
A s described elsewhere i n t h i s report, t h i s delay r e s u l t e d i n Bache H a l s e y g e n e r a t i n g i t s f i r s t " r u l e " m a r g i n c a l l i n Hunt a c c o u n t s o n March 1 9 , s e v e r a l d a y s a f t e r t h e Hunt a c c o u n t s h a d f a l l e n i n t o a l i q u i d a t i n g d e f i c i t l a r g e enough t o create a n e t c a p i t a l d e f i c i e n c y 284/ i n t h e firm. -

The Commission h a s p l e n a r y a u t h o r i t y u n d e r S e c t i o n 1 5 ( c ) ( 3 ) t o d e f i n e " m a r k e t v a l u e " f o r o p e n t r a d e commodity f u t u r e s p o s i t i o n s f o r b r o k e r - d e a l e r s c a r r y i n g such p o s i tions. The s t a f f recommends t h a t t h e Commission u n d e r t a k e r u l e m a k i n g , i n c o n s u l t a t i o n w i t h CFTC, t o amend t h e n e t c a p i t a l r u l e t o d e f i n e " m a r k e t v a l u e " f o r commodity f u t u r e s p o s i t i o n s t o b e c a s h m a r k e t o r s p o t month p r i c e s i n "limit-up" o r "limit-down" t r a d i n g c o n d i t i o n s , and t o

2 8 4 / I t i s n o t e w o r t h y t h a t Edwards a n d P a i n e Webber, w h i c h - o n March 2 7 e r r o n e o u s l y i n f o r m e d t h e NYSE and t h e p r e s s , r e s p e c t i v e l y , t h a t t h e y would e x p e r i e n c e no l o s s i n Hunt a c c o u n t s , a t t r i b u t e d t h e i r e r r o r t o t h e u s e o f futures p r i c e s r a t h e r than spot prices i n valuing the Hunt a c c o u n t s .

r e q u i r e firms f o r n e t c a p i t a l purposes to use such values t o compute m a r g i n r e q u i r e m e n t s and a c c o u n t e q u i t i e s or deficits. 285/ The m e a s u r e h e r e i n p r o p o s e d i s n o t w i t h o u t p r e c e d e n t i n the industry. On May 2 8 , 1 9 8 2 , t h e Comex a d o p t e d O r i g i n a l M a r g i n R u l e Q , 286/ w h i c h r e q u i r e s f i r m s t o c o l l e c t a d d i t i o n a l margin f r o m customer on c e r t a i n d a y s i n which a p r i c e l i m i t e d m a r k e t moves a g a i n s t h i s p o s i t i o n . The amount t o b e c o l l e c t e d must b e s u f f i c i e n t t o m a r g i n t h e 287/ p o s i t i o n t o t h e " s p o t month" s e t t l e m e n t price - p l u s or m i n u s c e r t a i n d i f f e r e n t i a l s . 288/ To t h e e x t e n t a d d i t i o n a l margin is r e q u i r e d under t h e X e , t h e r u l e s p r o v i d e f o r v a r i o u s f o r m s o f c o l l a t e r a l i n c l u d i n g some i r r e v o c a b l e l e t t e r s o f c r e d i t t o b e a c c e p t e d b y members a n d member f i r m s as m a r g i n . I n e f f e c t , O r i g i n a l Margin Rule Q r e q u i r e s t h e u s e o f s p o t p r i c e s to v a l u e open t r a d e f u t u r e s p o s i t i o n s f o r purposes of c o l l e c t i n g margin i n price-limited t r a d i n g markets. The r u l e i s a n i m p o r t a n t s t e p t o w a r d s c o r r e c t v a l u a t i o n o f open t r a d e f u t u r e s p o s i t i o n s i n t h e s e markets.

Obviously, c a r e f u l c o n s i d e r a t i o n o f t h e e x a c t formulat i o n o f t h e r u l e would b e n e c e s s a r y . The Commission may wish not to value long open t r a d e f u t u r e s p o s i t i o n s to spot i n a r i s i n g m a r k e t or s h o r t open t r a d e f u t u r e s p o s i t i o n t o s p o t i n a f a l l i n g m a r k e t as t h e s e p o s i t i o n s a r e i n c r e a s i n g i n v a l u e a n d c a n be l i q u i d a t e d a t f u t u r e s prices. I t may a l s o b e a p p r o p r i a t e t o c o n s i d e r a d j u s t ments f o r m a r k e t price s t r u c t u r e . 286/ - Commodity E x c h a n g e I n c . , By-Laws, C h a p t e r 6 a t 12-13 ( 1 9 8 2 ) . Rules
&

Regulations,

287/ S p o t month i s d e f i n e d i n O r i g i n a l M a r g i n R u l e Q a s - t h e n e a r e s t m a t u r i t y f o r which f u t u r e s c o n t r a c t s are t r a d e d f o r a p a r t i c u l a r commodity. 288/ - The d i f f e r e n t i a l s a r e d e s i g n e d t o t a k e i n t o c o n s i d e r a t i o n p r i c e s t r u c t u r e s , known a s " c o n t a n g o " a n d "backwardation", i n which, i n t h e absence of c e r t a i n price l i m i t e d t r a d i n g c o n d i t i o n s , t h e s e t t l e m e n t price o f t h e b a c k months e x c e e d s t h e s e t t l e m e n t p r i c e o f t h e s p o t month, or t h e s e t t l e m e n t price o f t h e s p o t month e x c e e d s t h e s e t t l e m e n t p r i c e o f t h e b a c k months, r e s p e c t i v e l y .

The rule should help to protect broker-dealers from losses by reducing, in part, the valuation problems and delaying effects of the use of futures prices referred to above. The Comex rule also will have an impact on net capital calculations. As discussed more fully below, the net capital rule incorporates certain commodity exchange rules by reference. It is not, however, dispositive of the staff Is concerns. First, the Comex rule applies only to commodities traded on that exchange. Second, the rule does not address valuation for purposes of computing account equity or deficit. Finally, the rule itself is subject to 289/ change without regulatory oversight. It is important that the valuation of customer commodity accounts in these aberrant market environments 290/ be made consistent with the underlying purposes of thenet capital rule and its emphasis on realistic assessment of the immediately realizable value of assets. The Commissi~n, with the CFTC, should address this issue. 291/

289/ - Section Sa(12) of the Commodity Exchange Act, 7 U.S.C.

S7a(12) (Supp. IV 1980) , specifically provides that rules "relating to the setting of the levels of margin" need not be submitted to the CFTC for its approval.

290/ -

The staff would not recommend the use of spot month prices to value all open trade futures positions, only those positions experiencing adverse limit-up or down trading conditions.

291/ The competitive disadvantages to broker-dealers/FCMs

- of unilateral action by the Commission are obvious.

Although the Comex has instituted Original Margin Rule Q, the'use of cash market or spot month prices to value commodity accounts would be a fundamental change for other commodity exchanges. As a practical matter, brokers subject to such a regulation would call customers for valuation margin both sooner and in larger amounts than firms not subject to such a regulation. Thus, the resolution of this issue by the CFTC and the Commission should be economically and competitively neutral.

263

C.

I n c o r p o r a t i o n o f Margin Requirements o f Commodities Exchanges

During t h e t i m e o f t h e crisis, and a t p r e s e n t , f o r p u r p o s e s o f computing d e d u c t i o n s to n e t c a p i t a l f o r undermargined commodity a c c o u n t s Appendix B o f t h e n e t c a p i t a l r u l e incorporated by r e f e r e n c e t h e maintenance margin r e q u i r e m e n t s o f t h e a p p l i c a b l e b o a r d s o f t r a d e , or i f t h e r e are no s u c h r e q u i r m e n t s , t h e n t h e c l e a r i n g o r g a n i z a t i o n margin requirements a p p l i c a b l e to such p o s i t i o n s . 292/ S t a t e d s i m p l y , when a b o a r d o f t r a d e i n c r e a s e s m a r g i n r e q u i r e m e n t s , t h e Uniform N e t C a p i t a l Rule a u t o m a t i c a l l y r e q u i r e s g r e a t e r m a r g i n , t h u s i n c r e a s i n g customer p r o t e c tion. S i m i l a r l y when m a r g i n s a r e l o w e r e d , t h e U n i f o r m N e t C a p i t a l Rule r e q u i r e s less m a r g i n , t h u s d e c r e a s i n g c u s t o m e r protection. Therefore, because of t h i s incorporation, u n i l a t e r a l a c t i o n b y b o a r d s o f t r a d e o r c l e a r i n g associations w i l l d i r e c t l y a f f e c t the level of financial protection a f f o r d e d by t h e n e t c a p i t a l r u l e . The s t a f f b e l i e v e s t h a t t h e Commission s h o u l d c o n s i d e r w h e t h e r it b e l i e v e s i t t o b e appropriate f o r t h e l e v e l o f p r o t e c t i o n a f f o r d e d by t h e n e t c a p i t a l r u l e to b e w i t h i n t h e d i s c r e t i o n a r y a u t h o r i t y of these entities. 293/
It should be understood t h a t , d e s p i t e t h e f a c t t h a t c o m m o d i t i e s t r a n s a c t i o n s o f a b r o k e r - d e a l e r may n o t b e i t s predominant business, t h e e f f e c t o f margin i n c r e a s e s and decreases can be dramatic. An e x a m p l e i s t h e 3 3 % r e d u c t i o n i n Comex m a r g i n s o n March 2 6 t h . Faced w i t h c a p i t a l c h a n g e s r e s u l t i n g from aged m a r g i n c a l l s i n t h e Hunt a c c o u n t s , B a c h e t u r n e d t o Comex t o s u s p e n d t r a d i n g a n d f i x s e t t l e m e n t

292/ S e e - -, R u l e 1 5 c 3 - l b ( 3 ) ( x i i ) , ( x i i i ) a n d ( x i v ) , 1 7 C.F.R. 2 4 0 . 1 5 ~ 3 - l b ( 3 ) , ( x i i ) , ( x i i i ) and ( x i v ) (1981). 293/ - T h e 'Commission a l s o i n c o r p o r a t e s b y r e f e r e n c e - t h e m a i n t e n a n c e margin r e q u i r e m e n t s o f t h e examining a u t h o r i t y f o r b r o k e r - d e a l e r s i n d e t e r m i n i n g t h e amount o f c h a r g e s " to n e t c a p i t a l f o r o u t s t a n d i n g margin calls r e l a t e d to securities positions. See Rule 1 5 c 3 - l ( c ) ( 2 ) ( x i i ) , 1 7 C.F.R. 2 4 0 . 5 ~ 3 - 1 ( ~ ) ( 2 ) ( x i i )( 1 9 8 1 ) . However, r u l e s r e l a t i n g to maintenance margin by examining a u t h o r i t i e s , s u c h a s t h o s e o f NYSE, a r e s u b j e c t t o , a n d s h a l l n o t See t a k e e f f e c t , u n t i l a p p r o v e d b y t h e Commission. S e c t i o n 1 9 ( b ) ( l ) u n d e r t h e E x c h a n g e A c t , 1 5 U.S.C. 7 8 s ( b ) ( l ) ( 1 9 7 6 ) . O b v i o u s l y , t h e Commission h a s n o s u c h s i m i l a r a u t h o r i t y o v e r b o a r d s o f t r a d e o r commod i t i e s clearing organizations.

p r i c e s o r r e d u c e m a r g i n r e q u i r e m e n t s . - The Board a c t e d 294/ f a v o r a b l y o n t h e s e c o n d Bache r e q u e s t and v o t e d t o r e d u c e margin r e q u i r e m e n t s from $60,000 t o $40,000, p e r c o n t r a c t . 295/ T h i s r e d u c t i o n p e r m i t t e d Bache t o a p p l y $ 8 0 m i l l i o n o f w h a t had b e e n t h e H u n t s ' o r i g i n a l m a r g i n d e p o s i t t o s a t i s f y variation c a l l s with the c l e a r i n g association. The e a r l i e s t o f t h e H u n t s ' a g e d v a r i a t i o n m a r g i n c a l l s were e l i m i n a t e d a n d n o c a p i t a l c h a r g e s were r e q u i r e d . This r e s u l t occurred d e s p i t e t h e f a c t t h a t t h e Hunts d e p o s i t e d no a d d i t i o n a l c a s h or b u l l i o n , t h e r e had been n o f a v o r a b l e improvement i n s i l v e r p r i c e s and t h e l i q u i d a t i n g v a l u e o f t h e a c c o u n t s h a d n o t i n c r e a s e d . 296/

294/ D u r i n g t h e m a r k e t c o n d i t i o n s i n c o t t o n s e e d o i l f u t u r e s which a d v e r s e l y a f f e c t e d I r a Haupt & Co., Haupt a d v i s e d t h e r e l e v a n t exchange and c l e a r i n g a s s o c i a t i o n t h a t i t would b e u n a b l e t o meet i t s m a r g i n r e q u i r e m e n t s s h o u l d t h e market continue t o drop. T h e r e a f t e r , t h e exchange d i d n o t r e o p e n , t r a d i n g was s u s p e n d e d , a n d s e t t l e m e n t prices fixed. S e l i g s o n v. N e w York P r o d u c e E x c h a n g e , 3 7 8 F.Supp. 1 0 7 6 , 1 0 8 2 (S.D.N.Y. 1974). T h i s e x a m p l e is c h o s e n b e c a u s e o f t h e d r a m a t i c i m p a c t o n b r o k e r - d e a l e r s o f t h e Comex r e d u c t i o n i n m a r g i n s . It should be noted t h a t t h e margins i n e f f e c t a t t h e t i m e were e x t r e m e l y h i g h i n r e l a t i o n t o h i s t o r i c a l s i l v e r margins. The s t a f f ' s p o i n t i s n o t i n t e n d e d t o a d d r e s s t h e i s s u e o f t h e a p p r o p r i a t e l e v e l o f s i l v e r margin, or w h e t h e r t h i s a c t i o n b y C ~ m e xwas a p p r o p r i a t e . Rather, i t h a s been c h o s e n to i l l u s t r a t e , and t h i s d i s c u s s i o n a d d r e s s e s , t h e e f f e c t s o f i n c o r p o r a t i o n by r e f e r e n c e o f board o f t r a d e margin requirements on t h e l e v e l o f p r o t e c t i o n a f f o r d e d by t h e C o m m i s s i o n ' s U n i f o r m N e t C a p i t a l Rule.

295/ -

- s t e p s t o r e d u c e t h e amount o f t i m e a m a r g i n c a l l may b e
C

2?6/ The Commission and t h e CFTC h a v e r e c e n t l y t a k e n i m p o r t a n t o u t s t a n d i n g b e f o r e a c h a r g e o r a d j u s t m e n t t~ n e t c a p i t a l must be taken. S e e S e c u r i t i e s Exchange A c t Release Nos. 17564 ( E ' e b G r y 20, 1 9 8 1 ) , 17927 ( J u l y 9 , 1 9 8 1 ) ; Commodity F u t u r e s T r a d i n g C o m m i s s i o n , " P r o p o s e d r u l e amendments: Minimum F i n a n c i a l a n d R e l a t e d R e p o r t i n g R e q u i r e m e n t s , " 4 5 Fed. Reg. 4 2 6 3 3 ( J u n e 2 5 , 1 9 8 0 ) ; Commodity F u t u r e s T r a d i n g C o m m i s s i o n , " F i n a l R u l e s : Minimum F i n a n c i a l and R e l a t e d R e p o r t i n g R e q u i r e m e n t s , " 4 5 Fed. Reg. 79416 (December 1, 1 9 8 0 ) . T h e s e c h a n g e s are h e l p f u l i n a s s u r i n g b r o k e r - d e a l e r f i n a n c i a l s t a b i l i t y , b u t do n o t a d d r e s s o r r e s o l v e t h e p r o b l e m raised here.

- 265

The situation on March 26 is only an example. The level of margin requirements for commodity futures positions is within discretionary authority of commodity exchanges and the level can be lowered or raised by exchanges' unilateral action. Section 5a(12) of the Commodity Exchange Act explicitly excepts the "setting of levels of margin" from those rules which must be submitted to the CFTC for approval. Each change in the level of commodity futures margin requirements affects the quality, timing and level of financial protection afforded by the net capital rule. Had the market in silver continued to drop and had the Comex continued to lower margin, Bache and others would have been able to continue to defer recognizing the massive losses mounting in accounts in computing regulatory capital. The staff is not suggesting that the Comex would or would not have taken such action. The example, hawever, serves to illustrate that when the Uniform Net Capital Rule incorporates board of trade or clearing association rules, the level of protection afforded by the rule is subject to change without effective control or oversight by the Commission. By illustrating this weakness, the staff is not necessarily advocating that the margin setting authority be removed from commodity exchanges or clearing associations. 297/ The staff believes, however, that after further deliberation some alternative to the current scheme of regulation should be developed which will be compatible with commodities activities of broker-dealers yet assure that the levels of financial protections afforded by the net capital rule are not subject to reduction by the unilateral action of commodities exchanges. IV. ADEOUACY OF CREDIT INFORMATION A. Introduction Another notable feature of the silver crisis was the extent to which broker-dealers lent to the Hunts without detailed information on the then-current extent of the Hunts' overall silver position, their cash resources or their maturing debt or contractual obligations.

297/ In the past the Commission has stated its opinion that
- it may be appropriate for a federal entity to have, at

See a minimum, oversight over margin on futures. - Statement of Philip A. Loomis, Jr. before the Subcommittee on Conservation, Credit, and Rural Development of the House Committee on Agriculture (October 1, 1981); Statement of Harold M. Williams, before the Senate Committee on Banking, Housing and Urban Affairs (May 29, 1980).

The staff believes that a regulation requiring firms to obtain and review comprehensive customer financial information and to keep that information current would help assure that credit decisionmakers have adequate information upon which to evaluate customers' accounts. The staff believes, however, that establishing the limitations on exposure to loss recommended in the foregoing section of this report should eliminate, in substantial part, the need for more extensive financial information requirements and would entail substantially less burdensome compliance procedures.

B. Existing "Know Your Customeru Rules

Present standards pertaining to customer information required to be obtained by broker-dealers are embodied in rules of self-regulatory organizations. The most significant and best known of these is Rule 405 of the New York 298/ Stock Exchange. - These "know your customern rules 298/ - New York Stock Exchange, Rules of Board, Diligence as to Accounts, Rule 405, N.Y.S.E. Guide (CCH) 1 2405. New York Stock Exchange Rule 405 is popularly known as the "know your customer" rule. It provides in relevant part: Every member organization is required through a general partner, a principal executive officer or a person or persons designed under the provisions of Rule 342(b)(l) to (1) Use due diligence to learn the essential facts relative to every customer, every order, every cash or margin account accepted to carried by such organization and every person holding power of attorney over any account accepted or carried by such organization. (2) Supervise diligently all accounts handled by registered representatives of the organization.
(3) Specifically approve the opening of an account prior to or promptly after the completion of any transaction for the account of or with a customer, provided, however, that in the case of branch offices, the opening of an account for a customer may be approved by the manager of such branch office but the action of such branch officer manager shall within a reasonable time be approved by a general partner, a principal executive officer, or a person

Footnote continued on next page.

o b l i g a t e b r o k e r - d e a l e r s t o know t h e background o f t h e i r c u s t o m e r s and t o s u p e r v i s e t h e i r a c c o u n t s o n a c o n t i n u i n g b a s i s t o b e a s s u r e d o f t h e i r c u s t o m e r s ' a b i l i t y t o meet t h e i r f i n a n c i a l o b l i g a t i o n s . - I n a d d i t i o n to o b t a i n i n g 299/ a l l e s s e n t i a l f a c t s r e l a t i n g t o e v e r y c u s t o m e r and e v e r y a c c o u n t p r i o r t o o p e n i n g t h e a c c o u n t , t h e NYSE r e q u i r e s b r o k e r s to review customer a c c o u n t s monthly t o d i s c o v e r e x c e s s i v e c o n c e n t r a t i o n s of s e c u r i t i e s , paying p a r t i c u l a r a t t e n t i o n to low-priced s p e c u l a t i v e s i t u a t i o n s , e x c e s s i v e t r a d i n g i n p a r t i c u l a r a c c o u n t s , l a t e p a y m e n t s by c u s t o m e r s and p r e p a y m e n t s t o c u s t o m e r s . - NYSE Rule 405 a n d 300/ o t h e r r u l e s a p p l y t o c o m m o d i t i e s a c c o u n t s c a r r i e d by 301/ broker-dealers. F o o t n o t e c o n t i n u e d from p r e v i o u s p a g e .

or persons d e s i g n a t e d under t h e p r o v i s i o n o f Rule 3 4 2 ( b ) ( l ) . The member, g e n e r a l p a r t n e r , o f f i c e r o r d e s i g n e d p e r s o n s a p p r o v i n g t h e opening of t h e a c c o u n t s h a i l , p r i o r t o g i v i n g h i s a p p r o v a l , be p e r s o n a l l y informed a s t o t h e e s s e n t i a l f a c t s r e l a t i v e t o t h e c u s t o m e r and t o t h e n a t u r e o f t h e p r o p o s e d a c c o u n t and s h a l l i n d i c a t e h i s a p p r o v a l i n w r i t i n g o n a document which is a p a r t o f t h e p e r m a n e n t r e c o r d s o f h i s o f f i c e or o r g a n i z a t i o n .
299/ N e l s o n v. Hench, 428 F. Supp. 4 1 1 , 419 ( D . Minn. 1 9 7 7 ) .

300/ - N e w York S t o c k Exchange, Manual o n S u p e r v i s i o n and

Management o f R e g i s t e r e d R e p r e s e n t a t i v e s and Customer A c c o u n t s ( 1 9 6 2 ) ( h e r e i n a f t e r " S u ~ e r v i s i o nM a n u a l " ) . The s u p e r v i s i o n Manual h a s r e c e n t l y b e e n r e v i s e d . . N e w York S t o c k Exchange, P a t t e r n s o f S u p e r v i s i o n - A Guide t o t h e S u p e r v i s i o n and Management o f R e g i s t e r e d R e p r e s e n t a t i v e s and Customer A c c o u n t s ( 1 9 8 2 ) ( h e r e i n a f t e r "Revised Manual").

301/ - Some r u l e s s p e a k s p e c i f i c a l l y t o c o m m o d i t i e s a c c o u n t s see, e.g. - -,

N e w York S t o c k E x c h a n g e , R u l e s o f B o a r d , T r a n s a c t i o n s - Employees o f Exchange, Member O r g a n i z a t i o n s o r C e r t a i n Non-Member O r g a n i z a t i o n s , R u l e 4 0 7 , N.Y.S.E. Guide ( C C H ) 1 2407. 1 R u l e s which d o n o t s p e a k s p e c i f i c a l l y t o commodities t r a d i n g have n o n e t h e l e s s been e n f o r c e d by SROs w i t h r e s p e c t t o b o t h s e c u r i t i e s and c o m m o d i t i e s t r a d i n g . - - .- i s t r i c t B u s i n e s s See, e.g , D Conduct Committee v . L.L. C e r e g h i n o , NASD N o . C.A. 8 6 1 ( D i s t r i c t No. 2 , August 1 7 , 1 9 8 1 ) ( s u s p e n s i o n o f r e g i s t e r e d r e p r e s e n t a t i v e f o r unauthorized commodities t r a n s a c t i o n s i n customer a c c o u n t on t h e ground t h a t s u c h a c t i o n s v i ~ l a t e d5 1 , A r t . I11 o f t h e NASD R u l e s o f F a i r P r a c t i c e ) and I n t h e M a t t e r o f Andrew J. Remington, NYSE H e a r i n g P a n e l D e c i s i o n 81-42 (May 2 1 , 1 9 8 1 ) ( R e g i s t e r e d R e p r e s e n t a t i v e b a r r e d from c o m m o d i t i e s t r a d i n g f o r s e v e n months f o r t r a d i n g i n c o m m o d i t i e s f u t u r e s i n customer accounts w i t h o u t w r i t t e n a u t h o r i z a t i o n ) .

As a vehicle for insuring the adequacy of information in credit decision-making, Rule 405 is deficient in that 302/ it does not provide specific information requirements. Indeed, the Supervision Manual in effect at the time of the silver crisis explicitly reserved to firms broad discretion in the Rule's application. The Manual describes that the Rule : is written so as to leave to the firm's judgment what facts are essential in the varying circumstances of each new account. The facts essential in the opening of one account may not be sufficient for the opening of 303/ another account. Although the text just quoted suggests that Rule 405 has been broadly written to permit or encourage firms to seek more information in accounts with greater exposure, the Rule's generality has also permitted firms to seek less information from customers. This can occur especially where such a practice may produce an advantage over competitors. Particularly in situations involving larger, more lucrative accounts, competitive considerations provide disincentives to vigorous pursuit of the Rule's objectives. Unless every broker-dealer insists on the same degree of financial disclosure by a customer, there will be a tendency for firms to relax standards to lure or retain profitable business from customers who resist disclosure of financial information. It is, ironically, these large, prof itable accounts, frequently trading in size in volatile markets, that create the greatest exposure for a firm and hence require the most extensive customer information for effective risk management. Similarly, self-regulatory organizations may be reluctant to enforce strict interpretation of "know your customer" rules for fear that certain business that would otherwise go to its members would be driven into other markets. Both of these conditions were present during the events leading up to the silver crisis.

302/ - The "know your customer" rules serve several functions.

.

One purpose is to protect brokers from defaulting customers. Another purpose is to provide a basis of information about customers so that brokers recommend suitable investments. Securities and Exchange Com-. mission, Report of Special Study of Securities Markets, H. Doc. No. 95, 88th Cong., 1st Sess. 316 (1963). Accord, Revised Manual at 41.

303/ Supervision Manual at 7.

While it is neither currently applicable to commodity accounts, nor mandatory in its application, NYSE Rule 304/ 721, - adopted as a part of the rigorous suitability requirements for options trading, is more specific than Rule 405 in delineating information required to be ob305/ tained. - However, Rule 721 provides, in pertinent part, that: Refusal of a customer to provide any of the information called for in * * * this Rule shall be so noted on the customer's records at the time the account is opened. Information provided shall be considered together with the other information available in determining whether and to what extent to approve the account for options transactions. 306/ Customer refusal to supply information thus does not preclude opening the account, and the same competitive disincentives to compliance exist in Rule 721 as are created by Rule 405's lack of specificity. Thus, were the Commission to adopt financial information requirements, although Rule 721 would be helpful, as a model it is not sufficiently mandatory to be effective in this area. In addition to the competitive disincentives to compliance already noted, existing "know your customer" rules have a number of other inadequacies as tools for risk management. Most notably, in light of experience in the silver crisis, existing regulations: 1. Do not require firms to obtain information about customers' positions at other firms; 2. Do not require firms to learn the extent or timing of customers' maturing debt or contractual obligations or the extent of the liquid resources available to meet them; and 304/ - New York Stock Exchange, Rules of Board, Opening of Accounts, Rule 721, N.Y.S.E. Guide (CCH) 1 2721. 1 In its recent "Options Study", the Commission's staff thoroughly studied the existing "know your customer" rules, and discussed additional requirements, embodied in large part in NYSE Rule 721, necessary for options trading. Thus, the staff has recently revisited the current state of these "know your customer" rules. See generally, Report of the Special Study of the Options Market to the Securities and Exchange Commission, House Comm. on Interstate and Foreign Commerce, 96th Cong., 1st Sess. (1978).
-

306/ -

N.Y.S.E.

Guide (CCH) 1 2721 at 4553. 1

3. Do not require firms to obtain the foregoing information on a current basis rather than solely upon the opening of an account.

It was precisely this information that broker-dealers lacked in the winter and spring of 1980 as they maintained or increased the Hunt silver positions they carried. C. Requirements for Financial Information The foregoing analysis suggests that edisting "know your customer" rules are inadequate as risk management tools when the issue of sufficient information for exposure to loss and credit decision-making is considered. In resolving the issue of inadequate financial information of customers, however, there are a number of factors to consider. Most fundamentally, the staff believes that the Commission must determine whether it wishes to continue broad discretion to the management of individual firms to make credit and exposure determinations that can affect the stability of the entire industry. If so, then the most appropriate response to the silver crisis may be to impose new financial information regulations to insure that firms have appropriate information to make responsible judgments, without placing any restrictions, as would exposure limitations, on the substance of the judgments made. If, on the other hand, the Commission wishes to protect the stability of individual firms and the industry by establishing limitations on exposure to loss, then detailed and mandatory financial information rules would not be as essential. The staff favors limitations on exposure to loss for several reasons:
(1) Regulations requiring that firms obtain financial information from customers do not offer any assurance that broker-dealers will not incur excessive exposure to loss, overextend lending or make poor judgments. As such, these regulations cannot go as far as assuring the stability of broker-dealers as can a direct limitation on exposure to loss;
( 2 ) Any adequate financial inf2rmation regulation would necessarily require obtaini+.%~d frequently updating such detailed information;

( 3 ) Jurisdictional problems, limited enforcement resources and the complexity inherent in such a provision would, as a practical matter, make it difficult to enforce its requirements so as to eliminate the competitive disincentives to compliance associated with present regulation; and

( 4 ) Customer and firm resistance to such a regulation can be anticipated.

307/ A limitation on exposure to loss would as discussed be less intrusive and more simple to prescribe, administer, and enforce. On balance, the staff does not recommend rules prescribing required customer financial information preferring as an alternative to a limitation on exposure to loss. Were such a limitation to loss put into place, the Commission will have time to evaluate its effectiveness and consider whether minimum financial information regulations are necessary or appropriate.

V .

DISCLOSURE OBLIGATIONS
A.

Introduction

Certain entities involved in the "silver crisis" were subject to a variety of disclosure obligations because of their or their parents' status as publicly held corporations. - The staff found no disclosure to investors of 308/ the existence or extent of the exposure in certain firms that ultimately led to the crisis. - As a consequence, 309/ public investors were not aware of the risks and exposure to loss due to the effects of the crisis at certain entities. It is important to again emphasize the need for issuers to timely disclose to the investing public material information and changes in financial condition. 1. The Significance of Disclosure It closure and the ficance is difficult to overstate the significance of disof information to the investing public. Congress Commission have reiterated the need for, and signiof, timely disclosure of information to investors.

307/ See - - discussion

infra at pages 252 to 256.

308/ Bache, Merrill Lynch, Paine Webber, Dean Witter and - Hutton are, or were at the time of the crisis, principal

subsidiaries of publicly held corporations. a publicly held broker-dealer.

Edwards is

309/ In this discussion the staff offers no opinion on the

- adequacy of disclosure by the broker-dealers discussed

in this report with respect to their responsibilities under the reporting and anti-fraud provisions of the federal securities laws.

Congress h a s , b e g i n n i n g i n 1934, s t a t e d t h e s i g n i f i c a n c e f o r i n v e s t o r s o f a d e q u a t e and a c c u r a t e i n f o r m a t i o n a b o u t i s s u e r s . 310/ The C o m m i s s i o n r e p e a t e d l y h a s r e c o g n i z e d t h e s e n e e d s f o r i n f o r m a t i o n . 311/ The N e w York S t o c k E x c h a n g e has recognized t h e needfor timely disclosure. 312/

310/ - The H o u s e R e p o r t o n t h e S e c u r i t i e s E x c h a n g e

A c t states:

"NO i n v e s t o r , n o s p e c u l a t o r , c a n s a f e l y buy a n d s e l l s e c u r i t i e s upon t h e e x c h a n g e s w i t h o u t h a v i n g a n i n t e l l i g e n t b a s i s f o r forming h i s judgments t o t h e v a l u e o f t h e s e c u r i t i e s h e b u y s o r s e l l s . The i d e a o f a f r e e and o p e n p u b l i c m a r k e t is b u i l t upon t h e t h e o r y t h a t c o m p e t i n g judgments o f b u y e r s and s e l l e r s a s t o t h e f a i r price of a s e c u r i t y b r i n g s a b o u t a s i t u a t i o n w h e r e t h e m a r k e t price r e f l e c t s as n e a r l y as p o s s i b l e a just price. ~ u s as a r t i f i c i a l m a n i p u l a t i o n t e n d s t t o u p s e t t h e t r u e f u n c t i o n o f a n o p e n m a r k e t , so t h e h i d i n g and s e c r e t i n g o f i m p o r t a n t i n f o r m a t i o n obs t r u c t s t h e o p e r a t i o n o f t h e m a r k e t s as i n d i c e s o f real value. T h e r e c a n n o t be h o n e s t m a r k e t s w i t h o u t h o n e s t p u b l i c i t y . " H.R. Rep. No. 1 3 8 3 , 7 3 r d Cong., 2d 1 Sess. 1 (1934).

311/ - " T i e See l u - merits", mS leyc uDr ii st c eo s A rcet i s

o f Material C o r p o r a t e D e v e l o p R e l e a s e No. 5092, ( O c t o b e r 1 5 , 1 9 7 0 ) ; " P u b l i c a t i o n of Information p r i o r to or A f t e r t h e F i l i n g a n d E f f e c t i v e Date o f a R e g i s t r a t i o n S t a t e ment under t h e S e c u r i t i e s A c t o f 1933", S e c u r i t i e s A c t Release N o . 5009 ( O c t o b e r 7 , 1 9 6 9 ) ; "Notice t o R e g i s t r a n t s Engaged i n D e f e n s e a n d O t h e r Long Term Cont r a c t s a n d P r o g r a m s o f t h e Need f o r Prompt a n d A c c u r a t e D i s c l o s u r e o f Material I n f o r m a t i o n C o n c e r n i n g S u c h A c t i v i t i e s " , S e c u r i t i e s A c t R e l e a s e NO. 5 2 6 3 ( J u n e 22, 1 9 7 2 ) ; " D i s c l o s u r e o f t h e Impact o f P o s s i b l e Fuel Shortages on t h e Operation of Issuers Subject t o t h e R e g i s t r a t i o n and Reporting p r o v i s i o n s of t h e F e d e r a l S e c u r i t i e s Laws", S e c u r i t i e s A c t R e l e a s e N o . 5 4 4 7 (December 2 0 , 1 9 7 3 ) : " R e p o r t o f I n v e s t i g a t i o n i n t h e Matter o f S h a r o n S t e e l C o r p o r a t i o n a s i t R e l a t e s t o P r o m p t Corporate D i s c l o s u r e " , S e c u r i t i e s E x c h a n g e A c t Release N o . 1 8 2 7 1 (November 1 9 , 1 9 8 1 ) .

The t i m e l y d i s c l o s u r e o f i n f o r m a t i o n i s e s p e c i a l l y s i g n i f i c a n t t o s e c u r i t i e s e x c h a n g e s upon w h o s e f a c i l i t i e s t h e s e c u r i t i e s o f l i s t e d c o m p a n i e s are t r a d e d . The New York S t o c k E x c h a n g e Company Manual s e t s f o r t h t h e a f f i r m a t i v e d i s c l o s u r e o b l i g a t i o n s o f N e w York S t o c k Exchange l i s t e d companies. Footnote c o n t i n u e d on n e x t page.

In addition to recognizing needs for timely disclosure, the Commission has recently enhanced the mandatory disclosure system to require management's discussion and analysis of financial condition and results of operations. 313/ The staff believes that these obligations, by requiring, for example, identification of uncertainties that are reasonably likely to result in the registrant's liquidity increasing or decreasing in any material way, comprehensively address financial changes such as occurred in the silver crisis. 314/ These disclosures must be fully addressed by issuers in t E a n n u a l report on Form 10-K - and updated 315/ 316/ in the quarterly report on Form 10-Q. Footnote continued from previous page. "A corporation whose securities are listed on the New York Exchange Inc. is expected to release quickly to the public any news or information which might reasonably be expected to materially affect the market for those securities. This is one of the most important and fundamental purposes of the listing agreement which each corporation enters into with the Exchange." New York Stock Exchange, Section A2, Part 1 at A-18. The N.Y .S.E. Company Manual "cod if i [es] the policies, requirements, procedures, and practices of the Exchange relating to listed companies and their securitiestt (Id., Introduction). 313/ See - - SEC Integrated Disclosure Adoptions, Securities Act Release Nos. 6383, 6384, 6385 (March 11, 1982). 314/ See - - Item 303(a)(l) of Regulation S-K contained in Securities Act Release No. 6383. Regulation S-K is to be codified at 17 C.F.R. 240.100 - et seq.
.

s ,

315/ See - - Sections 13 and 15(d) of the Exchange Act, 15 U.S.C. S78m and 780 (1976 & Supp. IV 1980). See description of Form and Form at Fed. Sec. L. Rep. (CCH) 11 27,047, 31,101. These disclosures must also be addressed in an issuer's annual report to shareholders. 316/ See - - Rules 13a-13 and 15d-13 under the Exchange Act, 17 C.F.R. SS240.13a-13; 240.15d-13 (1981). See description of Form and Form at Fed. Sec. L. R ~ ~ ( C C H )
H 1 27,045Af 31,031.

The d i s s e m i n a t i o n o f t h i s r e p o r t w i l l a g a i n s e r v e t o c a u t i o n i s s u e r s regarding t h e i r r e s p o n s i b i l i t i e s under t h e f e d e r a l s e c u r i t i e s l a w s and t o remind i s s u e r s o f t h e import a n c e o f d i s c l o s i n g on a t i m e l y b a s i s t o t h e market p l a c e m a t e r i a l changes i n a r e g i s t r a n t ' s f i n a n c i a l c o n d i t i o n . 2. Improvements f o r D i s c l o s u r e o f A d v e r s e E f f e c t s o f Customer D e f a u l t s

I t is i m p o r t a n t f o r i n v e s t o r s t o be a w a r e o n a t i m e l y b a s i s i f t h e t o t a l o b l i g a t i o n s of a s i n g l e customer t o , or d i r e c t l y a f f e c t i n g , a b u s i n e s s s e g m e n t o f a n i s s u e r a r e so s i g n i f i c a n t t h a t a n e v e n t o f d e f a u l t by a c u s t o m e r would 317/ have a n a d v e r s e e f f e c t on t h e segment. -

One framework t o d i s c u s s t h e s e i s s u e s m i g h t be t o recommend amending R e g u l a t i o n S-K t o i n c l u d e d i s c l o s u r e of t h e adverse e f f e c t s of customer d e f a u l t t a k i n g i n t o c o n s i d e r a t i o n t o t a l lending t o a customer, t o t a l obligat i o n s o f a c u s t o m e r i n e f f e c t g u a r a n t e e d by t h e i s s u e r , t o t a l r e c e i v a b l e s from a c u s t o m e r i n c l u d i n g margin c a l l s o r c a l l s f o r o t h e r d e p o s i t s o f c a s h o r o t h e r a s s e t s by a n i s s u e r , o r o t h e r o b l i g a t i o n s w h i c h would r e s u l t i n l o s s t o a s e g m e n t upon t h e e v e n t o f a d e f a u l t o f a c u s t o m e r . 318/ 317/ The Commission h a s c o n s i d e r e d a n a l o g o u s d i s c l o s u r e s o f t h i s type important. A t t h e t i m e of t h e e v e n t s o f t h e s i l v e r crisis, p r i o r t o t h e a d o p t i o n o f t h e i n t e g r a t e d d i s c l o s u r e system ( See S e c u r i t i e s A c t Release N o s . 6383, 6384, 6 3 8 5 ; (March 11, 1 9 8 2 ) ) I t e m I ( c ) ( v i i ) o f R e g u l a t i o n S-K r e q u i r e d , d i s c l o s u r e o f t h e d e p e n d e n c y o f a b u s i n e s s s e g m e n t upon a s i n g l e c u s t o m e r or a f e w c u s t o m e r s , t h e l o s s o f a n y o n e o f whom would h a v e a n a d v e r s e e f f e c t on t h e s e g m e n t . With c e r t a i n amendments, t h i s p a r t i c u l a r d i s c l o s u r e o b l i g a t i o n h a s been included i n t h e u p d a t e d R e g u l a t i o n S-K. -Item lOl(c)(vii) See o f R e g u l a t i o n S-K.

318/ The p r o p o s e d c h a n g e would e l i c i t d i s c l o s u r e o f f u t u r e s - p o s i t i o n s b e c a u s e t h e y a r e o b l i g a t i o n s where a n i s s u e r s t a n d s a s g u a r a n t o r of i n d i v i d u a l s 1 o b l i g a t i o n s under I P. t h e f u t u r e s c o n t r a c t s comprising positions. J o h n s o n , Commodities R e g u l a t i o n S2.43 a t 279 ( 1 9 8 2 ) . The b r o k e r - d e a l e r , a s a member o f e x c h a n g e c l e a r i n g o r g a n i z a t i o n s , is o b l i g a t e d t o d e p o s i t c a s h c l e a r i n g margins t o s u p p o r t its customers p o s i t i o n s and to p e r f o r m o n t h e o b l i g a t i o n s o f e a c h c o n t r a c t by s t a n d i n g f o r o r making d e l i v e r y o f t h e u n d e r l y i n g commodity. F o o t n o t e c o n t i n u e d on n e x t p a g e .

Again, because of the directed nature of this report, the staff has not considered on an issuer or industry wide basis, the appropriate timing or placement of such a disclosure obligation. This issue would appear ripe for the Commission to direct the staff to consider the appropriate form, placement and frequency for disclosure of the adverse effects of potential customer defaults. Although the report has focused on concentrated commodities positions the staff believes that concentrated securities positions hold the potential for effects on broker-dealers and issuers similar, though in many respects less volatile, to concentrated commodities positions. The staff recommends that disclosure requirements in this area be reviewed to consider whether additional or amended requirements are appropriate.

3. Disclosure of Contingent Liabilities

As previously noted, broker-dealers carrying customer commodity positions stand as guarantors of customers' obligations to clearinghouses. Where the commodity futures obligations of particular customers, concentrated in one or a few markets, become so substantial as to be material to the financial condition of a firm, disclosure of firms' guarantee of these obligations as contingent liabilities may be warranted. While FASB 5 appears applicable to such a situation, it does not specifically address liabilities associated with customer commodity positions. There may be, accordingly, a need for guidance in this area. The staff recommends that the groups with responsibility for the establishment of accounting standards, such as the FASB and the AICPA, in cooperation with the Commission staff, review current standards with a view to determining if clarification is required of disclosure obligations under these circumstances.

Footnote continued from previous page. Thus, if a customer defaults on margin calls, the brokerdealer is nevertheless liable to the clearing agency for clearing margin in full, and if the customer's positions are liquidated to a deficit, the broker-dealer bears the risk of loss. The proposed improvement would elicit disclosure of loans from brokers secured by physical commodities because they are an obligation where a default exposes an issuer to loss.
).

VI.

SELF-REGULATORY ORGANIZATION OVERSIGHT

I n t h e s t a f f ' s view, t h e Exchange's f a i l u r e to ident i f y o n a t i m e l y b a s i s t h e crisis and t h e c o n s e q u e n t f a i l u r e t o t a k e t i m e l y r e m e d i a l a c t i o n , was d u e t o t h e f a c t t h a t t h e Exchange b a s e d i t s s u r v e i l l a n c e o f i t s members i n v o l v e d i n t h e s i l v e r c r i s i s o n a b e l i e f t h a t i t would b e p r o v i d e d c a n d i d , a c c u r a t e , a n d c o m p l e t e i n f o r m a t i o n promptly and spontaneously. A s discussed i n the p a r t Based o n t h e N e w York S t o c k E x c h a n g e , t h i s d i d n o t o c c u r . upon i t s r e v i e w , t h e s t a f f b e l i e v e s t h a t t h e E x c h a n g e s h o u l d implement b e t t e r p r o c e d u r e s f o r t h e c o n d u c t o f s u r v e y s t h a t , i n cases o f s u b s t a n t i a l c o n s e q u e n c e s u c h as e n c o u n t e r e d d u r i n g t h e s i l v e r c r i s i s , would i n c l u d e , a t a minimum, s u b m i s s i o n t o t h e E x c h a n g e o f h a r d c o p y d a t a , f i e l d v e r i f i c a t i o n o f s u c h d a t a , and a t t e s t a t i o n o f t h e a c c u r a c y o f d a t a s u b m i t t e d t o t h e Exchange by a s e n i o r A s d e t a i l e d i n t h i s r e p o r t , t h e r e was o f f i c e r of a firm. a s i g n i f i c a n t breakdown i n t h e c o o r d i n a t i o n a n d e x c h a n g e o f i n f o r m a t i o n between t h e F i e l d Examination S e c t i o n and t h e Surveillance Coordination Section. The E x c h a n g e ' s organizational bifurcation of surveillance resporlsibilities b e t w e e n t h e s e s e c t i o n s c l e a r l y d i d n o t work. Although t h e Exchange h a s r e c e n t l y merged t h e s e s e c t i o n s , t h e E x c h a n g e should adopt procedures and s u p e r v i s o r y c o n t r o l s to a s s u r e t h e closest p o s s i b l e c o o r d i n a t i o n between t h e i n d i v i d u a l s p e r f o r m i n g t h e s u r v e i l l a n c e and examining f u n c t i o n s . VII. SEGREGATION OF COMMODITIES AND SECURITIES ACTIVITIES

Most b r o k e r - d e a l e r s who e n g a g e i n c o m m o d i t i e s a n d s e c u r i t i e s t r a n s a c t i o n s getierally c o n d u c t b o t h i n o n e entity. Since the occurrence of t h e events described i n t h i s r e p o r t , a t l e a s t o n e major b r o k e r - d e a l e r , m o t i v a t e d i n p a r t by its e x p e r i e n c e i n t h e s i l v e r crisis and i n t h e wake o f a l o n g - t e r m s t u d y b e g u n b e f o r e t h e c r i s i s , h a s r e o r g a n i z e d i t s c o r p o r a t e s t r u c t u r e t o p l a c e i t s commod i t i e s a c t i v i t i e s i n t o a s u b s i d a r y of t h e t h e b r o k e r dealer. The c o n c e p t o f r e q u i r i n g c o m m o d i t i e s a c t i v i t i e s to be p l a c e d i n t o a s e p a r a t e s u b s i d i a r y r a i s e s p o l i c y a n d e c o n o m i c i m p l i c a t i o n s w h i c h g o beyond t h e s c o p e o f t h i s report. The d i s c u s s i o n h e r e i n i s m e r e l y t o i n f o r m t h e Commission t h a t t h i s s t r u c t u r e c o u l d b e c o n s i d e r e d

an alternative to further regulation of commodities activities. - Segregation from a broker-dealer of the 319/ risks associated with commodities trading would, in theory, protect the broker-dealer if its commodities affiliate were to experience financial difficulty because of abusive practices or significant losses. 320/ Segregation may be costly and complex. There are several major components to the additional costs associated with creating a separate subsidiary. There may be substantial start-up costs associated with the creation of the new entity. In addition, the creation of a separate subsidiary would require allocation and possibly less efficient use of total available capital in order to support regulatory minimum financial requirements in the separately capitalized entities. The financial strength of each may be reduced. Moreover, the separate entities

319/ - Putting high risk activities outside the broker-dealer

structure may remove them from effective regulation. For example, once the government securities activities of a broker-dealer are placed in a separate subsidiary of a corporate parent, generally speaking, the Uniform Net Capital Rule no longer functions to prevent the newly-formed government securities dealer from attaining over-leveraged positions. Therefore, while segregation is an alternative, it may be an alternative only at the cost of effective regulation. Thus, the staff is not recommending segregation, as it believes the detrimental effects of certain transactions are better addressed through direct analysis of their effects and appropriate regulation of those activities to insure financial stability for, and customer protection at, broker-dealers.

320/ -

It sHould be noted that in the collapse of bank-sponsored real estate investment trusts in 1974 and 1975 affiliated banks often made substantial loans or purchased assets from troubled entities in order to prevent economic disaster. Such activities are, from the point of view of the parent entity, very important, for the entry of an affiliated entity into insolvency may, at the very least, harm the reputation of the parent corporation. In addition, it may affect the ratings assigned to the parent entity's debt and thus affect the borrowing costs of the parent or the broker-dealer subsidiary.

may r e q u i r e d u p l i c a t e r e g u l a t o r y a n d f i n a n c i a l a c c o u n t i n g , a s w e l l a s o t h e r s t r u c t u r a l c o m p o n e n t s which p e r m i t s e p a r a t e e n t i t i e s t o d o b u s i n e s s c r e a t i n g a d d i t i o n a l o v e r h e a d and a s s o c i a t e d e x p e n s e s . The s i z e n e c e s s a r y t o s u p p o r t a c o m p l e x s t r u c t u r e and o v e r h e a d may n o t b e p r e s e n t i n smaller broker-dealers. The s e g r e g a t i o n c o n c e p t merits f u r t h e r s t u d y . Howe v e r , i s s u e s r a i s e d by t h e q u e s t i o n a r e complex a n d would a f f e c t a l l broker-dealers, not only those the subject of t h i s report. Thus, t h e y are b e s t a d d r e s s e d through addit i o n a l s t u d y b y t h e Commission, i n p u t f r o m t h e f i n a n c i a l community a n d t h e p u b l i c comment p r o c e s s .

APPENDIX I BACKGROUND INFORMATION O N FUTURES MARKETS

BACKGROUND INFORMATION ON FUTURES MARKETS [From CFTC, Report to Congress In Response to Section 21 of the Commodity Exchange Act (May 29, 1981)l The Operation of the Futures Market In general, commodity futures contracts on organized exchanges involve standardized agreements that obligate the contracting parties to deliver or receive a specified quantity and grade of a commodity at a certain time in the future and are ordinarily entered into for the purpose of assuming or shifting the risk of price change. Since the contracts are usually not used for merchandising the actual commodity, the parties typically cancel their contractual obligations by liquidating their futures positions through offsetting trans actions prior to the maturation of the contract. 1/ Futures contracts in the United States are lawfully tradea on eleven licensed commodity exchanges that have been designed as "contract markets." The exact terms of the futures contracts are established by the individual commodity exchanges, but the terms must be approved by the CFTC before being placed into effect. The price of a futures contract is determined by open and competitive bidding by sellers and buyers in a designated trading area (often called a "pit" or "ring") on the trading floor of the contract market. Whenever a bid or offer made in the pit is accepted, a contract is formed. The party to the contract agreeing to make delivery of the commodity is referred to as the "short". The party agreeing to take delivery of the commodity is the "long". Futures trading, however, is generally not utilized as or intended to be a vehicle for delivery of the actual commodity. Delivery occurs in approximately only 2-3 percent of all futures transactions. The remaining contracts are liquidated by offsetting transactions. Participants in commodity futures markets may be divided into three general classifications--hedgers, speculators, and spreaders. Typically, a hedger is engaged in the production, distribution, processing or consumption of the actual commodity or its byproducts. In a representative situation, the

1/ - Contract liquidation through offsetting transaction is

accomplished by selling an equal number of futures contracts against long positions or purchasing an equal number of futures contracts against short positions. The liquidating purchases or sales must have the same delivery month as the previously acquired positions.

hedger holding an inventory of the physical commodity may establish an offsetting short position in the corresponding 3 futures markets. In contrast, the speculator does not endcavor to reduce the price risk of a cash market position but rather to prof it by anticipating the price movement of a com- % ; modity in which a futures position has been established. In effect, the speculator assumes the risk of price movements that the hedger seeks to avoid. The participation of knowledgeable, price-taking speculators increases trading volume and liquidity in the market, thereby lowering transaction costs and enhancing the markets1 hedging and pricing functions.
y + ,

2 4
,

The third trading category is known as spreading. The primary motive of the traders engaging in this activity is the profitable exploitation of discrepancies between futures prices corresponding to different delivery months on the same contract market or different contract markets trading the same commodity. Since these actions tend to reduce price divergencies, spreading serves to maintain an economic link between different markets or contract months. Spreading is technically a speculative endeavor and enhances market liquidity. Generally, an individual or firm wanting to trade futures contracts must do so through an FCM that is a member of a commodity exchange or, alternatively, through a non-member FCM or foreign broker that has a customer omnibus account with a member FCM. 2/ Before a futures position can be established for a cus~omer,however, exchange-established margin requirements must be met. Under exchange rules and regulations, customers are required to deposit with member FCMs a specified sum as margin for each futures contract purchased or sold. Normally, non-member FCMs collect required margins from their customers and, in turn, deposit those funds as margin with the member FCM. Margin payments commonly consist of cash or U.S Treasury bills. Also, FCMs may engage in or arrange loan agreements whereby their customers may pledge physical commodities or other assets as collateral and thereby obtain funds for margining futures positions. The purpose of margin on futures contracts is to insure FCMs against losses on customers1 positions and ultimately to guarantee the financial integrity of the futures market. In accordance with this, there are both initial and maintenance margin levels. The initial margin is the margin posted by a customer when a new futures position is opened. The maintenance margin, which is lower than the initial margin, is the

2 -/ An exception is a firm or individual that is a clearing

member of an exchange. Such firms or individuals can trade for their own account without using an FCM.

sum t h a t m u s t b e m a i n t a i n e d o n d e p o s i t a t a l l times. If the e q u i t y i n a c u s t o m e r ' s a c c o u n t d r o p s t o or under t h e maintena n c e l e v e l b e c a u s e o f a d v e r s e p r i c e movement, t h e F M i s s u e s C a margin c a l l t o restore t h e c u s t o m e r ' s e q u i t y p o s i t i o n to t h e i n i t i a l margin l e v e l . T h i s i s u s u a l l y d o n e a t t h e close o f t h e t r a d i n g d a y when f u t u r e s a c c o u n t s a t FCMs a r e c r e d i t e d w i t h p o s i t i o n g a i n s a n d d e b i t e d w i t h p o s i t i o n losses. Minimum c u s t o m e r m a r g i n l e v e l s a r e e s t a b l i s h e d b y t h e e x c h a n g e s ; h o w e v e r , FCMs may a n d o f t e n d o r e q u i r e l a r g e r margin d e p o s i t s from a l l or s e l e c t e d customers. The e x c h a n g e s u s u a l l y set margin r e q u i r e m e n t s f o r hedge and s p r e a d p o s i t i o n s a t a lower l e v e l t h a n m a r g i n s o r s p e c u l a t i v e t r a d e s . A l s o , m a r g i n r e q u i r e m e n t s d i f f e r f o r v a r i o u s commodities and change o v e r t i m e . 3/ F o r e x a m p l e , b e t w e e n S e p t e m b e r 1 9 7 9 a n d March 1 9 8 0 , margin r e q u i r e m e n t s o n s p e c u l a t i v e p o s i t i o n s i n s i l v e r v a r i e d f r o m $ 2 , 0 0 0 t o $ 7 5 , 0 0 0 p e r c o n t r a c t o n t h e Comex a n d $ 1 , 5 0 0 t o $ 3 0 , 0 0 0 o n t h e CBQT. Although f u t u r e s t r a d e s are e x e c u t e d between exchange members, s u b s e q u e n t f i n a n c i a l t r a n s a c t i o n s a s s o c i a t e d w i t h t r a d e s , d e l i v e r i e s , or open f u t u r e s p o s i t i o n s are conducted b e t w e e n members o f t h e e x c h a n g e c l e a r i n g o r g a n i z a t i o n . 4/ A d d i t i o n a l l y , t h e c l e a r i n g o r g a n i z a t i o n s e c u r e s and assures performance o n a l l open f u t u r e s c o n t r a c t s . To t h i s e n d , c l e a r i n g o r g a n i z a t i o n s r e q u i r e t h e p o s t i n g o f margin d e p o s i t s o n o p e n a c c o u n t s o f c l e a r i n g member f i r m s . The c l e a r i n g m a r g i n c o n s i s t s o f o r i g i n a l m a r g i n , w h i c h is t h e m a r g i n o n new o p e n p o s i t i o n s , a n d v a r i a t i o n m a r g i n , w h i c h i s b a s e d upon changes i n t h e e q u i t y value o f c l e a r i n g accounts with open positions. A f t e r t r a d e s a r e executed on a n exchange, t h e c l e a r i n g o r g a n i z a t i o n t a k e s t h e o p p o s i t e s i d e o f e v e r y t r a d e and t h u s s e r v e s a s a n i n t e r m e d i a r y b e t w e e n c l e a r i n g members, a n d , i n d i r e c t l y , b e t w e e n member FCMS t h a t a r e n o t a l s o members o f the clearing organization. I f , f o r example, d u r i n g a t r a d i n g

3 -/ G e n e r a l l y , f u t u r e s m a r g i n r e q u i r e m e n t s a r e c o n s i d e r a b l y lower t h a n m a r g i n r e q u i r e m e n t s i n s e c u r i t i e s . For example, t h e minimum m a r g i n f o r s t o c k s and i n d u s t r i a l b o n d s a r e c u r r e n t l y 5 0 a n d 30 p e r c e n t r e s p e c t i v e l y , w h e r e a s s p e c u l a t i v e margin l e v e l s f o r f u t u r e s c o n t r a c t s a r e g e n e r a l l y about f i v e percent of t h e value of t h e contract. 4/ - C l e a r i n g membership is d i s t i n c t from exchange membership. Some, b u t n o t a l l , e x c h a n g e members a r e a l s o members o f t h e i r respective clearing organizations. For t h i s r e a s o n a l l t r a d e s e x e c u t e d b y a f i r m t h a t i s a member o f t h e e x c h a n g e b u t n o t a member o f t h e c l e a r i n g o r g a n i z a t i o n m u s t b e e v e n t u a l l y s e t t l e d t h r o u g h a c l e a r i n g member.

session a futures transaction is executed at $ 3 . 2 0 a bushel in a particular corn future that subsequently closes at $ 3 . 2 5 a bushel, then the short has lost 5 cents a bushel and the long has gained 5 cents a bushel. In this example, the clearing organization would collect losses from the short's clearing firm and pay the gains to the long's clearing firm. At the close of trading, accounts of members of the clearing organization are debited or credited for the change in equity value of their positions in each contract on that day. In turn, clearing members, that are also FCMs, calculate the profits or losses of each of their customerst positions at the close of trading each business day. If, as a result of trading losses, funds in a customer's account fall below the maintenance margin level, a margin call is issued to the customer. In the event the customer fails to meet the margin call in a timely manner, the FCM may liquidate some or all of the customerts positions. In some instances, the FCM may be unable to liquidate positions quickly enough and the customer account may incur further losses resulting in a deficit balance in the account. If this problem occurs simultaneously in the accounts of many small customers, or a few large customers, the net capital of the firm is used to make up the deficit and the FCM could become financially threatened. Statutory and Regulatory Financial Requirements for FCMs Several statutory and regulatory provisions have been instituted to protect the financial positions of customers from the threat of FCM insolvency. Under the segregation provisions of the Commodity Exchange Act, an FCM is prohibited from using the equity in one customerts account to offset a deficit in another customer's account. 5/ The Commodity Exchange Act requires that funds received by an FCM for margining customer trades must be accounted for separately and must be segregated from the operating funds of the FCM. Under Commission (CFTC) regulations, if an individual customer's account has a deficit balance, the carrying FCM must deposit its own funds to compensate for the deficiency, thus, any customer's losses that exceed the level of deposits or equity in the customer's account and result in a deficit balance must be paid to the clearinghouse by the FCM from its own funds.

5/ -

he Commodity Exchange Act, as amended, Section 4d(2) , 7 U.S.C. Section 6d(2).

In the event of FCM insolvency, customers' financial interests should find adequate protection, so long as CFTC segregation provisions have been maintained. The use of equity from one customer's account as margin for other accounts is prohibited, and the financial positions of customers should be unaffected by FCM insolvency. However, if an insolvent firm violated account registration requirements, customer compensation can only be obtained through legal action against the firm's assets. Also, the insolvency of an individual firm could involve other bankruptcy-related litigation and, if the firm's assets are frozen by judicial action, there could be substantial delays in the return of customers' funds. In addition, there may be insufficient funds remaining in the estate of a bankrupt firm to fully set,tle all customer claims. To permit early detection of FCM-related financial difficulties and financially protect their customers, the CFTC has established minimum financial requirements that must be met by FCMs. 6/ The CFTC regulations also include an early warning system under which FCMs must notify the Commission (CFTC) and their designated self-regulatory organization if they are experiencing financial difficulty. At the onset of the study period, June 30, 1979, each person registered as an FCM was required to maintain net capital amounts equal to or in excess of the greater of $50,000 or 6-2/3 percent of aggregate indebtedness, or alternatively, four percent of segregated funds. 7/ Exchanges can, however, set financial requirements for their members which meet or exceed CFTC standards. An FCM violating CFTC standards can be required to transfer all customer accounts, trade for liquidation purposes only or cease business operations. The clearing organization has the responsibility of reconciling the trading liabilities between FCMs that are clearing members. As a result, defaulting clearing-member FCMs are responsible directly to the clearing organization

6/ - 17 C.F.R.

Section 1.17a(l) (1980).

7/ - The $50,000 per person net capital requirement applies

only to FCMs who are members of a designated self-regulatory organization. For non-members, net capital of $100,000 per person is required. Changes to these requirements have been recently proposed by the Commission (CFTC) Some of the proposals have been adopted; others remain under review. Note also that FCMs dealing in security markets could satisfy CFTC Minimum Financial Requirements if they maintain net capital equal to four percent of aggregate debit items in accordance with Securities and Exchange Commission requirements.

for these l i a b i l i t i e s . I f t h e m a r g i n d e p o s i t s and o t h e r assets o f t h e d e f a u l t i n g FCM a r e i n s u f f i c i e n t t o c o v e r i t s o b l i g a t i o n s , c l e a r i n g o r g a n i z a t i o n s have v a r i o u s c o n t i n g e n c i e s f o r meeting t h e deficiency. The m a j o r commodity e x c h a n g e s u s e s i m i l a r m e t h o d s t o restore d e f i c i t s , r e s u l t i n g from member d e f a u l t , i n t h e c l e a r i n g o r g a n i z a t i o n ' s a c c o u n t s . The p r i n c i p a l s o u r c e s o f funds f o r r e s t o r a t i o n of such a d e f i c i t a r e excess o p e r a t i o n a l and c a p i t a l f u n d s , s e c u r i t y d e p o s i t s o f c l e a r i n g members, and membership a s s e s s m e n t s .

APPENDIX I1 GLOSSARY

GLOSSARY 1/ Aggregation: The d i s c o u n t s u n d e r which a l l f u t u r e s p o s i t i o n s owned o r c o n t r o l l e d by o n e t r a d e r a r e combined t o d e t e r mine r e p o r t i n g s t a t u s a n d s p e c u l a t i v e l i m i t c o m p l i a n c e . Appreciation: An i n c r e a s e i n v a l u e .

Back Month: Any m a t u r i t y o f f u t u r e s c o n t r a c t s f o r a p a r t i c u l a r commodity o t h e r t h a n t h e s p o t month. [Source: Commodity E x c h a n g e , I n c . , O r i g i n a l M a r g i n R u l e Q . l . ( b ) ( 1 9 8 2 ) l . - d e f i n i t i o n o f " s p o t " , below. See Break:
A r a p i d and s h a r p p r i c e d e c l i n e .

Cash Commodity: The p h y s i c a l o r a c t u a l commodity a s d i s t i n g u i s h e d f r o m t h e " f u t u r e s I 1 . Sometimes c a l l e d s p o t commodity or a c t u a l s . Cash P r i c e : The p r i c e i n t h e m a r k e t p l a c e f o r a c t u a l c a s h o r s p o t commodities t o be d e l i v e r e d v i a customary m a r k e t channels. C e r t i f i c a t e d o r C e r t i f i e d Stocks: S t o c k s o f a commodity t h a t have been i n s p e c t e d and found to be of a q u a l i t y d e l i v e r a b l e against futures contracts, stored a t the delivery points d e s i g n a t e d a s r e g u l a r o r a c c e p t a b l e f o r d e l i v e r y by t h e commodities exchange. C l e a r i n g House: An a d j u n c t t o a commodity e x c h a n g e t h r o u g h which t r a n s a c t i o n s e x e c u t e d o n t h e f l o o r o f t h e e x c h a n g e a r e s e t t l e d . A l s o charged with a s s u r i n g t h e proper conduct of t h e exchange's d e l i v e r y procedures and t h e adequate financing of the trading. C l e a r i n g Member: A member o f t h e C l e a r i n g House o r A s s o c i a t i o n . A l l t r a d e s o f a n o n - c l e a r i n g member m u s t b e r e g i s t e r e d a n d e v e n t u a l l y s e t t l e d t h r o u g h a c l e a r i n g member. The number o f c o n t r a c t s i n Commitment o r Open I n t e r e s t : e x i s t e n c e a t a n y p e r i o d o f time w h i c h h a v e n o t a s y e t b e e n s a t i s f i e d by a n o f f s e t i n g s a l e o r p u r c h a s e o r b y a c t u a l contract delivery.

1/ - Source ( u n l e s s noted):

CFTC, G l o s s a r y o f Some Terms Commonly Used I n t h e F u t u r e s T r a d i n g I n d u s t r y ( G o v e r n ment P r i n t i n g O f f i c e , 1 9 8 0 )

Congestion: (1) A c o n g e s t e d m a r k e t s i t u a t i o n , b a s i c a l l y , i s a s i t u a t i o n i n which t h e m a r k e t i s " c l o g g e d " . When s h o r t s a t t e m p t to c o v e r t h e i r p o s i t i o n s t h e y are n o t l i k e l y t o f i n d a n a d e q u a t e s u p p l y o f c o n t r a c t s p r o v i d e d by l o n g s w i l l i n g t o l i q u i d a t e o r by new s e l l e r s w i l l i n g t o e n t e r t h e market, except a t sharply higher p r i c e s . A congested m a r k e t s i t u a t i o n i s o n e w h i c h is l i k e l y t o r e s u l t i n a " n a t u r a l " s q u e e z e o r which c o u l d b e e x p l o i t e d b y a manip u l a t o r ; ( 2 ) i n t e c h n i c a l a n a l y s i s , a n era o f r e p e t i t i o u s and l i m i t e d p r i c e f l u c t a t i o n s . D e p o s i t o r y o r Warehouse R e c e i p t : A d o c u m e n t i s s u e d by a b a n k , warehouse or o t h e r d e p o s i t o r y i n d i c a t i n g ownership of a s t o r e d commodity. I n t h e case o f many c o m m o d i t i e s d e l i v e r a b l e a g a i n s t f u t u r e s c o n t r a c t s , t r a n s f e r of ownership-of an a p p r o p r i a t e d e p o s i t o r y r e c e i p t may e f f e c t c o n t r a c t d e l i v e r y . Equity: The r e s i d u a l d o l l a r v a l u e o f a f u t u r e s t r a d i n g a c c o u n t a s s u m i n g i t were l i q u i d a t e d a t c u r r e n t p r i c e s . Excess: The d o l l a r amount by w h i c h t h e e q u i t y e x c e e d s t h e m a r g i n r e q u i r e m e n t s i n a t r a d e r ' s commodity f u t u r e s a c c o u n t .
A t r a n s a c t i o n i n which t h e b u y e r o f a Exchange f o r P h y s i c a l : c a s h commodity t r a n s f e r s t o t h e s e l l e r a c o r r e s p o n d i n g amount o f l o n g f u t u r e s c o n t r a c t s , o r r e c e i v e s f r o m t h e s e l l e r a c o r r e s p o n d i n g amount o f s h o r t f u t u r e s , a t a p r i c e d i f f e r e n c e m u t u a l l y a g r e e d upon. I n t h i s way, t h e o p p o s i t e hedges i n f u t u r e s of both p a r t i e s are closed o u t simultaneously.

EX-pit Transaction: Trades executed, f o r c e r t a i n t e c h n i c a l purposes, i n a l o c a t i o n o t h e r t h a n t h e r e g u l a r exchange t r a d i n g p i t or r i n g . ~ u t u i e sCommission M e r c h a n t : Individuals, associations, p a r t n e r s h ' i p s , c o r p o r a t i o n s and t r u s t s t h a t s o l i c i t or a c c e p t o r d e r s f o r t h e p u r c h a s e o r s a l e o f a n y commodity f o r f u t u r e d e l i v e r y on or s u b j e c t to t h e r u l e s o f any c o n t r a c t m a r k e t and t h a t a c c e p t p a y m e n t f r o m o r e x t e n d c r e d i t t o t h o s e whose o r d e r s a r e a c c e p t e d . (1) I n d e t e r m i n i n g w h e t h e r a s s e t s meet c a p i t a l Haircut: requirements, a percentage reduction i n t h e s t a t e d value o f assets; ( 2 ) i n computing t h e w o r t h o f assets d e p o s i t e d as c o l l a t e r a l or margin, a r e d u c t i o n from m a r k e t v a l u e . Hedging: Taking a p o s i t i o n i n a f u t u r e s market o p p o s i t e t o a p o s i t i o n h e l d i n t h e c a s h market t o minimize t h e r i s k o f f i n a n c i a l l o s s f r o m a n a d v e r s e p r i c e c h a n g e ; a p u r c h a s e or sale of f u t u r e s as a temporary s u b s t i t u t e f o r a c a s h t k a n s a c t i o n t h a t w i l l occur later.

~ n i t i a l a r g i n : C u s t o m e r s ' f u n d s p u t up a s s e c u r i t y f o r a m g u a r a n t e e of c o n t r a c t f u l f i l l m e n t a t t h e t i m e a f u t u r e s market p o s i t i o n is e s t a b l i s h e d . L i m i t (Up o r Down): The maximum p r i c e a d v a n c e o r d e c l i n e from t h e p r e v i o u s d a y ' s s e t t l e m e n t p r i c e p e r m i t t e d i n o n e trading session. L i m i t Move: A p r i c e t h a t h a s a d v a n c e d o r d e c l i n e d t h e p e r m i s m e l i m i t p e r m i t t e d d u r i n g one t r a d i n g s e s s i o n , as f i x e d by t h e r u l e s o f a c o n t r a c t m a r k e t . Liquidation: Making a t r a n s a c t i o n t h a t o f f s e t s or c l o s e s o u t a long f u t u r e s position. Long: (1) One who h a s b o u g h t a f u t u r e s c o n t r a c t t o e s t a b l i s h a m a r k e t p o s i t i o n ; ( 2 ) a m a r k e t p o s i t i o n which o b l i g a t e s t h e h o l d e r t o t a k e d e l i v e r y ; ( 3 ) o n e who owns a n i n v e n t o r y of commodities. Margin: The amount o f money or c o l l a t e r a l d e p o s i t e d by a c l i e n t w i t h h i s b r o k e r , or by a b r o k e r w i t h t h e c l e a r i n g h o u s e , f o r t h e p u r p o s e o f i n s u r i n g t h e b r o k e r or c l e a r i n g h o u s e a g a i n s t loss o n o p e n f u t u r e s c o n t r a c t s . The m a r g i n i s n o t a p a r t payment o n a p u r c h a s e . (1) O r i g i n a l o r i n i t i a l m a r g i n i s t h e t o t a l amount o f m a r g i n p e r c o n t r a c t r e q u i r e d by t h e b r o k e r when a f u t u r e s p o s i t i o n i s o p e n e d , ( 2 ) M a i n t e n a n c e m a r g i n is a sum which must be m a i n t a i n e d o n d e p o s i t a t a l l times. I f a c u s t o m e r ' s e q u i t y i n a n y f u t u r e s p o s i t i o n d r o p s t o or u n d e r t h e l e v e l b e c a u s e of a d v e r s e p r i c e a c t i o n , t h e b r o k e r must i s s u e a margin c a l l t o restore t h e c u s t o m e r ' s e q u i t y . Margin C a l l : A r e q u e s t f r o m a b r o k e r a g e f i r m t o a c u s t o m e r t o b r i n g m a r g i n d e p o s i t s u p t o minimum l e v e l s - ( 2 ) a r e q u e s t by t h e c l e a r i n g h o u s e t o a c l e a r i n g member t o b r i n g c l e a r i n g m a r g i n s b a c k t o minimum l e v e l s r e q u i r e d by t h e clearinghouse rules.
N e t Position:

The d i f f e r e n c e b e t w e e n t h e o p e n l o n g c o n t r a c t s a n d t h e o p e n s h o r t c o n t r a c t s h e l d i n a n y o n e commodity.

Omnibus A c c o u n t : An a c c o u n t c a r r i e d by o n e f u t u r e s commission m e r c h a n t w i t h a n o t h e r f u t u r e s commission m e r c h a n t i n which t h e t r a n s a c t i o n s o f t w o o r more p e r s o n s a r e combined a n d c a r r i e d i n t h e name o f t h e o r i g i n a t i n g b r o k e r r a t h e r t h a n designated separately. Open I n t e r e s t : The sum o f f u t u r e s c o n t r a c t s t o o n e d e l i v e r y month or orie m a r k e t t h a t h a s b e e n e n t e r e d i n t o a n d n o t y e t l i q u i d a t e d by a n o f f s e t t i n g t r a n s a c t i o n o r f u l f i l l e d byp d e l i v e r y . A l s o c a l l e d " o p e n c o n t r a c t s " or "open commitments".

O r i g i n a l M a r g i n : Term a p p l i e d t o t h e i n i t i a l d e p o s i t o f m a r g i n money r e q u i r e d o f c l e a r i n g member f i r m s b y c l e a r i n g h o u s e r u l e s ; p a r a l l e l t o t h e i n i t i a l m a r g i n or s e c u r i t y d e p o s i t r e q u i r e d o f c u s t o m e r s by exchange r e g u l a t i o n s . P o s i t i o n : An i n t e r e s t i n t h e m a r k e t , e i t h e r l o n g o r s h o r t , i n t h e f o r m o f o n e o r more o p e n c o n t r a c t s . The maximum p o s i t i o n , e i t h e r n e t l o n g o r n e t Position Limit: s h o r t , i n o n e commodity f u t u r e or i n a l l f u t u r e s o f o n e c o m m o d i t y c o m b i n e d w h i c h may be h e l d o r c o n t r o l l e d b y o n e p e r s o n a s p r e s c r i b e d b y a n e x c h a n g e o r by t h e CFTC. P r i c e Movement L i m i t : Maximum p r i c e a d v a n c e o r d e c l i n e f r o m t h e p r e v i o u s d a y ' s s e t t l e m e n t p r i c e p e r m i t t e d f o r a commodity i n one t r a d i n g s e s s i o n . Pryamiding: The u s e o f p r o f i t s o r e x i s t i n g f u t u r e s p o s i t i o n s as margin to increase t h e s i z e of t h e p o s i t i o n , normally i n s u c c e s s i v e l y smaller i n c r e m e n t s .
R o l l Forward:

L i f t i n g a n e a r f u t u r e s p o s i t i o n a n d ree s t a b l i s h i n g i t i n a more d e f e r r e d d e l i v e r y m o n t h .

S e t t l e m e n t or S e t t l i n g P r i c e : The d a i l y price a t which t h e c l e a r i n g h o u s e clears a l l t r a d e s and settles a l l a c c o u n t s b e t w e e n c l e a r i n g members f o r e a c h c o n t r a c t m o n t h . Settlement prices are used t o d e t e r m i n e b o t h margin c a l l s and invoice prices f o r deliveries. The term a l s o r e f e r s t o a p r i c e e s t a b l i s h e d by t h e e x c h a n g e to e v e n u p p o s i t i o n w h i c h may n o t b e a b l e t o b e l i q u i d a t e d i n r e g u l a r t r a d i n g .
(1) The s e l l i n g s i d e o f a n o p e n f u t u r e s c o n t r a c t ; ( 2 ) Short: a t r a d e r whose n e t p o s i t i o n i n t h e f u t u r e s m a r k e t shows a n e x c e s s o f open s a l e s o v e r open purchases.

S p e c u l a t o r : An i n d i v i d u a l who does n o t h e d g e , b u t who t r a d e s i n commodities f u t u r e s with t h e o b j e c t i v e of achieving p r o f i t s t h r o u g h t h e s u c c e s s f u l a n t i c i p a t i o n o f p r i c e movements. Spot: Market o f immediate d e l i v e r y o f t h e p r o d u c t and immediate payment. A l s o r e f e r s to t h e n e a r e s t d e l i v e r y month o n f u t u r e s c o n t r a c t s . S p o t Commodity: The a c t u a l c o m m o d i t y a s d i s t i n g u i s h e d f r o m futures. Same a s A c t u a l s or C a s h Commoditv. Spot Price: The p r i c e a t w h i c h a p h y s i c a l c o m m o d i t y i s s e l l i n g a t a g i v e n t i m e and p l a c e . Same a s C a s h P r i c e .

S p r e a d ( o r S t r a d d l e ) : The p u r c h a s e o f o n e f u t u r e s d e l i v e r y month a g a i n s t t h e s a l e o f a n o t h e r f u t u r e s d e l i v e r y month o f t h e same c o m m o d i t y , t h e p u r c h a s e o f o n e d e l i v e r y month o f o n e commodity a g a i n s t t h e s a l e o f t h a t same d e l i v e r y month o f a d i f f e r e n t c o m m o d i t y , o r t h e p u r c h a s e o f o n e commodity i n o n e m a r k e t a g a i n s t t h e s a l e o f t h a t comm o d i t y i n a n o t h e r m a r k e t , t o t a k e a d v a n t a g e o f and p r o f i t from a change i n p r i c e r e l a t i o n s h i p s . The term " s p r e a d " i s a l s o used to r e f e r t o t h e d i f f e r e n c e between t h e p r i c e o f o n e f u t u r e s month a n d t h e p r i c e o f a n o t h e r month o f t h e same commod i t y

S w i t c h : O f f s e t t i n g a p o s i t i o n i n o n e d e l i v e r y month o f a commodity and s i m u l t a n e o u s i n i t i a t i o n of a similar p o s i t i o n i n a n o t h e r d e l i v e r y month o f t h e same commodity. Transfer Trades: E n t r i e s made u p o n t h e b o o k s o f f u t u r e s c o m m i s s i o n m e r c h a n t s f o r t h e p u r p o s e o f (1) t r a n s f e r r i n g e x i s t i n g t r a d e s from one a c c o u n t to a n o t h e r w i t h i n t h e same o f f i c e w h e r e n o c h a n g e i n o w n e r s h i p i s i n v o l v e d or ( 2 ) t r a n s f e r r i n g e x i s t i n g t r a d e s from t h e books o f one commission merchant t o t h e books o f a n o t h e r commission m e r c h a n t where no c h a n g e i n o w n e r s h i p is i n v o l v e d ; ( 3 ) exchanging f u t u r e s f o r c a s h commodities; ( 4 ) exchanging f u t u r e s p o s i t i o n s , o n e o f which w a s t a k e n t o f i x t h e p r i c e o f a commodity i n v o l v e d i n a c a l l s a l e . V a r i a b l e Limit Margins: The p e r f o r m a n c e d e p o s i t r e q u i r e d w h e n e v e r t h e d a i l y t r a d i n g l i m i t s o n p r i c e s o f a commoIn d i t y are r a i s e d i n a c c o r d a n c e w i t h exchange r u l e s . p e r i o d s o f e x t r e m e p r i c e v o l a t i l i t y , some e x c h a n g e s p e r m i t t r a d i n g a t p r i c e l e v e l s t h a t exceed r e g u l a r d a i l y l i m i t s . A t s u c h times, m a r g i n s a l s o a r e i n c r e a s e d . Warehouse R e c e i p t : A document e v i d e n c i n g p o s s e s s i o n by a w a r e h o u s e ( l i c e n s e d u n d e r t h e U.S. Warehouse A c t , o r u n d e r t h e l a w s o f a s t a t e ) o f t h e commodity named i n t h e r e c e i p t . Warehouse r e c e i p t s , t o b e t e n d e r a b l e o n f u t u r e s c o n t r a c t s , must be n e g o t i a b l e r e c e i p t s c o v e r i n g commodities i n wareh o u s e s r e c o g n i z e d f o r d e l i v e r y p r u p o s e s by t h e e x c h a n g e o n which such f u t u r e s c o n t r a c t s are t r a d e d .

APPENDIX I11 SUMMARIES OF HUNT-RELATED ACCOUNTS WITH BROKER-DEALERS

PRELIMINARY NOTE This appendix contains, for selected dates before and during the silver crisis, summaries of aggregate Hunt family and related entities' positions with the broker-dealers the subject of this report. The summaries of positions with broker-dealers are derived exclusively from the monthly statements and daily commodity account profiles generated in the automated bookkeeping systems of those firms and produced to the Commission. The summaries of Hunt positions with Bache Group's two non-broker-dealer subsidiaries are derived from account statements and other documentation produced to the Commission.

21

2 l
dl1

1 iii iff iii ii! iif B11 iii iiB 1ii iii i1i

911 9i1 ii1 g"$g i 1

B3 au% Ii1 ri1 $3 at; d tjj% 5i% a#

NOTES TO THE BACHE GROUP POSITION SUMMARY 1/ - All Hunt-related accounts with each Bache Group subsidiary are aggregated. 2/ - Unrealized profit (loss) on futures positions is computed using futures prices.
3/ - Treasury bills are valued at face.
4 -/

Stocks are valued at full market value. Group stockholdings are not included.

The Hunts' Bache

5/ - Does not include the value of 159 bags of silver coins.

6/ -

Unless otherwise noted, positions with Bache Halsey are shown as they appear in its monthly statement and daily commodity account profiles. This summary is prepared on a cash basis and, after March 25, may not reflect adjustments for debits or credits attributable to settlement of, or later adjusting entries for, transactions that occurred on dates shown in the table. Bache Halsey's practice during the crisis was to book all liquidating transactions in the Hunt accounts into a single account, later reclassifying the transactions and proceeds as needed to close out the various Hunt family positions. As a result of this practice, Commission broker-dealer examiners have been unable to entirely reconcile account documentation for the period of the Hunt liquidations as generated by Bache Halsey's autom~tedbookkeeping system with documents manually prepared at the time, with other information supplied to the Commission by Bache Halsey and with the testimony of witnesses. futures position with Bache Halsey includes 150 contracts and a corresponding unrealized loss attributable to the Huddlestons' 750,000 ounce long forward position on LME. On March 25 and thereafter, that position and the associated losses are shown in account with Bache London to reflect the March 24 reledgering of that position.

7/ - For January 31, February 29 and March 14, 1980, the Hunt

8/ - Physical silver received by Bache Halsey as collateral for margin calls is valued prior to liquidation at spot prices and included in stated equity (deficit). Such collateral is shown remaining in account at Bache Halsey following liquidation until the date upon which it was delivered in settlement of the transaction effecting the liquidation. In the interim, the collateral is valued at the trade price and included in stated equity. an accrual basis, with loan amounts outstanding being reduced as of the trade dates of collateral sales.

9/ - Liquidation of Bache Metals' loan collateral is shown on

tLHP P

EmITEs R I -

L m M , PIm33,

(Silver, other Assets,

uxlm M Elpity)

m,MC.

SILVER
PtIYSICAt HWCROF nwm'

I
clxxs
~

OTBER

ASSETS

ORm!nmms
m aces> 1/
Z r n

VALUE

July 31, 1979 lhrnt M l y WC Placid

RIROD
m d m

Dec. 31. 1979

Hunt P a l l y WC Placid

HIROD
Fennd 'XIWI.

,+
I

Jan. 31. 1980 Hunt R a i l y

Placid

mc

'

Feb. 29, 1980

Hunt m l l y
WC placid

HIROD
rmlmd

Mr. 14, 1980 Hrnt PBlily Placid

mc

HIROD

Mr. 25, 1980 Hunt F a i l y

mc

Pkld

'

HIROD RRuod
- .

C
-I0 U W

0 .

2
4

or a m 5 0 4 c
P I 4 4
4

PI

I X a 0 m m

:sN z
uwu m 1 UO

5z
Urn am 4 0 0 4 5 c
--I

>S

ZQ

.- Z m PI SSU
4 5 z 0 u CUC -(OX m Ll u U

u c u

ZES
l u X n

SRS

o , : v c u o U-I U 4 w 4
4

uq 04
C 4
0

4 U

5 - r

U C.* C u b u > u UU 0 2 s mu NU5 ux.*

C-I C

"2 !rm
""0

o n u

-3:

u4 OUY u-I t Urn

2-24

EZ A m
u c u

5::

w t u Ncm

$5

9&3' 2 :

un. u 4 om4 O-IX wWz . w e n a 0 2 U> - 0I 4 u u m u4-I a 3 4 1 u u r n 4 4 .rn u d m 0 4WU h > q a o r

= ; I

I$ , , fl
Yt
4

8 8 jlra:k "
1 1 ;
N

h sgao:I 898,
I"? Fis 4
1 1

$(+++ 8 8 8% 8; <:I 3s zz 3 ZCWE : ~ ~ ! ! 2

mm

L
U

a a

mwooo
I I

a .! 5

Be!

--bjblb : a -- I I BB
2
I l l

q3:::
4

I-I. I rl-1000

-E
I.N

?: ?

~E E I ~ I
4

--

I
I

w 8 o o o

-I :

I I

p.

5-1

mm
1
S I L V E R

y P 0 6 r m ~ . P .m m L OD. IK. m (Silver, other - a t, LGans And Equity)

OTHER

1
ASSETS

J d y 31, 1979
Dee. 31, 1979

Jan. 31, 1980

Peb. 29, 1980
k.14, 1980

J nxasucy bilL valued at faoe. 2

1/ StDcks valued a t full market value.

u 01 h r c h 27, 28 a net futures p i t h include8 a r t p i t - establbhed in thed a31,mtheas prt of tk liquidation of lamhcollateral h o ~t
ard the lag futures p i t i o n .
&ea not tefLect eubsequmt entries tht

Ihe net futrnee p i t i o n presented herein closed out these poaitiolm.

, W PMLY AN) R E l X E X l PlTITIeS POGITIaGPAINE WEBEER

IK.

(Silver h t u r e s , Other Assets,

S I L V E R

LDaM A d Elpity)

O T H E R

A S S E T S
SlccKScamER

PFaTIKIoss> 1/ J u l y 31, 1979 Hurt m i 1 y Placid <6,588,756> 0 <6,588,=

BILIA 2/

3/

kc. 31, 1979 H u r t Fanily PlAcid TOTAt

Jan. 31, 1980 H u r t PBnily Placid

3-m-668 v ,

9,280,000 0

- -

xi-%%
-0 59,661,790 ,661,
-0101,702,850 101,702r850 -0107,095,125

-0-

<3r096r0U> -0<3,096,041> <22,920,288> -0<Z,920,288> <38,168,419> 0

24,815,000 -04,815,006 25,115,000 0 25,115,006

- -

Rb. 29, 1980

B u r t E'adly Placid

TowL
W. 14, 1980

- -

41r425,000 0

- -

H u r t Family Placid

<36,954,581> 0 <36,951,581> <48,064,046> -0-

40,985,000 -020,985,000 40,985,000 0 40,985,O od

0 94,326,000 34 ,326, ~6 -0-

- -

W. 25, 1980

Hurt Fadly Pkid

>-<

- -

W. 26, 1980 H u r t -fly

Placid

m .

<46,907,893> -0-

<Kmm5
>-<
<17,966,868> 0

40,985,000 -04a;mmrw 9,42Sr000 -0-

-0-

% E %
-0-

Uar. 27, 1980

H u r t Psnily Placid

- -

TOTAL
W. 28, 1980

u;rp;wa

%%E %%?Ei
-0-

Hurt m i l y Placid

m 'nYrAL -

<2,1SrS31> -0<2,265,m - 00 --

-0-0-0- 0 -

- 0

Mar. 31, 1900

Bunt m f l y Placid
Apr. 30, 1980

%%%
-0-

H u r t Psnily Placid

-0-0l m d -it f i

-0-0-

m -

( l a r ) an f u t u r u p ~ i t ir c a p h d u s i q fumrea p r i e s . h

y munury b i l l . valued a t fete. y stocks v a l d a t f u l l market vdU3.

H l FAMILY POSITIONS-DEAN WI'ITER REXWLtCG W' ( S i l v e r Futures, Other Assets, And Equity)

S I L V E R
NET FmuREs FCSITION

OTHER 'FVNRES UNREALIZED PKW IT <LOSS> 1/

A S S E T S <DEBIT> CREDIT
BALANCES
Jawl"y

PROFIT

<DEFIC IT

July 31, 1979

- 0 -.
3,800 23 ,.895 <656,502>

<3,344,704> <31,480,871> <23,364,047> <21,134,256> <13,983,799> <2,975,838> <2,975,838> <4,377,475> <22,827,638> <22,836,143> <3,651,648>

3,597,171 12,017,079 11,857,198 28,984,054 24,165,851 22,735,720 20,224,584 18,100,047 4,621,312 4,555,532 4,974,364

Jan. 31, 1980

H H

M r 14, 1980 a.
M a r . 25, 1980 Mar. 26, 1980

<1,126,575>

I I-'

U r 373 , 317>
<1,438,340> <232,140> - 0 - 0 -

Mar. 27, 1980

M a r . 28, 1980 Mar. 31, 1980
Apr. 30, 1980

-0-

1/ 2/ 3/ -

Unrealized p r o f i t and loss ccmputed using f u t u r e s prices. Treasury B i l l s valued a t f a c e . Stocks valued a t f u l l market value.

HUNT FAMILY PCGITICNS--A.G. EWAFC6 & SONS, INC. ( S i l v e r Futures, Treasury B i l l s And Equity)

S I L V E R
NET FWIVRES WGITION NUMBER OF (DIvmACTS PFOFIT W<SHOKT) <I13SS> 1/

TREASURY BILLS 2/

<DEBIT)

CREDIT BATANCES 114,935 <14,455,303> 28,401 1,284,940 4,084,940 6,510,000 6,510,000 6,510,000 <5,989,000> <5,989,000> - 0 -

@xJITy <DEFICIT>
27,935 3,001,072 1,468,401 2,419,940 2,574,940 lr500,000 1,000,000 500,000 <4,024,700> (4,081,544)

July 31, 1979

Dee. 31, 1979

100 200 100 100 100 100 100 100

<172,000> 15,641,375 (375 1000> <830,000> <31475,000> <6,975,000> <7,475,000> <7,975,000> - 0 - 0 - 0 -

85,000 1,815,000 1,815,000 1,965,000 1,965,000 1,965,000 1,965,000 1,965,000 1,965,000 1,908,156

Jan. 31, 1980

Feb. 29, 1980

M r 14, 1980 a. Mar. 25, 1980

Mar. 26, 1980

Mar. 27, 1980

Mar. 28, 1980

-0- 0 - 0 -

Mar. 31, 1980

A e 30, 1980 w

-0-

1/ - Unrealized prof it (loss1 cc~nputedusing f u t u r e s p r i c e s . 2/ Treasury B i l l s valued a t face.