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Businessweek Archives

Fathoming Whitewater



Judging by the baying of vengeful Republicans around the country and armies of investigative reporters camped out in Little Rock, Bill and Hillary Clinton's controversial Whitewater Development Corp. real estate investment threatens to become a scandal capable of capsizing a Presidency. Now that the Clintons reluctantly have bowed to the public clamor and asked for a special counsel to probe the matter, some Washington insiders say it may be just a matter of time before the First Couple is implicated in wrongdoing.

The special counsel will have plenty to investigate. The complex assemblage of allegations, popularly dubbed "Whitewatergate," involves influence peddling, illegal campaign contributions, improper diversion of funds, and conflicts of interest. The web of business and political ties may have seemed routine in the incestuous small-town atmosphere of Little Rock, but it takes on a shadier cast when Washington turns a spotlight on it.

NO SURPRISES? Lending credence to these charges is the White House's suspicious behavior, such as the Clintons' stubborn reluctance to disclose Whitewater records and the removal of Whitewater documents from the office of Deputy White House Counsel Vincent Foster Jr. shortly after his suicide last July.

But considerable evidence, including government documents and statements from several of the key players, suggests that the Whitewater case could end with a whimper, not a bang. There is certainly a chance the special counsel could turn up damning new evidence, for many facets of Whitewater remain murky. Even if that kind of evidence doesn't materialize, it's still quite possible that the Clintons will be found to have committed minor infractions or indiscretions.

But the odds that the Clintons will face formal charges appear slim. "The allegations have been blown up way, way out of proportion," says Thomas P. Vartanian, a former senior thrift regulator under several administrations. The Clintons have denied wrongdoing.

One major reason for skepticism is that the government has already looked into many of the dealings of Whitewatergate's central figure, James B. McDougal, the Clintons' partner in Whitewater and majority owner of Madison Guaranty Savings & Loan. Madison was taken over by the government in 1989 at a cost of $50 million. Although McDougal and Madison have been investigated by five federal agencies, prosecutors have come up empty-handed.

Four years ago, for instance, the feds took McDougal to court on fraud charges stemming from two sales of largely undeveloped real estate in south Little Rock to Madison insiders, including brothers of McDougal's wife Susan. According to the government, McDougal and Madison engaged in various sham transactions to inflate his pay, since McDougal received a bonus tied to sales from Madison's real-estate arm.

The trouble for the government's case was that McDougal never cashed out any of the more than $100,000 in bonuses he accrued from Madison's real-estate sales, some of it from these transactions. And McDougal's attorney, Sam T. Heuer, noted at trial that both buyers appeared to be serious investors because they later made moves to develop the properties, including personally paying for legal fees and site surveys.

That suggested to the jury that the deals weren't rigged to line McDougal's pockets--and that McDougal's unwarranted optimism about real estate coupled with a lax management style, rather than fraud, led to Madison's downfall. "In my mind, I didn't think McDougal was greedy," recalls jury foreman Gene Stumbaugh. "I just think he lost control." McDougal was acquitted after just six hours of jury deliberation.

Challenges facing the special counsel range far beyond the record of McDougal's prosecutions. The credibility of several likely prosecution witnesses, including former Madison employees who admitted at McDougal's trial that they altered thrift documents, will be at issue. And the statute of limitations for civil cases will lapse in March. That will force the special counsel to seek criminal charges, which require a far tougher standard of proof.

Much of the special counsel's investigation is expected to focus on four major sets of allegations:

--The Whitewater payoff. Critics contend that McDougal, whose thrift was regulated by the state of Arkansas and the federal government, gave the Clintons a financial boost in return for lax oversight.

It's hard to make the case that Whitewater was such a payoff. McDougal and Clinton were longtime friends, having met in 1968 when the two were campaigning for then-Senator J. William Fulbright. In 1978, McDougal was four years away from buying Madison, and Clinton was state Attorney General. When McDougal bought Madison in 1982, Clinton was out of office.

The venture has been characterized as a sweetheart deal for the Clintons because they received a 50% stake yet put up no money. But neither did McDougal. He says the Clintons were entitled to their share because they borrowed half of the initial $203,000 investment--all of which was financed by adjustable-rate loans.

According to McDougal, the project was doomed almost from the outset. Shortly after the partners purchased 230 acres along the White River, interest rates shot up as high as 20%, sharply hiking the partners' interest costs. Problems with the survey cost $20,000 to correct and helped stall the project for nearly a year. "The project was crippled going in," says McDougal. "Toward the end, I just wanted to liquidate it."

While the ownership was 50-50, McDougal says he poured in more money for capital improvements than the Clintons did. By his reckoning, McDougal lost $115,000, while the Clintons lost $9,000. McDougal thought he was more entitled to the tax losses, so he bought out the Clintons for $1,000 in December, 1992--a transaction handled by Foster. McDougal, who says he gave all his Whitewater records to the Clintons, disputes a report done for the Clinton campaign that pegged the couple's loss at $68,900. Whether the loss was $9,000 or $68,900, it's hard to call it a reward to the Clintons.

Some critics wonder why the Clintons never took a tax deduction for the loss if they in fact lost money on the deal. A senior White House aide says that's because the First Family would have been limited to a $3,000 deduction each year for a passive loss--or about a $900 tax savings. As incoming President, Clinton knew he would be audited, and the legal costs of documenting the loss could have exceeded the tax break.

Why did the Clintons stick with Whitewater? The aide says that by the time Clinton became governor again in 1983, Whitewater was already a lost cause. But if McDougal had bought the Clintons' stake, it would have looked as if someone who ran a state-regulated business was bailing the governor out. The Clintons felt it was better politically to stick with the investment rather than to take the flack. "They were stuck with a bad deal," the aide says.

McDougal didn't seem to get anything out of the arrangement either. Republicans contend that in exchange for their interest in Whitewater, the Clintons helped keep the ailing Madison open during the mid-1980s, when it should have been closed.

That ignores what was going on at the time in the thrift industry. Buffeted by a real estate slump, the industry was imploding. The problems at Texas S&Ls supervised by the Dallas office of the Federal Home Loan Bank Board, which also oversees Little Rock institutions, were overwhelming. And the federal deposit insurance fund for thrifts didn't have the money to shut down


Moreover, there is evidence that Arkansas regulators didn't go easy on Madison. Beverly Bassett Schaffer, Clinton's securities commissioner, says reports show that Madison's financial condition actually improved in 1985. But when federal regulators realized the thrift had a negative net worth in 1986, they moved quickly to oust McDougal. After she saw a report from the thrift's new auditors in 1987, she asked the Federal Savings & Loan Insurance Corp. to shut Madison down. "They told me they would not do it," recalls Schaffer, who is now a private attorney based in Fayetteville, Ark. "The insurance fund was broke."

Madison was finally closed in 1989 when federal money became available. McDougal stoutly denies that he received favors. "I want them to assign every investigator to look at this and then find anything that Bill or Hillary Clinton ever did for me."

--Influence peddling. In 1985, the First Lady, then a partner at the Rose Law Firm in Little Rock, represented Madison in its bid to get authorization from Schaffer for a preferred stock offering. The approval of the offering, which never actually was sold, has been questioned. Schaffer says that because the most recent federal exam showed the thrift was solvent, she approved the proposal.

Critics are suggesting that Hillary Clinton's representation of a firm before a regulator appointed by her husband amounted to nothing less than influence peddling, made worse by the fact that she had business dealings with the thrift's owner. It's safe to assume the governor's wife wasn't treated as just another lawyer. But Stephen Gillers, a professor at New York University's School of Law and a leading legal-ethics expert, says there was no impropriety. Lawyers are only now starting to struggle with ethical rules for two-lawyer couples, but it's clear, he says, that the rules wouldn't bar a lawyer from appearing before a state agency when the lawyer's spouse is governor.

In the case of Hillary Clinton, "that would exclude her from a vast amount of important work," Gillers says. It was up to the government--not Hillary--"to create mechanisms to insure public credibility for the decision-making process," he says. Giller adds that Clinton's unrelated business dealings with McDougal don't present a problem, either.

--Full disclosure. The Rose Law Firm represented the Federal Deposit Insurance Corp. in a negligence suit against Frost & Co., Madison's former auditors. Critics say that a firm that had in the past worked for Madison shouldn't have been hired to sue its onetime accounting firm. And they say the FDIC never would have hired the Rose Law Firm if its past work for the S&L had been


Rose partner Webster L. Hubbell, now the Associate Attorney General, says he informed the FDIC about the firm's representation of Madison on the preferred stock offering, though FDIC officials say they have no recollection of the disclosure. But the agency says the earlier work wouldn't be an issue in any event. An internal FDIC memo says the stock offering "was not substantially related to the lawsuit against Frost and would not be considered a disqualifying conflict."

More of an issue to some FDIC insiders was the fact that Hubbell's father-in-law was an executive of the thrift's real estate arm and had won a judgment against the FDIC that was on appeal--a link Hubbell disclosed, according to FDIC records. While some FDIC staffers wanted the Rose firm replaced, April Breslaw, the FDIC official in charge of the case, defended the firm. Hubbell was involved only in an indirect way, Breslaw said in an internal 1989 memo, and his kinship was not a reason to take a case away from a law firm "that has obtained fine results for me on other matters."

--Small-business scam. David Hale, a Little Rock businessman, alleges that McDougal and Clinton asked him in 1985 to make a $300,000 loan to a marketing company owned by McDougal's wife. Hale, who ran a government-backed investment company, says the money was actually used to bolster Madison's finances. At one point, according to Hale, the money ended up in Whitewater's account.

If true, obtaining the loan under false pretenses might be illegal. But Clinton and McDougal deny the conversation ever took place.

Heuer, McDougal's lawyer, notes that at that time, Madison Guaranty was undercapitalized by $8 million, and the $300,000 loan would not have been much help. But more important, Hale's background may make him a slender reed to hang charges on. He didn't reveal the conversation until last fall, shortly before he was indicted on unrelated charges of defrauding the Small Business Administration of $800,000. A trial is expected soon. Hale also may have an ax to grind: Five years ago, Madison foreclosed on a 1986 loan for $300,000 on which Hale hadn't made payments. Neither Hale nor his lawyer returned calls seeking comment.

It could take years for the special counsel to sift through all this. And the Clintons have not helped their case by appearing to have something to hide. There could be a bombshell in their files, though the chances at this point seem slim. "We do have some embarrassment here," says Representative Jim Leach (R.-Iowa). "But I don't think we have an episode that is of Presidency-toppling proportions." All the same, the White House will have to inhale a lot of smoke before the special counsel decides whether there is a fire here.


Some key allegations against Bill and Hillary Clinton seem questionable

-- Clinton's administration in Little Rock kept financially ailing Madison Guaranty open longer than it should have in return for favors from Madison owner JAMES MCDOUGAL, a partner with the Clintons in Whitewater Development.

But a 1986 letter from state securities regulator BEVERLY BASSETT SCHAFFER to the Federal Savings & Loan Insurance Corp. shows Clinton officials wanted to close Madison more than a year before it was taken over in 1989.

-- A loan to McDougal's wife, Susan, by his friend DAVID HALE, a Little Rock businessman, was improperly used to shore up Madison. But that charge is based on accusations by Hale, whose credibility is clouded by his indictment on unrelated fraud charges.

-- HILLARY RODHAM CLINTON had a conflict of interest when she represented Madison before Commissioner Schaffer, whom her husband appointed. Yet a leading legal expert, Stephen Gillers of New York University, says legal ethics rules don't prevent a lawyer from appearing before state agencies even if the lawyer's spouse is governor.

-- Hillary Clinton's former law partner, Associate Attorney General WEBB HUBBELL, failed to disclose a potential conflict of interest when their firm represented the Federal Deposit Insurance Corp. in a suit against Madison's auditor. FDIC documents, however, indicate there was no interest conflict.

DATA: BUSINESS WEEKDean Foust in Little Rock and Stan Crock in Washington

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