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Troubled Whitewater

A secret conflict calls Kenneth Starr's
role as special prosecutor into question.

By Joe Conason and Murray Waas

---

A special Nation investigation has uncovered a previously undisclosed conflict of interest involving special prosecutor Kenneth Starr and one of the leading players in the Whitewater drama that is the focus of his inquiry -- the Resolution Trust Corporation. Confidential R.T.C. and court files obtained by The Nation show that from the beginning of his tenure as Whitewater special counsel, Starr has been operating with this critical conflict kept under wraps: Until January, Starr's own law firm -- in which he remains a senior partner, and has acted on its management committee -- was being sued for professional negligence by the R.T.C., a suit that ended with the signing of a secret agreement saving Starr's firm, by R.T.C. estimates, close to $700,000.

Throughout Starr's term as special counsel, neither he nor the two Republican-led Congressional committees looking into Whitewater have publicly acknowledged the circumstances or the compromising implications of Starr and his partners' being sued by the very agency whose officials and actions figure in the case he has been probing for the past nineteen months. Furthermore, the R.T.C. complaint against Kirkland & Ellis, Starr's firm, relates to work it did for a federally insured thrift that went bust in 1990 -- an eerie parallel to the failure of Madison Guaranty and counseling done for that S&L by Rose Law Firm partner Hillary Clinton, questions that lie at the heart of Whitewater. The R.T.C. action against Kirkland & Ellis was filed in May 1993, nearly a year before Starr's appointment as special counsel, and accused his firm of "aiding and abetting breaches of fiduciary responsibility" at a Colorado thrift, the First America Savings Bank.

Moreover, some of the same officials whose conduct Starr has been investigating were involved in the decision to sue his law firm. Indeed, one of Starr's first headline-making actions as special counsel was to probe the suspension of L. Jean Lewis, an R.T.C. senior investigator who initiated the Whitewater inquiry. But the very people Starr has been examining in the Lewis matter -- including John Ryan, then the acting chief of the agency, and Ellen Kulka, its general counsel -- were involved in decisions regarding the lawsuit against Kirkland & Ellis. The R.T.C. official who informed Lewis of her suspension in August 1994 was assistant general counsel Thomas Hindes, the same attorney who signed the memorandum approving the suit against Starr's firm.

R.T.C. officials say that while Starr's investigation of them may have had no material effect on the eventual agreement between the agency and Kirkland & Ellis, they had good reason to be intimidated: A week before a court-mandated settlement conference between the R.T.C. and the law firm, a federal grand jury convened by Starr began its investigation of the R.T.C.'s Whitewater activities. And the day before the settlement conference, Starr's office asked the R.T.C. to temporarily suspend its own internal investigation of Lewis's conduct.

The R.T.C.'s complex civil action against Kirkland & Ellis -- which also named First America's officers, directors and outside accounting firm, Deloitte & Touche, as defendants -- charged it with actively assisting a "deferred tax" transaction that resulted in the "unlawful transfer" of nearly a million dollars from First America to a holding company controlled by the bank's officers and directors. Although the funds were entered on the bank's ledger in 1988 as "income tax expense" and "deferred tax liability," they instead went into the pockets of First America's officers and directors, in the form of dividends and "consulting fees," according to the R.T.C.'s legal complaint. (Kirkland & Ellis, which served as First America's "primary outside counsel," was not implicated in any of the insider loans, diversions of funds or other questionable dealings engaged in by the bank's officers.)

This situation posed a stark legal and ethical problem for Starr, who suddenly was using the full prosecutorial powers accorded him as special counsel to investigate plaintiffs in a lawsuit against his own firm. In effect, Starr had put himself in a position to exercise the leverage of possible criminal sanctions against a group of federal officials who would decide whether and how the R.T.C.'s case against his Kirkland & Ellis partnership should be settled.

"It is a conflict both palpable and unacceptable for a part-time prosecutor to be investigating the conduct of public officials while those same officials are pursuing serious civil charges against the prosecutor's own law firm," says Stephen Gillers, professor of legal ethics at New York University. "Judge Starr is a prominent figure in American law, but the credibility of his investigation -- already compromised by the circumstances surrounding his appointment as independent counsel, and by his decision to continue active practice while in office -- is now further tarnished by the revelation of a conflicting interest that spans nearly his entire tenure."

This information and even the R.T.C. documents The Nation has brought to light were provided to Congress and have been kept from the public for several months, at the least. Senator Alfonse D'Amato and Representative Jim Leach, chairmen of the Congressional committees investigating Whitewater, have had the documents -- as submitted to their panels -- since last July, according to reliable sources on Capitol Hill. (Through a spokesman, Leach told The Nation that he has no knowledge of the facts or allegations involved, and considers Starr to be "an individual of impeccable integrity.")

Ironically, the three-judge federal appeals court panel that removed Robert Fiske as the first Whitewater special prosecutor and replaced him with Starr said it was necessary because independent counsels needed to be "protected against perceptions of conflict." The pretexts for the extraordinary removal of a special prosecutor, however, were rather obscure constructions of ethical conflict. In reality, the successful political pressure campaign that led to Fiske's ouster originated because his critics were dismayed he was not pursuing the Clintons more aggressively to determine their connection with the failure of the Madison Guaranty S&L, with possible influence over regulatory personnel and with other dealings they deemed suspicious.

The transactions that eventually led to the R.T.C. charges against Kirkland & Ellis began in 1987. That was when First America, already in financial trouble and under close scrutiny by the Federal Home Loan Bank Board, first sought federal approval to make cash payments of "deferred taxes" to National Savings Bancorporation of Colorado, its holding company. Despite the fact that such transfers were expressly prohibited by F.H.L.B.B. regulators, the "deferred tax" payments were transferred at the direction of John Hilliard, the president of First America. To justify his decision to ignore the bank regulators, Hilliard and his deputies asked their attorneys at Kirkland & Ellis to prepare a legal opinion about the payments and the accounting treatment.

In a July 1987 letter to Kirkland & Ellis attorney John Fitzgerald seeking the opinion, First America's assistant controller, Kerry Murdock, admitted that the transfers to National Savings would in fact not be used to pay taxes but instead would be spent for the benefit of the holding company's shareholders and directors.

The R.T.C. complaint in the First America case notes that "Kirkland & Ellis had actual knowledge that the purpose of the transfers of funds...was not to pay [First America's] 'deferred tax' liability, but to implement a scheme to transfer funds" for the benefit of Hilliard and certain shareholders and officers of both institutions.

By failing to advise Hilliard and Murdock that such payments should not be made, the R.T.C. charged, Kirkland & Ellis breached its professional duty to First America and the bank's other shareholders. The complaint goes on to suggest that the bank's lawyers intentionally lent legal cover to the scheme. "Rather than addressing what Fitzgerald knew to be the improper and illegal purpose of the payments," the R.T.C. alleged, the Kirkland & Ellis lawyer wrote an opinion that "narrowly focused" on the laws cited by the F.H.L.B.B. to forbid them. The result was that Hilliard and Murdock ignored the federal objections to the tax scheme and continued to transfer funds from the bank to the holding company, none of which were ever used to pay taxes.

When F.H.L.B.B. examiners inspected First America's books in June 1988, they discovered the illegal payments; in succeeding years, further examination of First America by federal authorities revealed a variety of other questionable dealings. After First America closed its doors in March 1990, it came under the jurisdiction of the Resolution Trust Corporation, created by Congress the year before to clean up the nationwide financial debacle caused by the failure of hundreds of savings and loans and other thrift institutions (including Madison Guaranty, the Arkansas S&L that was run by the Clintons' partners in the Whitewater Development Corporation). It took that agency three years to develop the court case that extended to implicate Starr's law partnership.

By then, the U.S. Attorney's office in Denver was also pursuing criminal charges against Hilliard and Murdock. The multi-count indictment against Hilliard, which was tried in June 1993, included bank fraud, misapplication of funds and money laundering. Murdock pleaded guilty to misapplication of funds. Hilliard was convicted on twenty-four similar counts, but his conviction was overturned on appeal. Rather than face a retrial, the former bank president pleaded guilty four months later to two counts of misapplication of bank funds, one count of bank fraud and one count of making false entries in bank records.

Whitewater's Undertow

Robert Fiske, a partner at the New York law firm of Davis, Polk & Wardwell, was chosen as the first special counsel on Whitewater in 1994. Upon his appointment by Attorney General Janet Reno, Fiske severed all ties with his prestigious firm. Fiske's critics swiftly grew dissatisfied with the former federal prosecutor's investigation, however, and professed to see inherent conflicts between his background and his post. For example, he was scored because International Paper, a client of Davis, Polk, had once sold land to the Whitewater Development Corporation. Foremost among the critics was The Wall Street Journal, whose "mean-spirited and factually baseless" editorials about Whitewater were cited in a report by Fiske as an element in the suicide of White House counsel Vincent Foster.

The Journal became an unrelenting adversary of Fiske following his comments on Foster's death. Its editorial writers accused him of engaging in "political damage control" and "coverup," and scornfully cited his leave of absence from his law firm as "something other than resignation," pointing out that "Davis Polk is a sprawling firm with sprawling clients.... Seems to us there's a potential for conflict of interest with practically the whole world."

Under a renewed statute governing special counsels that had been signed into law after Fiske's appointment, power to name a special counsel passed from the Attorney General to a panel of three federal appeals judges. After a controversial luncheon between one of those judges, David Sentelle, and Senators Jesse Helms and Lauch Faircloth, both Republicans from Sentelle's home state of North Carolina, the judges removed Fiske and named Kenneth Starr as his replacement on August 5, 1994. (Helms, Faircloth and Sentelle denied that Whitewater was discussed at their lunch; even if true, as five former presidents of the American Bar Association noted, Sentelle violated his responsibility to uphold "the appearance of impartiality.") Sentelle and his colleagues cited conflict-of-interest problems as the reason for their unusual action. For his part, the new special counsel promised to be "absolutely fair and impartial."

The circumstances surrounding Starr's appointment were not the only subject of dispute as he took the reins from Fiske, however. The choice of Starr, a former Solicitor General in the Bush Administration, drew criticism because he was a highly partisan Republican who had donated and raised funds for G.O.P. Congressional candidates and had briefly flirted with running for the party's Senate nomination in Virginia only months before his appointment. Critics and supporters agreed that Starr -- who came close to a Supreme Court nomination while working for Bush -- is a highly ambitious attorney whose prospects would improve vastly under a future Republican administration.

To some observers, Starr's decision to stay active at his law partnership was just as worrisome as his extensive Republican ties. He declared his intention to continue drawing income from the firm, to remain on Kirkland & Ellis's management committee and to keep representing its clients. In order to deflect concerns about both his partisanship and his partnership, Starr brought in Samuel Dash, the Democratic attorney who had served as counsel to the Senate Watergate committee, as his outside ethics counsel. Clearly Starr hoped that the presence of Dash would quash any suggestion that he or his office might do anything improper, and would lend an appearance of concern about potential conflicts or prejudices. As conservative legal scholar Terry Eastland put it, "This is what the independent counsel law has always been about -- appearances."

The first reported action taken by Starr after he replaced Fiske was to subpoena records from the R.T.C. regarding its treatment of L. Jean Lewis and two of her fellow investigators in the agency's Kansas City office who also had worked on the Whitewater matter. Only ten days after Starr's appointment, the three R.T.C. investigators had been placed on a two-week administrative leave by the agency's top officials as punishment for what was described as "noncompliance with R.T.C. policy and procedures." Lewis had, among other things, secretly taped a conversation with another R.T.C. official regarding Whitewater, and then provided that tape to Republicans in Congress, which was revealed at a public hearing. Upon learning of the suspensions, Republicans charged that Lewis and the others were being punished by Clinton appointees because they had vigorously pursued Whitewater leads and had provided information to those on the Hill who were also looking into Whitewater.

Within a week after the temporary R.T.C. action against Lewis and the others was announced, Starr requested that the Whitewater grand jury in Washington issue subpoenas to the R.T.C. for all documents relating to their suspension. The purpose of the subpoenas, according to newspaper reports at the time, was to determine whether R.T.C. or other federal officials had attempted to obstruct justice by intimidating Lewis and her colleagues.

That August 24, R.T.C. general counsel Ellen Kulka faxed a letter to Starr offering her agency's full cooperation with his efforts, including any matters involving the Kansas City office. "We are very willing to arrange that they respond to any request you make of them to provide information and to travel upon your request at R.T.C. expense to meet with you or your staff," Kulka wrote. She also offered to assign the three investigators to work with Starr. Kulka's letter was copied to acting R.T.C. chief John Ryan; the agency's deputy general counsel, Andrew Tomback; and its assisant general counsel, Thomas Hindes.

Nearly a year later, when Tomback testified before the House Banking Committee about the R.T.C.'s role in Whitewater, he said that Starr had never responded in writing to Kulka, although a telephone call was received from a Starr aide declining the help of Lewis and her colleagues. On August 9, 1995, Starr explained why: It was, he wrote, "for the sole reason that the administrative leave of these three employees was, and remains, under active investigation."

Avoiding the Spotlight

At the same time that Starr was beginning his review of the R.T.C. action against its Kansas City employees, the R.T.C.'s attorneys were considering how to proceed in their case against his law firm. A trial date had been scheduled for the next year, August 1995, and the government was in a strong position -- thanks in part to the successful prosecutions of the two First America officials.

However, in early September 1994, a federal judge in Denver ordered Kirkland & Ellis and the R.T.C. to enter into settlement negotiations over the First America case that September 28. In an internal R.T.C. memorandum analyzing the case against Kirkland & Ellis and dated September 7, 1994, agency attorneys predicted that a trial would probably lead to a judgment against the law firm of more than $1 million, including interest charges since the time of the original offense. That figure, the R.T.C. lawyers assumed, might be reduced by 30 percent -- because of the greater culpability of the First America officials Hilliard and Murdock -- to around $770,000. By computing the assumed probability of success in the suit at 70 percent, and subtracting another $240,000 in litigation expenses, the R.T.C. lawyers concluded that a minimum acceptable cash settlement from Kirkland & Ellis would be $300,000.

"We presently plan to start negotiations with a proposal starting at two or three times that amount," the September 7 memo said. At the same time, it noted, the R.T.C. was considering an additional claim of joint and several liability against Kirkland & Ellis, which could have increased the eventual judgment due from the law firm.

Yet no deal was reached at the September 28 conference between the sides. (Perhaps coincidentally, confidential documents show that the very day before the scheduled meeting, the R.T.C.'s inspector general informed its acting chief executive officer that Starr's office had just contacted the R.T.C. to request a temporary suspension of its investigation of Lewis so as not to interfere in the Starr probe.) Four months later, the settlement talks were still going nowhere, according to another R.T.C. memo dated January 9, 1995. "Recent attempts at negotiating a settlement in the case have failed," the memo to the R.T.C.'s deputy general counsel for litigation reported, "and, at this juncture, no prospects for settlement are expected. The case is set for trial sometime in the summer of 1995." But the case against Kirkland & Ellis never went to trial as scheduled.

Instead, the parties finally agreed to a settlement in late December 1995, which was signed by Kirkland & Ellis on January 2 of this year. For a payment of $325,000 from the law firm, the R.T.C. agreed to drop the charges and release Kirkland & Ellis from any liability involving the deferred tax payments. The settlement agreement includes a section in which Kirkland & Ellis asserts that it "expressly denies any wrongdoing."

But before the case was dismissed, there was another item of concern to Starr's law partners: secrecy. The penultimate clause of the agreement is a promise of confidentiality by the R.T.C., which says that except as required by law or court order, it "shall take no action, directly or indirectly, to initiate disclosure or public comment concerning this settlement...[and] that R.T.C. [would] exercise its best efforts to preserve the confidentiality of the information...by cooperating with [Kirkland & Ellis] to obtain an appropriate protective order or other reliable assurance that confidential treatment will be accorded the information...."

What is perhaps most startling about the story of Kenneth Starr, his law firm Kirkland & Ellis and their tangled relations with the Resolution Trust Corporation is that all of the above facts have been known to both the House and Senate committees investigating Whitewater since last summer at the latest. Requests for comment from Starr remain unanswered. For his part, Starr's ethics adviser Sam Dash, a Georgetown Law School professor, told The Nation that Starr did not bring up the potential of a conflict of interest with him until October or November of 1995, more than a full year after court-mandated settlement talks between the R.T.C. and Kirkland & Ellis, and the nearly simultaneous intensification of Starr's R.T.C. obstruction-of-justice probe. Dash said at that point he advised Starr it was not necessary to recuse himself from the R.T.C. investigation. Dash noted that Starr had not personally been involved in representation of the Colorado thrift, and that he had also removed himself from any role in negotiations with the R.T.C. to settle the agency's lawsuit against Kirkland & Ellis.

Dash conceded that Starr, if he were hearing a matter regarding the R.T.C. as a judge, would have to recuse himself under the Judicial Code of Ethics. But the same standards do not apply to federal prosecutors, he maintained, who have more discretionary leeway. "A prosecutor's actions are limited by the courts, criminal procedural rules, the Bill of Rights and by the tremendous public spotlight on their actions." This, of course, points up the utility of secrecy clauses such as the one written into the agreement between Kirkland & Ellis and the R.T.C.

Joe Conason is a columnist and executive editor of The New York Observer. Murray Waas is a Washington reporter. Research assistance for this story was provided by Chris Weeks. Research support provided by the Investigative Fund of The Nation Institute.